EU-Centered Credit Crisis Continues

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The 2011 Credit Crisis continued Tuesday with the Stoxx Europe 6000 index hitting a two-year low, the Swiss taking desperate measures to control the franc, more record high prices for credit default swaps (bond insurance) on British Banks and yields on 10-year U.S. treasuries hitting an all-time low. Despite the dramatic turn of events, stock losses were somewhat muted.

U.S. markets opened sharply lower, but the Nasdaq and S&P 500 recovered toward the close in a technical move that involved filling the gap down that took place on the open. The Dow however still had a 101 point loss at the close. In Europe, the German DAX was down 1.0% and the CAC-40 in Paris 1.13%. While these losses would have been considered significant only a few months ago, they are minor compared to what has taken place on a number of trading days since late July. The British FTSE up even up 1.06%, despite trouble in the UK banking sector.

The British banks most in trouble are the ones that were nationalized during the 2008 Credit Crisis -- Royal Bank of Scotland and Lloyd's Banking Group. Credit default swap (CDS) rates for these banks are higher than they have ever been. CDS rates for HSBC and Standard Chartered are at one-year highs. The problem with these banks seems to be toxic loans left over from earlier in the 2000s. It is not clear if they were included in a sweeping statement made Monday by Josef Ackermann, CEO of Deutsche Bank, that "numerous" European banks would collapse if they were forced to recognize all losses against their holdings of government debt.   

The most significant market event yesterday was the Swiss capping the value of the franc. The Swiss National Bank (SNB) said it would "no longer tolerate" a euro franc exchange rate below 1.20. The franc then had a significant drop against all major currencies. A similar approach was tried in 1978 and it did succeed in stabilizing the franc back then. Such currency intervention measures generally only work for a short time however. It remains to be seen how long it will take before the franc begins rising again.

The new Credit Crisis is also showing up in U.S. treasury rates just as the one in 2008 did.  The 10-year yield made another all-time low at 1.97%, taking out the 2008 low. Global money flows into U.S. government bonds during periods of financial system instability because they are still seen as safe havens. While the 10-year is only a little below its low in 2008, the two-year at 0.20% on Tuesday is well below its low point back then.

Credit Crises are not very short events. The previous one lasted six months. This one could last that long or even longer. The cause of the problem has to be gotten under control. In this case, it is the ongoing debt crisis in Greece and the emerging ones in Italy and Spain. While a default in Greece could happen this fall and create some finality there, the problems in Italy and Spain are only in their early stages. So, this could go on for some time.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Bailout to Bailout: The Bear Stearns Bailout and Its Aftermath

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

It was soon realized that the temporary loan given by the Federal Reserve to Bear Stearns would not be enough to keep the company afloat. Indeed this was probably already known before the loan's announcement was made on the afternoon of the 14th. The Fed, particularly the New York regional division, worked feverishly all weekend to find a definitive solution to Bear's insolvency. They decided to have JP Morgan take over Bear at a price of $2.52 a share, a rather sharp haircut to the Friday closing price of $30 a share ... and an even steeper discount to the official book value of $84 to $97 a share for Bear stock, which the CEO had announced was unimpaired only two days earlier.

Not only did JP Morgan get Bear Stearns essentially for free, but the Federal Reserve further guaranteed $30 billion (later reduced to $29 billion) of Bears troubled mortgage bonds. JP Morgan was by no means just a lucky bystander in this transaction. Its CEO sat on the board of governors of the New York Fed and got to influence the decision that proved highly favorable to them - in more ways than one it turned out. JP Morgan was a counter party to a large number of derivatives on Bear Stearns books and Bears failure would probably have sunk JP Morgan shortly thereafter. So the Fed's giveaway bailout of Bear Stearns was also an indirect bailout of JP Morgan. Membership (in the Fed) obviously has its privileges. Bear Stearns not being a Fed member wound up being thrown to the wolves.

While JP Morgan and the Bear Stearns bondholders were winners because of the Fed arranged bailout, stockholders and credit default swap (CDS) holders wound up being the big losers. If Bear Stearns had actually declared bankruptcy, the CDS holders would have had a big payday. However, once again the Fed's interference in the market turned winners who had made the correct investment decision into losers by changing the rules of the game at the last moment.It turned out that the stock holders had more clout and wound up successfully agitating for an increase in the takeover price to $10 a share. Even at that price some of the 'smart money' lost big, including British investor Joe Lewis, who lost over a billion dollars, and renowned mutual fund manager Bill Miller whose fund had large holding of Bear stock. The American taxpayer, as per usual, was put on the hook and would also wind up paying for Bear Stearns mismanagement and the Fed's gifting to JP Morgan.

As a result of being blindsided by Bear Stearns failure, the Fed set up the Primary Dealer Credit Facility (PDCF) in March of 2008. For the first time in its history, the Fed allowed broker-dealers to also borrow from them, not just commercial banks. Lehman Brothers was an immediate beneficiary of this new program, which probably kept it from failing shortly after Bear Stearns did. The legality of this new Fed operation was at best tenuous, but the Fed seemed to have little concern for following its mandate of controlling inflation or restricting its activities to those specifically granted to it by the U.S government. After all why should the Fed be concerned about such things since it knew the government was unlikely to try to keep it from doing whatever it wanted to do - legal or otherwise.

NEXT: Run on the Bank, 2008 - Indymac

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

Australian and Canadian - the Only Dollars Worth Holding

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

By the November 14, 2007 meeting of the New York Investing meetup, deterioration of the U.S. dollar had become pronounced. The trade-weighted dollar had fallen further through its long-term support level and hit a series of new all time lows. Not surprisingly, the euro hit a series of new highs reaching an exchange rate of 1.47 to the dollar. The rallies in the Australian and Canadian dollars (both economies are based on food and commodity production) were even stronger however. At one point, it had taken approximately two Australian dollars to get one U.S. dollar, by November of 2007 only around 1.1 Australian dollars were necessary to get an American dollar. In the early 2000s, one U.S. dollar got you 1.61 Canadian dollars, but by November you would only get 91 Canadian cents.

There were two talks that month at New York Investing that dealt with what was going on in the currency market and the implications for investing, "Investing Like It's 1979" and "How to Profit from the Falling Dollar" (see http://investing.meetup.com/21/files). Currency movement don't exist in a vacuum of course, but affects the price of commodities because they are priced in U.S. dollars. By November 2007, Oil had gotten to $97 a barrel making a series of all time highs, although it first broke its nominal 1980 high of $39.50 a barrel in 2004. While oil was a leader in reacting to the value of a declining U.S. dollar (the dollar had been falling since 2002), gold's reactions were more coincident to changes in the American currency. Gold had reached $848 an ounce getting close to its nominal intraday high of $875 in 1980, but not enough to establish a new record. Of the three inflation-related commodities, silver was by far the laggard, reaching only $16 plus and ounce, not even near its $50 an ounce high from 27 years earlier.

The specifics of how to invest in currencies and commodities, such as ETFs (exchange traded funds) and foreign currency denominated CDs and accounts were not only handled in the talk, "How to Profit from the Falling Dollar", but in three videos produced by the New York Investing meetup. These videos represented an investing blueprint for the average investor on how to handle the new inflationary environment the Federal Reserve had created. Please see these video for more on this topic:

Currencies I – How to Profit From the Falling Dollar
http://www.youtube.com/watch?v=dTImG1dWT4k

Currencies II – How to Profit From the Falling Dollar
http://www.youtube.com/watch?v=XhfwatOCx_k

Commodity Investing – How to Profit From the Falling Dollar
http://www.youtube.com/watch?v=IG5zApWcOk0

Next: Sub-prime Housing Leads to Sub-prime Financial Institutions

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please go to: http://investing.meetup.com/21