In the event, what we have seen is one major corporation after another get bailed out, supported, converted, acquired.. Bear Stearns, Lehman, Fannie, Freddi, Citi, Wamu, Washington Mutual, Merrill... the list goes on and on
The bigger questions now are:
Can the United States Avoid a Debt Crisis & National Bank Crisis?
We have repeated been lectured to, told that any failure of the government to act forcefully is going to lead to a financial meltdown. Bush, Obama, Paulson, Bernanke... all have threatened and blackmailed us.
However, EACH of the solutions has been tailored to bailing out institutions. We argue that Congress should be acting to protect prudent individuals and stemming or slowing down the unending deluge of foreclosures. That is the only way to stem the banking crisis.
Confidence has sunk to new historic lows. That is because we are scared of losing our jobs, scared that we are headed into a depression and scared by the Presidents of the United States telling its citizenry that we are heading into a depression unless we pay off billions to fat cat bankers, which is essentially what the bailouts are achieving. In the eight business days before it failed, Washington Mutual suffered net withdrawals averaging $2 billion per day, based on data released by the Office of Thrift Supervision, essentially a run on the bank.
Hardly a day passes (and then only on weekends, when the spigot is temporarily turned off) that we're not doused with an outpouring of dispiriting news on the economy. Among last week's negative reports, that on jobs -- and more specifically the lack of them -- was prominent. New claims for unemployment insurance shot up to 667,000, the most in 27 years, while continuing claims mounted to 5.1 million, another record high since 1967 and a mighty leap up from 2.8 million a year ago.
If you're keeping score, you can toss in another 1.4 million getting benefits under a program launched last year, raising the total on the dole to 6.5 million. And the Labor Department revealed that mass layoffs (50 or more in one very fell swoop) doubled in January, and put roughly 235,000 people out of work.
With jobs vanishing at an alarming rate, consumer confidence is dwindling apace. The latest Conference Board reading sank to 25, the poorest showing in the four decades since the survey was started. Moreover, as Goldman Sachs' Seamus Smyth points out, the real shocker in the dismal data is consumer's expectations, which are as close to nil as we hope and pray they'll every get: an unprecedented 27.5, sharply below the previous low of 45.2 set back in December 1973, when the economy and the stock market were going big-time into the tank.
If nothing else, the consumer's sour, even forlorn, sentiment makes a mockery of the notion that the consumer will yet again come riding to the rescue, brandishing his wand of plastic. Not a chance; the poor guy lacks both the will and, more important, the wherewithal, to go charging off on a spending binge.
As MacroMaven's savvy Stephanie Pomboy puts it in her usual understated style: "The U.S. consumer's legendary lust for credit died with the housing bust. As he vows to live within his means -- or even (children, cover your ears) reduce his debt -- all of Ben's horses and Nancy's men cannot get consumers to borrow and spend."
Stephanie goes on to warn that if, as she suspects, households attempt to live the way they did before assets were confused with income, consumer spending is destined to be restrained for a long, long stretch.
That means, she logically infers, that corporate profits "will be depressed for years (not just quarters) to come." A dire prospect, she allows, that has not exactly gone unnoticed by investors, as evident in the pathetic performance of equities.
In sum, nothing in the cruel hard data or the more ephemeral mood of the citizenry persuades us that we've seen even the beginnings of the end of the Not-So-Great Depression. So do yourself a favor: In viewing the stock market, no matter how tempting the occasional upticks, stay skeptical.
Reason #1. Too many banks at risk.The FDIC currently keeps tabs on 117
troubled banks with $78 billion in assets. However, based on our analysis and on
TheStreet.com’s Financial Strength Ratings, we find that institutions at an elevated
risk of failure include 1,479 banks and 158 thrifts with total assets of $3.2 trillion. In
that sense, the banking troubles in the U.S. could be 41 times bigger than the
FDIC’s list implies.
Reason #2. Too many debts. According to the Fed’s second quarter Flow of
Funds report, just the pile-up of mortgages alone is overwhelming: $14.8 trillion.
Plus, there are an additional $20.4 trillion in consumer and corporate debts, also
going bad at a frightening pace. So even without any further decline in housing, the
overall private-sector debt problems in the United States could be over double what
we’ve seen so far.
Reason #3. Too many of those debts are now sinking into delinquency. More
Americans are falling behind on their credit card payments than at any time since the
months following the 9/11 attacks. Delinquencies on auto loans are at the second-
highest level since 1990. Plus, an unprecedented one in 10 U.S. residential
mortgages is now delinquent or in foreclosure.
Reason #4. The overwhelming build-up of derivatives. Derivatives are
essentially bets and debts. Large banks, hedge funds and others place the bets on
interest rates, stocks and currencies. Plus, they bet on financial events like the
possibility of a major bankruptcy. If they win, they make big profits. If they lose, it
can be devastating.
Based on the just-released second quarter report of the Comptroller of the
Currency (OCC), the total notional value (face value) of derivatives held by U.S.
banks is now $182.1 trillion — a shocking number.
Proponents of derivatives say that giant number overstates the risk mainly
because each major player balances its bets by playing both sides of the market —
like roulette players who bet on both red and black at the same time.
What these proponents have neglected to consider is the double-zero scenario —
when virtually everyone loses: When trading partners go under, heightening the
danger that they will fail to pay up on their bets and cause a chain reaction of defaults
throughout the entire system.
Look. In the Mafia’s numbers racket, anyone who reneges on gambling debts can
wind up at the bottom of the East River with cement in his boots. But in the banking
industry, bankers who default can still walk off with millions. Reason: Regulators are
AWOL. They have no mechanism for clamping down on defaults, except to usher the
company into bankruptcy and try to find another institution to assume the obligations.
How big is the overall credit exposure in the derivatives market? According to the
OCC, it’s still huge — over double the 2007 level, which was already astronomical.
Specifically, for each dollar of capital, JPMorgan Chase has credit exposure of
$4.30; Bank of America is exposed to the tune of $1.94; Citibank is exposed to the
tune of $2.58; and HSBC America has $3.06 in exposure. This means that, in a worst-
case scenario, a system-wide breakdown in derivatives payments would be enough to
bankrupt each and every one of them at least two times over.
So if you’ve been wondering why the Fed has rushed in so swiftly to rescue or
merge big players that have gone under, now you know: Other than Washington
Mutual, every one of the recently failed behemoths — Bear Stearns, Lehman, Merrill
Lynch and especially AIG — had a pile of derivatives that needed to be disposed of.
Reason #5. All roads lead to JPMorgan Chase. Here’s the big unspoken
dilemma of the derivatives disease:
Remember, we told you a moment ago that the total amount of derivatives on the
books of all U.S. commercial banks is $182.1 trillion. Well, guess how much of that
is on the books of JPMorgan Chase? $91.3 trillion, or 50.1% of the total — a
virtual monopoly!
As long as all is going well, that monopoly might be attractive. But now that so
much has turned so sour so fast, it means that Morgan is emerging as the nation’s
primary junkyard for discarded derivatives. And indeed, so far, Morgan has been the
firm the Fed has consistently chosen to pick up the debris left behind by the major
derivatives players that have gone south.
Nearly all roads in the labyrinthian world of derivatives lead to the House of
Morgan; without Morgan, the U.S. financial system as we know it today would
probably not exist.
This is not exactly reassuring. Nor is it reassuring that Morgan has exposed 430%
of its capital to the oft-questionable credit of its trading partners.
In sum, the debt and banking problems facing the U.S. Congress go far beyond
just the task of buying up bad mortgages or mortgage-backed securities. Even the
$700 billion proposed bailout package would be a drop in the bucket.
Reason #6. The financing needs generated by the $700 billion would be far
too much for bond markets to absorb. When asked where to spend bailout money,
administration officials and members of Congress have no shortage of ideas. But
when asked where the money is going to come from, they have no answer.
The reality is that Mr. Obama isn’t likely to raise the funds by hiking taxes.
Instead, the government’s only recourse will be to borrow most of the money.
The tab so far? With $200 billion promised to Fannie and Freddie, $85 billion
lent to AIG, $700 billion proposed for the banking bailout and hundreds of billions
more in special lending facilities by the Fed, we’re already closing in on $1.5
trillion.
What does that mean to you? Simply this: To raise that much money, the
government would have to shove aside credit-thirsty private borrowers like a bull in a
china shop. It would suck up any remaining liquidity in the drought-stricken credit
markets. And it would put massive upward pressure on interest rates, including the
rates you or your company must pay.
Asneak preview: The U.S. Treasury just had to sell a record $34 billion of 2-year
Treasury notes, followed by a $24 billion sale of 5-year notes — the biggest such
sale in more than five years. Bond prices plunged and interest rates surged.
Now, you can expect an avalanche of such sales in the months ahead. Bond traders
can see it coming too. That’s why they’re selling the heck out of long-term bonds and
why bond prices just plunged eight points in a virtual straight line.
Reason #7. Even before Uncle Sam starts borrowing in massive amounts, the
credit markets are already suffering dangerous convulsions. You can see it
everywhere on Main Street — almost 600 of the nation’s auto dealers going belly-up
... hundreds of thousands of small and medium-sized businesses losing immediate
access to needed capital ... cities, states school and churches feeling a sudden pinch.
Meanwhile, here at our Weiss Research offices, we can see the credit
convulsions right on our Bloomberg terminal: The standard baseline for private-
sector interest rates — the London Interbank Offered Rate (LIBOR) — has surged,
with the three-month rate jumping.
This is the symptom of panic — millions of individuals and thousands of
institutions stampeding away from risk and desperately trying to climb to high
ground.
What do they want? The
safety and liquidity provided by U.S. Treasury bills. And they want it so badly, they’re
willing to pay an unusually high price for it. Result: The price of 3-month T-bills has
surged, driving their yield down to their lowest level since World War II.
Moreover, the difference, or spread, between the LIBOR rate and the T-bill rate is
now bigger than it was during the Long Term Capital Management panic of 1998 and
even during the Crash of 1987.
As long as the spread remains at or near these crazy-high levels, it means
three things: The credit markets remain in turmoil. Any government bailout plan
is not working. And the economy is being strangled by the scarcity of credit.
Yes, the government’s massive bailout package, if passed, could buy some
temporary calm. But since it can hardly address the debts we’ve told you about —
let alone tame the derivatives dragon — it leaves a gaping hole through which
financial panic can spread again.
Reason #8. Main Street is in tatters. While Congress and the administration are
busy spending hundreds of billions of dollars to support Wall Street, Main Street is
falling apart at the seams. Factories are closing. Layoffs are rising. Spending is
slowing. And the downturn that began in the U.S. is spreading to other economies
overseas.
So, yes, policymakers can try to plug the holes in the financial dike. But fresh
leaks are springing elsewhere. It will be next to impossible to hold back the flood
now on its way.
Our Prescription:
If the Dow Jones Industrial Average follows the
lead of the major financial stocks, it will fall to about 7200 — or almost four
thousand points below current levels. We’ve recently adjusted our forecast to 5500
on the Dow.
And as we’ve told you from the outset of this crisis, every time the government
attempts to inject bailout money, it spurs a temporary rally. That gives you a golden
opportunity to sell any stocks you still have, with the exception of the special
situations we recommend.
These government-inspired rallies are also your best opportunity to position
yourself for big gains as the crisis continues to spread — with contrarian investments
like inverse ETFs.
Bottom line: Regardless of this latest bailout, continue to invest and save
prudently. That means utilizing safe havens for your money — banks with a Financial
Strength Rating of B+ or better ... U.S. Treasury bills ... and money market funds that
invest almost exclusively in short-term Treasury securities or equivalents.
|
