What Went Wrong (W3) and More…?
These are some of the recent big stories:
1) Fannie Mae and Freddie Mac rescued, Lehman Brothers in Chapter 11, Merrill Lynch sold to Bank of America, AIG, Washington Mutual and Wachovia all being rescued in different ways.
2) Morgan Stanley and Goldman Sachs relinquished their investment bank status.
3) The Fed rescue plan proposed was turned down by Congress and then passed.
4) Central banks around the world made massive liquidity injections, and cut interest rates (except the BoJ)
5) Stock shorting rules were introduced and interbank lending seized up.
6) Bradford and Bingley failed, HBOS was effectively rescued by Lloyds TSB, Fortis was rescued by three governments and Dexia was rescued by two.
7) Stock markets around the world are in major oversold mode, in the final minutes of today’s US market session stocks headed due South, the DJIA closed – 679 points to its lowest level in five years after a major credit ratings agency said it was considering cutting its rating on General Motors Corp.
For the last 30 years The American economy and increasingly the World’s economies have bee built on credit, and that credit is used for everyday needs and thing, but can also be used to purchase Big Ticket items, over time this access to Credit was broadened, loosened and ran unchecked in the US and EU.
Over the past 2 years there appeared a dramatic change in the ability to create new lines of credit, that credit constriction dried up the flow of money, slowed new economic growth and the buying/ selling of assets all level of assets, especially visible has been the mortgage backed assets.
That said, many financial institutions were left holding mortgage backed assets that had dropped precipitously in value and were not bringing in the amount of money needed to pay the loans.
Thus, drying up the institutions cash reserve, resulting in their credit, and ability to continue to make new loans.
For many years the cheap credit which made it very easy for people to buy houses and make other investments was based on pure speculation. Cheap credit created more money in the system and people wanted to spend that money, they did spend it.
They bought houses on the theory that the price would go up and then flip to another buyer, that practice increased demand and caused “Bubble.”
Also, private equity firms leveraged billions of dollars of debt to purchase front line companies, and by doing so created hundreds of billions of US$s in wealth by simply shuffling paper, while not creating anything of hard value.
Then there came the speculation in commodities, especially in Crude Oil and energy, the prices skyrocketed North in response.
With all of the continuing demand that resulted in expanding supply and the credit drying up the housing market turned sour and turned South. This housing market slump set off a chain reaction in our economy, that of the UK and Europe.
When individuals and speculative investors were no longer able to flip homes for a quick profit, the adjustable rates mortgages adjusted higher, and those mortgages were no longer affordable for many homeowners, thus 10s of thousands of mortgages went into default, leaving investors and financial institutions holding the bag.
This action caused massive losses in mortgage backed securities and many banks and investment firms began bleeding money due to mark to market accounting rules (since relieved some), and caused a glut of new on previously owned house unsold on the market depressing housing prices, and slowing the growth of new home building causing many home builders to go out of business, and sending the laborers to the unemployment lines.
The depressed housing prices caused further complications as it made many homes worth much less than the mortgage value and some owners chose to simply walk away instead of pay their mortgage, the latest figure is 10MM families and homeowners in the US have properties that are valued at 20% less than the 1st mortgage, and many have 2nds, 3rds and home improvement loans. It is grim.
These massive losses caused many banks and lenders to tighten their lending requirements, but it was already too late for many, the damage had been done, leaving many financial institutions saddled with risky mortgage backed securities that is not sufficient collateral to exchange, and thus can no longer afford to extend new credit, and the main business of Bank’s is lending, remember you cannot sell out of an empty store. Again, current loans are not cash flow positive, hence banks cannot (or will not) make loans to individuals and businesses, and thus the banks and financial institutions are weakened and consolidating globally.
One analyst that I read put it this way: It’s a war zone out there, and the better part of valor is to keep your head down and your powder dry, and live to fight another day.” Stay tuned…
Now here is the And More part…
By: KK Hatanaka, Guest World Markets Analyst
Number 1, The World is reacting
The central concern among investors over the last few days has been the freezing of the interbank market.
Lending between banks has virtually stopped as the banks confidence in their counterparties has drained as more and more financial institutions have let the community know that they are in trouble.
Three-month euro interbank rates are now at an all-time high and three-month dollar interbank rates are currently 4.32 percent, up from 2.82 percent in mid-September.
Interbank rates are a key determinant of lending rates, so higher interbank rates combined with an aversion to lending is having a clear impact on the broader economy world wide
Interbank markets are also a vital tool for banks to manage their liquidity. In this climate, the huge injections of liquidity from central banks are vital.
The chances of a large-scale coordinated rescue package across the leading global economies is growing daily.
Yesterday there was a coordinated interest rate cut (except by the Bank of Japan) and G7 leaders meet on this Friday, and global financial leaders meet at the IMF/World Bank meetings on Saturday and Sunday this week. We should be closely watching these events as they unfold.
Some very important announcements over the past 60 hours:
The U.S. Federal Reserve announced it will buy commercial paper (short-term debt issued by corporations and banks).
Many companies rely on commercial paper to finance their day-to-day operations, effectively using it as a credit line. The extreme aversion to risk in the markets means that investors have significantly scaled back their purchases of commercial paper and interest rates have jumped. The intervention in the commercial paper market is separate to the $700 billion that has been allocated to buy up distressed financial assets in a plan approved by the U.S. government on Friday and marks the first time that the Fed has assets that not backed by collateral.
Fed Chairman Ben Bernanke signaled a shift in policy at a speech on Wednesday, October 8th, 2008 commenting that the outlook for economic growth has deteriorated and that inflationary pressures have eased. This gives a strong indication that there will be further interest rate cuts. The futures market had already priced in lower rates, but previous Fed comments had been careful to balance concerns about the economy (which call for lower interest rates) with concerns about inflation (which call for higher interest rates).
This morning the UK government announced a financial support package for domestic banks. GBP50 billion of government money has been made available to eight of the country’s largest financial institutions, who in return for access to this funding will give the government shares that guaranteed a fixed rate of interest but do not have voting rights. A further GBP200 billion of short term financing has been made available to provide liquidity. Share prices of commercial banks plunged on Tuesday; HBOS was down by 40 percent and Royal Bank of Scotland down by 39 percent. Share prices of the companies with access to the support package are currently registering double-digit gains.
A summit of EU finance ministers on Wednesday, October 8th, 2008 agreed to a set of principles for government action in rescuing financial institutions. These principles were reasonably broad and did not amount to a formal EU-wide action pan. Instead the region will deal with banks on a case-by-case basis. In addition, deposit insurance in the EU was increased yesterday from Euros 20,000 to Euros 50,000 ($68,000). This move was designed to reassure savers and prevent potentially destabilizing withdrawals from the banking sector and follows Ireland and Greece guaranteeing all depositors’ savings in the last few days.
Number 2, on Gold…
Since we are now part of the Global markets for a clearer understanding one must look at EU, UK, Asian economy, currencies and stock markets.
Turmoil and chaos abound now, as the domino effect will continue to effect to the world for a while. I do not think the markets have hit the bottom yet.
Obviously banks are leveraged up on loans an extent that easily exceeds the leverage of at risk banks in the U.S. and are in the process of deleveraging.
For example, more than 11 billion Euros were pumped into Fortis SA (Belgium – an international provider of banking and insurance services to personal, business and institutional customers) so far this week.
Furthermore, Belgium and France will pump more than 6 billion Euros to Dexia SA (Belgium – the provision of banking, financial and insurance services)
The German government helped out Hypo Real Estate (Germany – responsible for strategic guidance and acts as a gateway to equity and debt markets) with a loan guarantee of 15 billion Euros, addition to 35 billion Euros.
Ireland’s government will guarantee 400 billion Euros of deposits and debts belonging to its domestic banks for a period of two years. (they have already rescued Glitner Bank).
By the way, Gold could go higher in here and into 2009, but watch dollar movement……Investors are pouring money into Gold ETFs (Exchanged Traded Funds). For example, in the five trading days from September 17th to September 23rd, some $3.2 billion poured into the major gold funds.
In fact, Gold ETFs are now one of the biggest drivers of Gold prices. And the amount of Gold they hold continues to soar.
As of the end of September the biggest gold ETF, SPDR Gold Shares (GLD), held over 724 metric tonnes (23.3 million ounces) of gold
G5 (US, Germany, France, Italy, Japan) are major holder of Gold.
Gold (Tonnes) Q1 2008
United States – 8133.5
Germany – 3417.4
IMF – 3217.3
France – 2568.3
Italy – 2451.8
Switzerland – 1113.2
ETF – 879.0
Japan – 765.2
Netherlands – 621.4
China – 600.0
ECB – 563.6
Russia – 457.0
Taiwan – 423.0
Portugal – 382.5
India – 357.7
Venezuela – 356.8
United Kingdom – 310.3
Lebanon – 286.8
Spain – 281.6
Austria – 280.0
Belgium – 227.6
Algeria – 173.6
Sweden – 146.6
Libya – 143.8
Saudi Arabia – 143.0
BIS – n.a.
Philippines – 129.6
Singapore – 127.4
Dollar reserves
Rank Country/Monetary Authority billion USD (end of month)
1 China $ 1809 (June)
2 Japan $ 997 (August)
3 Russia $ 563 (September 26)
_ Eurozone $ 555 (July)
4 India $ 291 (September 19)
5 Taiwan $ 282 (August)
6 South Korea $ 243 (August)
7 Brazil $ 205 (Aug 31)
8 Singapore $ 175 (July)
9 Hong Kong $ 158 (August)
10 Germany $ 137 (August)
Number 3, on the US$ and Saudi Arabia
As we all know the Saudi Riyal (SDA) is pegged to the US$, but if the US budget deficit enlarges and interest rates go down, then Saudi may not be able to continue pegging to the SDA to the US$, just like what Kuwait did in May 2007, when its central bank parted company with its GCC partners and switched its exchange rate mechanism to a basket of currencies, and thus it became highest valued currency in the world.
Saudi Arabia’s banks are feeling the pinch from the global liquidity crunch as the government is caught between efforts to manage inflation and lending to private-sector banks.
There is a liquidity management problem in Saudi Arabia and in other countries around the world.
The Saudi Arabia Monetary Agency (SAMA), the kingdom’s central bank, may lower its bank lending rate if it finds that the banks face a cash shortage.
Record Crude Oil prices have flowed huge monetary liquidity through the Saudi economy, fuelling the highest rates of inflation in decades.
SAMA has repeatedly said the economy is insulated against the global financial meltdown because of a conservative monetary policy, however, liquidity is tightening because the situation with the US$ has created concern and raised the likelihood of the Riyal appreciating against the US$, making it difficult to lend in US$s, and as borrowing from international markets has grown more difficult, Saudi banks are finding increasingly difficult to face the crisis.
As I write this the Saudi banks still do not have a strategy to deal with the unprecedented global crisis, but the kingdom’s strategic Crude Oil reserves mean it is in a better positioned than many others countries.
Note: The Saudi Arabia’s economy is still fundamentally solid based on its hydrocarbon exports, but it is not completely insulated against the world crisis.
Number 4, what is in store
The US has not exhausted its remedies, the Fed can cut interest rates from 1.5% to zero. If that fails, it can inaugurate a mass purchase of the US debt.
As you know, the US government has a technology, it is called the US$ printing press, as said in Fed chief Ben Bernanke, helicopter speech, in November 2002.
The US Treasury/Fed can jump into any market to firm up the asset prices.
For example, the Fed can buy Florida property, SUV gas guzzlers from the used car lots, send them to the crusher and reclaim them as scrap. Plus the Fed can expand its menu of assets.
However, the question is will the US’s foreign creditors tolerate such action.
Have a look at what happened in Japan…they lost decade as the world’s top creditor, and they were bolstered with a vast pool of household savings to cushion the slump.
Now, America must start its purge with net external liabilities of $3T, and a savings rate near zero.
Foreigners own over half the US Treasury debt, and two thirds of all Fannie, Freddie, and other US agency bonds.
That is why the risk of a US$ collapse is one for the distant future. Right now the world faces the opposite problem.
There is a wild scramble for US$s as a $10T pyramid of global lending based on US$ balance sheets will create another chaos. This is a short squeeze on those who have used the US$ for a global carry trade.
International banks are facing margin calls on their dollar leverage. This is the reason why the Fed has to provide $1.25T in dollar liquidity for the entire global banking system.
But check this: The crisis will swallow up the UK, EU, Asian and emerging markets. Thus, making life easier for Washington, D.C. as the United States is again becoming a safe-haven, allowing the Fed to pursue monetary stimulus without being slapped down by the currency, debt, and commodity markets.
This weekend is very important for the world economic turmoil.
The world economy is entering a major downturn in the face of the most dangerous financial shock in mature financial markets since the 1930s.
Global growth is projected to slow substantially in 2008, and a modest recovery would only begin later in 2009.
The immediate policy challenge is to stabilize financial conditions, while nursing economies through a period of slow activity and keeping inflation under control. Stay tuned
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