Stock Market Meltdown
By Mike Whitney
|“Whatever is going to happen, will happen...just don’t let
it happen to you.” Doug Casey, Casey Research
" -- ---
It’s a Bloodbath. That’s the only way to describe it.
On Friday the Dow Jones took a 280 point nosedive on fears
that that losses in the subprime market will spill over into
the broader economy and cut into GDP. Ever since the two
Bears Sterns hedge funds folded a couple weeks ago the stock
market has been writhing like a drug-addict in a detox-cell.
Yesterday’s sell-off added to last week’s plunge that wiped
out $2.1 trillion in value from global equity markets. New
York investment guru, Jim Rogers said that the real market
is “one of the biggest bubbles we’ve ever had in credit” and
that the subprime rout “has a long way to go.”
We are now beginning to feel the first tremors from the
massive credit expansion which began 6 years ago at the
Federal Reserve. The trillions of dollars which were pumped
into the global economy via low interest rates and increased
money supply have raised the nominal value of equities, but
at great cost. Now, stocks will fall sharply and businesses
will fail as volatility increases and liquidity dries up.
Stagnant wages and a declining dollar have thrust the
country into a deflationary cycle which has---up to this
point---been concealed by Greenspan’s “cheap money” policy.
Those days are over. Economic fundamentals are taking hold.
The market swings will get deeper and more violent as the
Fed’s massive credit bubble continues to unwind. Trillions
of dollars of market value will vanish overnight. The stock
market will go into a long-term swoon.
Ludwig von Mises summed it up like this:
"There is no means of avoiding the final collapse of a boom
brought about by credit expansion. The question is only
whether the crisis should come sooner as a result of a
voluntary abandonment of further credit expansion, or later
as a final and total catastrophe of the currency system
involved." (Thanks to the Daily Reckoning)
It doesn’t matter if the “underlying economy is strong”. (as
Henry Paulson likes to say) That’s nonsense. Trillions of
dollars of over-leveraged bets are quickly unraveling which
has the same effect as taking a wrecking ball down Wall
This week a third Bear Stearns fund shuttered its doors and
stopped investors from withdrawing their money. Bear’s CFO,
Sam Molinaro, described the chaos in the credit market as
the worst he'd seen in 22 years. At the same time, American
Home Mortgage Investment Corp---the 10th-largest mortgage
lender in the U.S. ---said that “it can't pay its creditors,
potentially becoming the first big lender outside the
subprime mortgage business to go bust”. (MarketWatch)
This is big news, mainly because AHM is the first major
lender OUTSIDE THE SUBPRIME MORTGAGE BUSINESS to go
belly-up. The contagion has now spread through the entire
mortgage industry—Alt-A, piggyback, Interest Only, ARMs,
Prime, 2-28, Jumbo,—the whole range of loans is now
vulnerable. That means we should expect far more than the
estimated 2 million foreclosures by year-end. This is bound
to wreak havoc in the secondary market where $1.7 trillion
in toxic CDOs have already become the scourge of Wall
Some of the country’s biggest banks are going to take a
beating when AHM goes under. Bank of America is on the hook
for $1.3 billion, Bear Stearns $2 billion and Barclay’s $1
billion. All told, AHM’s mortgage underwriting amounted to a
whopping $9.7 billion. (Apparently, AHM could not even come
up with a measly $300 million to cover existing deals on
mortgages! Where’d all the money go?) This shows the
downstream effects of these massive mortgage-lending
meltdowns. Everybody gets hurt.
AHM’s stock plunged 90% IN ONE DAY. Jittery investors are
now bailing out at the first sign of a downturn. Wall Street
has become a bundle of nerves and the problems in housing
have only just begun. Inventory is still building, prices
are falling and defaults are steadily rising; all the
necessary components for a full-blown catastrophe.
AHM warned investors on Tuesday that it had stopped buying
loans from a variety of originators. 2 other mortgage
lenders announced they were going out of business just hours
later. The lending climate has gotten worse by the day. Up
to now, the banks have had no trouble bundling mortgages off
to Wall Street through collateralized debt obligations (CDOs).
Now everything has changed. The banks are buried under MORE
THAN $300 BILLION worth of loans that no one wants. The
mortgage CDO is going the way of the Dodo. Unfortunately, it
has attached itself to many of the investment banks on its
way to extinction.
And it’s not just the banks that are in for a drubbing. The
insurance companies and pension funds are loaded with
trillions of dollars in “toxic waste” CDOs. That shoe hasn’t
even dropped yet. By the end of 2008, the economy will be on
life-support and Wall Street will look like the Baghdad
morgue. American biggest financials will be splayed out on a
marble slab peering blankly into the ether.
Think I’m kidding?
Already the big investment banks are taking on water.
Merrill Lynch has fallen 22% since the start of the year.
Citigroup is down 16% and Lehman Bros Holdings has dropped
22%. According to Bloomberg News: “The highest level of
defaults in 10 years on subprime mortgages and a $33 billion
pileup of unsold bonds and loans for funding acquisitions
are driving investors away from debt of the New York-based
securities firms. Concerns about credit quality may get
worse because banks promised to provide $300 billion in debt
for leveraged buyouts announced this year……Bear Stearns
Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and
Goldman Sachs Group Inc., are as good as junk.”
We’ve never seen an economic tsunami like this before. The
dollar is falling, employment and manufacturing are
weakening, new car sales are off for the seventh straight
month, consumer spending is down to a paltry 1.3%, and oil
is hitting new highs every day as it marches inexorably
towards a $100 per barrel.
So, where’s the silver lining?
Apart from the 2 million-plus foreclosures, and the 80 or so
mortgage lenders who have filed for bankruptcy; a growing
number of investment firms are feeling the pinch from the
turmoil in real estate. Bear Stearns; Basis Capital Funds
Management, Absolute Capital, IKB Deutsche Industrial Bank
AG, Commerzbank AG, Sowood Capital Management, C-Bass,
UBS-AG, Caliber Global Investment and Nomura Holdings
Inc.—are all either going under or have taken a major hit
from the troubles in subprime. The list will only grow as
the weeks go by. (Check out these graphs to understand
what’s really going on in the housing market. http://www.recharts.com/reports/CSHB031207/CSHB031207.html?ref=patrick.net
The problems in real estate are not limited to residential
housing either. The credit crunch is now affecting deals in
commercial real estate, too. Low-cost, low-documentation,
“covenant lite” loans are a thing of the past. Banks are
finally stiffening their lending requirements even though
the horse has already left the barn. Commercial
mortgage-backed securities are now nearly as tainted as
their evil-twin, residential mortgage-backed securities (RMBS).
There’s no market for these turkeys. The banks are returning
to traditional lending standards and simply don’t want to
take the risk anymore.
Bataan Death March?
Leveraged Buy Outs (LBOs) have been a dependable source of
market liquidity. But, not any more. In the last quarter,
there was $57 billion in LBOs. In the first month of this
quarter that amount dropped to less than $2 billion. That’s
quite a tumble. The Wall Street Journal’s Dennis Berman
summed it up like this: “the Street is scrambling to finance
some $220 billion of leveraged buy out deals” (but) the
“mood has gone from Nantucket holiday to Bataan Death
Berman nailed it. The investment banks took great pleasure
in their profligate lending; raking in the lavish fees for
joining mega-corporations together in conjugal bliss. Then
someone took the punch bowl. Now the banking giants are
scratching their heads-- wondering how they can unload $220B
of toxic-debt onto wary investors. It won’t be easy.
“The banks and brokers are in the bull’s eye,” said Kevin
Murphy. “There’s article after article not only on subprime,
but also banks sitting on leveraged buy out loans.” (WSJ)
Credit protection on bank debt is soaring just as investor
confidence is on the wane. In fact, the VIX index (The “fear
gauge”) which measures market volatility--- has surged 60%
in the last week alone. The increased volatility means that
more and more investors will probably ditch the stock market
altogether and head for the safety of US Treasuries.
But, that just presents a different set of problems. After
all, what good are US Treasuries if the dollar continues to
plummet? No one will put up with 5% or 6% return on their
investment if the dollar keeps sliding 10% to 15% per year.
It would be wiser to one’s move money into foreign
investments where the currency is stable.
And, that is (presumably) why Treasury Secretary Paulson is
in China today---to sweet talk our Communist bankers into
buying more USTs to prop up the flaccid greenback. (Note:
The Chinese are currently holding $103 billion in toxic US-CDOs---and
are not at all happy about their decline in value.) If the
Chinese don’t purchase more US debt, then panicky US
investors will start moving their dollars into gold, foreign
currencies and German state bonds as a hedge against
inflation. This will further accelerate the flight of
foreign capital from American markets and trigger a massive
blow-off in the stock and bond markets. In fact, this
process is already underway. (although it has been largely
concealed in the business media) In truth, the big money has
been fleeing the US for the last 3 years. What passes as
“trading” on Wall Street today is just the endless expansion
of credit via newer and more opaque debt-instruments. It’s
all a sham. America ’s hard assets are being sold off to at
an unprecedented pace.
Credit Crunch: Whose ox gets gored?
When money gets tight; anyone who is “over-extended” is apt
to get hurt. That means that the maxed-out hedge fund
industry will continue to get clobbered. At current
debt-to-investment ratios, the stock market only has to fall
about 10% for the average hedge fund to take a 50% scalping.
That’s more than enough to put most funds underwater for
good. The carnage in Hedgistan will likely persist into the
That might not bother the robber-baron fund-managers who’ve
already extracted their 2% “pound of flesh” on the front
end. But it’s a rotten deal for the working stiff who could
lose his entire retirement in a matter of hours. He didn’t
realize that his investment portfolio was a crap-shoot. He
probably thought there were laws to protect him from Wall
Street scam-artists and flim-flam men.
It’ll be even worse for the banks than the hedge funds. In
fact, the banks are more exposed than anytime in history.
Consider this: the banks are presently holding a half
trillion dollars in debt (LBOs and CDOs) FOR WHICH THERE IS
NO MARKET. Most of this debt will be dramatically downgraded
since the CDOs have no true “mark to market” value. It’s
clear now that the rating agencies were in bed with the
investment banks. In fact, Joshua Rosner admitted as much in
a recent New York Times editorial:
“The original models used to rate collateralized debt
obligations were created in close cooperation with the
investment banks that designed the securities”….(The
agencies) “actively advise issuers of these securities on
how to achieve their desired ratings” (Joshua Rosner
“Stopping the Subprime Crisis” NY Times)
Pretty cozy deal, eh? Just tell the agency the rating you
want and they tell you how to get it.
Now we know why $1.7 trillion in CDOs are headed for the
The downgrading of CDOs has just begun and Wall Street is
already in a frenzy over what the effects will be. Once the
ratings fall, the banks will be required to increase their
reserves to cover the additional risk. For example, “As a
recent issue of Grant’s explains, global commercial banks
are only required to set aside 56 cents ($0.56) for every
$100 worth of triple-A rated securities they hold. That’s
roughly 178 to 1 ratio. Drop that down to double-B minus,
and the requirement skyrockets to $52 per $100 worth of
securities held---a margin increase of more than 9,000%”.
“56 cents ($0.56) for every $100 worth of triple-A rated
securities”?!? Are you kidding me?
As Mugambo Guru says, "That is 1/18th of the 10% stock
margin equity required in 1929"!! (Mugambo Guru; kitco.com)
The high-risk game the banks have been playing---of
“securitizing” the loans of applicants with shaky
credit---is falling apart fast. There’s no market for
chopped up loans from over-extended homeowners with bad
credit. The banks don’t have the reserves to cover the loans
they have on the books and the CDOs have no fixed market
value. End of story. The music has stopped and the banks
can’t find a chair.
The public doesn’t know anything about this looming disaster
yet. How will people react when they drive up to their local
bank and see plywood sheeting covering the windows?
This will happen. There will be bank failures.
The derivatives market is another area of concern. The
notional value of these relatively untested instruments has
risen to $286 trillion in 2006---up from a meager $63
trillion in 2000. No one has any idea of how these new
“swaps and options” will hold up in a slumping market or
under the stress of increased volatility. Could they bring
down the whole market?
That depends on whether they’re backed-up by sufficient
collateral to meet their obligations. But that seems
unlikely. We’ve seen over and over again that nothing in
this new deregulated market is “as it seems”. It’s all
stardust mixed with snake oil. What the Wall Street
hucksters call the “new financial architecture of
investment” is really nothing more than one overleveraged
debt-bomb stacked atop another. Ironically, many of these
same swindles were used in the run-up to the Great
Depression. Now they’ve resurfaced to do even more damage.
When the crooks and con-men write the laws (deregulation)
and run the system; the results are usually the same. The
little guy always gets screwed. That much is certain.
At present, the stock market is running on fumes. Another 4
to 6 months of wild gyrations and it’ll be over. The NASDAQ
plunged 75% after the dot.com bust. How low will it go this
Keep an eye on the yen. The ongoing troubles in subprime and
hedge funds are pushing the yen upwards which will unwind
trillions of dollars of low interest, short term loans which
are fueling the rise in stock prices. If the yen
strengthens, traders will be forced to sell their positions
and the market will tank. It’s just that simple. The Dow
Jones will be a Dead Duck.
So far, Japan ’s monetary manipulations have been a real
boon for Wall Street--enriching the investment bankers, the
big-time traders and the hedge fund managers. They’re the
one’s who can take advantage of the interest rate spread and
then maximize their leverage in the stock market. It works
like a charm in an up-market, but things can unravel quickly
when the market retreats or starts to zigzag erratically.
The recent rumblings suggest that the volatility will
continue which will push the yen upwards and cut off the
flow of cheap credit to the stock market. When that happens,
the end is nigh.
The American People: “We’re not a dumb as you think”
It’s always refreshing to find out that the majority of
Americans seem to have a grasp of what is really going on
behind the fake headlines. For example, The Wall Street
Journal/NBC conducted a poll this week which shows that
two-thirds of Americans believe that “the economy is either
in a recession now or will be in the next year.” That
matches up pretty well with the 71% of Americans who now
feel the Iraq War “was a mistake”. Americans are clearly
downbeat in their outlook on the economy and haven’t been
taken in by the daily infusions of happy talk about “low
inflation” and “sustained growth” from toothy TV pundits. In
fact, the mood of the country regarding the economy is
downright gloomy. “Only 19% of Americans say things in the
nation are headed in the right direction, while 67% say the
country is off on the wrong track”. Iraq , of course, is the
number one reason for the pessimism, but the dissatisfaction
runs much deeper than just that.
“Only 16% expressed substantial confidence in the financial
industry”—“18% in the energy or pharmaceutical
industries”—“17% in large corporations and 11% in
health-insurance companies”. Only 18% of the people have
confidence in the corporate media and only 16% in the
These are encouraging numbers. They show that the vast
majority of people have lost confidence in the system and
its institutions. They also illustrate the limits of
propaganda. People are not as easily indoctrinated as many
believe. Eventually the “bewildered herd” catches on and
sees through the lies and deception.
The American people know intuitively that something is
fundamentally wrong with the economy. They just don’t know
the details or the extent of the damage. Decades of
neoliberal policies have inflated the currency, broadened
the wealth gap, and destroyed manufacturing. Workers can no
longer buy the things they produce because wages have
stagnated through a stealth campaign of inflation which
originated at the Federal Reserve. When wages shrink, prices
eventually fall from overcapacity and the economy slips into
a deflationary cycle. This downward spiral ultimately ends
in depression. So far, that's been avoided because of the
Fed’s massive expansion of cheap credit. But that won’t
Economic policy is not “accidental”. The Fed’s policies were
designed to create a crisis, and that crisis was intended to
coincide with the activation of a nation-wide police-state.
It is foolish to think that Greenspan or his fellows did not
grasp the implications of the system they put in place.
These are very smart men and very shrewd economists. They
knew exactly what they were doing. They all understand the
effects of low interest rates and expanded money supply.
And, they’re also all familiar with Ludwig von Mises, who
"There is no means of avoiding the final collapse of a boom
brought about by credit expansion.”
A crash is unavoidable because the policies were designed to
create a crash. It’s that simple.
The Federal Reserve is a central player in a carefully
considered plan to shift the nation’s wealth from one class
to another. And they have succeeded. Nearly 4 million
American jobs have been sent overseas, the country has
increased the national debt by $3 trillion dollars, and
foreign investors own $4.5 trillion in US dollar-backed
assets. While the Fed has been carrying out its economic
strategy; the Bush administration has deployed the military
around the world to conduct a global resource war. These are
two wheels on the same axel. The goal is to maintain control
of the global economic system by seizing the remaining
energy resources in Eurasia and the Middle East and by
integrating potential rivals into the American-led economic
model under the direction of the Central Bank. All of the
leading candidates—Democrat and Republican---belong to
secretive organizations which ascribe to the same basic
principles of global rule (new world order) and permanent US
hegemony. There’s no quantifiable difference between any of
The impending economic crisis is part of a much broader
scheme to remake the political system from the ground-up so
it better meets the needs of ruling elite. After the crash,
public assets will be sold at firesale prices to the highest
bidder. Public lands will be auctioned off. Basic services
will be privatized. Democracy will be shelved.
The unsupervised expansion of credit through interest rate
manipulation is the fast-track to tyranny. Thomas Jefferson
fully understood this. He said:
“If the American people ever allow private banks to control
the issue of our currency, first by inflation, then by
deflation, the banks and the corporations that will grow up
will deprive the people of all property until their children
wake up homeless on the continent their fathers conquered.”
We are now in the first phase of Greenspan’s Depression. The
stock market is headed for the doldrums and the economy will
quickly follow. Many more mortgage lenders, hedge funds and
investment banks will be carried out feet first.
As the disaster unfolds, we should try to focus on where the
troubles began and keep in mind Jefferson ’s injunction:
“The issuing of power should be taken from the banks and
restored to the people to whom it properly belongs.”
Rep. Ron Paul is the only presidential candidate who
supports abolishing the Federal Reserve.
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