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"A Generalized
Meltdown of Financial Institutions"
Take a Look at
Professor Roubini's Crystal Ball
By Mike Whitney
11/24/07 "ICH"
-- - Reality has finally caught up to the stock market. The
American consumer is underwater, the banks are buried in dept,
and the housing market is in terminal distress. The Dow is now
below its 200-Day Moving Average -- the first big "sell" signal.
Anything below 12,500 could trigger program-trading and crash
the market. The increased volatility suggests that we are
watching a "real time" meltdown.
International Business editor
for the UK Telegraph, Ambrose Evans Pritchard, summed up
yesterday's action in the Asian markets:
"The global credit crisis
has hit Asia with a vengeance for the first time, triggering
a massive flight to safety as investors across the region
pull out of risky assets. Yields on three-month deposits in
China and Korea have plummeted to near 1pc in a spectacular
fall over recent days, caused by panic withdrawals from
money market funds and credit derivatives.
"'This' is a severe warning
sign,' said Hans Redeker, currency chief at BNP Paribas.
'Asia ignored the credit crunch in August but now we're
seeing the poison beginning to paralyze the whole global
economy.'" (Credit 'Heart attack' engulfs China and Korea"
Ambrose Evans Pritchard,UK Telegraph,)
The credit storm that began in
the United States with subprime mortgages has spread to markets
across the globe. In fact, the train has already crashed. What
we're seeing now is the boxcars piling up on top of each other.
On Tuesday Chinese government
officials ordered a complete halt to bank lending to slow the
speculative frenzy that has created an enormous equity bubble in
the stock market. According to the Wall Street Journal:
"Chinese authorities are
slamming the brakes on bank lending, in their latest attempt
to curb the runaway investment threatening to overheat what
is soon to be the world's third-largest economy. In recent
weeks, regulators have quietly ordered China's commercial
banks to freeze lending through the end of the year,
according to bankers in several cities. The bankers say that
to comply, they are canceling loans and credit lines with
businesses and individuals." ("China freezes lending to Curb
Investing Frenzy" Wall Street Journal)
The move illustrates how
concerned the Chinese are that a slowdown in US consumer
spending will trigger a crash on the Shanghai stock market. It
also shows that the Chinese are having difficulty dealing with
the inflation generated by the hundreds of billions of US
dollars absorbed via the trade imbalance with the US. China is
awash in USDs and that surplus is causing a steady rise in food
and energy costs. This could be mitigated by allowing their
currency to "float" freely. But a sudden, steep increase in the
Chinese yuan's value could also send the world headlong into a
global recession. For now, the lending freeze and price fixing
appear to be the way out.
Another sign that the markets
have reached a "tipping point" appeared in a Reuters article on
Wednesday; "Interbank Covered Bond Trading Halted on
Volatility":
"Renewed credit turmoil and
volatility led the European Covered Bond Council (ECBC) on
Wednesday to suspend inter-bank market-making in covered
bonds until Monday, Nov. 26.
The move is a sign of the
stress in the covered bond market, which is dominated by
German institutions that have almost a trillion euros of
covered bonds outstanding.
Covered bonds -- backed by
pools of assets that remain on the borrower's balance sheet
-- are usually highly liquid and typically rated triple-A by
ratings agencies. The ECBC's recommendation is aimed at
relieving the pressure on market makers who are forced to
quote prices at a fixed bid-offer spread.
"In light of the current
market situation and in order to avoid undue
over-acceleration in the widening of spreads, the 8-to-8
Market-Makers & Issuers Committee recommends that inter-bank
market-making be suspended," the ECBC said in a release."
Note: This isn't mortgage-backed
junk that's being sold, but highly liquid bonds that are usually
easy to cash in. The ECBC's action is a sign of pure desperation
and indicates that credit paralysis has infected the entire euro
banking system.
Reuters: "Due to general market
conditions and the specific mechanics of the inter-dealer market
making it even seems possible that inter-dealer market making
will not be resumed this year."
That's bad. The mechanism for
converting covered bonds into cash has broken down.
The dollar took another pasting
on Wednesday, sliding to $1.49 on the euro; another new record.
Gold shot up to $814 per ounce. Oil continues to flirt with the
$100 per barrel mark, and the yen rose to 107 per dollar forcing
a sell-off of hedge fund assets levered through the carry trade.
Jon Basile, economist at Credit
Suisse, summed it up like this: "There's a heck of a lot of bad
news out there." Indeed.
In California Governor Arnold
Schwarzenegger has joined with four mortgage lenders to freeze
adjustable interest rates (ARMs) for some of the state's
highest-risk borrowers; another unprecedented move. The Governor
hopes to avoid a collapse of the California real estate market
which has gone into a tailspin. Home sales have plummeted more
than 40 per cent for the last two months. Prices have dropped
sharply---roughly 12 per cent statewide. New construction has
slowed to a crawl. Layoffs are steadily rising. Jumbo loans
(mortgages over $417,000) have been put on the "Endangered
Species" list. Even qualified borrowers can't get mortgages.
Nothing is selling. California housing is "off the cliff".
Schwarzenegger's plan to keep
over-extended subprime mortgage-holders in their homes faces an
uncertain future. What incentive is there for homeowners to
continue paying exorbitant monthly rates when their payments are
not applied to the principle? The homeowners would be better off
bailing out, accepting foreclosure, and starting over with a
clean slate.
It's unrealistic to thinks that
Schwarzenegger can stop the tidal wave of foreclosures that are
sweeping across the state. An estimated 3 million homeowners
will lose their homes nationwide.
If you want to blame someone;
blame Alan Greenspan. He's the one who created this mess.
According to the economist Mike Shedlock:
"The Fed caused the credit
crunch by slashing interest rates to 1 per cent to bail out
its banking buddies in the wake of a dotcom bubble collapse.
All the Fed did was create a bigger bubble. This bubble is
so big in fact that it cannot even be bailed out. It's the
end of the line for a serially bubble blowing Fed.
"So not only was this the
biggest credit bubble in history, this was also the biggest
transfer of wealth from the poor and middle class to the
already enormously wealthy. That is the real travesty of
justice regardless of whether or not the price tag is $1
trillion, $2 trillion, or $10 trillion." (Mike Shedlock,
"Mish's Global Economic Trend Analysis")
The problem has gotten so
serious that even Secretary of the Treasury, Henry Paulson, is
putting up red flags. Last week, Paulson ignited a sell-off on
Wall Street when he made this statement:
"The nature of the problem
will be significantly bigger next year because 2006
[mortgages] had lower underwriting standards, no
amortization, and no down payments....We're never going to
be able to process the number of workouts and modifications
(to mortgages) that are going to be necessary doing it just
sort of one-off. I've talked to enough people now to know
that there's no way that's going to work."
The desperation is palpable.
Like Schwarzenegger, Paulson is trying to get mortgage-lenders
to provide a safety net for struggling borrowers who are
defaulting on their loans.
Paulson is calling for emergency
legislation that will allow the Federal Housing Administration
to play a greater role in the relief effort. The FHA has already
expanded its traditional role by taking on hundreds of billions
in extra debt just to keep a few "private" mortgage lenders and
banks from going bankrupt. Of course, when Paulson's plan goes
kaput and the debts pile up; it'll be the taxpayer that foots
the bill.
"Paulson also called the
Senate's failure to pass legislation overhauling mortgage
giants Fannie Mae and Freddie Mac frustrating," saying that
the two government-sponsored entities need to be playing a
bigger role in the housing market.
"If we ever need them it's
during times like today, and they're most valuable when
there is distress in the mortgage market," he said. "I'd
like to see them playing an even bigger role."(Wall Street
Journal)
Fannie and Freddie, have already
posted enormous quarterly losses and don't have the capital
reserves to put millions of subprime mortgage-holders under
their "government-sponsored" umbrella. Paulson is just grabbing
at straws.
Similar troubles are brewing in
the broader market where late-payments and defaults have spread
to credit card debt and new car loans. Every area of
"securitized" debt has suddenly veered off the road and into the
ditch. Last week the Fed injected more credit into the teetering
banking system than anytime since 9-11.
No one has predicted the
downward-spiral in the market more accurately than Nouriel
Roubini. Roubini is a Professor at the Stern School of Business
at New York University. His analysis appears regularly on his
blogsite, Global EconoMonitor. Last week's prediction was
particularly dire and is worth reprinting here:
"It is increasingly clear by
now that a severe U.S. recession is inevitable in next few
months...I now see the risk of a severe and worsening
liquidity and credit crunch leading to a generalized
meltdown of the financial system of a severity and magnitude
like we have never observed before. In this extreme scenario
whose likelihood is increasing we could see a generalized
run on some banks; and runs on a couple of weaker (non-bank)
broker dealers that may go bankrupt with severe and systemic
ripple effects on a mass of highly leveraged derivative
instruments that will lead to a seizure of the derivatives
markets... massive losses on money market funds with a run
on both those sponsored by banks and those not sponsored by
banks; ..ever growing defaults and losses ($500 billion
plus) in subprime, near prime and prime mortgages with
severe knock-on effect on the RMBS and CDOs market; massive
losses in consumer credit (auto loans, credit cards); severe
problems and losses in commercial real estate...; the drying
up of liquidity and credit in a variety of asset backed
securities putting the entire model of securitization at
risk; runs on hedge funds and other financial institutions
that do not have access to the Fed's lender of last resort
support; a sharp increase in corporate defaults and credit
spreads; and a massive process of re-intermediation into the
banking system of activities that were until now altogether
securitized." (Nouriel Roubini's Global EconoMonitor)
"A generalized meltdown of the
financial system".
Looks like Chicken Little might
have gotten it right this time; "The sky IS falling."
Mike Whitney lives in
Washington state. He can be reached at:
fergiewhitney@msn.com
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