The credit crisis continues. On Thursday Citigroup saw its shares drop almost 7%, while Bank of America saw a drop of 5.3% as analysts expressed concern that these major banks "will be forced to sell assets, raise capital or cut its dividend to shore up its capital ratios. "
In the past week we have seen the CEOs of both Citigroup and Merrill Lynch get managed. These are two of the largest banks in the US and they have both fired their CEO in the last week. Similarly, losing a lot of money is not a good career move, as Merrill's Stan O'Neil and Citi's Charles Prince just found out. We said it when Bear Sterns and Lehmans had trouble and we said it again when British Bank Northern Rock had to be bailed out; "there is never just one cockroach."
During the summer, we saw the Fed and many other central banks around the globe add massive amounts of liquidity into the system. Last week, the Fed was at it again injecting $ 42 billion into the system – which is the largest one time injection that has ever been made. Now we are seeing one bank after another make huge write-downs of sub prime debt on their books.
We have written numerous pages on this topic, but will give it a bit more ink here as we want our readers to understand the severity of this problem. In the last 10 years or so, the US has run up a massive trade deficit. This deficiency was caused by the US buying more imported goods than they exported, which was assisted by many foreign central banks playing what we like to call "the great race to the bottom currency game." What these foreign bankers would do was keep their currency low, so that their goods looked well priced for the American consumer.
To add insult to injury, these foreigners who held all these new US dollars, then decided to re-invest these dollars back into the US via bonds and treasuries, which would help keep the dollar propped up. During this time, the US interest rates were still quite low, but because all of this foreign capital invested into the US treasuries, the dollar remained reasonably strong – so everyone was a winner.
Ever since we started publishing the Trend Letter, we have asked the question "when will these foreign holders of US dollars finally decide enough is enough – and diversify out of the declining dollar?" The answer appears to be last August this year. As the real risks of the sub prime credit problems started to surface, many holders of the US dollar decided it was time to get out. In October of this year we posted the headline on our web site that read "Record Flight of Foreign Investors" (visit the In the News section daily for times). In that article it described how
"Mortgage market and credit turmoil shown in a Treasury Department report that said foreigners dumped a record net $ 163 billion of US securities in August, when credit risks roiled markets and forced the US Federal Reserve to cut its discount rate charged on loans to banks." This was the largest exodus of funds out of the US since they started tracking this data in 1978. Up to that point we typically saw an inflow of capital to the tune of over $ 100 billion per month.
There have been many financial situations in the past number of years and many of them have been called a "crisis." But we believe that this current credit crisis will turn out to be the grand daddy of all crises. We are seeing bank after bank declare massive new losses. And these are not little banks either as we saw with Merrill Lynch and Citigroup in the past week. We have been keeping tabs on the meltdown in this sector reporting on the number of failed lenders each month. Today the total of failed lenders is up to 179. Around the world we are hearing of more and more banks requiring central banks to bail them out.
In our October 21 st Flash Report we talked about the new bail out fund that the Treasury orchestrated with Citigroup, Bank of America, JP Morgan and others. What these banks are trying to do with this bailout fund is to put some stability into the credit market.
These banks and the Treasury department all know that there is going to be a huge liquidation of assets in the next year, so they are trying to try to make it an organized liquidation. The reason for the concern is the massive amount of Structure Investment Vehicles (SIVs) floating around. Many of these SIVs are associated with banks and this is why we are now starting to see the fallout with all of these banks having to write down massive losses. Please review the October 21st Flash Report for the rest of that story.
The result of all of this mess has been that much of the source of credit is getting squeezed now. A report shows that last week for the 12th straight week, asset backed commercial paper declined – this time by $ 9 billion. The fact is that since August, we have seen a reduction of over 26%, as mortgage linked commercial paper is simply not coming back to the market – resulting in less credit available for mortgages and other loans. With a declining inventory of mortgage and loan credit available, fewer businesses and homeowners will be able to get financing.
The main reason for all of these problems was a practice of over lending money to people who simply did not qualify for mortgages on homes that could not afford. As all of these sub prime mortgage holders have their mortgages come up for a rate rest, they are facing huge increases in their monthly payments – some up over 100%. Many if not most of these homeowners bought their home with very little if any equity. Today, the value of that home is 15%, 25%, or more, below what they paid for the home. So now these folks are facing a huge increase in payment, on a mortgage that is 15% – 25% more than the house is worth. With no equity in the home, as the pool of capital available for mortgages shrinks, many of these sub prime homeowners will not be able to get financing. As this sad scenario continues to unfold, we can expect to see more and more foreclosures on many of these sub prime homes.
This is not a pretty picture, in fact it may turn out to be one of the ugliest economic crises the west has ever seen. We hope not, but with this credit crisis, the bursting of the housing bubble and what we see as rising unemployment, the Fed will have no options left but to inflate. Therefore, we expect to see the Fed continue to lower rates as it is pretty much all they can do – the result will be rising inflation. The question is will it be enough to rescue the lagging US economy?
If you wonder why the dollar is at a record low at 75.99, why gold is at a 30 year high at $ 837 and why oil is at over $ 95 – now you have a pretty good idea.