Archive through March 18, 2008

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rdumas

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Post Number: 1247
Registered: 11-2006

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Monday, March 17, 2008 - 01:58 pm:

Yet another great article from the Australian Investment Review site.

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2:19 PM Mar 17, 2008

STEPHEN BARTHOLOMEUSZ

Dogged by a Shadow

The "rescue" of Bear Stearns by JP Morgan Chase and the US taxpayer sends a truly ominous signal that the US authorities are now frightened that the sub-prime crisis threatens the integrity and stability of the core of the US financial system.

The key to the rescue appears to be not the $US2 a share that JP Morgan will pay for the investment bank, whose shares were trading at $US30 last week, but the willingness of the Federal Reserve Board to fund $US30 billion of Bear Stearns "less liquid" assets – inevitably its sub-prime exposures, which enabled JP Morgan to guarantee its former rival’s counterparty risks.

The Fed had tried to stabilise Bear Stearns last week with emergency funding using JP Morgan as a conduit – because the Fed can’t lend directly to investment banks – but that wasn’t sufficient in the face of a massive "run" on the investment bank that saw more than $US17 billion of funds withdrawn from it in only two days last week. It was the first time in nearly 50 years that the Fed had arranged emergency funding for anything other than a regulated deposit-taking bank.

The funding of the bail-out is a step beyond that, one that takes the Fed into territory it has avoided since the Great Crash. The US authorities have in the past allowed banks and other financial institutions to fail rather than risk creating 'moral hazard' – a conviction that risk-taking is underwritten by the taxpayer – within the US financial system.

Bailing out Bear Stearns says the authorities believed its failure would have systemic implications – the same fear that drove the UK Government’s funding and ultimately nationalisation of Northern Rock, the first nationalisation of a bank in the UK since the 19th century.

Bear Stearns wasn’t too big to fail, but rather too well-connected. In the post Glass-Steagall environment – the Depression-era legislation designed to quarantine the banking system from securities market activities that was repealed in 1999 – the inter-connectedness of the investment banks and the trading banks has grown dramatically.

The less-regulated 'shadow banking system' the investment banks inhabit is as large as the conventional banking system in the US and there is a massive overlap between the two. The failure of one of the major investment banks – Bear Stearns is the fifth-largest Wall Street investment bank – would have serious ramifications for its counterparties, including the banks. The Fed clearly believed those ramifications were so serious that it had to intervene.

Apart from the linkages Bear Stearns would have with the mainstream banking system and other non-banks, the failure of one of the Wall Street heavyweights would have brought extreme pressure to bear on peers already weakened by their own exposures to the sub-prime crisis.

At the moment the financial regulators in the US and Europe are dashing from one spot fire to another, dousing them with liquidity and, in the cases of Northern Rock and now Bear Stearns, taxpayer support to try to contain the contagion.

If and when the global financial system is stabilised, they are either going to have to live with the precedents they’ve established – moral hazard encourages recklessness within financial systems – or re-regulate to create a better demarcation between banks and non-banks. It would be no surprise if the US, which always looks to legislative responses in the aftermath of financial crises, reintroduced a version of Glass Steagall.

There is going to have to be some form of co-ordinated response by the prudential regulators to the lessons of the sub-prime crisis.

The global credit markets have developed on the back of unregulated or under-regulated activity and the ingenuity of the big investment banks and other non-bank institutions. They lack transparency and the prudential controls imposed on regulated institutions. Yet they have become such a core element of the individual financial systems of developed economies and international banking that their implosion threatens global financial and economic stability.

While there will be an element of self-correction in response to the sub-prime crisis – it will be a while before a AAA credit rating wrapped around a pile of junk loans has any credibility – either the shadow banking system will have to be brought out of the shadows or the regulators/legislators will need to find a way to shut down the conduits between that system and their banking systems.

==============================================================

coyotte

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Monday, March 17, 2008 - 02:36 pm:

Question :

Why would the $au be dropping , whilst POG is rising ?

The "Sea of Uncertainty" is defeated by the nimble vessel "Probability", not the unwieldy vessel "Prediction".

kate

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Registered: 04-2005

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Monday, March 17, 2008 - 02:41 pm:

Rudy

I've spent the last 15 mins trying to access the article in any shape or form and the only thing I came up with was a FT article which of course includes the useless link. I can't send you the article direct because I don't have a scanner. I'll have another read of the article and see if I can summarise the main points. The FT article will give you a brief introduction.

Kate

kate

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Monday, March 17, 2008 - 02:45 pm:

I suppose the link may be useful!

http://ftalphaville.ft.com/blog/2007/09/17/7352/a-one-in-three-chance-were-headi ng-for-the-rocks/

rdumas

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Post Number: 1248
Registered: 11-2006

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Monday, March 17, 2008 - 03:08 pm:

Hi Kate,

I had originally assumed that you had downloaded the original report and would have it available in pdf format.

Thanks for that other link. At least we can get the gist of the article from those extracts. It sure is looking like the 'Ugly' scenario has a greater than 10% chance now.

ody

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Post Number: 2240
Registered: 10-2006

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Monday, March 17, 2008 - 03:16 pm:

RESOURCES NOT NECESSARILY A SAFE ANSWER

Inevitably, with financials down and having become risky rather than safe, investors look for alternatives. Some of these, like gold, may for the time being make perfect sense.
Shortages in wheat, wool, etc. are also likely to remain. One could do worse than buying what will definitely be needed (or desired), while steering clear of what people are trying to sell. And yet, there is evidence that at least in some cases buying commodities (the raw materials, I mean, not necessarily the equities) is becoming speculative. I think that the risk of that happening is MAJOR, especially because the financial crisis obviously has further to run. Beware, fellow investors, of what might come to be a commodities bubble - the next inflated asset class. Here is a snippet from today's Australian which proves that some fairly significant speculation is already occurring.

And Kate: thanks for providing the link in your most recent post that I saw. Interesting and helpful material. I cite from The Australian of today:
----------------------------------------------------------
Capital flight is hard to track, but a window into the activity of financial investors in commodities is available from the Chicago futures market. It reveals that speculative and investor interest in commodities on that market has soared from $US160 billion to $US220 billion since last October. Investors are betting on prices rising further, with the net long position rising from $US48 billion to $US78 billion in the same period.
----------------------------------------------------------

And I shall leave things at that. Don't need to comment, I feel, on the rescue of Bear Sterns - we can all see where it comes from, and why and how it matters. I thought I might mention the resources (potential) problem, as that is where most people are NOT looking for an asset bubble. The danger is that the further the financials fall, the further resources will rise beyond the level where they should be. There is definitely an inverted relationship between these two.

Of course there are other sectors enjoying some support, like health - but I don't think the threat of a big bubble there is as large as in resources.

All of which is not to say that careful buying of resources may not be a winner - and at least in the short run it could still be highly profitable.

Must go now, definitely.

rdumas

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Post Number: 1249
Registered: 11-2006

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Monday, March 17, 2008 - 03:22 pm:

Hi Kate,

Some one was kind enough to send me that pdf file so I will look forward to reading it tomorrow morning. I have to go out now and not sure when I'll be back.

mrlunch

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Post Number: 291
Registered: 09-2006

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Monday, March 17, 2008 - 03:25 pm:

Coyotte - I'm not exactly sure but the moves are fairly large especially for this timezone. I noticed it earlier today and am hoping someone else has a better explanation!

I tried to play the fact trading today.

kate

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Post Number: 852
Registered: 04-2005

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Monday, March 17, 2008 - 03:33 pm:

Rudy, thats great!

Coyotte
The carry trade is unwinding at an alarming rate. Check out how high the yen has gone up today.

Ody
I wouldn't touch commodities with a ten foot barge pole at present, good will be sold off with bad to meet margin calls. They'll also come under pressure if there is some intervention to support the USD.

mrlunch

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Post Number: 292
Registered: 09-2006

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Monday, March 17, 2008 - 04:10 pm:

Thanks Kate - carry trade does make sense.

But the move today is large and all of a sudden and I think is actually explained by the Fed meeting on Sunday and cutting rates 0.25% when there was talk of a much bigger cut.

The fact that gold is rising as well says something... though it is off its highs.

resillent1

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Post Number: 397
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Tuesday, March 18, 2008 - 05:13 am:

Before we give this decoupling from the US in a negative way, too much credence.

Lets have a look at a chart of this decade with both the S&P500 and the XAO in AUS$. Both indexes are re-based to 100 on 1/1/2000.

XAO is the higher line.

Given the monetary policy each country is currently running, I don’t see the longer-term trends changing. The slight underperformance of the XAO in 2008 (and its only very slight when adjusted for currency) is likely to soon be reversed as the US rate cuts are contradictory to their inflation environment; however a reversal may just mean that we start to fall slower than the US.

ody

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Tuesday, March 18, 2008 - 05:52 am:

SOMETHING AFFECTING US VERY DIRECTLY

http://www.brisbanetimes.com.au/news/business/china-locks-out-bhp-and-rio-ore/20 08/03/17/1205602326667.html

rdumas

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Post Number: 1250
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Tuesday, March 18, 2008 - 07:38 am:

Hi Resilllent1,

When you made the comments about the exchange rates and that my figures would be substantially altered by taking them into account I thought that you were talking about the affect of the falling US$ on their imports and exports. I didn't realise that you were talking about the indices.

Thanks for clearing that up. As usual, your observations always throw up a different way of looking at things and are much appreciated.

rdumas

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Post Number: 1251
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Tuesday, March 18, 2008 - 07:42 am:

Hi Ody,

During my business life, when we had to negotiate with the Chineses on