Safehaven | Now We Know the Real Reasons For the Credit "Crisis"

April 06, 2008

Now We Know the Real Reasons For the Credit "Crisis"
by Clif Droke

I've purposely kept my comments concerning the credit crisis at a minimum since it began dominating the daily news headline. My reasoning for this is because I knew the crisis was overblown and overstated in the press and that there had to be a very good reason for it. The only problem is I didn't know exactly what the reason was.

Time tells all, however, and I knew that sooner or later the truth must out!

One thing experience has taught is that every notable market crash, panic, bear market or financial crisis is the result of careful planning and forethought by the monetary authorities. With trillions of dollars at stake, nothing happens without their tacit or explicit approval and there is simply no such thing as a crisis that happens by "coincidence." For happenstance to be allowed to run its course in with trillions in derivates out there would be certain death for the financial system. As the economist Dr. Stuart Crane was fond of saying, "Things [in the monetary world] don't just happen to happen. They happen because they were planned to happen."

Another thing Dr. Crane used to say was that you can always tell the underlying reason for any crisis by waiting to see what the results of that crisis are. In the final analysis, the results, as he pointed out, are in what the crisis fomenters expected to yield as the fruit of their labors. And it's no coincidence that in every case, a financial crisis always yields the following results:

1.) Greater consolidation within the banking and financial industry with the smaller players being merged into the bigger players, or else swept away;
2.) Greater regulator powers for the monetary authorities.

There has never been an exception to this outcome in the history of U.S. financial crises.

Well, lo and behold, the results of this latest financial crisis are starting to become apparent. The following news article was published over the weekend and it points very conclusively to one of the main reasons for the late crisis. I quote the following article in part:

Treasury Dept. Seeks New U.S. Power to Keep Markets Stable

By Edmund L. Andrews

WASHINGTON -- The Treasury Department will propose on Monday that Congress give the Federal Reserve broad authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.

The proposal is part of a sweeping blueprint to overhaul the country's hodge-podge of regulatory agencies, which many specialists say failed to recognize rampant excesses in mortgage lending until after they triggered what is now the worst financial calamity in decades.

According to a summary provided by the administration, the plan would consolidate what is now an alphabet soup of banking and securities regulators into a trio of overseers responsible for everything from banks and brokerage firms to hedge funds and private equity firms.

While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it avoids a call for tighter regulation. The plan would not rein in practices that have been implicated in the housing and mortgage meltdown, like packaging risky subprime loans into securities carrying AAA ratings.

The Fed would also be given some authority over Wall Street firms but only when an investment bank's practices posed a threat to the financial system over all."

I nearly fell over when I saw the following paragraph in this news article:

"Under the proposal, the S.E.C. would merge with the Commodity Futures Trading Commssion, which regulates exchange-traded futures for oil, grains, currencies and the like."

The SEC merging with the CFTC??? So much could be said about this but I'll hold off on commenting until more details become available.

The article continues, "Yet another proposal in the blueprint would, for the first, time create a national regulator for insurance companies, an industry that is now regulated by state governments. Administration officials argue that a national system would eliminate inefficiencies of having 50 different state regulators, who have jealously guarded their powers and are likely to fight any encroachment by the federal government."

The proof is always in the pudding, and there are more than a few figgy surprises in this one. It does at least validate what I've long suspected was a manufactured crisis, which flies in the face of the commonly held belief that the crisis was unavoidable or else systemic and beyond the control of the financial authorities. Nonsense! The authorities had this "crisis" under their control the whole time and the latest revelations only serve to underscore this fact.

Discussion abounds concerning the Fed's contribution to the credit crisis when, during the final years of Greenspan's reign as Chairman, credit expansion was ballooning at a parabolic rate. This is the reason most commonly ascribed to creating the credit problem and it gives one the erroneous impression that the simple act of credit expansion is a recipe for guaranteed disaster in itself. Yet what few commentators ever discuss is that credit expansion is a two-part process: while unmitigated credit growth may set up a future crisis, it is only when the Fed starts tightening the spigot and money contracts that the problems actually begin. Tight money is the real culprit here.

Consider the insights provided many years ago by Dr. Crane on how the Fed creates financial crises:

"In March 1929 there was a little meeting in New York. After that meeting, Bernard Baruch sells out [of stocks], the Rockefellers sell out, the Kennedys sell out, all of the big bankers sell out. The big people were out [of the stock market] by August. Then the Federal Reserve cut the money supply four times in a month. There were four drastic reductions in the money supply.

"Then one day in October the banks called all of their loans on all of their margins at the same minute. Every bank in the money desk - and these were call loans, callable on demand. People had their stock on margin, borrowing 90%. Now they went to the banks and the banks weren't lending, they were calling. They run to the market and everyone's trying to sell. The banks had shut the money off. The call desks were closed. The money desk shut down....and all these people were running around trying to sell because they had to sell 10% down and they were wiped out. All of the people who weren't on the inside were gone."

Some things never change, it would seem.

A commonly heard statement among confused investors is, "I don't understand it! A few weeks ago, investors greeted bad news with selling and the major averages went lower. Now, bad news is greeted with buying and the indices completely ignore the bad news!"

The answer to this conundrum is simple. How the stock market responds to news (good or bad) is determined by internal momentum. When the market's main internal momentum gauges are up (as reflected in the rate of change of the number of stocks making net new highs), the market is more likely to respond to good news favorably and to ignore negative news. When the internal momentum is downward trending (as it was in December-January), the market is vulnerable to bad news.

The market's internal momentum structure is changing and is one reason why investors who are basing their investment decisions on the financial climate that prevailed in the previous few months are in for a lot of frustration. In the month of April we'll be looking at how the shift in market internal momentum will affect us and how we can profit from it.

Clif Droke
ClifDroke.com

Clif Droke is the editor of Gold Strategies Review., providing forecasts and analysis of the leading North American small cap, mid-tier and senior mining stocks from a short- and intermediate-term technical standpoint since 1998. He is also the author of numerous books, including "Channel Buster: How to Trade the Most Profitable Chart Pattern" For more information visit www.clifdroke.com