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Words from the (Investment) Wise for the Week That Was (September 15 - 21, 2008)

These are the quick market stats for the past week: the MSCI World Index up by 0.3%, the S&P 500 Index up by 0.3%, the Reuters/Jeffries CRB Index down by 0.1%, the US Dollar Index down by 1.6% and the ten-year US Treasury Note yield up by 4 basis points.

An uneventful week? Not if you consider the monumental swings that characterized trading from hour to hour and resulted in the most turbulent week in financial markets since 1987.

Credit markets virtually seized up during the first three days of last week as a modern-day bank run occurred with investors withdrawing money from brokerage, money-market and bank accounts, sending the three-month US Treasury Bill, a beacon of safety, to nearly 0% - its lowest level in more than 60 years. Actions by the US government on Thursday and Friday, however, saved the day, resulting in the yield on short-term Treasuries spiking to just more than 1% by the end of the fateful week.

Thomas Meyer, chief economist of Deutsche Bank in London, summed up the situation most appropriately: "If a body dehydrates, it falls over and if it gets worse it can die. Likewise the financial system is starved of liquidity right now so the central banks will have to keep providing it."

Triggering a reversal in fortunes on Thursday and Friday was a tidal wave of announcements regarding US government proposals to return stability to the financial system, including the promise of a comprehensive solution, in Resolution Trust Corporation "dumpster" style, to fix the root of the financial problems by removing illiquid and toxic housing and mortgage-related assets from the balance sheets of financial companies; a pledge to provide a guarantee program for troubled money-market funds; and the banning by the SEC of short selling of 799 financial stocks until October 2 (and similar action by the UK regulators).

Also, Lehman Brothers filed for Chapter 11 bankruptcy, a bank consortium, including three banks in the US and seven in the EU, revealed plans to create a $70 billion fund to provide emergency liquidity, the Fed announced several initiatives to provide additional support to financial markets, which include broader collateral eligibility at the Primary Dealer Credit Facility (PDCF) and Term Securities Lending Facility (TSLF), Bank of America (BAC) agreed to buy Merrill Lynch (MER) for $50 billion, and AIG (AIG) became nationalized by means of a $85 billion secured loan from the US government. (Any guess who replaced AIG as Man United's principal sponsor? Click here for the sad truth.)

According to Bespoke, one can tell that a story is really important when the The Wall Street Journal runs the lead headline across the entire front page. During the past week the headline ran the entire front page on five occasions!

And for good measure, here is the front page of the Brooklyn Daily Eagle newspaper on the day of the initial Wall Street Crash in 1929 (Hat tip: Charlestone Voice).

Next, a tag cloud of the text of all the dozens of articles I have read during the past week. This is a way of visualizing word frequencies at a glance. Not too many surprises here, especially not seeing "banks" featuring prominently.

Commenting on the outlook for equities, David Fuller (Fullermoney) remarked as follows: "... central banks are now in a position to switch their policy emphasis from fighting inflation to stimulating GDP growth. They may remain crisis oriented, but at least we are beginning to see the coordinated intervention that I have been discussing and expecting.

"I will certainly not be selling during what I expect is the beginning of the end of this bear market. However, as conditions improve I am likely to shift some of my 'just in case' cash holding into equities over the next few months."

Following an analysis of bear market troughs, Goldman Sachs concluded: "Using returns and valuation in prior bear markets as a template to assess the current situation implies the S&P 500 would bottom at 1070. ... profit cycle ... suggests the market bottoms four months before corporate profits trough, which we anticipate will occur in 1Q 2009. This pattern suggests the S&P 500 will trough in 4Q 2008."

Next week is likely to be pivotal to stock markets' recovery, but I am still of the opinion that markets are bottoming out. I would not be surprised if a year-end rally has in fact already commenced.

Before highlighting some thought-provoking news items and quotes from market commentators, let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.

"Sentiment among global businesses has not been materially affected by the renewed turmoil in global financial markets. Global businesses are worried, but this has been their mood for much of the past year since the financial shock hit," according to the Survey of Business Confidence of the World conducted by Moody's Economy.com. "European businesses are the most nervous, followed closely by those in the US and Japan. Asian businesses remain the most upbeat."

The Federal Open Market Committee held the Fed funds target rate steady at 2% on Wednesday for the third straight meeting. The accompanying statement cited the recent turmoil in financial markets and the ongoing slowing in economic growth, but said that growth should soon pick up. The statement noted recent high inflation, but said this should ease, although it did say that "the inflation outlook remains highly uncertain". The FOMC cited both downside risks to growth and upside risks to inflation that were of "significant concern". There was no indication of a bias towards lower rates. The decision to hold the Fed funds target rate steady was unanimous.

Putting the US economic situation and the proposed Treasury action in perspective, Asha Bangalore (Northern Trust) said: "The optimism surrounding the Treasury plan is justified but it should be noted that economic recovery is several quarters ahead. The credit crunch and household balance sheet position will both play a critical role in how soon the economy gathers steam. Lest we forget, occupants are necessary for the huge number of unsold homes, which will occur only with significant gains in employment."

For the rest, economic fundamentals took a back seat as investors reflected on the effects of the bail-out mania.

Week's economic reports

Date Time (ET) Statistic For Actual Briefing Forecast Market Expects Prior
Sep 15 8:30 AM NY Empire State Index Sep -7.4 NA 1.4 2.8
Sep 15 9:15 AM Capacity Utilization Aug 78.7% 79.6% 79.6% 79.7%
Sep 15 9:15 AM Industrial Production Aug -1.1% -0.3% -0.3% 0.1%
Sep 16 8:30 AM Core CPI Aug 0.2% 0.2% 0.2% 0.3%
Sep 16 8:30 AM CPI Aug -0.1% -0.2% -0.1% 0.8%
Sep 16 9:00 AM Net Foreign Purchases Jul $6.1B NA $55.0B $53.4B
Sep 16 2:15 PM FOMC Policy Statement - - - - -
Sep 17 8:30 AM Building Permits Aug 854K 930K 925K 937K
Sep 17 8:30 AM Housing Starts Aug 895K 950K 950K 954K
Sep 17 10:35 AM Crude Inventories 09/13 -6328K NA NA -5828K
Sep 18 8:30 AM Initial Claims 09/13 455K 440K 440K 445K
Sep 18 10:00 AM Leading Indicators Aug -0.5% -0.2% -0.2% -0.7%
Sep 18 10:00 AM Philadelphia Fed Sep 3.8 -10.0 -10.0 -12.7
Source: Yahoo Finance, September 19, 2008.

In addition to Fed Chairman Ben Bernanke testifying at Congress's Joint Economic Committee on Wednesday, September 24, next week's US economic highlights, courtesy of Northern Trust, include the following:

1. Existing Sales (September 24): Sales of existing homes are predicted to have declined in August to an annual rate of 4.92 million from 5.00 million in July.

2. Durable Goods Orders (September 25): A 1.8% decline in orders of durable goods orders is the most likely forecast for August. Consensus: -1.6% versus 1.3 in July.

3. New Home Sales (September 25): The consensus forecast is a 510,000 annualized sales pace of new homes in August, down from 515,000 in July.

4. Real GDP (September 26): The 3.3% preliminary estimate of real GDP growth in the second quarter is expected to be unchanged. Consensus: 3.3%.

5. Other reports: Consumer Sentiment Index (September 26).

Click here for a summary of Wachovia's weekly economic and financial commentary.

A summary of the release dates of economic reports in the UK, Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues on, among others, the trend of the US dollar.

The performance chart obtained from the Wall Street Journal Online Online shows how different global markets performed during the past week.

Source: Wall Street Journal Online, September 21, 2008.

Stock markets around the world suffered badly during the first three days of last week, but wiped out most of the losses on Thursday and Friday. The week's movements - MSCI World Index +0.3% and MSCI Emerging Markets Index -1.2% - give little indication of the drama that transpired from hour to hour. The fact that these two indices surged by 5.7% and 10.1% respectively on Friday provides a clue as to the severity of the movements.

The table below, courtesy of Bespoke, highlights the percentage changes that global equity markets experienced from their Thursday lows until Friday's close. Russia led the way with an increase of 20.2%, followed by Hong Kong (+18.7%), China (+15.1%), Singapore (+10.9%) and the UK (+10.0%). Forming the rear guard, Japan (+5.5%) and Australia (+6.1%) registered the most "muted" gains.

With the exception of the Dow Jones Industrial Index (-0.3%; YTD -14.1%), the US stock markets all edged higher over the week as shown by the major index movements: S&P 500 Index -3.2% (YTD -15.4%), Nasdaq Composite Index (+0.6%; YTD -14.3%) and Russell 2000 Index +4.6% (YTD 1.6%). Friday's session, which also happened to be a quarterly options expiration day, saw the highest volume (2.98 billion shares) ever traded on the NYSE, including significant short squeezes.

The outperformance of small caps is noteworthy as they have a history of often turning up before large caps at market bottoms. A breakout through the 760 level should be positive for the broader market.

The Russell 2000 Index has already managed to break through both its 50- and 200-day moving averages, whereas the Dow Jones Industrial Index and S&P 500 Index are still flirting with their 50-day lines. On the other hand, the Nasdaq Composite Index still has some work to do in order to catch up with its moving averages.

Click here or on the thumbnail below for a market map, courtesy of Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.

The table below, prepared by Bespoke, shows the performance of the ten S&P 500 sectors for the past week. Only two sectors, Energy and Financials, managed gains. Defensive sectors such as Utilities, Telecom, Consumer Staples and Health Care had the largest declines.

Bespoke also provided the best- and worst-performing stocks in the S&P 500 for the week. As shown, Merrill Lynch (MER) (+73.0%) was the best performer, while AIG (AIG) (-68.3%) was down the most. Investor interest in financials stocks was sparked by governmental bail-out efforts, including a temporary ban by the SEC on short selling of 799 financial stocks and reports that the Treasury Department was working on a plan designed to help banks dispose of troubled assets. The extreme spread of the gains/falls summarizes the tumultuous nature of the trading.

Fixed-interest instruments
US Treasury Notes saw yields falling during the first half of the week, but reversing strongly on Thursday and Friday with two-year Treasuries recording their largest one-day jump since 1981.

The ten-year US Treasury Note rose by 4 basis points to 3.76%, the UK ten-year Gilt yield was unchanged at 4.60% and the German ten-year Bund increased by 5 basis points to 4.23%. Emerging-market bonds tumbled as investors shunned risky securities.

US mortgage rates also increased, with the 15-year fixed rate rising by 13 basis points to 5.70% and the 5-year ARM 18 basis points higher at 5.97%.

Interbank lending markets were in crisis during the first part of last week as demand for cash sent yields on the three-month US Treasury Bill, a beacon of safety, to nearly 0% - its lowest level since 1941. Actions by the US government on Thursday and Friday thwarted the run on brokerage, money-market, savings, and even checking accounts, resulting in the yield on short-term Treasuries spiking higher to 1.01% by the end of the week.

The TED spread (i.e. 3-month dollar Libor less 3-month Treasury Bills), a measure of risk aversion and illiquid repo conditions, widened to 313 basis points on Thursday before easing back to 221 basis points by Friday afternoon.

The US dollar traded lower during the past week amidst the shenanigans of the credit crisis and the perception that the various bail-out actions could flood the world with dollars. "As large institutions continue to tumble, and the Fed turns on the printing press in an attempt to limit the damage, the flight to safety will mean a flight from the dollar and further trouble for US markets," remarked Bud Conrad of Casey Research.

Over the week the US dollar declined against the euro (-1.8%), the British pound (-2.2%), the Swiss franc (-2.3%), the Japanese yen (-0.5%), the Australian dollar (-1.4%), the New Zealand dollar (-3.3%) and the Canadian dollar (-1.3%).

The Reuters/Jeffries CRB Index closed virtually unchanged during the past week as declines in agriculture, livestock and industrial metal commodities were counteracted by solid increases in precious metals and crude oil.

Gold bullion scored its biggest daily gain since 1980 on Wednesday, rising by 9.0% on the back of safe-haven buying and hitting an intraday high of $902.60. The entire precious metals complex - gold (+13.1%), platinum (+5.1%) and silver (+15.6%) - recorded strong gains for the week.

"In a total disaster, where there is a run from paper currency, you'll get your biggest bang for your buck in gold," said legendary Peter Bernstein. "You don't have to buy much gold to have an effective hedge," he added, noting that "if everything hits the fan, gold should be worth several thousands dollars an ounce".

West Texas Intermediate recovered from a low of $91.02 a barrel on Tuesday to close the week at $102.75 on the back of violence in Nigeria, hurricane disruptions to oil production and refining activity in the Gulf of Mexico area, and US gasoline stocks sinking to their lowest levels in 39 years.

Commenting on the outlook for oil prices, BCA Research said: "The growth slump has spread across the developed world and is threatening many emerging markets, causing investors to scale back expectations for energy demand and allowing prices to plunge lower. Implied option volatility has been high and rising for many commodities, which is typical capitulation selling. While these phases do not typically last long, we advise against buying into weakness at this time."

The following chart shows the past week's movements for various commodities.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in optimally managing our wealth. And also remember what Elroy Dimson from the London Business School said: "Risk means more things can happen than will happen."

Source: Slate

Jon Stewart (The Daily Show): The economy & you - Wall Street collapse
"Jon Stewart figures the Wall Street collapse won't hurt you, assuming you fit into one of a few broad archetypes."

Source: Jon Stewart, The Daily Show, September 18, 2008.

John Authers (Financial Times): Wall Street's wild week
John Authers looks at possibly the most chaotic week on Wall Street in history, ending with a two-day rally.

Source: John Authers, Financial Times, September 19, 2008.

Francesco Guerrera (Financial Times): Wall Street's rescue
"The government's plan to take on Wall Street's troubled assets provides short-term relief, but long-term uncertainty, says Francesco Guerrera. The details will determine whether this will truly end the financial crisis."

Source: Francesco Guerrera, Financial Times, September 19, 2008.

Asha Bangalore (Northern Trust): Proposed Treasury action reassures markets
"The Fed and Treasury have undertaken several measures to stabilize global financial markets this week. The latest Treasury action plan to shore up institutions with boat loads of illiquid debt on their books and the use of funds from the Exchange Stabilization Fund to insure money market funds has reassured markets, temporarily. The Treasury's proposed comprehensive plan to address the financial crisis and the use of funds from the Exchange Stabilization Fund to insure money market funds reassured markets today which led to a rally in equity prices and a sell-off in the bond market.

"But the coast is not clear on the money market front. The spread between the 3-month Libor and 3-month Treasury bill rate was 224 bps as of this writing, down from 297 bps yesterday compared with a spread of 111 bps on September 8.

"Equity market rallies have been impressive on both September 18 and 19. The self-off in the Treasury market at the long-end signals market fears about the implications of the debt that is piling the balance sheet of the US economy. The 10-year Treasury note yield was around 3.77% today, up from 3.41% on September 17.

"The optimism surrounding the Treasury plan is justified but it should be noted that economic recovery is several quarters ahead. The credit crunch and household balance sheet position will both play a critical role in how soon the economy gathers steam. Lest we forget, occupants are necessary for the huge number of unsold homes, which will occur only with significant gains in employment."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, September 19, 2008.

Financial Times: Push for crisis breakthrough
"A breakthrough agreement to create a giant US government-sponsored vehicle to take on toxic assets in the financial system looked possible on Thursday night as Treasury Secretary Hank Paulson, Federal Reserve chairman Ben Bernanke and top lawmakers convened a dramatic meeting to discuss the financial crisis.

"The US Treasury said the meeting discussed a 'comprehensive approach to address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and financial markets.'

"The Treasury added that Mr Paulson and Mr Bernanke were 'exploring all options, legislative and administrative, and expect to work through the weekend with Congressional leaders to finalise a way forward'.

"Democratic leader Harry Reid said the administration had not yet presented a detailed proposal but congressional leaders looked forward to receiving one 'in a matter of hours not days'."

Source: Krishna Guha, Michael Mackenzie, Ralph Atkins and Paul Davies, Financial Times, September 18, 2008.

BCA Research: Unwinding Armageddon
"Fears of Armageddon are rapidly being unwound, sending risky assets surging higher.

"The announcement that US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are developing a plan to remove troubled assets from the balance sheets of financial companies is extremely encouraging for equity markets. We have published several times over the past year a checklist of events that need to ease banking sector stress and restore confidence in financial markets. While the details of the plan have not yet been decided, let alone released, on the surface this appears to be the 'open ended' commitment that we have been waiting for to put a floor under risky assets.

"That said, not all is rosy heading forward: the U.S. economic outlook remains bleak and financial sector deleveraging will likely persist, providing a tough earnings environment. Correspondingly, it will be critical that investors refocus on fundamentals and be selective once fears of Armageddon have been unwound. Stay tuned."

Source: BCA Research, September 19, 2008.

Jim Sinclair (MineSet): Potential infinite bailouts to explode money supply
"1. Today's reported potential infinite bailout of all and any portends, if adopted, is the largest increase in dollars outstanding since the Jurassic Age.
2. It closely models actions undertaken regarding the production of currency liquidity seen in the "Weimar Republic."
3. It is reported now that more than 1000 hedge funds are on the rocks. This has the potential for a significant financial impact.
4. The only way to hide the numbers from the statistics produced by the suspected actions of the Fed is to value the indebtedness purchased at 100%, claiming a wash transaction.
5. The only conclusion is that when the smoke clears and the advertised actions have been adopted, nothing more dollar negative than this has ever occurred due to the potential expansion of T bills and therefore dollar supply explosion.
6. Gold is the only currency with no liability attached to it which, as you have seen recently, will be selected as the currency of the people."

Source: Jim Sinclair, MineSet, September 19, 2008.

BBC News: Soros - bank problems to worsen
"The international financier George Soros says the financial storm is set to get worse before it gets better. Mr Soros told Newsnight that he expects more banks to collapse."

Source: BBC News, September 16, 2008.

ABC News: Greenspan's take on weakening economy

Source: ABC News, September 15, 2008.

Financial Times: Panic grips credit markets
"The panic in world credit markets reached historic intensity on Wednesday, prompting a flight to safety of the kind not seen since the second world war.

"Barometers of financial stress hit record peaks across the world. Yields on short-term US Treasuries hit their lowest level since the London Blitz, while gold had its biggest one-day gain ever in dollar terms. Lending between banks, in effect, stopped.

"Speculation mounted that the Federal Reserve, which refused to cut rates on Tuesday, could be forced into an embarrassing U-turn or might further expand its market liquidity operations.

"The $85 billion emergency Fed loan for the troubled insurance group AIG, announced on Tuesday night, failed to curb the surge in risk aversion. Instead, markets were hit by a fresh wave of anxiety.

"One cause for fear came when shares in a supposedly safe money market mutual fund fell below par value - or 'broke the buck' - owing to losses on debt in Lehman Brothers, which filed for bankruptcy protection on Monday.

"This raised the risk that retail investors in other such funds could panic and pull out their money.

"All thought of profit was abandoned as traders piled in to the safety of short-term Treasuries, with the yield on three-month bills falling as low as 0.02% - rates that characterised the 'lost decade' in Japan. The last time US Treasuries were this low was January 1941.

"Shares in the two largest independent US investment banks left standing - Morgan Stanley and Goldman Sachs - fell 24% and 14%, respectively, as the cost of insuring their debt soared, threatening their ability to finance themselves .

"Morgan Stanley was holding preliminary merger talks with Wachovia, a troubled regional lender, and could approach other banks and look at other options in the coming days, people familiar with the situation said. Washington Mutual, another regional lender, has hired Goldman Sachs to contact potential buyers.

"HBOS, a leading UK mortgage lender pressed into sales talks by the government after its share price halved this week, agreed to a £12bn takeover by Lloyds TSB.

"A key measure of fear in the fixed-income markets - the so-called Ted spread, which tracks the difference between three-month Libor and Treasury bill rates - moved above 3%, higher than the record close after the Black Monday stock market crash of 1987.

"US authorities fired back with the Treasury announcing it was borrowing $40bn to give to the Fed to use for its emergency lending - in essence removing balance sheet constraints on the size of this assistance.

"The Securities and Exchange Commission announced new curbs on short selling."

Source: Krishna Guha, Michael Mackenzie, Gillian Tett, Financial Times, September 18, 2008.

Asha Bangalore (Northern Trust): Markets recover after distrust and anxiety
"The Fed is now not only the 'lender of last resort' but also the 'investor of last resort'. Today, the Federal Reserve Bank of New York injected a record $105 billion to manage the federal funds rate which has exceed the target rate for four consecutive days. The Fed also made available $180 billion to other major central banks (Bank of England, European Central Bank, Bank of Canada, Bank of Japan and the Bank of Switzerland) and they have engaged in coordinated actions to provide liquidity.

"Thomas Meyer, chief economist of Deutsche Bank in London, sums up the situation most appropriately: 'If a body dehydrates it falls over and if it gets worse it can die. Likewise the financial system is starved of liquidity right now so the central banks will have to keep providing it.' The extent of risk aversion and fear is reflected in the spread between the 3-month Libor and 3-month Treasury bill rate. It shot up to 303 basis points yesterday. Today this spread widened further to 313 bps. This is 76 bps higher than the peak spread (237 bps) posted on August 20, 2007, the month when the ongoing crisis commenced."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, September 18, 2008.

MarketWatch: Fed acts to help money market funds
"The Federal Reserve took two steps to boost market liquidity on Friday morning, the central bank said. The Fed will extend loans to banks to finance their purchases of asset-backed commercial paper from money market mutual funds - a move the Fed says will help funds meet investor demands. The Fed will also buy from primary dealers short term debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan banks. The moves come after the Fed chairman and other officials met Thursday night to hammer out a broad plan to fight the financial crisis."

Source: Robert Schoeder, MarketWatch, September 19, 2008.

Bespoke: Fed to accept lower quality assets as collateral
"'Fed Loosens Standards on Emergency Loans' - NYTimes, 9/15.

"'In an obscure but highly important announcement late Sunday evening, the Fed said it would let Wall Street firms post as collateral much riskier assets - including equities, junk bonds, subprime mortgage-backed securities and even whole mortgages - in exchange for emergency loans through the Primary Dealer Credit Facility.'

"You think a Gregg Jefferies rookie card is worth anything in collateral? How about those old Beanie Babies? Or maybe old Cabbage Patch Kids dolls? Who knows what they'll take at this point."

Source: Bespoke, September 15, 2008.

Yahoo News: Banks roll out $70 billion loan program
"A group of global banks and securities firms announced late Sunday a $70 billion loan program that financial companies can tap to help ease a credit shortage that threatens global financial markets.

"The ten banks, which include JPMorgan Chase and Goldman Sachs, said they were committing $7 billion each for the pool. The pool would act as a signal to the marketplace that banks, brokerages, and other financial companies can lean on the fund to take care of borrowing needs.

"The banks said the program will be available to participating banks which can get a cash infusion up to a maximum of one-third of the total size of the pool. The size of the loan program might increase as 'other banks are permitted to join.'

"All participating banks intend to use this facility beginning this week, the statement said.

"The banks also include Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Merrill Lynch, Morgan Stanley and UBS."

Source: Joe Bel Bruno, Yahoo News, September 15, 2008.

Charlie Rose: A discussion about the crisis on Wall Street
The participants in this 56-minute discussion are: Lawrence Summers, Charles Gasparino, Andrew Ross Sorkin, Nouriel Roubini and Josh Rosner.

Source: Charlie Rose, September 15, 2008.

Charles Kirk (The Kirk Report): Bailouts are band-aids
"Though it is difficult to recognize, an economic crisis is a really good thing. It cleans up the system, destroys the excess, and it brings valuations low so that the risk/reward of being an investor is most advantageous. Like always, financial crisis creates opportunity.

"Yet, it seems, this lesson is lost among all who continue to work against the natural evolution of the market and free market economy. Right now, the government is pulling every string possible in an attempt to save the country from financial ruin. We've watched our leaders go from telling us that there is no problem to worry about to now taking billions of dollars out of our pockets (and those of future generations) to help the rich and powerful who've made poor choices over the past few years.

"I say enough is enough. The rich and powerful want us to pay for their problems and they threaten our financial futures if we don't follow along. This is ransom, pure and simple, and we should not tolerate it any longer.

"Bailouts are band-aids. While they reduce the pain, they don't cure the disease. We need to get back to a country that generates wealth because it is the smartest and most creative and that its businesses are the most productive, profitable, and competitive. Not a country that continues to lie to itself and creates one bubble after another in a desperate attempt to continue a standard of living that simply is no longer deserved.

"As Americans, we value money above all else, but we've lost a true understanding of how to create it. Instead, we try to look for short cuts that wreak utter havoc. And, even amid our darkest days, we continue to try to do the same instead of facing facts, owning up to our mistakes, and punishing those who deserve to be punished so we can move on.

"In sum, let Rome burn. What will result is a much better America and a stronger financial system. But, if we continue to let our government transfer wealth in the same manner we've seen all year, the road ahead will be much tougher than anyone currently wants to think about. It will only delay the inevitable and the quicker we face and own up to our mistakes, the better off we will be. It is time for the system to punish the stupid. Let's make sure they do so we can move on, get on the right track, and prosper once again."

Source: Charles Kirk, The Kirk Report, September 17, 2008.

YouTube: Peter Schiff - let the free market work it out!
Don Harrold interviews Peter Schiff on recent developments regarding the credit crisis.

Source: YouTube, September 18, 2008.

Peter Schiff (SafeHaven): Comrade Bernanke does it again
"By nationalizing nearly 80% of AIG for $85 billion, the Fed is doing a lot more than simply flushing taxpayer money down the toilet. The greater wrong is allowing the agency that has the power to print money to take control of a private enterprise, especially without the approval of the company's shareholders. The move represents the largest lurch toward socialism that this country has ever seen, and signals the end of the vibrancy of America's once vaunted free market economy. Since there is no limit to the amount of money the Fed can create, there is no limit to the number of assets they can acquire."

Source: Peter Schiff, SafeHaven, September 17, 2008.

David Fuller (Fullermoney): Impossible to know how and when all this will play out
"$50 billion here, $70 billion there, and soon we are talking real money. And that's just from the Fed. Other central banks around the globe are also pumping in huge amounts of liquidity, all in an effort to stem the latest and rapidly developing chapter of the banking crisis. China cut rates and also reserve requirements yesterday and will shortly do so again.

"A good thing too, since every newspaper that I have seen today features - 'Crisis' - on the front page headline and stock markets are in turmoil.

"We are now seeing the beginning of a coordinated policy response from central banks ... This is much more likely to cushion rather than draw a line under stock market declines because the west's banking debacle is of unprecedented severity, at least in my lifetime. Inevitably it has global repercussions, as we are also seeing.

"It is impossible to know how and when all this will play out, because the final chapters have yet to be written by central banks and their respective treasuries. However, I assume that they have begun the process of shifting their main focus from fighting inflation to reviving growth.

"Central banks need to stimulate economic growth because the current trends are very disinflationary. They will want to ensure that welcome disinflation does not slip into a Japanese-style deflation of the 1990s, let alone a sustained global deflation which would be far worse.

"Meanwhile, the disinflation is certainly not all bad because property and other asset bubbles are inflationary, and will always burst at some point. However it is not easy to be philosophical about this process when one's own asset bubbles, in terms of participation, happen to burst.

"Global deleveraging continues, which is why crude oil traded near $91 today, well down from its peak at $147.27 on July 11th. It is also a partial explanation for the strength of the US Dollar Index and yen, the latter shown here in terms of the euro's fall against the Japanese currency.

"Is this Back to the Future, to use the title of Steven Spielberg's film in another context? I believe so, in that we will be able to participate in a renewed bull cycle for Fullermoney themes which served us so well earlier in the decade - precious metals and other resources, Asian-led emerging markets and global infrastructure development - all of which should be among the leaders of the next up cycle. However we will have to be patient for a while longer, awaiting evidence that the down cycle has ended."

Source: David Fuller, Fullermoney, September 16, 2008.

John Hempton (Bronte Capital): What comes around goes around
"Herstatt Bank went bust in 1974. I was at primary school so I don't remember. It's a famous bank bust because it gave its name to time zone risk usually referred to as Herstatt risk.

"The problem was that Herstatt received irrevocable payments of Deutsch Marks in the German time zone against a delivery of US Dollars in New York later the same day. Herstatt failed between acceptance and delivery.

"The German failure triggered losses around the world.

"Well what comes around goes around. It appears that KfW - a German government owned lender - transferred Euro 300 million to Lehman on the day of its bankruptcy.

"It was very kind of the German taxpayer to contribute so much for the benefit of Lehman creditors! Far more than the US taxpayer did ... 34 years is a long time for pay-back. But pay-back came."

Source: John Hempton, Bronte Capital, September 17, 2008.

Bloomberg: Roubini - US financial industry facing "disaster"
"Nouriel Roubini, an economics professor at New York University, talks about the turmoil in financial markets and outlook for the sale of Lehman Brothers."

Source: Bloomberg, September 15, 2008.

CNBC: Meredith Whitney on Wall Street's future
"Weighing in on Bank of America's latest deal and the future of Wall Street, with Meredith Whitney, Oppenheimer & Co. and CNBC's Maria Bartiromo."

Source: CNBC, September 15, 2008.

CNBC: Wilbur Ross - possibly a thousand banks will close
"Wilbur Ross, chairman and CEO of WL Ross shares his reaction on the fallout of Lehman Brothers and explains why as many as 1,000 regional banks are set to go under. He speaks to CNBC's Martin Soong in this web-exclusive interview."

Click here for the full report.

Source: CNBC, September 15, 2008.

Financial Times: BofA to buy Merrill Lynch for $50 billion
"Merrill Lynch on Monday rushed into an agreement to be acquired by Bank of America for $50 billion in a sign that the crisis gripping Lehman Brothers is forcing rival investment banks to seek partners to avoid suffering the same fate.

"In a dramatic U-turn on Sunday, BofA entered discussions with Merrill after pulling out of the bidding for Lehman, partly prompted by the US government's refusal to supply financial help for a Lehman takeover.

"BofA's chief executive Ken Lewis has long coveted Merrill in the belief that a merger of the lender's commercial banking operations and Merrill's retail brokerage arm would be a formidable combination in the US financial services industry.

"However, a deal could saddle BofA with more troubled assets. The bank bought the stricken mortgage-lender Countrywide and a purchase of Merrill would force it to clean up the bank's trading books, which have already cost Merrill some $52 billion in writedowns and credit losses."

Source: Francesco Guerrera, Financial Times, September 14, 2008.

Barry Ritholtz (The Big Picture): Layman's explanation of AIG vs Bear vs Lehman
"I got called yesterday from the producers of The Daily Show, who asked for an explanation of this understandable to the 'lay person'.

"Here is what I said to them:

• Lehman Brothers was like the little kid pulling the tail of a dog. You know the kid is going to get hurt eventually, and so no one is surprised when the dog turns around and bites the kid. But the kid only hurts himself, so no one really cares that much.

• Bear Stearns is the little pyro - the kid who was always playing with matches. He could harm not only himself, but burns his own house down, and indeed, he could have burnt down the entire neighborhood. The Fed stepped in not to protect him, but the rest of the block.

• AIG is the kid who accidentally stumbled into a bio-tech warfare lab ... finds all these unlabeled vials, and heads out to the playground with a handful of them jammed into his pockets."

Source: Barry Ritholtz, The Big Picture, September 17, 2008.

Barry Ritholtz (The Big Picture): The lessons of Bear Stearns

Source: Barry Ritholtz, The Big Picture, September 17, 2008.

Financial Times: US Treasury raises Fed funding
"The US Treasury on Wednesday announced it was creating a supplemental funding programme to ensure that the Federal Reserve has the cash it needs and its ability to provide emergency liquidity support for the markets is not constrained by the size of its own balance sheet.

"The move was intended to deal with fears that the US central bank's balance sheet was overstretched following the AIG loan announced on Tuesday.

"The Treasury said it would sell bills at the Fed's request as part of the process of helping it better manage its balance sheet.

"The Fed said on Tuesday it would lend AIG up to $85 billion in emergency funds in return for a government stake of 79.9% and effective control of the company - an extraordinary step meant to stave off a collapse of the giant insurer that plays a crucial role in the global financial system.

"The Fed said the loan was expected to be repaid by the proceeds of selling AIG operating companies. A senior Fed staffer said the most likely outcome was an orderly liquidation of AIG, though it was possible that the firm could survive as an ongoing business.

"The loan is at a punitive interest rate of three-month Libor plus 850 basis points, giving AIG a strong incentive to repay it as soon as possible. It will be secured on all AIG's assets, including those of its subsidiary companies.

"The Fed said in a statement it was acting to prevent 'a disorderly failure of AIG' which would 'add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance'."

Source: Francesco Guerrera, Aline van Duyn and Krishna Guha, Financial Times, September 16, 2008.

Economagic: Borrowings sky-rocket

Source: Economagic, September 15, 2008.

Asha Bangalore (Northern Trust): FOMC holds Fed funds rate steady
"The Fed held the Federal funds rate steady at 2.0% today after three dramatic market moving events - Lehman Brother's bankruptcy, the sale of Merrill Lynch, and the shaky status of AIG. It was a unanimous vote to hold the funds rate unchanged, in stark comparison to prior meetings in 2008 which always included a dissent. The fact that the Fed widened the range of securities considered eligible for borrowing at the fund before today's meeting but left the Federal funds rate unchanged suggests that it views the Federal funds rate as appropriate to promote growth and sees financial market issues as a matter of inadequate liquidity.

"The policy statement shows a shift to a neutral intermeeting bias, with the risk of higher inflation and weaker economic growth placed on equal footing.

September 16, 2008
'The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee.'

August 5, 2008:
'Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.'

"However, the language and tone of the first paragraph leans toward greater concern about growth in the inflation-growth debate. The statement duly noted that financial market stress 'has increased significantly' and 'labor markets have weakened further'. The statement listed three factors - tight credit conditions, the ongoing housing contraction, and some slowing in export growth - that are likely to hold back economic activity. 'Slowing export growth' was included in this statement, which is consistent with the nature of economic reports from abroad."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, September 16, 2008.

Asha Bangalore (Northern Trust): Leading index points to continued weak economic conditions
"The Conference Board's Index of Leading Economic Indicators (LEI) dropped 0.5% in August, following a revised 0.7% decline in the prior month. The July-August average of the LEI is now down 2.8% from a year ago, the largest drop in the current business cycle and matches the decline posted in the second quarter of 2001 when the US economy was in a recession.

"In August, orders of consumer durable goods, stock prices, interest rate spread, and consumer expectations made positive contributions. The recent sharp decline in equity prices implies that this component will make a negative contribution in September. The interest rate spread should make a smaller positive contribution compared with the August reading. Building permits, orders of durable capital goods, the manufacturing workweek, initial jobless claims, supplier deliveries, and real money supply made negative contributions."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, September 18, 2008.


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