Bank Index
Sovereign Bank
Washington Mutual
Bank RI
Posted on 07/18/2008 1:24:49 AM PDT by TigerLikesRooster
Worst Case Scenario
By John Riley
Chief Strategist
07/15/08
What a year - bank and brokerage failures, Federal bailouts, sub-prime mortgage mess and a looming derivative disaster. What would happen if things continue to unravel? What would that look like?
Runs on the Banks
With the failure of IndyMac, we’ve already seen a run on a bank force its closure. What if a few more banks had runs? Depositor panic could cause runs at several banks that are on the edge of failure. A run could push them over.
The FDIC is spending about 10% of its reserves on bailing out IndyMac. How many more depositors can they protect? And they aren’t making all of the Indymac depositors whole, about 10,000 depositors had more than 100,000 on deposit. The initial word from the FDIC is that those depositors may only get 50 cents on the dollar for amounts above $100,000.
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Bank Index |
Sovereign Bank |
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Washington Mutual |
Bank RI |
| We are not suggesting any of these are about to fail. We are including them to show how widespread the bear market in banks has been, from local to regional to national. | |
Brokerage Failure (maybe more than one)
The failure of Bear Stearns should act as a warning to other brokerages that are heavily invested in sub-prime mortgages and derivatives. The Fed’s response was to give brokers access to an emergency fund. Several large firms including Lehman, Merrill and Goldman have had to utilize these funds. Yet their stocks continue to tumble as losses mount. Which will be next?
Fed Chairman Bernanke, for all his “wisdom”, has already announced that he expects to see another brokerage fail before the end of the year. Will the Fed set up another emergency fund? Will there be more bail-outs? Did the last one help?
 Brokerage Index |
 Lehman Brothers |
 Morgan Stanley |
 Merrill Lynch |
 UBS PaineWebber |
 Legg Mason |
| Like the banks, brokers have been in a severe bear market of their own making. Sub-prime and derivatives have created a toxic cocktail. With some brokers down over 60% it is anybody's guess where the bottom will be and which ones will survive. | |
Mortgage Giants Fail
According to Fannie Mae and Freddie Mac’s own year end statements for 2007, they have less than 2 cents of assets for every dollar of mortgage and debt liability. Former Fed Governor William Poole has said that the two are already insolvent, based on certain accounting methods.
We’ve already seen the Fed’s “bail-out” of Fannie and Freddie, if you can call it that. It is no more than letting them borrow more money to solve a problem of borrowing too much money.
 Fannie Mae |
 Freddie Mac |
 CountryWide |
 National City |
| Fannie Mae and Freddie Mac were supposed to handle the best quality mortgages. They don't look any better off than the sub-prime lenders like Countrywide and National City. | |
A Derivative Calamity
We’ve seen how much the major banks have in these esoteric instruments. (Trillion Dollar Secret) The failure of Barings Bank and Long Term Capital (LTC) shows the damage they can do when they go bad.
Former Fed Chairman Alan Greenspan testified that the reason the Fed bailed out LTC was to prevent a collapse of the US economic system. LTC’s bailout was only a billion dollars. JP Morgan, Citibank and BankAmerica combined have over $150 trillion in derivatives. Yes, TRILLION.
JP Morgan has assets backing up their derivatives of only 1.56%. By comparison, Citi and BankAmerica are solid as rocks with a whopping 3.57% and 3.43% respectively.
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Notional Amount of Derivatives 1st Quarter 2008
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Total Assets
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Total Derivatives
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Asset/Derivative Ratio
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| JP Morgan |
$ 1.40 trillion
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$ 89.99 trillion
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1.56%
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| BankAmerica |
$ 1.33 trillion
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$ 37.94 trillion
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3.57%
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| Citibank |
$ 1.29 trillion
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$ 37.69 trillion
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3.43%
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| Wachovia |
$ .66 trillion |
$ 4.88 trillion
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13.64%
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| HSBC |
$ .18 trillion |
$ 4.28 trillion
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4.40%
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Source: Comptroller of Currency Format: CIS
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Since derivatives are not regulated, they are not marked to the market daily, so we have no idea how much of a price swing their derivative portfolios have. But given our knowledge of other markets, it is safe to assume value changes of 1% to 2% are normal in any given week.
And since our recent history tells us we should question the assets of banks, can we really be sure of the value of JP Morgan’s assets? Or Citibanks? Or BankAmerica? How much of their assets are non-performing? How much are New England mortgages? How much are credit card balances?
If one of the big three fail, what does the Fed do then? They don’t have anywhere near enough money to bail them out. And because of the counter-parties involved in derivatives, it is likely that the failure of one party could lead to the failure of several others. This was the concern with Bear Stearns, and why the Fed acted so quickly. But Bear was no where near the size of a JP Morgan or Citibank.
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Increase in Derivative Portfolios past 12 months
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| JP Morgan |
27.08%
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| CitiBank |
25.35%
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| BankAmerica |
32.95%
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| With everything that has happened in the past year, these banks continued to pile on these risky investments. | |
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Source: Comptroller of Currency Format: CIS
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Concentration of Derivatives
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| Top 5 banks |
96.90%
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| All other banks |
3.10%
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Source: Comptroller of Currency Format: CIS
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A Banking Holiday
Let’s continue down this dark road a bit further and assume the worst has happened and the Fed is forced to contain the economic disaster by declaring a banking holiday. It is not as much fun as it sounds. Banks are closed until they can prove their solvency and with the continued decline in real estate, this gets harder and harder for banks.
Recent history with the S&L crisis of the late 80’s and the failure of RISDIC in RI in 1990, shows how our automated lives can work against us. In 1990, payroll check kept getting direct deposited into failed S&Ls in RI. It took weeks to stop the system and employees had no recourse or access to their paychecks. Automatic mortgage payments weren’t processed. ATMs didn’t work.
If the Fed called a banking holiday, it is very likely they would also close the stock and bond markets in the US, similar to after 9/11. Maybe they would be closed for a week to help calm things down.
But overseas markets would still be open and it is very likely that the Dollar would collapse, commodities and gold would skyrocket and foreign markets would tumble. When the US Markets re-open, it is likely they would also drop (a polite word for crash).
 US Dollar |
 Gold |
 Oil |
 Dow Jones Ind |
Macro bad – Micro good
While this is a terrible scenario, it doesn’t have to be for wise investors. Smart investors can take advantage of much of what is going on through strategic asset allocation and a flexible strategy.
The average Wall Street portfolio will suffer tremendous losses if this scenario plays out, with heavy losses in both the stock and bond markets.
But investors heavy in gold, commodities, (especially oil and agricultural commodities), and market hedges should not only be protected but profit from the worst case scenario. Investors that have hedged the US Dollar should also see profits from a collapse of the Dollar. And even if the foreign markets fall, say 20%, if the Dollar drops 25%, a US investor in foreign markets profits.
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Index Hedges
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 UltraShort Dow30 |
 US Dollar Index Bearish |
 UltraShort Financials |
 UltraShort MSCI EAFE |
| Hedges work in the opposite direction of the underlying index or investment. This is a way to profit from the decline of a market. |
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Investors that can’t construct this type of portfolio on their own or have the ability to manage their assets through a crisis like this should look to a professional money manager that has a real strategy for a bear market. Look for someone that has a proven track record of beating the markets over the past several years by avoiding following the Wall Street crowd.
Ping!
Reserve for later reading
Lol. What do we do?
Come on. The economy’s fine. Everything’s fine. Until a Dem is sworn in. THEN all of this will be a problem.
I see your irony and I agree with it.
Like a desperate gambler doubling down... or a risky bet that wins the jackpot? We'll know soon.
Excerpt:
* * * According to the Comptroller of the Currency, total Derivatives in the top 25 banks in the US amount to about 180 Trillion dollars. Not billion, trillion. 1000 times a billion. * * *The Trillion Dollar SecretTo put this in perspective, the US GDP for the 3rd quarter of 2007 was about 11 Trillion dollars. So they are playing a game with a pool of fictional money that is 16 times bigger than our economy.
Let that sink in. * * *
But what do I know, anyway? I'm just a disabled geezer living in Oregon. Lazy types can always rely on others like they did in college. A few may even check my freeper page.
OMG! And thanks for the ping.
BTTT
La di dah, we’ll all be fine! We’re America! We’re special! Nothing bad will ever happen to us!
If it all falls apart it will be tragic and devastating beyond measure and I will personally be inconsolable at the loss of what was and should have been.
But that said I hope it kills the stupid, irrational,infantile national discussions we have been having.
Global warming, gay marriage, carbon footprints, immigration insanity etc. Oft times I feel the world has gone mad and perhaps a complete breakdown is needed to end the hysteria. Not the way I would choose to go, but if happens so be it. I’ll be as ready as I can be if and when it does.
WASHINGTON -- A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest."What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."
The current economic woes, brought on by the collapse of the so-called "housing bubble," are considered the worst to hit investors since the equally untenable dot-com bubble burst in 2001. According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.
Despite the overwhelming support for a new bubble among investors, some in Washington are critical of the idea, calling continued reliance on bubble-based economics a mistake. Regardless of the outcome of this week's congressional hearings, however, one thing will remain certain: The calls for a new bubble are only going to get louder.
"America needs another bubble," said Chicago investor Bob Taiken. "At this point, bubbles are the only thing keeping us afloat."
If this were not true, it would be pretty funny.
But it's from the famous satire rag 'The Onion.' Bubble after bubble after bubble. How else are we supposed to buy crap we don't need?
Unfortunately, the world is not simply big enough for more than one monster-size bubble.
Ignore the sales pitch but please take a peek this YouTube video:
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