Next Financial Crisis "Lehman Moment' Is Coming Fast
Stock-Markets / Credit Crisis 2012 Jan 17, 2012 - 07:46 AM GMTBy: Money_Morning
Shah Gilani writes:
It seems that my Thursday edition of Wall Street Insights & Indictments was warmly received by the bullish crowd, many of whom reached out to me to thank me for my optimism.
I'm sorry to burst your bubbles, but I am not a raging bull (but thank you for asking).
In fact, I'm still bearish.
There's a big difference between being bullish and playing all stocks (and other asset classes) from the long (that means "buy") side, and judiciously buying select momentum stocks with fat dividend yields, which is what I was recommending on Thursday.
I was talking about taking the path of least resistance, which I identified as "upward," based on equity activity through year-end and so far in 2012. You've heard the old adage "the trend is your friend." Well, that's what I was talking about. The trend has been up.
I'm bearish because I'm afraid of a European meltdown and a "hard landing" in China.
But there's a huge danger in missing what could be the beginning of a real bull market.
So, it makes sense to start putting on solid positions and even speculating here and there. But I am not all in - not yet. However, the time is coming. But, that is also the problem.
I'm fearful that a crash is coming, and maybe soon. If we get one, and everything flushes out and we get a capitulation bottom amidst a global panic sell-off, then I'll be all in, all the way, for the long-term. I'm talking about loading the boat up with stocks and commodities and enjoying a generational ride that will last for maybe 10 years, or more.
What keeps me up at night now, however, is the echo of 2007. I call where we are now 2007.2. If we are facing 2007.2, then 2008.2 will follow with a vengeance.
I'm guessing the breakdown could come in the first or second quarter of this year (although it could also take as long as 18 months to develop, which would only make it 10-times as bad when it does come).
Think about what I'm about to lay out for you, and ask yourself, what if he's right?
In the spring of 2007, U.S. Treasury Secretary Henry Paulson, when addressing problems surfacing in the subprime mortgages arena said things "appear to be contained." Fed Chairman Ben Bernanke said: "We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited."
Comforting words, right?
Then, speaking to members of the Federal Reserve Bank of Chicago in May of 2007, Bernanke said, "Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market."
Comforting words, right?
Even before two Bear Stearns hedge funds imploded in June of 2007, the Fed Chairman was touting the virtues of derivatives and the widespread sale of mortgage-backed securities when he stated, "The key thing to remember is that these losses are not just held by American banks, as the bad loans were in Japan (referring to Japan's lost decade), but they are dispersed."
Comforting words, right?
Then, on August 9, 2007, after one Bear fund was shut down and the other fund temporary propped by an injection of some $3.2 billion from Bear itself, and the seemingly contained fallout from subprime and AAA mortgages hitting "dispersed" banks in Europe, the European Central Bank's (ECB) Website quietly announced that the ECB would provide as much funding as banks might wish to borrow at only 4%.
What was happening was that European banks weren't lending to each other. The commercial paper market was at a standstill, and there was no short-term funding facility open wide enough to finance their longer-term mortgage positions. And they couldn't sell their positions because after the Bear funds imploded, there were no buyers for mortgage bonds, even the super-senior AAA tranches many European banks and all the big American banks were holding.
Two hours later, 49 banks borrowed three-times what they were usually asking to borrow. And by the time trading closed in the United States on that same day, gold had spiked higher, as had safe-haven U.S. treasuries.
Of course, the equity markets were doing their own thing and were rising that summer, nearing new all-time highs (which they would reach in September 2007).
It took another year before we got our "Lehman moment." But, boy did it hurt.
Fast-Forward to Now....
We're being told by the Fed that our banks are in good shape. We're being told by bank CEOs that they are in good shape and their European exposure is limited. We're being told that there won't be any significant hit to our economy from events in Europe. We're being told that there won't be any significant spillover because European debts are dispersed and banks have derivatives hedges.
These are all lies.
Exactly like what happened in 2007, banks in Europe aren't lending to each other. The commercial paper market over here is closed to them. That's why the ECB announced it would effectively execute unlimited three-year term repos at 1%. And, by the way, they are taking just about anything for collateral, really.
Did 49 banks step up like in 2007? No, in 2007.2 (meaning now) some 500 banks stepped up and took $620 billion (489 billion euros) the following day. And they've been adding to that.
What's happening to gold in 2007.2? After selling off as part of the initial risk-on grab for equities a couple of months ago, it's rising again, and fairly quickly.
What about safe-haven bonds? U.S. bonds have been rising rapidly in price as investors clamor for safety. The 10-year closed Friday at a 1.87% yield, only 20 basis points from its all-time low yield, which it saw in September as European woes were strangling global markets.
How panicked is a lot of smart money? Yields on German and U.S. short-duration bills are less than zero. That means investors have bid up the price of these short-term safe government instruments that the premium they are paying is greater than their yield. Put another way, people are paying to place their money in safe government securities.
Comforting, right?
No, it's not.
Talk about concentration build-up. First of all, most U.S. banks and most European banks are still sitting on tons of mortgage-backed securities that they can't unload. And the U.S. housing market isn't getting any better, nor is Spain's, Ireland's, or China's.
Sure, foreclosures are down lately. But that's because of foreclosure moratoriums resulting from lawsuits. There are estimated to be 10 million homes for sale and over 11 million homeowners holding onto upside-down mortgages. What's going to happen when banks get on with foreclosing and start dumping houses again? It's about to happen.
All that nonsense about dispersed risks - don't believe it. There is no dispersion that matters because all the big banks in the U.S. and Europe and plenty of others hold the same asset mixes, the same duration mortgage pools, and the same sovereign debts.
But in the place where things are smoldering and there's kindling everywhere, European banks are buying more of their sovereign's toxic debts to stave off a collapse of the prices of the debts already on their books. It amounts to a crazy leveraging up on the same bet that sovereign debts will pay off 100 cents on the dollar.
And where are they getting the money to buy more of this crap? From the ECB, which is printing it against the backstop of the same countries who need banks to buy their constantly rolled-over debts.
It's musical chairs, and sooner or later the music is going to stop. Greece looks like it will be the first one standing, or in this case, falling down. Portugal could be next, or Spain, or Italy.
Greece has more than $1.26 trillion (1 trillion euros) of public sector debt outstanding. Do you think that a real default isn't going to crush a lot of banks? Wake up. And if you think that Greece defaulting (or even forcing a 50% haircut on private investors, that would be banks, folks) wouldn't spill over into other countries and across the globe... wake up.
Talks in Greece over private investors taking a 50% haircut - meaning they will only get 50 cents on the dollar on the 100 cents they lent out previously and the other 50% they are giving up will be replaced with longer-term bonds yielding less interest - aren't going well. Most analysts and even central bankers believe the haircut needs to be closer to 75% than 50%. Comforting words to be spoken while negotiations are ongoing, right?
Ah, then there's that little downgrade thing that happened on Friday after European markets were closed. Just because the downgrade of the U.S. from AAA to AA+ didn't cause our borrowing costs to rise doesn't mean it isn't going to happen in Euroland.
It will happen. Downgrades will trigger new capital calls as margin requirements will increase to offset the lower quality of collateral, we're talking about the same collateral folks, the same sovereign bonds. It's an increasing pile, make that pyre, and it's going to self-ignite.
We have a big week ahead; we have Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), and Bank of America (NYSE: BAC) reporting fourth-quarter numbers. We have housing starts (homebuilders are up 60% since their October lows) and new home sales. And Spain and Italy are auctioning off bonds on Thursday.
Our markets have risen nicely. And on Friday, after selling off hard on the S&P downgrade news, they rallied back impressively. I tell you, it's 2007.2.
Stocks are going one way, and credit markets are signaling trouble ahead.
Sovereign debt has replaced subprime as the powder keg. That makes the brewing storm infinitely more powerful than the subprime dust-up was. It's a question of how long before we get the Lehman moment.
We've survived, even thrived, on a series of "liquidity puts," which is what I call all central banks' stimulus and "free and easy" money thrown at banks to keep them afloat. In a politically charged 2012, that could change.
Keep this in mind. If we're facing 2007.2, then 2008.2 is coming right around the corner. It's just a matter of time.
That's why I say play the equity market diligently; we could scrape higher for a while, as we did in 2007. But, when the fat lady sings, it's going to be deafening.
And everyone knows the opera isn't over until the fat lady sings.
Source http://moneymorning.com/2012/01/17/its-2007-2-and-our-next-lehman-moment-is-coming-fast/
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