No Bottom Yet For Flailing
Jul 24, 2008
In recent months, even the
most blindly optimistic forecasters have come to grips with how
our banks and investment banks took wildly imprudent risks that
will result in horrific losses. The resulting sell-off in financial
shares has tempted many investors to scoop up these companies
at apparently fire sale prices. Wise investors should resist
the temptation, as the pain for financials is just getting started.
Although voices of prudence were dismissed at the time, these
banks' risks were leveraged largely through "off-balance
sheet" mechanisms that generated massive financial rewards
for the financials while keeping the losses supposedly at arm's
length. The resulting windfall yielded $26 billion in bonuses
for Wall Street in 2007.
The tolerance for the risks and leverage was based upon the widespread
belief that real estate prices were set to rise without correction.
We now know that this was a fairy tale.
Soon, gullibility gave way to greed, which soon led to fraud,
and the sub-prime world was born. It was camouflaged by means
of securitization, in the form of Collateralized Debt Obligations
(CDOs), sometimes packaged within triple "A"
bundles. This so-called "toxic waste" was passed on
to unsuspecting financial institutions around the world. The
hidden virus infected the entire vast international financial
system. Soon, the credit markets tightened, threatening first
their own financial crisis and then, with their reduced lending
ability, an economic recession.
When the Treasury/Fed team moved to rescue Bear Stearns and,
more recently, Fannie Mae and Freddy Mac, the $5 trillion-plus
burden of risk was neatly transferred to the American citizen.
This week, the Wall Street Journal commented on Nouriel Roubini,
the New York University economist. He aptly observed that it
was "the price of a system that privatizes profit and socializes
losses." People could be excused for protesting strongly
against such political policies as outrageously un-American.
The rescue of Fannie Mae and Freddy Mac, in particular, generated
a wave of buying amongst the so-called "bargain basement"
financial stocks, off some 80 percent from their highs. This
optimism was based largely on the belief that the taxpayer would
be forced to rescue the banks. But the banks are not the only
financial institutions in trouble. The home lending and credit
boom provided a feast for all manner of other speculations. Credit
cards lenders became very aggressive as did auto lenders and
lenders to students. Even businesses borrowed in order to participate
in the great consumer credit boom.
These categories of lending are vast, in sum, amounting to several
trillion dollars. All financials are exposed, but the degree
of infection is not yet fully understood. Soon, even the government
must wonder how much more taxpayer "rescue" the $14
trillion U.S. economy can afford?
As the recession takes hold, borrowers are heading for stringent
times, especially those with large, high cost credit card debts.
Likewise, their lenders, including many regional banks, are likely
to experience massive loan defaults. Then, there are the insurance
companies who have invested much of their own reserve funds in
In short, investors should become urgently aware that banks are
not the only financial institutions that will be adversely affected
by the severe economic conditions now looming ahead.
Before being tempted back into buying financial stocks as "bargains,"
investors should assess carefully whether or not the government
will be able, either financially or even politically, to extend
taxpayer obligations to underwrite the entire financial industry.
Finally, investors should estimate what the long-term cost of
government support will be in terms of higher taxes and the hyperinflation
that will cause the further debasement of the U.S. dollar. How
will they further inhibit future economic recovery?
While the true extent of the problem is hard to estimate, it
is a certainty that the U.S. dollar is likely to remain under
downward pressure. Gold is likely to experience strong upward
pressure as high inflation leads into hyperinflation and systemic
financial risks become increasingly manifest, offsetting the
downward pressures of recession.
For a more in depth analysis
of our financial problems and the inherent dangers they pose
for the U.S. economy and U.S. dollar denominated investments,
read Peter Schiff's book "Crash Proof: How to Profit
from the Coming Economic Collapse." Click here
to buy a copy today.
More importantly, don't wait for reality
to set in. Protect your wealth and preserve your purchasing power
before it's too late. Discover the best way to buy gold at www.goldyoucanfold.com, download our free
research report on the powerful case for investing in foreign
equities available at www.researchreportone.com, and subscribe to
our free, on-line investment
Euro Pacific Capital, Inc.
Browne is the Senior Market Strategist for Euro Pacific Capital,
Inc. Mr. Browne is a distinguished former member of Britain's
Parliament who served on the Treasury Select Committee, as Chairman
of the Conservative Small Business Committee, and as a close associate
of then-Prime Minister Margaret Thatcher. Among his many notable
assignments, John served as a principal advisor to Mrs. Thatcher's
government on issues related to the Soviet Union, and was the
first to convince Thatcher of the growing stature of then Agriculture
Minister Mikhail Gorbachev. As a partial result of Browne's advocacy,
Thatcher famously pronounced that Gorbachev was a man the West
"could do business with." A graduate of the Royal Military
Academy Sandhurst, Britain's version of West Point and retired
British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.
In addition to careers in British politics and the military, John
has a significant background, spanning some 37 years, in finance
and business. After graduating from the Harvard Business School,
John joined the New York firm of Morgan Stanley & Co as an
investment banker. He has also worked with such firms as Barclays
Bank and Citigroup. During his career he has served on the boards
of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's
Kudlow & Co. and the former editor of NewsMax Media's Financial
Intelligence Report and Moneynews.com. He holds FINRA series 7
& 63 licenses.