Two Billionaires Concur: Sell the Banks

by: Paul J. Lamont posted on: January 31, 2008 | about stocks: IEF / SHY / TLT    
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Financial speculator and billionaire, George Soros states in his FT.com commentary: “the current crisis is the culmination of a super-boom that has lasted for more than 60 years.” In June’s Higher Rates Reflect Default Risk we described the end of the last credit boom:

In 1928, the U.S. Treasury Bond similarly broke out of the channel and rose to a higher yield. This coincided with the end of ‘easy’ money which forced the deleveraging of the economy and concluded with the financial crisis of 1929-1932.

Compare the two Treasury Bond Yield charts below. In 2005-2006 higher bond rates “broke out of the channel” and inflicted damage on the housing market. This marked “the end of ‘easy’ money.” Similarly since 2006, there has also been a flight to quality.

(Chart above from Longwaveanalyst.com)

George Soros explains what happens next:

If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.

As we described last June, we expect 10 year Treasury Bonds to be sold for cash in the panic, just as occurred at the end of the last credit cycle. Billionaire investor Julian Robertson agrees. As he revealed to Fortune, the biggest bet that Robertson has in his own portfolio at the moment” is “long the price of two-year Treasury and short the price of the ten-year Treasury."

Printing Money to Avoid Immediate Banking Collapse

According to the Federal Reserve Board website, U.S. non-borrowed bank reserves have gone from $37B to $199M (nope, that’s not a typo) in the last month. We have been discussing this with Sitka Pacific Capital’s Mike ‘Mish’ Shedlock for the last two weeks. He concludes:

Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

Simply put, the U.S. banking system has no reserves. In addition, the FDIC has recently begun modernizing large-bank insurance rules. We hope this is a wake-up call to everyone as to the extent of the credit crisis. Bank account balances should be used only for transactions. Instead cash should be held in the form of U.S. Treasury Bills at a conservative brokerage or trust. Under the mattress is also perfectly acceptable (your parents or grandparents had to do it!). For investors, we advised last year to sell the banks. Banks will be soon forced to sell assets (yes, even 10 year Treasury Bonds) at deeply discounted prices to pay depositors.

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Paul J. Lamont

Paul J. Lamont

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This article has 5 comments:

  •  
    Brian Croner
    Jan 31 10:58 AM
    My Website
    Important article for me to read. I suspected just this.
  •  
    blah-blah
    Jan 31 01:12 PM
    This is like saying that since Mark Cuban hates stocks I shouldn't be buying them. If I was a billionaire, I wouldn't own any stocks either let alone bank stocks. Come to think of it I might turn into a fear monger like these guys if no other reason than it's fun.
  •  
    Greg Harris
    Jan 31 02:07 PM
    The lowering of non-borrowed reserves of which leading into this was about $41 billion, coincided with the $40 billion borrowing through the term auction facility. My interpretation is that the banks didn't just burn through their reserves, they've been reclassified because of the term-auction and the fact that the banks have no reason to hold extra any more extra reserves than they did before, becuase you don't make money on reserves and thus banks like to limit them as much as possible. They're former reserves turned into money. Focusing on reserves actually misses the point a bit I think. Banks in trouble will show capitalization problems and regulators coming to close them down before they burn through all their reserves unless there is a run on the bank. I don't recall hearing about any major runs on banks other than a brief one on CFC and Northern Rock.
  •  
    ewmayer
    Jan 31 02:18 PM
    Paul: thanks for the read. What is your advice for folks who have positions in long-term treasury bond funds? [E.g. American Century BTTTX and similar]. Those have enjoyed a nice runup in the past half-year: do you expect further price appreciation due to flight-to-quality, or would they also be endangered if banks start selling off shorter-term paper to raise cash?
  •  
    Hort
    Feb 02 08:55 PM
    Greg,
    Very good comments. I was concerned when I first read Paul's article, however when I went to the Fed website, it did not appear that the overall numbers were out of whack. Your explanation is credible, thanks!
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