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The End of U.S. Financial Domination

by: The Society August 08, 2008 | about stocks: BSC / FNM / FRE / SKF / XLF    

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by Eric Roseman

Inflate or die. That's the Federal Reserve's mantra since the sub-prime credit crisis first hit the investment scene last August.

Since then, this crisis has taken a destructive path and pummeled global equity and bond markets along the way. Global banks have also lost a combined US$1.6 trillion worth of stock market capitalization since last August. That makes this past year the worst year-over-year loss in history.

Before it's all over, Americans, Sovereign Wealth Funds (SWFs) and other investors will pay an astronomical price to rescue the battered U.S. financial system.

The Death of a 24-Year-Old Bull Market

The bull market for financial services stocks first began in 1982. And this bull market hit a crushing dead-end in August 2007. It will be years before this sector fully recovers.

Let's start with banks. Right now, large and small banks are desperate to recapitalize their smashed-out balance sheets. They continue to dilute shareholder equity through massive rights offerings and new issues. Dividends have been sliced and diced.

Since last August, banks have written off or lost a cumulative US$476 billion during the worst credit crisis in a generation.

The Last Nail in the Coffin for Financials

XLF Chart

We're Postponing, NOT Avoiding Systemic Risk

Over the last 12 months, the Federal Reserve and the U.S. Treasury have dreamed up and orchestrated spectacular bailouts to preserve the financial system and avoid systemic risk.

But what are they really achieving? Long-term the consequences of the Fed's actions will be horrendous. In the not-too-distant future, you'll see existing and future generations of Americans paying dearly for our leaders rescuing one financial institution after another.

There is no "avoiding" systemic risk. The final consequence of Morale Hazard is a larger, more threatening financial panic down the road.

When the government bails out institutions and nationalizes failed enterprises, they only increase long-term inflation. For starters, they have to pay for those bailouts. So the government ultimately turns to taxpayers to fund the expansion of credit. By interfering with capitalism's natural progression, the government delays its own financial reckoning.

In my opinion, an insolvent institution must be allowed to fail.

Morale hazard has played a major role on Wall Street and at the Bernanke Fed since March. Investors and analysts have seriously questioned the Fed's unorthodox role as lender of last resort.

What business does the central bank have to collateralize a failed institution's almost worthless debt with Treasury securities? That's what the Fed did with Bear Stearns Cos. in March. The Fed did the same thing for other troubled but unnamed investment banks and banks over the same period.

Is Morale Hazard Justified?

Is a bailout justified if that institution mismanaged its business model? More importantly, should the government rescue a financial firm in the interest of deterring systemic risk?

It's true that the Bear Stearns bailout deflected a major financial panic. But what really happened there? Contrary to most financial news reports in March, several large hedge funds were in the process of liquidating their accounts at Bear Stearns (BSC) (Bear Stearns was a leading prime broker for hedge funds).

One of the largest hedge funds in the world actually sparked a run by other hedge funds to get out of Bear Stearns. The entire gamut of players scrambled to get their assets out before it was too late. There's no doubt a major global financial panic would have ensued on March 17 without some sort of rescue.

In July, the government officially assured investors that Uncle Sam would guarantee GSEs or Government Sponsored Enterprises, Fannie Mae (FNM) and Freddie Mac (FRE). Prior to Secretary Treasury Paulson's assurances in mid-July, markets were reeling at the prospects of a Fannie and Freddie collapse.

Again, a failure of both mortgage giants would have caused sheer panic in global markets because of the significant role they play in mortgage financing, debt issuance, and liquidity to banks. So some will argue it was a good short-term solution...but at what cost?

The Piper Will Come Calling - Eventually

Bailouts and Morale Hazard have been highly subjective topics among investors and policymakers since March.

In the end, the United States will have to finance these and future financial bailouts with enormous amounts of credit, mostly from taxpayers. It's inevitable that all this credit will eventually drain on the economy, American capital markets, and ultimately the dollar.

The United States is already losing its financial supremacy to London, Frankfurt, Hong Kong, Singapore, and Dubai this decade.

Capital flows to safe, tax-efficient shores. We're likely to see new regulations in the U.S. as a consequence of the sub-prime mortgage debacle and other banking oversights. As a result, the United States will increasingly lose more market share to other international financial capitals.

Eventually, other financial systems will also feel strained by America's slow but progressive financial dilution.

The United States still plays a vital role in global finance. So it would be naïve to think Dubai or Singapore won't be affected by another major U.S. financial crisis in the future. That's why I continue to buy gold. All governments are tied in one form or another to each other as global trade and capital flows have grown increasingly inter-connected. There's no safe-haven overseas ahead of the next major crisis.

The dollar and other mismanaged currencies are just a bunch of drinks shaken and stirred by a warped bartender. Fiat paper is a poor store of absolute value compared to gold and other tangible assets like oil and gas.

Hedge your future with gold and other hard assets - paper money won't protect your purchasing power from the upcoming inflationary storm in the United States and eventually, everywhere else.

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This article has 10 comments:

  •  
    Aug 08 09:43 AM
    The Gold price chart still looks awful, there's a 50/50 chance we are going to the ~$650 and ounce range.

    I'm a trend player and there is no obvious/strong up trend in the charts of gold. So for now there are better options.

    I look at gold in the sub $700 range.
    Reply
  •  
    Aug 08 11:42 AM
    Well, we may well have encounter a morale hazard but I think it's more likely you mean a moral hazard.
    Reply
  •  
    Aug 08 12:04 PM
    I laugh at those people who THINK that gold/silver/platinum will "protect" their assets when the dollar shrinks in value like that of the "Weimar Republic!" There are perhaps only a few thousand precious metal investors out of a total 200 to 250 million American citizens. So.....when the value of the dollar drops to forty cents or less OR becomes inflated like that during pre WWII Germany, the Weimar Republic those individuals with gold/silver will be able to barter food/shelter etc with their buillon and NOT be noticed by those individuals who have "relatively worthless fiat money?" Guess what! I hope you have plenty of guns/ammo because once your gold/silver is spotted by the "less fortunate" YOU will become the target or "criminal minds." Globalism has so intertwined within all countries, all cultures, all business/corporations that when "America sneezes, Europe will catch cold!" London is purported to be the "New York" of Europe with regards to business. When our leaders realize that UNLESS WE stop being the "policeman" of democracy/terroism throughout the world because it is fastly becoming bankrupt; then Europe will have to pick up the tab for their own countries against Islamic extremism! ALL the countries of the world are run on "fiat currencies." All the other countries of the world are now experiencing the same problems that the US is with regards to "credit," and mortgages. Russia is the only country who is now on the "gold standard!" Looks like a "New World Order and a New World Government" is just around the corner! Just a fluke? It has been said that NOTHING in politics or finances is coincident but rather has been planned and implemented by such groups as the Bilderburgs, Illuminati, and the Banking interests for world domination! By the way, the Federal Reserve IS NOT a governmental department but is privately owned by the large banking corporations here in the US and abroad! Looks like Thomas Jefferson was right when he said that the Banks who could control the movement/flow of money can control the nations of the world!
    Reply
  •  
    Aug 08 03:00 PM
    First of all, it's "MORAL", not "MORALE".

    Second, you're a young fool.

    You can't see a reason institutions are not allowed to fail because you have always lived in a world where they don't.

    And you can dismiss "fiat paper" but it only makes you look stupider. Fiat money is the only kind of money there is. Since medieval times, we have known that the agreements behind banking (this "fiat" of which you speak) are many orders of magnitude more valuable than the hard assets that back them. That's just the math. I refer you to this paper:

    frbatlanta.org/fileleg...

    republished by the Atlanta fed.

    Finally, the problem we now see is that for all the talk about market efficiency, our financial system was more than slow to put the bad results of bad credit decisions where they belong - onto the holders of equity.

    Because of the "Invisible Hand" religion taught to you by people who should really know better, we came foolishly to believe that the financial industry would self-regulate the new world of private-label MBS and derivatives. About 700 years of market history should have told us that when there is nobody there insuring the quality of the inventory, an exchange will inevitably become a "Market For Lemons" and fall apart. It only happens EVERY SINGLE TIME. But this time, we knew better.

    If you really want to see what some true tax-inefficiency looks like, keep pushing for liquidations and collapses - just like the Hoover Administration did. Maybe its the only way people can learn, but I hope not.

    The bailout will not cause credit damage because the credit damage is already done. It's just a question of where it lands now. If our system of corporate ownership really was an efficient market - which it isn't - bad institutions should have been gobbled up by good institutions already and new capital should have flowed in to take advantage of the crisis mispricing of the financial assets (business efficiencies, valuable agreements) created by the MBS and derivatives markets (which certainly exist).

    But since the system is intrinsically inefficient, debt and deception by management and rogue institutions were heaped onto the equity of the good parts of the system to the extent that it may already be broken. The failure of banks to do equity deals during the past little run-up is telling. It shows the private equity finance system in the first stage of failure.

    THAT is why the government is coming in here. You don't want to see the second stage and you really don't want to see the third.
    Reply
  •  
    Aug 08 03:09 PM
    The question should be: who holds dollars? My understanding is that over 50% of the dollar supply is held by foreign central banks, foreign savers and investors and foreign institutions.

    The dollar is accepted as legal tender is most countries. In this content the dollar has value. I can go to almost any country in the world and use my dollars to buy goods, services and/or assets; the seller in turn will exchange their dollars for their own currency.

    The country’s central bank is left holding the dollar, which they reinvest in incoming producing assets. Sovereign Wealth Funds are simply a national vehicle for investing surplus dollars and other currencies into wealth producing assets. These wealth producing assets will generate goods, services and/or assets that will be exchanged for currencies.

    If one listens to our policy makers one thinks that this is a never ending circle that is raising the standard of living of the poor and downtrodden. The argument that one is exchanging something (goods, services, assets) for nothing (currencies) doesn’t hold water with them.

    They respond that economies are operating in a globalized economic environment and currencies are simply a medium of exchange to make the process work effectively. Currencies are governed by treaties and treaties can be changed to accommodate changing conditions.

    Because globalization is a new economic force, market forces have not yet worked through the system. These market forces will correct and strengthen the globalize economy not ruined it.

    The policy makers say that people of economic doom are simply ignoramus’s who don’t understand how the system works.
    Reply
  •  
    Aug 08 03:11 PM
    Right on Eric!

    People who denigrate supporters of gold and silver will be asking themselves "why didn't I buy gold?"

    My mother, who was European, told me stories about her father accumulating gold a little at a time over many years. When the European economies crashed, his gold kept a roof over their head and food on the table while many went hungry when the European economies crashed.

    Keep on spreading the good word. One thing I would advise is that one take possession of one's gold. ETF's and investment pools are fraught with danger in the event of a severe financial collapse. Don't trust anyone with your gold.
    Reply
  •  
    Aug 08 03:39 PM
    my grand father threw over 50lbs. of gold into the main river in germany so he would not be killed for it.you cant eat gold & you dont ned a roof over you after your ded.
    Reply
  •  
    Aug 08 04:59 PM
    notsosmart:

    "my grand father threw over 50lbs. of gold into the main river in germany so he would not be killed for it.you cant eat gold & you dont ned a roof over you after your ded."

    As they say, the fruit doesn't fall far from the tree.
    Reply
  •  
    Aug 12 10:48 AM
    dlaw you're on old fool, it seems. Suggest you pick up a copy of this book, which directly, compellingly and comprehensively refutes, well, pretty much everything you just said:

    Fiat Paper Money, The History and Evolution of Our Currency
    by Ralph T. Foster

    I'd also suggest that, rather than reading mythology published by the Fed for its own benefit, you take a look at what independent analysts think about the subject. You could start with:

    The Case Against the Fed
    by Murray Rothbard

    Finally, you are completely confused on one more point. You keep insisting that this was a 'market failure', which basically means the free market failed, and thus we need government to 'fix' it. But we do not have a free market. As a matter of fact, unbeknownst to 99% of Americans, America is not even a capitalist system - it's a corporatist system (i.e. a merging of govt and corporations which benefits both at citizen expense), and rather than a free market, we have a heavily subsidized and regulated MIXED market. So this has not been a free market failure - it's been, largely, a government failure and a Fed failure. If you cannot grasp this, despite the logic, fact and evidence in the resources to which I have pointed you, then you are a bigger fool than even your misguided post indicates.
    Reply
  •  
    Aug 21 07:16 PM
    Finally, someone calling it like it is. Unfortunately people still seem to be missing the big picture. The US government (through the Fed) has, over the last 2-3 decades, fabricated the illusion of massive American wealth. By playing on the fundamental greed of the American citizen they lulled them into a sense of complacent disinterest which allowed the government to pursue a reckless and immoral foreign policy that would otherwise have been untenable. Now, as the structure collapses, it is trying to "spin" this whole stinking cancerous system as fundamentally healthy. In a desperate attempt to convince people that the "shit don't stink" they are using every means at their disposal , from bandaid Fed intervention to CNBC media hype (manipulated by spin artists like Hank Paulson and corporate CEOs who have gotten rich on this ponsy scheme). It doesn't matter one bit. The entire US economy is a house of cards and no matter how much it is spun the "intrinsic value" of the US will eventually be reflected in the market, massive deficit and the failures of foreign adventures included.

    BTW, this is virtually the same strategy used by Hitler when he lulled the German people to sleep by appearing to build the economy as he consolidated power.
    Reply
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