The Financial Storm of the Century

Investors are scared and many think the entire financial crisis "STINKS".  Bill Gross of Pimco Funds was asked if the credit mess worldwide will get worse from here. Gross said, in so many words, "YES!!" "There are technical positions that need to be unwound," Gross said yesterday morning -- which is Wall Street gibberish for, "We've got to sell a lot of things and find substitutes to invest in."

A private bank liquidity fund was set up over the weekend, but additional capital, as opposed to liquidity, wasn't made available. Gross doesn't think the Fed will cut rates Tuesday but that they should.

The reasons include the bankruptcy of Lehman (LEH) and the purchase of Merrill Lynch (MER) by Bank of America (BAC). The world's largest insurance company AIG (AIG) is faltering and seeking a big Fed lifeline to keep afloat.

AIG, according to Gross, is a technically solvent company that shows "the perversity of the market." When the market perceives that AIG is having financial problems down the road, the credit rating services then downgrade AIG and thus creates a liquidation of AIG securities...a self-fulfilling prophecy.

Today the Fed's FOMC meets and the pressure to lower interest rates must be enormous.  Bill Gross thinks we are trying to stop a "forced liquidation situation" as there are too many sellers and not enough buyers and the markets know it.

Gov. Jon Corzine says "the laissez-faire deregulatory mode" of the past 10 months is partly to blame for the meltdown right now in the financial markets ("Laissez-faire" is a French term that has come to mean "absence of government control over business.") What is Corzine talking about?

The New Jersey governor said he never thought he'd see the day when this current financial mess would actually happen.

"Until we admit that we have a big financial and banking problem, plus the core problems we have in the economy...there is no major infusion of new capital in the system...and the fundamental economy is in very bad shape and the problem is growing, a problem which we have been denying for so long," Corzine continued.

The government was right to not intervene and bail out another distressed financial institution, says Nouriel Roubini, of NYU's Stern School and RGE Monitor. Look at the 1-year chart of the Financial Sector ETF (XLF) which doesn't include yesterday's horrific plunge:

But the government has already started down a "dangerous and risky" policy road, Roubini says, which resumed last weekend as the Federal Reserve announced "enhancements" to existing liquidity facilities that were created in response to the ongoing crisis.

The announced changes include:

• Broadening of the types of securities Wall Street firms can use as collateral when borrowing from the Fed to include lower-grade debt securities and equities.
• Stepped up schedule of so-called TSLF auctions to a weekly vs. bi-weekly basis.
• Removal of restrictions on how much commercial banks can lend to their brokerage units.

This final point means that banks are using Federally-insured deposits to support their brokerage units, which puts even greater risk on the Fed and (potentially) the FDIC, Roubini says.

Gov. Corzine feels there is more trouble to come with credit card debt, car loans and the massive commercial loans that are hanging in the balance. He feels there is a desperate need for more fiscal stimulus and government intervention.

Others think this financial catastrophe is partly due to government being over-involved and irresponsible. Fiscal profligacy over the past eight years leading to the worst federal deficits in history is also under the spotlight as part of the reason why the US dollar and banking system is looked at with such little confidence.

Gov. Corzine, former CEO of Goldman Sachs (GS), thinks the government needs to take some more risks and stimulate the macro-economy including creating jobs. This must be Corzine's reference to the "green collar jobs" that his party's presidential candidate, Barack Obama, sees as an imperative to keeping this "stinking mess" from plunging us into a lousy Depression.

Comments

[Gerry Sullivan:]

Corzine is correct about the US consumer in general and credit cards specifically. We have only seen the tip of the iceburg.
AIG is "technically solvent" but their credit protection costs 12%/year.
In the World Series of Poker, AIG would be referred to as the "short stack" and this is the "degree moment."
AIG, like Lehman, has huge corporate hubris. Where on Earth will AIG come up with $100 billion?
The Fed was right to let Lehman go and should do the same with AIG.
Then, work on saving the banks, which will be the financial survivors, and the financial powers of the future.

2008 Sep 16 08:51 AM

[Bill Black:]

Letting things go? These are not unwanted toys or clothes. THese companies have trillions of underlying assets insured. Not even the Banks will survive their unravelling. Its like 1929 all over again.

2008 Sep 16 08:59 AM

[Archman Inv...:]

Tom Brown wrote not less than 6 articles in the past month yelling the bottom was in.

He was dead wrong. He lost people a ton.

He should be in jail.

Zero Accountability.

2008 Sep 16 09:25 AM

[investor88:]

Marc's article title says it all "The financial storm of the century" which means it can rival the 1930s Great Depression in its severity. Creative destruction must be allowed to proceed and thereafter governments must take the lessons and avoid the mistakes made. We can only hope for the best but prepare for the worst as the unavoidable storm rages. The time will come when all these problems will present opportunities and until then we have to be cautious.

2008 Sep 16 09:29 AM