Is Ronald McDonald a Safer Bet than Uncle Sam?

This past week saw a remarkable occurrence. The cost of insuring against a U.S. default via credit derivatives hit record levels. It now costs more to insure against a U.S. default on their debt than it does to insure against a default by McDonald's (MCD). Ronald McDonald is deemed to be more trustworthy than Uncle Sam!

This is understandable in the light of the trillions of dollars in additional debt that Uncle Sam will soon be adding to its balance sheet. Yet, the lemmings on Wall Street continue adding to their U.S. dollar positions. Don't be surprised to see a bailout down the road for these Wall Street bets, which will have also gone bad.

The Black Hole is Growing

A couple of weeks ago, I remarked that a black hole nearly swallowed Wall Street. It looks like the black hole continues to grow. Wachovia (WB) has been sucked into the black hole. Don't these people know that you're not supposed to feed a black hole?

It looks like the black hole has also spread to Europe. Several European banks had to be bailed out this past week by European governments. Wall Street has always had great sales people (also known as con artists), and over the last few years, has managed to export more than half of its toxic paper to Europe. This gives new meaning to the term “Made in America!”

More ominously, we saw the black hole beginning to envelop the commercial paper market. The commercial paper market is the lifeblood of economic activity. It provides working capital for many corporations and municipalities.

Many major corporations have not been able to obtain funding for anything more than a few days in the commercial paper market. The state of California has also not been able to access funds. California Governor Schwarzenegger has told the U.S. government that California may need $7 billion quickly. I say just put it on the taxpayers' tab along with everything else.

The Lehman Domino Effect

When the government let Lehman (LEHMQ.PK) go out of business, they assured everyone that the effects would be minimal. They were wrong - What a surprise! Since the Lehman bankruptcy, most parts of the debt markets have ceased to function.

When Lehman went under, along with Washington Mutual (WM), the holders of the senior bonds of these firms lost most of their money. Everyone and I mean everyone, in the financial community had assumed that such an outcome would never occur. Everyone assumed that holders of senior debt would always be protected. Money market funds and others were left holding the bag. The bad Lehman debt forced some money market funds to “break the buck” which precipitated a mass exodus from money markets funds.

This exodus, in turn, led many money market fund managers to shift much of their money into the safety of very short-term Treasury bills. Money market funds had been one of the main purchasers of commercial paper, but no longer. The demand in the commercial paper market has nearly evaporated, with a fall of $95 billion just this past week. The situation in the commercial paper market cannot go on for long without an economy going into a steep nosedive. Look for a coordinated cut in global interest rates in the near future. Perhaps also direct purchases of commercial paper by either central banks or sovereign wealth funds.

Wall Street Shifts the Blame

Wall Street, of course, has tried to shift the blame onto short sellers and mark-to-market accounting. My suggestion would be to immediately install mirrors in Wall Street executive offices.

The ban on short selling has only had deleterious results. It has drained liquidity from markets, leading to greater volatility. It has also shifted the short selling from the financial stocks to the market more generally, engulfing sectors such as industrials, transport, energy, and materials.

The short-selling ban has also nearly closed down the issuance of convertible bonds. Convertible bonds could have been one possible source of much-needed capital for ailing financial firms.

Instead of shooting the messenger, Wall Street should be embracing mark-to-market accounting. Trust has been lost. Transparency is critical to re-gaining investors' trust in markets. Investors must be convinced that they are getting reliable information. Until then, many investors will opt to sit on the sidelines. Or perhaps, they will go to Vegas where at least the word Casino appears at the entrance.

Historical Echoes

Before the dim bulbs in Congress voted for the $700 billion bailout package, they had rejected the bailout earlier in the week. The dim bulbs were under intense pressure from constituents back home.

It seems like the hoi polloi, to borrow a phrase from the 1920s and 1930s, has lost all trust in the nation's so-called elite. Americans rightly wonder why their taxes should be used to rescue bankers from their folly. After all, even novice investors know that assets don't always go up. Yet, Wall Street gambled everything on assets going up forever.

In the 1930s, Wall Street bankers were called “banksters” because of the many swindles they perpetrated in the 1920s on investors. Today, investment bankers have once again taken the public on an expensive ride. In effect, Wall Street has operated a giant scheme to turn equity in Main Street houses into gigantic fees and bonuses for themselves. The finance blog, Dealbreaker, calculates that house sales and mortgage securitization generated roughly $2 trillion in fees since 2003!

An additional reason for the general discontent on Main Street may be that wages for the average person have remained stagnant for a long time while the incomes of the elite, led by Wall Street, have soared. The gap between the middle class and the super-rich is now larger than at any time since the Gilded Age of the 1920s.

Gold Bars

Another symptom of the distrust of the system is the enormous demand for gold and silver from small investors. There is such a demand for bars, bullion, and coins that it is difficult to find them anywhere without paying a premium.

I do own some gold and silver that I have owned for years. I'm just trying to find a good hiding place for them. Remember that in the 1930s, the government confiscated gold coins and made it illegal to own gold. Let's hope that history does not repeat itself.

Disclosure: None

Comments

[Smarty_Pants:]

Even the Ham-burgler would only steal your fries or burger and not your wallet like Uncle Sam has.

2008 Oct 07 11:10 AM