FatPat

Depressionary Tales

I see it very similary. I think it is not the right choice to invest in banks right now. I think that investment banks are the most vulnerable. But also insurance companies that have unhedged equity exposure. Increasing interest rates would be a death sentence in this environment. Banks need a steep yield curve in order to make profit. The problem is that the flight to savety decrases the yield on lon-term governments thereby effectively flatening the yield curve. At the same time the real short-term borrowing rate for banks is much higher as 2%, since banks do not trust each other anymore and are afraid of collapsing banks due to highly leveraged balance sheets. The government is also worried about inflation, it said today. I think this can only be a bad joke. Inflation was high due to increasing prices for commodities and increased import prices due to a weak dollar. This period is over. I personally think there has to be action and is has to come fast:

1. Prohibit short selling. That is what leads to stock prices of financial institutions leading to zero. This in turn scares away customers and deteriorates credit rating. The revenue base of the institution fails and refinancing debt becomes more expensive. A death spiral.

2. INJECT MORE LIQUIDITY. Inflation is not a problem. Federal tendor offers are oversubsribed 4-fold. What is a 2% repo rate good for if nobody can really use it. We need a steep yield curve.

3. Prevent house prices from falling. The easiest way to do this, is by ensuring that homebuilders that DECIDE to fault on a mortage for financial reasons are not allowed to do this for poorly speculative reasons (if theay can afford to pay the loan). This will prevent many houses from getting on the supply side.

4. Grant government loans at very low interst rates and long maturity to homebuilders who really cannot afford to pay mortages any more.

By taking these steps most of the other problems (falling stock market due to banks, insurances, real estates firm writing down/collapsing) will be solved simutaneously. Many people are asking: How does this affect the real economy, it is paper money burning here. This is far from the truth. The American stock market capitalization is bigger than the entire GDP. Most people are stockowners. Retirment plans are mostly defined contribution not defined benefit any more. This means, people WILL START SPENDING LESS when they see their saving of year shrink dramatically. This will lead to less spending, sell of houses, lower prices, lower stock markets, and so forth. We NEED INTERVENTION.

And the moral?

FIRST: I think we see now how dangerous financial derivatives really are. This time it is credit derivatives. But, the same is true for equity derivatives. They allow uncontrollably high leveraged balance sheet and fuel contagion between institutions and nations.

I see this crisis as very, very dangerous.