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Yesterday's news was about a potential Greek default and it caused a global
market selloff. Today, hopes of preventing a Greek default are causing
markets to rally. This alternating news flow is repeating over and over again.
Investors should pay attention to the big picture however and not the noise of
the day. The important thing to realize is that we are in a second global credit
crisis.
Credit crises follow certain patterns, which include: recognition of overpriced
financial assets, money flowing into safe havens, increased market volatility,
rising costs for financial insurance, and various forms of government action to
stop the problem. The specifics of the current credit crisis are below.
1. Government debt is being downgraded. This happened in Italy yesterday,
the U.S. in early August and many times in Greece. This is the upfront
recognition of the problem, which is almost always widespread public
knowledge by the time it happens. In 2008, securitized debt containing
subprime real estate loans was downgraded in mass, frequently from the triple
A ratings that had previously been given.
2. Global money is flowing into safe haven U.S. treasuries. When yields hit lower
levels than a previous credit crisis or all-time lows, this indicates this is
happening on a mass scale. U.S. government two-year notes had a yield
below 0.15% at one point this September 19th. During 2008, the two-year held
above 0.60%. The ten-year yield has fallen below the 2.04% low in 2008 and
below the all-time low of 1.95% in 1941.
3. Global money is flowing into safe haven currencies. In 2008, this was the U.S.
dollar and the Japanese yen. In 2010, this is the Japanese yen, the Swiss franc,
and gold (which needs to be thought of as a currency if it is to be analyzed
correctly). The Swiss franc rallied so much that the Swiss stopped it from trading
freely. The Japanese have also taken action to try to lower the value of the
yen.
4. Stock market volatility has increased enormously. In 2008, there were a
significant number of mini-crashes (a drop of 5% or more in one day). These
were more common in the U.S. back then. Now they are more common in
Germany, but they have been happening here as well. The flip side of
mini-crashes is sudden sharp moves up in the market. These are also occurring.
5. Bank stocks are the focus of the big moves up and down in the stock
market. U.S. banks and other financial stocks really got hit in 2008 -- a number
of the companies themselves went under. This time it's European banks falling
the hardest. One-day drops for some major EU and UK banks have been as
high as 10%. Bank stocks aren't dropping that much in the U.S., but they are
underperforming other sectors like technology.
6. Credit default swaps have hit record levels. Credit default swaps (CDSs) are
bond insurance and they became a big news item in 2008 when they rose to
unprecedented levels. While CDS rates for Greek sovereign debt have hit
records and are rising for the other highly indebted EU countries, they have
also hit records for some UK and EU banks in 2011 indicating a worse crisis than
in 2008.
7. Major and ongoing bailouts are taking place. The EU had to bail out Greece
in the spring of 2010 and then Ireland and Portugal. A second bailout for
Greece had to be arranged this July, even though the first bailout was
supposed to have taken care of Greece's debt problem. In 2008, the U.S. had
TARP and arranged for failing banks to be taken over by stronger banks (Bank
America is now in trouble again because of the legacy loans from the banks it
absorbed during this period). Fannie Mae and Freddie Mac had to be
nationalized.
8. Central banks are buying bonds in the open market. The EU has been
buying up Italian, Spanish, Irish and Portuguese bonds in order to hold down
interest rates in those countries. As long as it has an infinite access to funds, this
strategy will work. The Fed began buying U.S. debt instruments in the fall of
2008 during the Credit Crisis.
9. Global coordinated central bank intervention took place last week. The
need for global action is a consequence of the interconnectedness of the
world financial system. A major problem in one region (in 2011 this is Europe, in
2008 it was the U.S.) will invariably spread everywhere. Central banks
coordinate their activity to try to control the contagion.
10. The global economy is turning down. Problems in the financial system
impact the real economy and they can turn a shallow downturn into a major
one as has happened in 2008. Economic figures throughout the world have
flattened and there are some warnings of a bigger drop to come (extremely
low consumer confidence numbers for instance). GDP contraction in a number
of regions will be the final confirmation that another global credit crisis has
occurred.
Disclosure: None
Daryl Montgomery
market selloff. Today, hopes of preventing a Greek default are causing
markets to rally. This alternating news flow is repeating over and over again.
Investors should pay attention to the big picture however and not the noise of
the day. The important thing to realize is that we are in a second global credit
crisis.
Credit crises follow certain patterns, which include: recognition of overpriced
financial assets, money flowing into safe havens, increased market volatility,
rising costs for financial insurance, and various forms of government action to
stop the problem. The specifics of the current credit crisis are below.
1. Government debt is being downgraded. This happened in Italy yesterday,
the U.S. in early August and many times in Greece. This is the upfront
recognition of the problem, which is almost always widespread public
knowledge by the time it happens. In 2008, securitized debt containing
subprime real estate loans was downgraded in mass, frequently from the triple
A ratings that had previously been given.
2. Global money is flowing into safe haven U.S. treasuries. When yields hit lower
levels than a previous credit crisis or all-time lows, this indicates this is
happening on a mass scale. U.S. government two-year notes had a yield
below 0.15% at one point this September 19th. During 2008, the two-year held
above 0.60%. The ten-year yield has fallen below the 2.04% low in 2008 and
below the all-time low of 1.95% in 1941.
3. Global money is flowing into safe haven currencies. In 2008, this was the U.S.
dollar and the Japanese yen. In 2010, this is the Japanese yen, the Swiss franc,
and gold (which needs to be thought of as a currency if it is to be analyzed
correctly). The Swiss franc rallied so much that the Swiss stopped it from trading
freely. The Japanese have also taken action to try to lower the value of the
yen.
4. Stock market volatility has increased enormously. In 2008, there were a
significant number of mini-crashes (a drop of 5% or more in one day). These
were more common in the U.S. back then. Now they are more common in
Germany, but they have been happening here as well. The flip side of
mini-crashes is sudden sharp moves up in the market. These are also occurring.
5. Bank stocks are the focus of the big moves up and down in the stock
market. U.S. banks and other financial stocks really got hit in 2008 -- a number
of the companies themselves went under. This time it's European banks falling
the hardest. One-day drops for some major EU and UK banks have been as
high as 10%. Bank stocks aren't dropping that much in the U.S., but they are
underperforming other sectors like technology.
6. Credit default swaps have hit record levels. Credit default swaps (CDSs) are
bond insurance and they became a big news item in 2008 when they rose to
unprecedented levels. While CDS rates for Greek sovereign debt have hit
records and are rising for the other highly indebted EU countries, they have
also hit records for some UK and EU banks in 2011 indicating a worse crisis than
in 2008.
7. Major and ongoing bailouts are taking place. The EU had to bail out Greece
in the spring of 2010 and then Ireland and Portugal. A second bailout for
Greece had to be arranged this July, even though the first bailout was
supposed to have taken care of Greece's debt problem. In 2008, the U.S. had
TARP and arranged for failing banks to be taken over by stronger banks (Bank
America is now in trouble again because of the legacy loans from the banks it
absorbed during this period). Fannie Mae and Freddie Mac had to be
nationalized.
8. Central banks are buying bonds in the open market. The EU has been
buying up Italian, Spanish, Irish and Portuguese bonds in order to hold down
interest rates in those countries. As long as it has an infinite access to funds, this
strategy will work. The Fed began buying U.S. debt instruments in the fall of
2008 during the Credit Crisis.
9. Global coordinated central bank intervention took place last week. The
need for global action is a consequence of the interconnectedness of the
world financial system. A major problem in one region (in 2011 this is Europe, in
2008 it was the U.S.) will invariably spread everywhere. Central banks
coordinate their activity to try to control the contagion.
10. The global economy is turning down. Problems in the financial system
impact the real economy and they can turn a shallow downturn into a major
one as has happened in 2008. Economic figures throughout the world have
flattened and there are some warnings of a bigger drop to come (extremely
low consumer confidence numbers for instance). GDP contraction in a number
of regions will be the final confirmation that another global credit crisis has
occurred.
Disclosure: None
Daryl Montgomery
10 Reasons We Are in a
Credit Crisis
Daryl Montgomery
9/20/11
Credit Crisis
Daryl Montgomery
9/20/11
___________________________________________________________________________
Real e Luxury