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Wall Street Takes a $20 Billion Hit...and Counting
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Thursday, October 25, 2007 - Vol. 9, No. 254
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Wall Street Takes a US$20 Billion Hit...and Counting
Today's comment is by Mike Burnick, our Senior Editor and Global Markets Analyst, and editor of Market Shock Trader.
Dear A-Letter Reader,
The hot topic de jour right now is the joint Wall Street/Treasury Department proposal for a "super-fund" to help resurrect the gridlocked credit markets.
In my opinion, this initiative amounts to little more than a desperate, self-serving move to bailout Wall Street. The industry players involved are trying to put off the inevitable - another downside market shock in the financial sector.
Well according to an article in the New York Times, this financial day of reckoning may be even closer than you think.
"Collateralized debt obligations - made up of bonds backed by thousands of sub-prime home loans - are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own."
Collateralized debt obligations (or CDOs) are just one of the many derivative securities Wall Street created in recent years as they sliced and diced credit risks. CDOs are made up of thousands of individual loans (and other debt). Wall Street then repackages these loans and other debt in shiny triple-A-rated boxes, and sells them off to investors around the world.
Some CDOs May Become "Largely Worthless Overnight"
Pension funds, hedge funds, insurance companies and the big banks and investment firms themselves are the biggest holders of CDOs. These companies typically use off-balance sheet entities such as SIVs (see my wealth comment from yesterday), to buy CDOs with lots of leverage.
Up until now, investors holding these CDOs have mostly been getting paid on time - but not anymore. "On Friday, Standard & Poor's lowered the ratings on US$22 billion in bonds backed by mortgages made to people with weak credit in 2006," according to the article.
What triggered this downgrade? You guessed it; "continued deterioration in the housing market." Another ratings agency Moody's, took the same action in downgrading "a similarly large group of bonds earlier in the month."
When such a downgrade takes place, investors in these CDO securities are forced to markdown the value of their holdings, significantly in some cases. The result: Surprise! Your CDO's are now virtually worthless.
The CDO investors that are impacted by downgrades "may be forced to write down mortgage investments beyond the billions they have already written off. Some bonds, for example, may go from being valued at, say, 70 cents on the dollar to becoming largely worthless overnight," according to the Times.
Simple Equation: Higher Rates = More
Foreclosures = More Losses for Wall Street
As I have been saying since August, the next act of the credit crunch market shock drama is just getting underway. This mess may take longer to play out than the typical three-acts.
Home foreclosures recently hit a 35-year high. But even though foreclosure filings have doubled on a year over year basis for the past several months, many more adjustable rate mortgages will reset to higher interest rates next year and beyond. In other words, the worst of the housing recession still lies ahead.
Inevitably, this will trigger more foreclosures, leading to even higher mortgage loan losses and more Wall Street write-offs. It's a vicious cycle with no clear end in sight!
We're Still in the "Early Stages" of this Credit Crunch with More Market Shocks Ahead
How much worse can it get for Wall Street? Big banks and investment firms wrote-off about US$20 billion worth of CDOs and other bad debt over the last two weeks alone. That's just the tip of the iceberg.
"Investment banks issued some US$486 billion in debt obligations linked to mortgages in 2006 and the first half of 2007," according to the Times. So far, only a small fraction of these securities have actually been downgraded by S&P and Moody's.
An official at one of the credit ratings agencies said: "It's still the early stages of a very significant stress."
Translation: Brace yourself for more credit related market shocks ahead!
MIKE BURNICK, Senior Editor & Global Markets Analyst
EDITOR'S NOTE: Just yesterday, Merrill Lynch "discovered" another US$2.9 billion write-off due to bad sub-prime loans. That's on top of a US$5 billion charge Merrill took just a few weeks ago! This makes for the biggest quarterly loss in Merrill Lynch's 93-year history. There are likely to be many more losses ahead for Merrill and its Wall Street cronies, with US$500 billion in adjustable rate mortgages resetting in 2008 alone.
Obviously, the credit-crunch shock that's rocking the financial sector is far from over. That's why Mike recently recommended banking sector put options to his Market Shock Trader subscribers. In just over one week, these options have already soared almost 50%. Click here to find out how you get in on these kinds of gains.
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| Offshore |
Swiss Conservatives Win Big for Financial Freedom
ZURICH: Swiss politics is about to become even more conservative after the Swiss People's Party (SVP) won last Sunday's general election.
With the big SVP win, the party will now hold a record number of seats in the parliament. The SVP also has a guarantee retention of the two SVP seats on the governing, seven member Federal Council.
The People's Party took 28.8% of the vote in elections for the House of Representatives, up 2.1% from 2003 results. The People's Party gained the most votes among the four governing parties since 1919 and could win up to 62 of the 200 seats in the House.
So why is this important? With the SVP win, it means that Switzerland will remain the world's leading offshore financial haven. The SVP party will ensure Swiss banking secrecy remains secure.
It also guarantees that Swiss relations with the European Union will not be any easier. The EU has been a major critic of Swiss financial privacy laws. The SVP, and the Swiss people as a whole, repeatedly have rejected EU demands to repeal bank secrecy, which has traditionally attracted foreign investors to Switzerland.
The election also serves as a rebuff to EU, French and German demands that Swiss cantons raise their comparatively lower corporate and individual income taxes. The low taxes have attracted many wealthy citizens and companies from high tax EU nations.
The Swiss campaign was dominated by Justice Minister Christoph Blocher, the SVP leader and his party's hard-line stance on immigrants and crime.
The popular Blocher helped the SVP win on Sunday by lending his face to the cause. "Support Blocher! Vote SVP!" read posters plastered around Switzerland in the run-up to the parliamentary election as the party used the 67-year-old's image to mobilize voters.
BOB BAUMAN, Legal Counsel
EDITOR'S NOTE: In just two weeks, our Sovereign Society team will head to The Bahamas for our Offshore Advantage Academy event, at Atlantis Resort & Casino. There's still time to join us. We've invited experts from Switzerland and her surrounding banking neighbors to teach you the basics of offshore banking so you can safely take your assets offshore.
We'll also cover the basics of global investing, currency trading, offshore structures. You'll hear everything you need to secure your financial freedom before our election year in 2008. Once meetings are done, you're free to relax at the Atlantis Resort. Honestly, we only have a few seats remaining, so don't wait. Reserve your spot at our Offshore Advantage Academy today.
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Currencies
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Hong Kong's Dollar Soars Too High for
Comfort as the Greenback Slumps
According to Bloomberg, Hong Kong is selling its own currency for the first time in two years - because it's too high. They're dropping millions in Hong Kong dollars because they're concerned the falling dollar is shooting their currency too high for comfort.
The flood of foreign investment pouring into Hong Kong's equities is also putting pressure on the local currency's 24-year peg to the U.S. dollar. If they didn't react, their now soaring currency would lose its U.S. dollar peg.
The Hong Kong Money Authority (HKMA), the city's de facto central bank, sold off HK$775 million (US$100 million) to buy U.S. dollars. They dropped this US$100 million just as their currency touched 7.75 per U.S. dollar, the upper limit of the trading band.
In May 2005, the government created this band. It essentially means the bank pledges to buy or sell the Hong Kong dollar if it rises or falls more than five Hong Kong cents on either side of HK$7.8 to the dollar.
''The selling of Hong Kong dollars against U.S. dollars by the HKMA shows the authority is committed to the peg,'' said Frances Cheung, an economist at Standard Chartered Bank in Hong Kong. ''The peg will remain intact in the foreseeable future.''
Translation: They're doing what they can to stay pegged to the U.S. dollar and keep the USD/HKD exchange rate up - even if that means selling off their currency and buying dollars.
SEAN HYMAN, Currency Director
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