Why Rate Cuts May Not Rescue
this $900 Billion Market

Today's comment is by Mike Burnick, Senior Editor, Global Markets Analyst and editor of Market Shock Trader.

Dear A-Letter Reader,

There's a big issue still lurking on Wall Street: How to jumpstart the stalled market for asset-backed commercial paper (ABCP).

All the Feds men (and women) are deliberating again today on how to fix this problem, but more rate cuts may just not be enough to rescue this market.

In July, this market was worth US$1.2 Trillion. That's half the entire commercial paper market. Since then, the market has dropped to just US$900 billion, according to Federal Reserve data. So it's dropped more than 25% in just four months. That's on par with the share crash on Wall Street 20 years ago this month.

You can trace most of the asset-backed commercial paper to Wall Street's pet investments: "SIVs" (structured investment vehicles). Since this summer, the sub-prime credit crunch has tainted the vast majority of this asset-backed commercial paper.

But there are more issues to come. Nearly US$900 billion in ABCP will mature over the next six months and need to be "rolled-over" or refunded. The only option for many of these funds is to de-leverage. That means they must begin liquidating assets at whatever prices can be obtained to pay off their creditors.

According to various estimates I've seen, there are about three dozen SIVs operating globally. These SIVs carry a capital base of some US$400 billion. But that's NOT the total exposure to potential losses. That's because these SIVs are leveraged to the hilt the way many South American "banana-republics" used to be (or the way U.S. consumers are today). The total leveraged assets are perhaps US$2 trillion or more.

If a huge mass of traders dump their SIVs at wholesale prices, Mr. Paulson's bailout fund (er, that is "Superfund") worth US$80 billion will be just a drop in the bucket compared to a torrent of unwinding sub-prime investments.

All Eyes on Fed...But I'm Watching Libor Rates

Traders across the globe are awaiting the Fed's decision later today. But one unsettling indicator contradicts the widely-held belief that the Fed will surely rescue credit markets with more rate cuts.

The London Interbank Offered Rate (Libor), a key interest rate that big banks charge each other for overnight loans, remains at a stubbornly high level.

In fact, according to the Financial Times, the spread between three-month Libor rates, and the expected Fed funds rate three months down the road, remains unusually elevated at 60 basis points. This is down from a "peak of 95 basis points prior to last month's rate cut by the Fed. But under normal conditions, the swap should trade around 8bp."

Elevated Libor rates indicate a healthy amount of fear among banks and other financial institutions around the world. It shows they remain hesitant to lend to each other in the current environment.

Currently the three month Libor is around 5.1%, while the Fed funds rate is 4.75%. But the Fed is widely expected to cut rates later today by at least 25 basis points. Plus it's expected the Fed will cut another quarter-point cut in December. So something just doesn't add up.

In a normally functioning credit market, Libor should be no higher than about 4.6% (factoring in today's likely move). And Libor could now be as low as 4.3% (in the event of a 50 basis point easing by the Fed), but Libor is stuck at much higher levels than this.

Libor is signaling one of two things: Either the world's banks don't believe the Fed intends to cut rates further - or they doubt such easing will do any good for what really ails credit markets.

Either way makes for a potential nightmare on Wall Street this Halloween!

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR'S NOTE: These gridlocked credit markets won't be fixed overnight. No matter what the Fed announces later today, they'll still be locked up. And they'll get worse over the next six months when funds have to roll-over or refund over US$900 billion worth of asset-backed commercial paper. Don't wait for that to happen. Take action now with a few put and call options on the right sectors to hedge your portfolio. This way you can profit while Wall Street watches their sub-prime investments hit them where it hurts once again - on their balance sheets. Click here to learn more.

Is the U.K. Tax Haven Dead?

After what just happened in U.K., the wealthy Londoners may pack their bags and move to Switzerland or Monaco.

Let me explain. When the British Labour Party first won power in 1994, now Prime Minister Gordon Brown pledged to close the "non-dom loophole."

The "non-dom loophole" refers to a provision in the United Kingdom tax law, which gives wealthy U.K. residents some nice tax breaks. In fact, this small loophole has made the U.K. a major tax haven for foreigners - until now.

The U.K. gives major tax breaks to wealthy foreigners who actually make their home there. Under the law, anyone living in Britain who wasn't born there can simply choose "non-domiciled tax status." Once they make that choice, they escape almost all income taxes. In 1799, England created the tax break to help British colonialists avoid tax on their overseas income.

That means scores of billionaires living there only pay tax on the relatively small amount of income they bring into the U.K. each year. They do not pay U.K. taxes on their much larger worldwide earnings. This has made London a tax haven for everyone from Russian oil tycoons to thousands of investment bankers.

The country now has 68 billionaires - three times as many as four years ago. Only three of its 10 richest people were born in Britain. Experts estimated between150,000 to 200,000 non-doms reside in U.K. just this year.

But now the Labour Party, egged on by the so-called "Conservative" Party, is considering imposing an annual minimum tax on all foreigners in the United Kingdom. According to the new rules, if you claim non-dom status - then you pay a fee of £30,000 (US$62,000).

Cato Institute tax expert Dan Mitchell suggests that higher U.K. taxes could inspire the foreigners to move their economic activity to Switzerland.

According to the The Times of London, low-tax Switzerland would welcome wealthy foreigners from the British financial services industry who well may want to move.

The Labour proposal would exclude anyone who has lived in the U.K. for less than seven years. They don't want to scare away the many hundreds of bright foreign bankers who come to the City for a few years and then go elsewhere. Experts say your average wealthy hedge fund manager or private equity manager's taxes will go from 10% to 18% on his investments with the new fee.

So why are they doing this? First of all the Labour Party is embarrassed about the millions in non-dom Labour political fund donations. Also, the International Monetary Fund's just designated London as a de-facto tax haven.

But even talking tough on non-doms remains risky for the economy. Hedge fund managers could move to Zurich. Plus, the new tax may result in a big net loss to the Exchequer.

"The Monaco property market is booming," a leading real estate agent mused, referring to that tax haven for the wealthy. "These people already feel on safer ground there."

BOB BAUMAN, Legal Counsel

Wealth & Investments

The Horror Story Unfolding in the Markets

There's a horror story unfolding for bank stocks in the United States.

Sub-prime and other mortgage-backed bottlenecks have also infected banks across Europe, Canada and to a lesser extent, Asia.

The picture for bank stocks is grim. We're still looking for a bottom. Financial services stocks represent a hefty 20% of the S&P 500 Index.

Worse, I think, is the relentless rally in oil and gold since the Fed cut rates on September 18. Oil prices have surged more than 25% and gold is up almost 20%. Big market moves like this for the most widely followed commodities eventually won't be good news for bonds or stocks. At some point, assuming the rally in oil continues, the bulls will step aside and take profits.

The next great bear market won't happen just yet. I'm still moderately bullish on global stocks over the next 12 months.

On the bright side, foreign economies are much stronger than the United States. Foreign markets are growing bank credit at a faster clip and can probably absorb a soft U.S. recession, if it occurs. The Fed is also doing the right thing by cutting lending rates - not to save Wall Street but to rescue Main Street - bleeding a slow death in housing.

To be sure, volatility has returned to the markets since last summer. I urge investors to embrace market risk, otherwise your long-term returns will be miniscule at best. The key is to make sure you have a globally diversified portfolio across asset classes, minimize your trading costs and learn to properly hedge your investments.

ERIC ROSEMAN, Investment Director

P.S. In the next issue of The Sovereign Individual, I'll address stock-market hedging strategies to counter the markets' decline, including currencies and put options. Also, I'll show you how to easily and cost-effectively hedge against a bear market with foreign currencies, fixed-income, reverse-index funds and other strategies historically providing a negative correlation to equities. Don't receive our members-only newsletter? Sign up right now for our lowest yearly rate ever, and receive the next 12 issues.