Monday, June 30, 2008

An Old Fashioned Banking Crisis (Debt Deflation Spiral - Irving Fisher Gets Props)

It is becoming clearer by the day that my most pessimistic expectations regarding the US banking system were not bearish enough. The FED has used up more than 50% of its available treasuries portfolio to enter into repurchase agreements with different banks in a valiant attempt to liquify their balance sheets. This helped slowdown the crisis a bit, but as has been mentioned numerous times in print and online - liquidity is not going to be enough.

We have a solvency issue on our hands. Once the assets on the banks balance sheets (mortgage backed securities and retained mortgage loans and credit card loans) are marked down to true value over the coming three years it will become clear that our entire banking system is insolvent. How can the government fix this? Back in the early 1980s during the international debt crisis when our banking system was at a similar inflection point the Government adopted a novel banking rule. The basic premise was that sovereign countries cannot go bankrupt. This allowed the banks to avoid writing down the value of their assets and maintain some semblance of equity / solvency. Then slowly over a period of years the banks rebuilt their balance sheets.

We are at a similar inflection point here. The main lobby has been for massive fiscal stimulus via government deficit spending. Today Bill Gross of Pimco fame was out in force lobbying for a $500 billion fiscal stimulus / deficit spending housing bill. The dream is that if we can keep our economy going and out of recession then somehow we will be able to service the massive debt burden on our shoulders at the consumer level. I personally don't believe this is possible.

So what are the implications for investing, trading, speculating:

1) Stay short financials (they are in secular decline)
2) Begin to take profits in commodities (nearing blow off phase)
3) Begin to take on more selective shorts
4) Accumulate capital / cash and hoard lidiquity to purchase bargain assets in a few years at more attractive valuations (re: businesses, real estate, and equities).

I personally am going to try and stay a bit more aggressive as usual.

-Ben