An Explanation of The Global Financial Crisis

Hey folks, 

Recently I had a brief conversation with a buddy of mine, who thought it would be a good idea to explain in simpler terms what the hell is going on in our country with this financial fiasco, and dissect what caused this mess aside from the bursting of the housing bubble. After a few Tangeray & Tonics (T&T) I decided to bang away on my laptop and here is my analysis of this mess.  Before I get started however, at the very bottom I answered 7 questions that I think are at the forefront of peoples mines.  Since the questions are independent and unrelated to this writing, feel free to skip to the 7 questions & answers below, especially if you’re looking to invest and make some quick money or thinking about liquidating your 401k and move to Cuba where living is cheap and heath-care is free (save me a spot).  By the way don’t get cute and ask me why 7 questions – why 26 letters in the alphabet? Ok we move on.. 

First courtesy of today's [Oct 7th '08] Wall Street Journal above is a chart that illustrates how all the markets have been doing so far this yr, and let me warn you, you may want to close your eyes:  It shows "Cash is King" - up 3%, Bonds are chillin - pretty much flat, and Stocks taking a killing - with Emerging Market stocks leading the way, down a whopping 40%, yikes!  Hey that's yesterday's news anyway, and since most of you are young and can make it up over the next 25 yrs we'll be optimist and say the glass is only half empty.

Alright so this is meant to be a relatively straightforward synopsis of our current Global Financial Crisis: what really ignited it, how it quickly spread, and the potential fallout if the government doesn’t intervene to stave off a worldwide catastrophe. We all know that there is a severe downturn in the housing market that was the catalyst to banks losing billions of dollars on bad lending practices, but to say that’s all that’s causing the U.S. to be a “Banana Republic” is overly simplistic, and not accurate.  I think as adults it’s very important for us to understand what this Economic crisis is all about, and have some perspective as to what took place at the highest levels of government and financial institutions over the last several weeks. 

I’ll begin with my former boss Richard “Dick” Fuld, and his testimony on Capitol Hill yesterday, where Congress, protesters, and Wall Street watched for three hours as Dick aka “the Gorilla”, the gruff former Lehman CEO, a once proud and respected Wall Street executive was lambasted by Democrats and Republicans alike for presiding over the BIGGEST collapse of a corporation in history.  Yes the largest, it was huge, we’re talking about the failure of a firm that had over $600 billion in Assets and 28,000 employees - eviscerated in a cloud of financial dust, but that’s only the beginning of the story. 

Oh yeah Lehman’s CEO (Richard Fuld) totally mismanaged Lehman, and because of complete arrogance and stubbornness drove the firm right into Bankruptcy by refusing to negotiate with others except on his own terms.  If he had humble himself, listen to others, not gotten greedy and focus on what was going on around him, then employees and investors alike would not have lost everything!, but he was arrogant, belligerent, and wielded way too much power – which now caused him to destroy a 158yr old legendary firm (once know as – Shearson Lehman), but there is a story to this that is not being told, and I’ll try to tell you guys what’s the deal, and why it’s important we sorta understand the reason why we need smart leaders running Government…

Let it be known that the (U.S.) Government made a major error in judgment, that will haunt them, and punish us for many many yrs, perhaps even decades.  They should NOT have let Lehman collapse, they were mis-led by the Treasury Secretary ( Paulson), who as recent as 2yrs ago was Mr Fuld’s major adversary when Paulson was then the CEO of Goldman Sachs ( undoubtedly the most powerful Investment Bank in the world).  Yesterday a few congressmen were trying to get Mr Fuld to hint that he [ the Treasury Secretary] was complicit in allow others to conspire to bring down the House of Lehman.  It’s a very complex and hard to explain scenario of events, but there is evidence out there that Goldman Sachs (“GS”) was at the helm of a group of “bandit” financial institutions (aka Hedge Funds) that pile drive Lehman into the brink of collapse [ by earlier spreading false rumors about the firms demise igniting panic selling of company stock], and when Lehman finally turned to the Treasury for assistance Paulson essentially didn’t return Fuld’s phone calls nor provide reasonable assistance to a firm on the verge of atomic detonation.  Moreover Paulson instructed his former GS lieutenant’s ( Lloyd Blankfein now CEO of Goldman Sachs), (John Thain now CEO of Merrill Lynch), ( Bob Steele  now CEO of Wachovia Bank), and AIG (world’s largest insurance company, major client of GS… who’s new CEO is a former Goldman Sachs exec) to strengthen their businesses knowing the Lehman will be forced into Bankruptcy.  This was called by the Gov’t insiders “foaming the runway” to allow for a only soft disruption in the financial markets by the collapse of Lehman.  Man-oh-man how insanely foolish was Paulson and his cronies… The collapse of Lehman was anything but SOFT, it led to “complete” grid-lock and chaos WORLDWIDE… now the largest banks across every continent was scrambling for survival, Why? Well this is what unfolded: 

Right after Lehman decided to file for bankruptcy a small and once thought to be very safe money manager/investor name the Reserve Fund that manages ~ $50bln and invented Money Market investing decades ago “crashed” when they lost almost $1bln on Lehman investments – i.e. they did something call “breaking the buck” – which is akin to putting money into a savings account, and then having the bank telling you that your Savings account “balance” is now reduced, because the Bank doesn’t have enough to give you and other Depositors.  Setting aside the concept of FDIC protection, it doesn’t take a financial genius to understand that savings, checking and money market accounts are sacrosanct – you gotta know it’s where Companies put payroll before it pays employees, where the elderly keep their nest eggs, where most Non-Profits and Corporations keep funds to finance their operations, if these are not safe havens, then nothing is. So the beginning of a world wide panic in the financial markets was in motion… 

What happened in the U.S.?  

Well first was absolute pandemonium - Disappearing on the same day as Lehman was the venerable, iconic Merrill Lynch, when Merrill slickly agreed to be acquired by Bank America (the largest Bank in the U.S.)… I say slickly because Bk America was in talks to buy a floundering Lehman, but surprisingly bought Merrill instead which all of a sudden began to teeter on the brink of collapse.  What’s the smoking gun with this deal?  Let’s just say Lehman and all the big Banks were in a “Poker” face-off with lot’s to lose, and Lehman was forced to disclose it’s hand by the Treasury to all the players, including the vulnerable ML and GS crew – not to help Lehman, but to help themselves. For Treasury (Paulson) had already colluded with the others to stick a fork in Dick Fuld… 

The very next morning AIG needed a $100 bln in a bad way.  The Lehman collapse reverberated right on their doorstep – undiagnosed by the idiots in Treasury was that AIG made a very expensive bet (effectively) that if Lehman defaulted on paying it’s debt they would pay [ the lingo is known as default insurance].  It’s a fatal business bet that now has all banks worldwide inter-married in a financial catastrophe – one to the tune of something like $40 trillion+ [ can I say that’s almost equivalent to the GDP of the World ].  AIG being the biggest catastrophe insurer worldwide (insuring ships, planes, companies, countries, natural disasters, etc), the biggest owner of Aircrafts worldwide ( leasing planes to all the big commercial Airlines – and when I say all I mean all, including AA, Delta, Continental, Jet Blue, Virgin, Quantas, Air Jamaica, AirItalia, Air France, etc ) immediately had to be bailed out by the Fed Gov’t. 

And it only got worse, within a week…

• The 6th largest Bank, Washington Mutual (WaMu) on the brink of collapsing was taken over by the Feds, and sold to JP Morgan for virtually nothing.
• The remaining two big investment banks Goldman Sachs and Morgan Stanley safe but not sound were forced by the Feds to cease being “purely” investment banks, and were changed into “regular” banks – meaning that they had to be “depositary” institutions ( checking, savings, etc – like Commerce Bank)… because that’s the simplest form of banking the Gov’t understands.
• Most recently the 4th largest bank Wachovia Bank on the brink of collapse was forced into the hands of Citibank and Wells Fargo.
• Put it this way any one of these banks would have  3 times more Assets than South Africa’s annual GDP ($300bln+); all the Banks in the entire Caribbean probably times 5 – Point is they were enormously big freaking firms - now GONE! 

Then comes the panic and gridlock…

With banks losing money by the billions seemingly every week, lending (credit) CEASED! Now NASA we have a problem – with out the “credit” markets functioning all major companies stood to run out of “cash”, effectively choking financially and going out of business in a matter of months. I’m talking companies the likes of McDonalds, American Express, Boeing, GE, Kodak, American Airlines, Verizon, AT&T, Con Ed, Time Warner, Viacom, Disney, etc.  Colleges and Universities, Football, Basketball & Baseball teams, etc. Cites and States would shut down, as many government employees fired or furloughed – including Police, Firemen, and Teachers. As a matter a fact Google Vallejo Calif and see if they’re able to pay their bills. You get the point “Main Street” - instead of Bush bombing Bin Laden, he just bombed you!, and right on time, just a couple of weeks before he rides off into the sunset.  Despite you "flipping the proverbial bird" at Wall Street, the politicians bowed to the reality.  They needed to infuse hundreds of billions to try to “un-freeze” the credit markets to entice banks to lend again, since banks are terrified to lend money to any company anywhere [ i.e. effectively not Even G.E. could borrow money to pay bills like payroll, telephone bills, etc seriously, can you believe that???... perhaps the worlds biggest manufacturer,  rejected!).  Of course that huge infusion became known as the famous $700 bln Wall St bail out.  How it works is very complex and controversial, and I for one doubt the $700bln is sufficient, since we haven’t even looked at the proverbial elephant in the room – Credit Card debt.  On top of that the Gov’t quietly gave $24bln in loan guarantees to Ford, GM & Chrysler, which is really only a drop in the bucket [they’ll be back before Christmas], since these useless Car makers are losing business to Toyota & Honda every day, and will be gone in less than 5yrs (of course unless McCain & Palin bombs Japan, which is quite possible)…  

It’s now “airborne” - U.S. successfully exported their illness overseas in a nasty way… I call it Economic Bubonics…

Last wk

• Great Britain had to bail out two of their largest financial institutions ( HBOS and Bradford & Bingsley).
• The Netherlands had to bail out Fortis bank - I believe their 2nd largest financial institutions.
• Belgium had to bailout their 2nd largest bank Dexia,
• Germany decided to guarantee 100% of their citizens money in their savings/ checking accounts at Banks in Germany.
• Spain is facing the dire consequences of severe over-development driven by speculation, and cheap money from foreign investors, particularly from Russia and Great Britain. This bubble has burst, and an ugly recession looms.
• France will be drawn into the economic chaos as a result of the interdependency of the European Union, and the collapsing economies in the U.K, Ireland, Spain and Italy.
• No doubt the strength of the European Union will be tested, and if they stay stronger than Great Britain, I would argue that it may force England into seriously considering joining the E.U..  If the E.U. tumbles, it will toss the smaller Euro countries into a severe recession, and lead to an immediately flight to the (U.S.) dollar ( for safety)… this is very bad for the economically starved U.S. – we need a weak currency to cheapen our goods, servics, real estate, etc and attract outside investment, etc.
• Russia (Emerging Market) completely shut down their markets for virtually a whole week (unheard of) as panic selling saw money leave there in boat loads – To say their economy is in a severe crisis is an understatement.
• Brazil and many of the other Latin American countries (Emerging Markets) are seeing their currency drop significantly as investments are sold and similar to Russia, money being repatriated out (of LATAM) and back into the U.S. and Europe…
• The Chinese stock (Emerging) market is crashing as economic growth has stalled, inflation is projected to become problematic as a global recession looms due to the obvious lack of overseas demand.
• India (Emerging Market) shares the same fate as China and perhaps worse, as true to the Capitalist doctrine prosperity was greatly concentrated, but poverty highly distributed.

Basically folks, if Bush’s idiots at the Treasury had simply extended a ~$10bln loan (guarantee) to Lehman to prevent the firms collapse the cascading domino effect, because of the $40 trillion catastrophic (financial insurance) market would not have been set in motion.  Obviously your comment would be that this would’ve only hidden the underlying problems, and not really fixed it – to which I totally agree, but the issue here is TIME my friends.  Time is what the Treasury should’ve aimed for, and they’re now unable to buy it.  A loan guarantee to Lehman would’ve given the Governments worldwide time, to develop an effective solution – now they’re simply plugging holes in a dam.  What they ignored is that in probably 3-5yrs approximately 75% of $40+ Trillion “default” insurance would’ve lapsed ( like car insurance, or home owners insurance) – in essence the fools at Treasury by allowing the collapse set-off a tsunami of a Train-wreck… as the Democratic Congressman ask Lehman’s CEO yesterday, was Lehman unfairly treated by the U.S. Treasury to the benefit of Goldman Sachs? …  I can’t wait for the book! 

By the way my views aren’t some afterthought or Monday morning analysis – I actually predicted this outcome late last year (2007) after Bear Stearns was bailed out, and told quite a few clients (Hedge Fund) and colleagues if Lehman collapsed, it would have dangerous consequences for the U.S. economy.  Hey but I’m no expert, and there is massive disagreement about bailing out Lehman, but just know that folks like Bill Clinton, Suze Orman, and other pretty smart folks said the Government made a fatal error in judgment by not helping out Lehman and preventing this chaos. 

PS – A few final points and things that folks should understand: ( Questions & more Questions)

1.   What happens when a Bank is bailed out?  Investors / Wall street lose everything [ i.e. – virtually 100% of their investment] … creditors may recover some cash after all assets are sold off (50 cents on the dollar, etc)… so no one benefits except for most customers (depositors) who have savings/checking accounts since they’re FDIC protected [ now up to $250k and higher in some cases] 

2.   What will happen to the $700 billion given to Treasury?  Treasury will use the funds to buy the “toxic” or bad Mortgage loans from the Banks at anywhere from 20% to 60% LTV (value of the loan) – it depends on if the loan ranges from Subprime: Loans made to folks with poor payment and credit history, or no money down loans, to “Prime” loans: Mortgages back by decent homes, lots of equity, and are currently being paid.

a.   After Treasury buys the loan it will keep it till it can sell it at a profit, or till the loan is “paid off” by the homeowner.   Since homeowners pay their Mortgages every month the value of the mortgage should increase over time as it’s paid.  If the Home is sold the Mortgage is paid off immediately – which is very good for Treasury (and Taxpayers).  However if the homeowner stops paying their mortgage, then the home is foreclosed, and Treasury will then sell the home to recover some (residual) money.  In this case Treasury (Taxpayers) may lose some money, because of this (let's be real) broke individual.

b.   Treasury also has the option to sell the Mortgages to investors, who are willing to buy the loans since they trust that the Government would have verified that the investment has some (inherent) value and is free of fraud.  This is the PRIMARY goal of this $700bln bailout, which is to establish a value for the loans, and persuade investors that these investments are SAFE.  The quicker the government sells the loans to investors the quicker we get our $700bln back!! 

3.   When will the Real Estate Market rebound?  Most experts who are NOT slick double dealing morons on TV expousing b/s views to benefit off clueless uninformed investors believe that it will take at least till the end of 2009 to mid 2010 for the R/E market to improve.  They believe that on “average” Real Estate prices will continue to fall by another 25%+, even in strong markets like New York City. They also believe that it will take a major economic expansion similar to the effect the dot-com era had on the U.S. economy in the mid 1990's for the R/E to rebound and get as robust as it did during the last 8yrs+. 

4.   Why will Real Estate prices fall so much?  Most sane experts believe Real Estate prices will continue to drop substantially, because banks are flatly not lending money to anyone, but those with the best credit and at least 20% to put down on a home.  Also banks just don’t have the money anymore.  Again, I repeat banks have much less money to lend now, so they will only lend to those who they believe can repay.  To make matters worse, mortgages are mostly 30yr loans, that means a bank has to keep the loan for 30yrs if it can’t sell it to another “sucker” investor.  These secondary investors who were often European Banks aren’t interested in buying any loans from the U.S. for many many solar eclipses.  Another reason why R/E prices will fall precipitiously for a while – RISING UNEMPLOYMENT!  Unemployment in the U.S is rising with no end in sight.  No need to explain what that does for the housing market, because it's clear.  Investors should be looking at buying apartment buildings, because renting will be very sexy for a while. 

5.    Is this a good time to invest in the stock market?  Don’t believe the hype, this is NOT a good time to buy any stocks, except for a handful of companies like (say) Coca Cola, Pepsi, Wal Mart, Campbell Soup, Proctor & Gamble, Phillip Morris (Altria), etc but only if they are really CHEAP! What’s cheap and why these companies?  Cheap is relative, but if the (Market) value of these companies have dropped to levels similar to where they were around 9/11, or 1998 then that’s a good barometer.  These companies make sense to buy, because in good & bad times they tend to prosper, since their products are household names, viewed as necessities, and pretty cheap.  If this doesn’t make sense, then please stay away from the Stock Market buy only can goods, a six pack of Bud, beef jerky, a Hummer, and 100 Megamillion lotto tickets.      

6.   Is this a good time to sell stock (401k, etc)?  NO, NO, NO!!! It’s the worst time to sell.  Only sell if you absolutely have to – for instance, if you need the funds for an emergency.  Basically wait for the market to stabilize, which I think will be sometime in December after the November election.  No matter who wins (hopefully Barak), there will be violent Stock Market turbulence as investors try to understand what the changing presidential landscape brings to the nation.  Again wait till a few weeks after the Election for the market to stabilize. If it falls significantly then definitely don’t sell, but if it rallies big time sell sell sell!  Believe me you’ll be rolling with the big boys and selling at the same time – only idiots buy stock at the highs an sell at the lows.  Conversely if the market drops big a few weeks after the election, buy the stocks you like that are CHEAP! 

7.   What other investments are good to invest in?  Anyone who has over $150k in cash to invest should think seriously about investing in Municipal bonds. It’s probably the best investment deal from a risk/reward perspective in the market at this time [according to many savvy investors].  Remember to buy the Muni Bonds of your “own” state, since you’ll receive a triple Tax benefit ( i.e. – you won’t have to pay City, State or Federal Taxes on the interest earned on the investment).  When is the last time you heard of an entire state defaulting on it’s debt?  I thought so, besides these states are paying out the “waz-zoo” to borrow money right now (believe me they are), so here’s your chance to screw your state before they screw you with higher taxes.  Actually it’s pretty smart since you’re offsetting the higher property and income tax they’re about to bang us with, by not having to pay squat on the money you earning on them.  Trust me I wish I had a few extra bucks to do this myself… By the way if you don’t have $150k it doesn’t mean you can’t buy Muni Bonds, it just means you can’t buy as many as some one who is loaded, so go for it – be broke but look smart and smile alot.   ; )

Of course they’re many many more questions to be answered, but these are a few of the ones I think are pretty important that people should understand.  Remember these are my opinions and thoughts only – no one else (hence the lack of quotes, and credits).  Feel free to ask your own financial guru, after all I never said I was one, but if you like what I said, and you have more specific or complex questions feel free to email me ( again chrisb920@gmail.com ).  No question is too stupid to ask, unless I said “now that was a dumb question”, but then it’s too late.  Comments are also welcome. 

Anyway I hope this was helpful…pass it on to others if you think it’s valuable info, and please I really don’t care to hear about my messed up grammar or punctuation - this is not Shakespeare .   

Take care,

Chris,