The financial crisis gains momentum

I really, really hate being a 'prophet of doom' type. I upset even those closest to me when I talk about the current financial crisis, because they say that since there's nothing they can do about it, they see no point in talking about it. Some have even accused me of schadenfreude, which certainly isn't true, since my financial ox is about to be gored as hard as anyone else's!

However, I come from a background that has taught me to remain aware of my surroundings and what's going on in my environment. It's taught me, if I see danger approaching, to sing out loud and clear to let others know, and take what precautions I can to defend and protect myself and my loved ones. That's why I continue to post about the financial crisis on this blog: not because we can somehow magically prevent the inevitable from occurring, but because there are some things even 'little people' like us can to do preserve at least something of what we have. We'll talk about them at the end of this article.

However, if we plan on doing those things, we'd best act fast, because time appears to be running out. Here are the latest developments.


1. The Eurozone is showing signs of imminent implosion.

• The Telegraph reports: 'The eurozone banking system is on the edge of collapse as major lenders begin to run out of the assets they need to keep vital funding lines open ... Many banks, including some French, Italian and Spanish lenders, have already run out of many of the acceptable forms of collateral such as US Treasuries and other liquid securities used to finance short-term loans and have been forced to resort to lending out their gold reserves to maintain access to dollar funding ... Moody's on Friday downgraded France's three largest banks, BNP Paribas, Credit Agricole and Societe Generale in light of what the US rating agency said were "liquidity and funding constraints".'
• Bloomberg reports that wary European CEO's are moving their funds and corporate assets out of more threatened economies into sounder ones: 'Contingency planning for an unraveling of the currency involves cutting investment, moving money to Germany, transferring headquarters to northern Europe from southern, and even going out of business, according to interviews with more than 20 executives ... “How do you control an explosion in a controlled way?” Fiat SpA (F) Chief Executive Officer Sergio Marchionne told reporters in Brussels on Dec. 2. “That’s a contradiction in terms. This will be an implosion of some size with potentially disastrous consequences".'
• Bank runs are already occurring in Greece, and there are signs they may be spreading to other Eurozone nations. Der Spiegel points out: 'Many Greeks are draining their savings accounts ... By withdrawing money, they are forcing banks to scale back their lending -- and are inadvertently making the recession even worse ... The hemorrhaging of bank savings has had a disastrous impact on the economy ... Many Greeks now hoard their savings in their homes because they are worried the banking system may collapse ... Those who can are trying to shift their funds abroad. The Greek central bank estimates that around a fifth of the deposits withdrawn have been moved out of the country.' Britain is already preparing for the problem to spread to other Eurozone nations.
• The impact of a possible collapse of the Eurozone is only now beginning to sink in. Fox Business reports: 'Citigroup's chief economist on Thursday warned a collapse of the currency will result in years of a global depression that could send unemployment spiking above 20% in the West ... The comments ... underscore the growing concern that policymakers won’t be able to forge a credible solution that will keep the currency union intact.'
  

John Hussman, writing at Hussman Funds, sums up the European problem as follows:

Investors were quite excited last week when central banks announced a coordinated reduction in the interest rate for U.S. dollar swap lines.

. . .

Very simply, what happened last week was a liquidity operation - essentially, European banks can now borrow dollars for a fraction of a percent less than they previously could. This prevents transactions denominated in dollars from "freezing up" across Europe (since European banks are no longer willing to lend to each other). But it does nothing to address the sovereign debt crisis. It does nothing to make European banks more solvent.

. . .

Europe doesn't face a liquidity problem. It faces a solvency problem. What investors really want isn't just for someone to buy distressed European debt, but for someone to buy that debt and willingly take a loss on it so the money doesn't ever actually have to be repaid. That isn't going to happen easily. Short of major fiscal improvements in Europe (which appear increasingly hopeless in the face of an oncoming recession) any solution will have to explicitly or implicitly impose losses on someone.

There's more at the link. Technical, but highly recommended reading.


2. Consumer demand for goods - and, therefore, demand for raw materials and components by producers - appears to be drying up.

• Yesterday Reuters reported: 'Texas Instruments cut its outlook for the current quarter and warned demand was broadly lower as customers reduce their inventories ... Weak economies in the United States and Europe have sapped demand for microchips and investors have been looking for signs of when the industry will bottom out and begin to improve ... Worries about slow demand have pushed manufacturers in recent months to trim inventories of chips and other components, a trend that is continuing, Ron Slaymaker, TI's head of investor relations, told analysts on a conference call.'
• The world's chemical industries are experiencing a similar problem. Canada's Globe and Mail reported today: 'Shares in E.I. du Pont de Nemours & Co., one of the world’s biggest chemicals makers, dropped almost 5 per cent after the company warned on profit. It cited weakening demand, particularly for products such as polymers, used in a range of goods, and consumer electronics ... The warning – which came a day after Texas Instruments cut its earnings forecast – could fuel fears that earnings growth will slow down next year after several years of strong profit increases for big companies following the recession. The chemicals industry is often seen as an economic bellwether, since its products are used in a wide range of consumer goods, from soap and saucepans to computers and solar panels. DuPont’s warning follows a similar cut in profit outlook by Wacker Chemie, the German chemicals company, and downbeat comments from BASF, another German chemicals group, as the industry tries to cope with shrinking inventories.'
  

In the light of earlier reports about container ships sailing with only partial loads from the Far East to Europe and America, signaling a reduction in the quantity of goods ordered by wholesalers and retailers for this Christmas season, I'm not surprised to see producers reporting a slowdown in demand as well. What this means, of course, is that economic activity overall is slumping - just when other financial pressures on the world economy are peaking, as we'll discuss next.


3. The MF Global bankruptcy has revealed a nightmarish risk threatening the entire world's financial system.

Thomson Reuters reports:

Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.

MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.

If anyone thought that you couldn’t have your cake and eat it too in the world of finance, MF Global shows how you can have your cake, eat it, eat someone else’s cake and then let your clients pick up the bill. Hard cheese for many as their dough goes missing.

Current estimates for the shortfall in MF Global customer funds have now reached $1.2 billion as revelations break that the use of client money appears widespread. Up until now the assumption has been that the funds missing had been misappropriated by MF Global as it desperately sought to avoid bankruptcy.

Sadly, the truth is likely to be that MF Global took advantage of an asymmetry in brokerage borrowing rules that allow firms to legally use client money to buy assets in their own name - a legal loophole that may mean that MF Global clients never get their money back.

There's much more at the link.

The entire article is very well-written and explained. It's essential reading if you want to understand why MF Global's collapse has uncovered an international financial house of cards so fragile that it's almost certain to collapse. That company wasn't the only one involved in this misuse of client funds. Many of the world's largest banks and financial institutions have done the same thing; and all of the client assets they've used in that way are now at risk, as the financial derivatives markets totter. If one goes, they're all going to go. As Zero Hedge explains:

And there you have it: in this world where distraction and diversion often times is the only name of the game, while banks were pretending to have issues with their traditional liabilities, it was really the shadow liabilities where the true terrors were accumulating. Because in what has become a veritable daisy chain of linked shadow exposure, we are now back where we started with the AIG collapse, only this time the regime is decentralized, without the need for a focal, AIG-type center. What this means is that the collapse of the weakest link in the daisy-chain sets off a house of cards that eventually will crash even the biggest entity due to exponentially soaring counterparty risk: an escalation best comparable to an avalanche - where one simple snowflake can result in a deadly tsunami of snow that wipes out everything in its path. Only this time it is not something as innocuous as snow: it is the compounded effect of trillions and trillions of insolvent banks all collapsing at the same time, and wiping out the developed world and the associated 150 years of the welfare state as we know it.

In this light, it makes far more sense why, as we suggested yesterday, the sanest central bank in Europe, the German Bundesbank, is quietly making stealthy preparations to get the hell out of Dodge, as it realizes all too well, that the snowflake has arrived: MF Global's bankruptcy has already set off a chain of events which not even all the world's central banks can halt. Which is ironic for the Buba - what it is doing is "too little too late." But at least it is taking proactive steps. For all the other central banks in the Eurozone, and soon the world, unfortunately the deer in headlights image is the only applicable one. And all because of unbridled greed, bribed and corrupt regulators sleeping at their job, and governments which encourage the TBTF ['Too Big To Fail'] modus operandi as the only fall back one, which in turn gave banks a carte blanche to take essentially unlimited risk.

We are all about to suffer the consequences of all three.

Again, more at the link. (I think the phrase 'trillions and trillions of insolvent banks' is a misprint in the original; I believe the author meant to refer to 'trillions and trillions of [dollars in leveraged derivatives coming due], insolvent banks all collapsing at the same time', etc.)

The inevitable result of MF Global's use of customer assets to underwrite its trades is going to be chaos in every derivatives brokerage, as customers try to ensure that their assets remain legally theirs, despite being in the temporary custody of the brokerage and/or its agents. This is already beginning to produce legal ramifications over who owns what asset(s) managed by MF Global. For example, Bloomberg reports:

An HSBC Holdings Plc (HSBA) unit sued the MF Global Inc. brokerage trustee to establish whether he or another person is the rightful owner of gold bars worth about $850,000 and silver bars underlying contracts between the brokerage and a client ... “HSBC has received conflicting instructions regarding ownership and disposition of the property,” it said. “Accordingly, HSBC is exposed to multiple liabilities with respect to the disposition of the properties.”

Again, more at the link. Look for this contagion of uncertainty to spread - rapidly.

The MF Global collapse may prove, in hindsight, to have been the domino that started a worldwide collapse in financial derivatives, of which there are about $1.4 quadrillion in circulation (see Point 5 of my earlier article here). To put that figure in perspective, the capitalization of all the world's stock markets - all of them - is no more than $36 trillion: one-fortieth of the derivative total. The entire derivatives market is nothing more than a financial house of cards . . . and it's begun to topple.


4. There aren't enough bailouts in the world to avert this financial storm.

Since the crisis hit in 2007/8, governments and central banks around the world have been trying desperately to shore up the financial system, plug the leaking holes in the fiscal dikes, and reassure all of us that things will be OK in the end. They've incurred trillions of dollars in new debt, and spent it on so-called 'stimulus packages' that were designed to get the world's economies moving again.

They were all lying, and all their efforts have failed. Let John Hussman sum it up for us.

What we have increasingly observed over the past decade is nothing but the gradual destruction of the ability of the financial markets to allocate capital for the benefit of future growth. By preventing the natural discipline of the markets to impose losses on poor stewards of capital, and to impose interest rates high enough to force debtors to allocate the capital usefully, the world's policy makers are increasingly wrecking the prospects for long-term economic growth.

Again, more at the link.


5. What can we do about this crisis?

Not much, in global terms: it's inevitable. However, here's what I'm going to do as an individual:

1. I'm going to add to my (not very extensive) food reserves. I'm not wealthy, and can't afford to build up a large reserve; but if normal supplies are disrupted due to problems with the US banking system, I want to be able to feed myself and those for whom I'm responsible for at least a few weeks until supplies are once again available.
2. I'm going to withdraw a chunk of my emergency financial reserve, and keep it on hand in cash. Again, I don't have a lot, but if the use of credit cards, checks and other common financial instruments is disrupted for a few days to a few weeks due to problems in the banking system, I want to be able to buy food, gasoline, etc. (By the way, if your bank accounts are with large institutions that are highly exposed to the global financial meltdown, if I were in your shoes, I'd immediately move at least half my financial assets to a local credit union or small bank - one that's well-capitalized [check that carefully!] and less exposed to failure. I think all of us should, if possible, start keeping at least a month's expenditure in our possession, in cash, just in case.)
   
3. I'm going to continue to implement the measures I've discussed previously, in an attempt to prepare myself as best I can for what I believe has now become an imminent financial disaster.

Those are my short-term plans. Your mileage may vary. We may yet find a way through this mess that doesn't involve too much financial pain and suffering to people like you and I . . . but right now, if it exists, I can't see it. Still, I'll continue to hope for the best, even as I try to prepare as best I can for the worst.

Peter