The Black Swan

[TaoJones]

In a stunning story from today's Telegraph (London) comes word that leads me to believe this may be the day we will look back on in future as the day the Black Swan arrived; the day the unthinkable became plausible; the day a catastrophic worldwide financial meltdown reached the tipping point.

* * * * *

"Bank losses from credit crisis may run to $1,600bn, warns Bridgewater

"By Ambrose Evans-Pritchard

"Last Updated: 1:59am BST 08/07/2008

"Bridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn (£800bn) [$1.6 trillion], four times official estimates and enough to pose a grave risk to the financial system.

"The giant US hedge fund said that it doubted whether lenders would be able to shoulder the full losses, disguised until now by 'mark-to-model' methods of valuing structured credit.

" 'We are facing an avalanche of bad assets. We have big doubts as to whether financial institutions will be able to obtain enough new capital to cover their losses. The credit crisis is going to get worse,' said the group in a confidential report, leaked to the Swiss newspaper SonntagsZeitung."

* * * * *

For the full report, go to:

Bank losses from credit crisis may run to $1,600bn, warns Bridgewater - Telegraph

How is this significant to the lives of cruisers?

Because anyone requiring credit to effect the purchase of expensive items like sailing vessels will discover that he/she will be competing for that credit in an already severely pinched credit market, thereby driving up the cost of financing. The banks, themselves, will be beating the bushes and looking under every rock for any available dollar to help meet their capital requirements.

It should be obvious that only governments can provide the necessary capitalization to prop up the financial system. And, in an almost cruel side note, this story runs on a day when it is revealed that the US government may have to nationalize the giant GSEs (Government Sponsored Entgerprises) Federal National Mortgage Association (FNMA or Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).

Think carefully about the inferences to be drawn from the last paragraph of the article:

"If Bridgewater is anywhere near correct, governments alone have the wherewithal to rescue the system. This would mean the de facto nationalisation of the banking systems in the US, Britain and Europe."

TaoJones

[ssullivan]

Interesting. I was just reading this as well this AM.

My question:

Where did the $1,600Bn go?

In a financial system, other than looking at the fed printing money, isn't it true that there is a "conservation of cash" just like a "conservation of energy" in Physics?

More clearly, that money had to go somewhere, didn't it?

Who benefited from this credit fiasco? What group *made* $1.600Bn from the banking oversights?

[Southern Star]

Wow Tao - truly sobering. And you are right about the potential long-term impact on financing a boat purchase. This should also add some concern to purchasers of new boats - I suspect that the rise in oil prices will have already stretched many manufacturers to (or past) their limits and, those with demand loans and floating interest rates will be particularly vulnerable. I suppose the only saving grace is that the banks would rather not move in this market to foreclosure/power of sale/forced bankruptcy, but still....

Of course, this may also prove to be an incentive for some to liquidate now and move up their proposed departure dates for some extended cruising. I suspect it will be a very long time before real estate and many equity investments appreciate in any meaningful way.

Brad

[scallywag]

Where did the money go in 1929? Did not the government say it could not happen again? The stocks are going south because people have placed items on credit and now are not paying for what was charged. The house around the corner sold 2 years ago for $850k , now the bank is asking $455k. The oringinal seller probably invested the money and is now looking at far less money being invested. The SUV used car market is flat. The value of a car, boat, or house is only what someone is willing to pay. I guess I better learn how to fish.
John

[David_Old_Jersey]

Originally Posted by ssullivan

Where did the $1,600Bn go?

It never existed. The Banks and other financial institutions effectively printed it. Instead of Dollar Notes they used plain old A4 paper and numbers in computers. Then it got spent / injected into the real (and not so real) economy. How could it all go wrong.........

Unravelling the USD1.6 Trillion (I have heard higher and lower - no one actually knows) is the problem. It should be impossible without making 1929 look like a blip. But the plan is to do exactly the same as that which created the problem - pretend everything will be ok and hope everyone else does the same. To be succesful this will also involve not doing anything equally as dumb over the next 20 odd years! Time will tell on that last one..........

FWIW I think the US will pull it off - cos' they still write enuf of the rules and do understand the potential problem that could arise by playing things too straight. The Uk? I think we have a few more structural issues with our economy, but our problems are less - but still.......

Of course doesn't mean that their won't be sh#t loads of money to be made between now and then. Even if "then" proves to be 1929 with knobs on

[chris_gee]

This is quite complicated.
It might pay to distinguish between money and value.
Excessive money was created, partly by printing partly by reducing bank reserves etc. Many countries did this in in effect a competitive devaluation. As the US cut rates and pumped up the money supply, other countries followed suit to maintain dollar pegging or to prevent their currencies rising impeding exports.
Some of the money went to China and the oil producers who then recirculated it to the US. Japan maintained very low interest rates to try to get out of a 10 year deflation.
The banks, investment banks, and hedge funds accessed this low interest rate money particularly from Japan, and sought to gain greater returns than the low ones available, by speculating and leveraging up that is borrowing 10 -30 x their own money. With all the easy money more risky endeavours got money cheaper than they normally would. That is there was a lower risk premium and risk tended to be underestimated.
This money drove up stock markets and housing.
If housing doubled in price that doesn't mean that twice the money was spent. The guy who sold his house at 800K now worth 400k may well have bought another at 800k. There are still two houses worth perhaps 400k each. If he didn't upgrade and borrow, he may well have invested the money which was then loaned out.
The builder who built for say 500k and sold for 800k made a profit from those fighting to buy and make a killing. Some of that money was recirculated to lawyers, realtors, tradesmen, and ommodity providers, and in taxs.
Similarly in the market. When a share went from say 10 -100$. There might have been say a million shares. Only a proportion were sold so the price increased at the margin. This however is taken as an increase in worth for the company from 10M to 100M. However much less than this actually changed hands. Paul got the 100 and Peter paid it. While a great deal of interchange may have taken place (most trading being intra day or short term like a few months much of the gain in the market as a whole was notional. That is if all or even many shareholders tried to sell at 100 the price would collapse.
When a lot of these companies were caught short having made high risk loans to those who could not pay and the bubbles burst, many were caught short. As risk rose and the bankers took heavy losses now partly disclosed they became reluctant to lend and did not have the money to lend. Those who were heavily leveraged found that as the value of their collateral fell they faced margin calls to pay back their borrowings and were forced to sell depressing prices further. Central banks tried to prop them up with massive injections of loan funds but again much of the loose money went into speculation particularly commodities or simply to keeping the banks solvent. This sets up two problems tighter money and inflation coming through. The average guy is squeezed with higher bills and no increase in wages or perhaps a decrease at least in real terms. He also has less money in his house than he thought he had and in his retirement funds or investments. Worse the dollar that he had is now worth much less.
In reality he didn't really have the free increase in wealth he thought. Very likely he had a house, car perhaps a boat and some retirement savings and some loans. He still maybe has them unless he actually had relatively little stake to begin with and was late to the game when he may have lost the lot.
So who got the money?
Well the hedgies found quite a bit stick to their fingers with their 5% fee and 20% of the profits but not the losses, though in a zero sum game some won some lost.
Those who sold out was it Blackstone that floated the plunged?
The execs on their multi million salaries, and similar termination packages did ok.
The banks got bailed out. and can borrow at less than the rate of inflation.
Those most aware of what was happening were also likely to be able to help themselves and pass the parcel.
The government kept the scheme going by borrowing in depreciating money so at least they got time.
Who loses? Savers, and pensioners for a start. Speculators. Probably the middleclass who pay for it in stagnant real wages, higher costs and bailouts.
Not my field so just my thoughts.

[anotherT34C]

There is no conservation of cash, or even conservation of wealth... although at first glance it might seem as if there should be (this is related to the 'lump of labor' fallacy).

Wealth can be created by lots of esoteric means, most of which I don't understand, but a simple one (simplest, maybe?) to understand for the sake of example, is to 'invent' a way to use your employees more efficiently to create more product. Everybody wins, wealth increases. Globalization has been a massive worldwide creation of wealth in this manner, as human capital gets used increasingly efficently.

[Sailormann]

In a financial system, other than looking at the fed printing money, isn't it true that there is a "conservation of cash" just like a "conservation of energy" in Physics?

When we were on the "Gold Standard" i.e.: when paper money was merely a more convenient tender than the gold that governments held in banks to back it up - the conservation theory held true. Not any longer.

Most of the 1.6 trillion never really existed. It was paper wealth and the only security for it was popular consensus. Basically, everybody seemed to agree that a particular house (or other asset) was worth a certain amount of money. Based on that, people borrowed money, and banks lent it.

Now, there is no longer as much consensus about the value of things, so what was once worth $500K is perceived to be worth $400K. Because there is no gold in Fort Knox to back up the value of each of the dollars that the asset is supposed to be worth, the value can change dramatically with the tides of opinion.

This is why Wall Street has been able to make obscene profits over the last 30 years.

More clearly, that money had to go somewhere, didn't it?

It has disappeared back into the thin air that people pulled it from. It was never hard, cold cash to begin with. It was primarily capitalised assets, some tangible and others not.

Who benefited from this credit fiasco? What group *made* $1.600Bn from the banking oversights?

Primarily investment bankers. To a lesser extent, investors. CEO's, etc. The rich got a WHOLE lot righer over the last couple of decades, the middle class hollowed out and the poor became a larger percentage of the population.

[TaoJones]

Not to be overlooked, as well, is the fact that our system is based on a "fractional reserve." That is, for every dollar a bank holds (whether it comes via deposit, borrowing, or capital gain), it can lend approximately ten dollars. With the loss of the $1.6trillion, the additional $12.8trillion (approx.) that could be generated by that fraction is lost with it.

In a marketplace where credit is already shrinking, this combined loss of approximately $14.4trillion of capital and credit, combined, is more than the annual gross domestic product of the US, the world's single largest economy.

What is more, while the $1.6trillion loss is Bridgewater's current best guess, it isn't even the largest estimate of the loss out there - others have put the figure as high at two to three, even four to five times that amount.

The bottom line is that until this debacle plays itself out, no one really knows how bad the damage to the world's financial system is. Without a doubt, though, it is at least significant, and, worst case, crippling.

Virtually every living person will have his/her life effected to some extent, and not beneficially.

TaoJones

[Ex-Calif]

You get up, you put your pants on one leg at a time and you go to work. Just like every day of the week.

You stay out of debt by buying only what you can afford within your means, you have cash reserves and you invest in tangible assets/companies. When the dark day comes you don't panic and sell.

You get up, you put your pants on one leg at a time and you go to work. Just like every day of the week.

I just don't think the global economy can crash - never will. Talk about the big numbers all you want but they are just numbers. A trillion dollars? At today's population that's like $166 bucks a piece right?

Tell you what - I'll chip in mine and for 4 others. Who do I send the check to to save a global meltdown?

Better yet. Me and 100,000 friends will get a fund together to bail this thing out. We'll make it exclusive, 10% down arrange finacing for the rest. 200,000 people will be so pissed not to have missed the initial offering they will be dying to get in on the front end. That's drive the price up and we'll turn our capital in 6 months and double our money.

That's how this spooky stuff works...

BTW - The only people scareed are living paycheck to paycheck. I have 6 years salary saved up - sure much of it is in investments but I have a year's cash too.

Stay out of debt people - Life is a lot rosier...

[ssullivan]

Originally Posted by Ex-Calif

BTW - The only people scareed are living paycheck to paycheck.

Not sure about that. I'm kind of nervous because I can't figure out where to stash my investment cash.

For the first time in my life, thanks to more drastically frugal living than I'd say most of the people on here who are always saying to live cheaply have done - living in a truck - I have a little stash to invest.

Unfortunately, I can't seem to find the right place to go with it, so it's still sitting on the sidelines, getting washed away by inflation.

[GordMay]

Originally Posted by ssullivan

Not sure about that. I'm kind of nervous because I can't figure out where to stash my investment cash...
... Unfortunately, I can't seem to find the right place to go with it, so it's still sitting on the sidelines, getting washed away by inflation.

How about investing in your boat loan; if the loan interest rate is as high as any likely earnings rate ?

[ssullivan]

Originally Posted by GordMay

How about investing in your boat loan; if the loan interest rate is as high as any likely earnings rate ?

That is an excellent thought, Gord. It is one of the possibilities we had been considering. Being an neophyte when it comes to investing (since I've never had a few buck before to do so), I am left with this:

My boat loan is 6.5%. Are there better rates to be had out there (over 5 -10 yrs) by say, purchasing an index fund while the indexes are down a bit?

I tend to get paralyzed because I want to make the correct decision, but I can't seem to find enough data to make any moves.

Your suggestion, at least, is a way to get a guaranteed rate of return of 6.5% (toward positive net worth) and takes a lot of worry and pressure off.

On the other hand, if the dollar tanks some more, and I can earn my income in say... Euros, or some other currency that's strong, I can watch my boat loan's payoff fall every year with the dollar. If there is a drastic currency shift, it could be like getting 25% off your boat!

My mother used to say, "you think too much!" I think this might be one of those cases!

[Ex-Calif]

Sully there are lot's smarter investment people on here than me so 2 cents mode...

The dollar is weak - you are betting it's gonna get worse and stay there for the life of your investment. Things that are down invariably go up so you missed the ride down IMHO. To buy anything Euro based now with your discounted dollars is nutso.

Your boat loan is fixed and you are probably paying interest only for the first 5 years. So it's 6.5% down the drain every year unless you can get a duduction as primary residence then it's a little better. Pay the loan and the impact is not immediate - your money is just parked in an investment - and we all agree what a great (not) investment a boat is. However, pay down the loan and then possibly refinance at better than 6.5% and your cash flow improves - then you pay the note and add a couple of hundred against the principle every month. If you have a 10-year note that could cut the payment period in half.

Option 3 is to invest in the USA and try to get better than a 6.5% return for the next 5 years. As much as I hate to admit (not really) it TaoJones is right. I don't think we are at the bottom of this yet. I just don't think we have as far to go as he does LOL.

Either way getting 6.5% in teh market for the next few years will be a real trick.

Getting out of debt is always a good deal except....

If you secured Japanese money at 2.5% and 118 yen per dollar 5 years ago. And invested that money at 5% in the USA. You'd be a pretty happy camper as soon as the dollar hardens up again.

However - we are going to strengthen against a lot of currencies after the elections IMHO...

Here's a simpler version - You owe at 6.5%. If you have cash laying around you better be getting 6.5% + say 5% to make not paying down the loan a smart move...

[imagine2frolic]

Sulli,

If I was you I would just pay as much as possible to the principal every month. That would be your investment, and a simple one.

My truck payment was for 6 years I paid it off in 20 months. My property I paid $50k extra towards the principal in 3 years. I used it as my savings account, and lived frugal life.