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VIDEOWhat Does the Fed Know?
By
John Mauldin
Jan 28, 2008 8:35 am
The concern that there is the potential for a much worse credit crisis than we are currently experiencing is what is driving the Fed.
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Brother, Can You Spare a Billion?
The risk of a deeper capital shortfall may help explain why New York's Insurance Superintendent Eric Dinallo is trying to arrange a bank-led bailout of the bond insurers. Downgrades would cast doubt on the credit quality of $2.4 trillion of bonds the industry guarantees. Dinallo met with executives of banks and securities firms this week to ask them to extend capital to bond insurers and stave off credit rating reductions.
"Barclay's Capital has come up with a very big and very scary number," said Donald Light, an insurance analyst at Boston-based consulting firm Celent. "It indicates that the cost of a bailout of the bond insurers is a lot less than the cost of shoring up these banks' mark-to-market losses."
You can bet that the various investment banks being asked to shore up the capital of the monoline companies are not going to do it as a donation. They are going to get the equity and debt of the company. I don't often make bets about the stock prices of individual companies, but I think those who think a "rescue" of MBIA and Ambac and others will be good for shareholders are going to be in for a rude awakening. It will not be pretty.
The Barclay's report said that Financial Guaranty Insurance Company is likely to be downgraded. The company has insured just $315 billion in bonds.
The Financial Times reports that several groups are looking into setting up new monoline insurance companies. Once Warren Buffett announced that he planned to do just that, several other groups decided to follow. "The plans by TPG, Mr. Ross and others have not been finalized and could come to nothing, but any attempt to bring fresh competition to the market would complicate the capital raising hopes of Ambac, MBIA and others." That is a mild understatement.
$5 Billion a Quarter
Here is how I think the next few quarters are going to play out. Each new downgrade triggers more losses at financial institutions. You don't write down a bond insured by MBIA as AAA until there is actually a write-down. And then you do, and announce it at the end of the quarter. Along with the rest of the losses caused by new downgrades. We are going to see massive write-offs every quarter by the same financial institutions that have already written off $100 billion. We are only in the beginning innings.
There are very serious suggestions that several extremely large banks (and not just in the U.S.), of the "too big to be allowed to fail" size, technically have negative equity. With each announcement of a new massive write-off, we will see yet another large capital investment announced as well.
And every time it happens, the market is going to be disappointed. And continuing disappointment is what keeps a bear market intact. Couple that with earnings disappointments from companies with exposure to consumer spending, and you have a recipe for a bear market that could linger for awhile.
I think there is very serious risk that taxpayer money is going to have to be spent on shoring up some of the financial players that are at risk. There will be much screaming and wailing and gnashing of teeth before that happens, but it is quite possible.
As I am closing this letter (as I have yet another meeting tonight), I take special note that Bank Credit Analyst has changed their forecast. They now are forecasting a recession, but they see one that is worse than I am predicting. They think the recession will last a year and that GDP will be around a -2% for that time period. I will call Martin Barnes when I am back in Texas next week and get an update for you. Martin is one of the best economic minds I know, and I value his opinion highly.
Next week I will review my thoughts from this whirlwind trip to Europe. Let me say that at least the people I met with were generally more bearish than I am. That is a little disconcerting. A few think I am quite the Pollyanna. And now that Martin is bearish, maybe I should enjoy being the "optimist" in the crowd.
Planes, Trains, and Santa Barbara And Charlie Wilson's War
I fly back tomorrow on a 777, and am still waiting to hear what caused both engines in a 777 to simply fail at the same time at Heathrow last week. Speaking of deep concern.
Then Tiffani (my daughter and the person who runs the business) and I fly to Santa Barbara to meet with Jon Sundt and his team from Altegris for two days of planning at Jon's ranch. It has been a few years since we have been there, and I really enjoy the views of the ocean from his mountain retreat. Not to mention the food, as we all take turns trying to out-do the last cook. Jon is actually quite good.
The train ride from Geneva to Zurich is one of my favorites. It is such a lovely country. This was my first time to Zug; and I can see the attraction, as one hedge fund after another is moving there as the canton offers serious tax advantages. I like to see competition between various governments as to who can offer the best tax advantages. I wish the U.S. would consider such a move.
I like the proliferation of cheap airlines in Europe. But if you can, I would suggest avoiding Clickair. In addition to cheap fares, they offer the most cramped seating of any plane I have ever been on.
One final suggestion. Go see the movie Charlie Wilson's War. Besides being one of Tom Hanks' roles (he should get an Oscar), it offers a different view of Afghanistan and the anti-communist movement in the '80s. I suggest that before you go you should read Chip Wood's essay called "It wasn't just Charlie Wilson's War."
While there is much to enjoy about the movie, they did stretch a point. The role played by Julia Roberts was fictional. The real hero was a man many of us know and respect, called Jack Wheeler. Read Chip's well-written and fascinating essay for the rest of the story. It is worth the time.
Enjoy your week. I am off to dinner with Tom Fischer from Jyske Bank, who has come from Copenhagen to meet with me. It is always a pleasant time with him. It has been a good week for making new friends and meeting old ones. My time with my partners at Absolute Return Partners here in London has been especially enjoyable. And for whatever reason, jet lag did not seem to bother me this week. I usually struggle for a few days with it when I come to Europe. More on the view from Europe next week. Enjoy your week, and keep those hedges on.
No positions in stocks mentioned.
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