“The Stock Market has reached a permanently high plateau.” Irving Fisher, Yale Economics Professor, September, 1929. The poor man was the leading Economist of his day, and was highly leveraged in the Stock Market before the great crash. After September 1929, Irving Fisher was financially wiped out.
Bear Sterns spokesmen Alan Schwartz CEO said on Tuesday March 11, 2008 that “Bear was not in trouble, and would withstand the Sub-Prime meltdown. On Friday March 14, 2008 “Bear” borrowed and unknown amount from the Federal Reserve to continue operations. The loan is for 28 days. Good luck! Read on.
In the mid 70’s, Continental Illinois Bank set out to become the largest Commercial and Industrial lender in the World. Between 1976 and 1981 the banks lending jumped form about $5 billion to more than $14 billion, while its total assets grew from $21.5 billion to $45 billion. A 1978 article in Dun’s Review pronounced the bank one of the top five companies in the nation. An analyst at First Boston Corp praised Continental, noting that it had “superior management at the top and its management are very deep”. In 1981 a Solomon Brothers analyst echoed this sentiment, calling Continental “one of the finest money-center banks going.” During late 1981 and early 1982 the stock market price of Continental was deteriorating (from a high of 42.00 to 6.50-a drop of 84%). However, Analysts continued to recommend purchase. Interestingly enough, Continental was offering 16% fixed rate loans with the Prime at 20%. Many bankers muttered, “I don’t know how they do it?”
In March 1982 Fitch Investors Service downgraded six large bank ratings, but retained its AAA rating on Continental. In May 1984, The Office of the Controller of the Currency departed from their policy of not commenting on individual banks, took the extraordinary step of issuing a statement denying the agency had sought assistance for Continental and noting the OCC was unaware “of any significant changes in the bank’s operations, as reflected by rumors.
Optimism about Continental’s financial condition ended abruptly in July 1982, when Penn Square Bank, N.A. in Oklahoma failed. Penn Square had generated billions of dollars in extremely speculative oil and gas exploration loans, many of which were nearly worthless, and Continental had purchased a monumental $1 billion in participations from Penn Square. Depositor raids (pulling there money out) crippled the bank. Continental and other banks pressed regulators to find a way to prevent a deposit payoff of Penn Square, a course preferred by the Federal Reserve. The other large banks refused either to inject money into Penn Square or to waive their claims on the Bank. The refusal to waive their claims meant that the contingent liabilities of the Federal Deposit Insurance Corporation would have incurred payouts that were in excess of their funds. This presumably left only one course, namely, the Federal Reserve must “bail out” the bank. The bottom line was that the Fed’s “loaned” the bank the money (printed it) in the amount of $4.5 billion.
Technically the Federal Reserve purchased the banks bad loans. This “loan” was not paid back until 1993 (eleven years). All this going on while the CEO stated that the bank “had no intention of pulling in its
horns.” Does any of this sound familiar? Who really paid for the bailout? You did of course, through Income Taxes and Inflation. We pay for extraordinary speculation by others. A wonderful concept.
Last week my Wife called me and asked if I knew anything about Fremont Savings and Loan, a local Savings and Loan that has a branch across the street from Leisure World. I asked her why? and she said a friend of hers had gone to the bank prior to its opening to make a deposit and was greeted with a line a block long. The people in line told her the bank is going broke. I looked up the bank (Fremont General Corp) and discovered they were large originators of sub-prime loans. There problem was they had sold this crap into Mortgage backed bonds with the caveat that they would maintain a Net Worth at a minimum of $250 million. Woops, their net worth is presumably about $100 million. The bank on March 4, 2008 received a default notice on $3.15 billion. Maintaining a net worth level of at least $250 million was part of the agreement with investors who purchased the loans in March 2007 to support the bank’s obligation to repurchase any loans sold in the deal. To meet the sales terms, Fremont would need to put the amount of money required to make up the difference between its net worth and the agreed upon level in a reserve account or provide a letter of credit for that amount, and Fremont in a press release said that it is not in a position to do either. So far, Fremont has been asked to repurchase about $11 million of the loans sold under the deal. Not surprisingly, Fremont has not filed a Financial Statement since March of 2007.
The good news is that my Wife’s friend got her money, and as she left the bank, she noticed the line at the bank had expanded to about 3 city blocks. Good luck Fremont.
This “Financial Panic” as I have said cannot be averted with interest rates cuts. It’s a Credit Crisis for which the average Joe in the street has lost there trust in the Banks. The next chapter in this “speculative bubble” could be very painful for investors, and the general public. The Political and Social solution to all these mounting problems will be printing more money, Bail Out’s, and higher Income Taxes.
For those of you, who have CD’s at any Federally Insured Bank; remember that you are only insured up to $100,000 per account. It may be time to move money in excess of $100,000 into Treasury Obligations.
My solution is simple: over the next few weeks we will own US Treasury Bills and Notes, Gold, and some Silver. I will watch from the sidelines. Yield on Treasuries are very low, but remember, in the Depression (1932) 90 Day T-Bills traded at a negative yield because it was the only safe place to put “cash”. Now is not the time to panic, but defense, safety, risk aversion, and liquidity is currently the only strategy.
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