Bloomberg yesterday ran an item saying, "Standard and Poor's said it may cut ratings on $12 billion in bonds backed by sub-prime mortgages," the article gets even more scary as it continues, "because losses will rise beyond its previous expectations."
The article goes on to quote S&P, "We expect that the U.S. housing market, especially the sub-prime sector, will continue to decline before it improves . . ."
In addition, the Financial Times yesterday ran a front page lead item titled, "Moody's set to attack private equity industry." The items goes on, ". . . Moody's is to launch an attack on the booming private equity industry, criticizing its use of debt to buy companies . . ."
[Editor's Note:The Mother of All Financial Disasters]
We have long been warning of the often unseen risks inherent in the excessive credit our regulators have permitted our hedge funds to raise. And even more, the degree to which they have been allowed to invest in highly-leveraged instruments such as: CDPCs (Credits Derivative Product Companies, able to leverage themselves up to 30 times) and which, in turn, invest in leveraged instruments such as CDOs (Collateralized Debt Obligations), offering a staggering total leverage to the hedge fund of 54 times its capital!
Added to this, these funds, marketed under the soothing title of "hedge funds," are most often "un-hedged."
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In good times, this leverage has yielded great returns to investors and vast rewards to fund managers. In bad times, however, in a fund leveraged 54 times, a drop of a mere 2 percent in asset values could wipe out the entire equity of the investors.
But, we wonder how many investors are aware of the massive risks they have been exposed to in order to achieve the high yields that appealed to their greed?
As our readers know, we have previously termed that phenomenon as, "stealth risk."
Of course all this leverage would not have been possible if credit markets had not been so aggressive in their lending.
We have long pointed to the grossly inflated asset values of a world awash in liquidity — liquidity made possible by historically easy credit.
No wonder that today, Bloomberg ran an item referring just to European credit markets in which the Royal Bank of Scotland describes it as, a "bubble that has been blown up to almost obscene proportions."
[Editor's Note:Big Government Lies Exposed. Go Here Now.]
We agree wholeheartedly with that comment.
However, we were very interested that, in the very same Bloomberg item, an American analyst at JP Morgan Chase & Co offers the soothing-siren advice, saying that spreads are, "in the zone where investors should be buying."
We are frankly shocked, but not surprised that a "responsible" American banker is advising his clients to "buy" debt in face of what we have long advised our readers will probably prove to be one of the greatest credit crunches in history!
A downgrading of debt instruments causes selling to levels where the new, higher yields reflect the newly perceived risks.
Credit down-grading also forces sales as debt. As higher grade debt, held by some major financial institutions (insurance/trust companies and the like), falls to credit levels at which those institutions are no longer permitted, by industry regulations, to hold the debt instruments.
Added to the problem of official downgrading of marketable debt, is the problem of allowing the establishment of a depressed market price for a category of perilously non-marketable debt instruments.
Here we turn again to the great purveyors of hidden (stealth) risk, the hedge funds.
As we have pointed out many times, many of the assets of hedge funds are in "privately" placed instruments, including both equity and debt.
As there is no liquid market for the instruments, accounting rules allow the investments to be held on the books of hedge funds at "cost" regardless of any underlying concerns as to their eventual value.
If, however, a holder of a tranche of a series of private debt puts even a portion of their holdings up to public auction which triggers a sale, a perceived "market price" is established. Then the accounting rule demanded that all holders of other tranches of the same debt series mark their holding to "market."
This was the great risk to which Merrill Lynch exposed not only itself, but also all other holders of the same debt series of the troubled Bear Stearns hedge funds, recently in the news.
[Editor;s Note:Bernanke Reveals `Fiscal Crisis` Ahead]
Some tranches of the auctioned bonds were bid not at a two percent discount, but at fewer than 50 cents on the dollars! This was the prime reason for the abandonment of the auction! (Hide the truth at all costs!)
Nevertheless, it exposed just a part, of a major part of the truth concerning un-hedged, hedge fund risk.
As if that was not enough to rattle our credit markets, just listen for a moment to the new, news emanating from certain Wall Street observers.
As we write, CNBC is at long last openly raising questions about the credibility of the U.S. Treasury CPI inflation figures.
As our readers know, we have been pointing to the unreliability of the CPI. We have even been mocked for saying they are, "politically cooked."
But we are not alone.
As we write, Fed Chairman Ben Bernanke is on CNBC addressing an audience. He is referring most interestingly to the importance on inflation rates of "public perceptions of inflation." We agree, but we point out that we Americans have long been brought up to believe our government.
The trust of many Americans in the government's word has been severely tested by the Iraq war. We believe they will be tested far more severely over the inflation figures which, at less than a third of what we think is real rate, now threaten to cut their investments, savings, and our currency to shreds.
We also note that Mr. Bernanke's voice is very shaky and uncertain as he takes in a public discussion of inflation. He knows the truth and he both looks and sounds scared.
We also note that that University of Michigan's Inflation Expectations Index rose by 10 percent from 3 percent to 3.3 percent in April and May. Although some 50 percent above the CPI, this is still some 50 percent below the true rate of 6 percent, as indicated in chart 1 below.
Now, it could be that Mr. Bernanke normally sounds nervous when speaking in public. If so, our readers should discount our concern at this "body language" indicator of the truth.
Recently, I chatted with my former colleague, Lou Dobbs of CNN. In response to my question on the sham inflation numbers, Dobbs replied bluntly, "I have no faith in the CPI numbers . . . My faith has been shaken by the insistence of government not to reveal what our officials do know . . ."
[Editor's Note:Buffett: The best book ever written on investing.]
As long ago as September 16, legendary inflation-buster Paul Volcker said he was, ". . . worried about inflation and the [political] pressure [put] on the U.S. central bank to do nothing about it." (That is, to keep rates on hold rather than raising them.)
At that same day conference, Gerald Corrigan, managing director of Goldman Sachs Group was reported as saying (after the legendary Volcker had spoken), "There is a small risk that the old inflation genie could sneak out of the bottle on us again. Once the genie is out of the bottle, it is very, very difficult and expensive to put it back in the bottle."
We agree totally with Corrigan's last sentence. Worse still, we feel that the inflation genie, which we term "stealth inflation" is coming out of the bottle, with true inflation at 6 percent minimum (see chart 1). Furthermore, the inflation genie loves the growth inspiring low interest rate and easy credit environment. It is the ideal climate for inflation growth.
As we have said before, we believe our Fed is frozen by fear. It is in a state of public denial and keeps it key federal funds rate at 0.75 percent below what we see as the "true" inflation rate.
So we ask our readers to think, what will happen to the obscene credit markets and especially to their largest clients if the Fed is forced to accept reality and raise rates?
Finally, we draw our readers' attention to the fact that tomorrow (Wednesday) there are no less than three Congressional hearings into, guess what . . . hedge funds!
We feel that, led by the sub-prime debt market, and closely followed by a mushrooming hedge funds problem, embroiling many previously prestigious financial lending institutions, the credit markets are unwinding, big time!
Stand by for the fallout that we feel will reach both far wider and deeper than most expect.
Editor's note:
Big Government Lies Exposed. Go Here Now.
The Mother of All Financial Disasters
Bernanke Reveals `Fiscal Crisis` Ahead
Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.
Buffett: The best book ever written on investing.
