Earlier today, BNP Paribas SA, France's largest bank, announced that it froze three asset-backed securities funds because it's no longer able to fairly value the funds' holdings due to "the complete absence of liquidity in certain market segments of the U.S. securitization market …"
Our readers will not be surprised as we have long warned of this growing credit disaster.
In response to BNP Paribas's announcement, the European Central Bank pumped 94.8 billion euros ($130 billion) - the largest amount ever - into the European banking system in an effort to prevent a credit crunch.
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Meanwhile, President Bush, looking worried, said in his press conference this morning, "All the evidence in the housing markets, points to a soft landing."
Given the real fear, of which Jim Cramer allowed us a brief glimpse in his "meltdown" interview on CNBC last Friday, the President's statement was nothing short of amazing.
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If that were not enough, the President had previously claimed, in his prepared introduction, that, "The American economy is the envy of the world." Try telling that to the foreign exchange markets!
These statements were not just amazing, they were frightening.
Of course, our leaders are expected to sound upbeat in the face of reality. But upbeat statements must have credibility. If not they sound out of touch and create yet more concern.
The President's statements clearly had no credibility and certainly had us more worried.
We are increasingly concerned that our government is asleep at the switch and is merely reacting with soothing words, when the truth of the underlying economic and financial problems, that have long been clear to people like us, emerge into the open.
What is needed is decisive leadership as we urged on the Fed earlier this week.
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Something meaningful has to be done to allow cooler heads to revalue the denial of real risk, over the past few years of greed.
It is understandable that banks like BNP are unable to assign a fair value to their assets. This is for three prime reasons.
First, derivatives are often very complex. Many in top management do not fully understand them. Least of all are they certain where the ultimate risk is being held.
Secondly, the liquid, traditional subprime credit market has effectively dried up. So there is no "normal" market price.
Plus, if the owners of this unwanted debt were to offer their assets for auction, they may be able to fetch only a fraction of their value. This would trigger a revaluation of other similar assets. If a significant write down of assets were to happen, it could place many major financial institutions in liquidation.
So the third reason is an acute fear of admitting the reality of a fall in their asset values and an unwillingness to sell. So they freeze their funds to prevent their investors (clients) from selling.
(On this point, Aug.15 could become a key date. It is the last date, by which hedge fund holders have to give notice of a sale, for the last quarter of 2007, the very quarter that we believe could prove to be traumatic.)
As we said yesterday, Bear Stearns has even sought the protection of offshore jurisdiction to allow it to avoid investor claims.
Aside from soothing words, it now appears that our politicians are thinking of bailing out the greedy lenders in what was a subprime lending boondoggle.
And that means throwing ultimate liability onto the back of the taxpayer. How's that for capitalist, free market accountability?
How does all this affect the ordinary investor, who is not directly involved in the subprime lending scandal?
As my colleague David Frazier so ably points out today in MoneyNews.com, the sad news is that the subprime lending crisis is only a sideline. A most important sideline, but a sideline, all the same.
[Editor's Note:12 Ways to Recession Proof Your Portfolio]
The real problem, for the bulk of our readers is that there is increasing and cumulative evidence that American consumer spending is slowing down. This is the really serious problem, still denied by most of Wall Street, its media cheerleaders and by our senior politicians.
Consumer spending accounts for some 70 percent of our GDP. Any slowdown will affect both our economy and our equity markets severely.
Already, we are seeing large institutional money managers who are paid to be in equities, rotating into defensive stocks such as healthcare, consumer staples, and utilities. (The later, as they appear to be anticipating a Fed rate cut, as our government wakes up to the seriousness of our economic position.)
Earlier this week, I used a boxing analogy, when describing the antic of the Fed. Continuing on that vein, we believe that the subprime debacle will prove to be a major shock.
We also face other potential shocks.
If the Chinese do actually sell dollars, as they have suggested they might do, in the event the U.S. imposes tariffs on Chinese imports - even some of their U.S. dollar holdings - it would provide an additional shock.
If our Fed were forced to raise rates either to combat stealth inflation, we have long told you about, or to defend the U.S. dollar from a meltdown, it would provide yet another severe shock.
Now, a boxer, who may be tired but is still strong, can absorb the shock of even severe blows. On the other hand, when he is weak, one major blow can put him on the canvas.
Contrary to the siren words of Wall Street, its cheerleaders and our senior politicians, we believe that our economy is turning down and has been for some three months or so.
This means that, in boxing terms, we are now (economically) weak.
We are now in so much danger that a shock, such as a severe credit crunch, could put us on the floor, economically.
So, the importance of the subprime debacle is not restricted to even the vast debt markets. It can easily spill over into economic depression.
We do not believe that today's Presidential statement, "Our economy is the envy of the world," is credible right now and the price of our dollar reflects that sentiment.
We urge our readers to remain cautious.
Editor's note:
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The Mother of All Financial Disasters
12 Ways to Recession Proof Your Portfolio
