Monday, August 8, 2011

So What Do We Do Now?

It's not a very good day for the market, the US was downgraded and further sovereign downgrades are likely. After all, how does it make sense for France to have a AAA rating when the CDS market actually thinks it has a much higher chance of default than the US?  Also, Spain's AA and Italy's A+ ratings are a joke, so don't be surprised to see them in the B range soon.  This is going to create havoc not just in the markets but in the actual solvency of US banks themselves.  Our banks have about $640 billion in exposure to the PIIGS (Portugal, Ireland, Italy, Greece & Spain) much of it in credit default swaps (CDS) our banks wrote because they thought the debt of those countries was safe.  Clearly, if you start seeing a chain reaction in Europe of defaults, that could easily sink our banks who would then need ANOTHER bailout (note the severe weakness in the shares of Citigroup and Bank of America lately, though granted much of it is due to the ongoing mortgage mess).  The problem is, where is that money going to come from?  We obviously can't afford another TARP plan (boy that $862 billion Obama wasted on his first stimulus would sure have come in handy if the fit hits the shan) and barring just turning on the printing presses and handing out cash directly, there doesn't seem to be much the Federal Reserve can do either.  Trying to save our Too Big To Fail (TBTF) banks might have created a problem that is just Too Big To Solve.

I do realize the picture I'm painting in the above paragraph is pretty negative and is probably the worst case scenario.  But as we saw from 2008, even worst case scenarios can turn out to be conservative as you never really know what the real risks are in a complex global financial system.  After all, who would have thought that GE might be in danger of missing payroll because Lehman went under?  That is something that happened after a money market fund lost money on Lehman debt, causing a run on money market funds, which fund the commercial paper market that helps corporations meet day to day cash needs.

So where to invest when times are like this?  There really aren't any good answers to that one.  A lot of people would say gold.  And they are probably going to be correct long term as you can definitely see the scenario where both the ECB and the Federal Reserve start the printing presses en masse.  My only problem with gold though is that EVERYONE seems to own it and once you start seeing hedge funds go bust or have to liquidate positions for margin calls, you can see gold take a huge hit in a very short period of time.  It could very easily go down 30% from here, at which point it would make sense to buy.  I'd probably stay away from other commodities as many are related to the economy and as you can see with Oil being once again at $83, they can move down pretty fast.  It times of crisis, all correlations go to 1, even when they really shouldn't. 

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