This week has started off miserably. China had problems within their banking system last night as bank transfers, ATMs, online banking and wires did not work. Europe announced that their E500 billion bailout fund for banks is no longer the case; they now say that 60 billion Euros will be the limit…retroactively. To put this in perspective, Spain had already been promised 100 billion Euros for their banking system; I guess the money is not coming? Our stock market has started the day down 230 points and the 10 yr. Treasury yield is now 2.64%, this is another .12 basis points higher on the day and now nearly 70% higher than it was back in April.
As I wrote over the weekend, this is “one gigantic global margin call.” Please understand how many of these interest rate derivatives work. When the rates go against you, “margin” must be posted. By “margin” I mean collateral. Collateral must be shifted from the losing institution to the one on the winning side. When the loser “runs out” of collateral…that is when you get a situation similar to MF Global or Lehman Bros., they are forced to shut down and the vultures then come in and pick the bones clean…normally. Now it is no longer “normal,” now a Lehman Bros will take the whole tent down.
To put in perspective what is happening, Zerohedge calculated that the Fed lost $35 billion this morning alone and $250 billion over the last 2 months. The Fed only has (had) $65 billion of equity capital yet in just several hours they lost half of it…again…this is because they hold $3.5 trillion in assets. This is the equivalent of a trader putting up $2 and buying $100 worth of assets, they have 50-1 leverage. They may not even be the most egregious out there. There are derivative contracts that are over 100-1 leverage that must post collateral each day. At least the Fed doesn’t have to post any collateral against losses because they can be “trusted.”
Can you see what is happening? The “button has been pushed” either on purpose, inadvertently or because “they had to.” Banking laws over the last 3 months have been altered to allow “bail ins” where depositors lose rather than governments “bailing out” losing banks. Do you think that these laws were changed by mistake, or inadvertently? No, the laws were changed because they KNEW this was coming. Now control has been lost in the sovereign government bond markets which are creating “losers” all over the place. The problem now is that the entire world’s banking system is a chain, a daisy chain where if one goes down…they all go down. Yes, yes I know, there are those running around saying “but we are hedged”…so there is nothing to worry about. Really? Someone somewhere is on the losing side of the trade. With over a $1 quadrillion (with a big fat capital Q) derivatives market a 5% move creates over $50 trillion worth of winners and losers. Do you know of any institution that could absorb even a small piece of this? What if JP Morgan took only 2% of this loss, could they pony up $1 trillion? Maybe… and only… if they could use customer funds would be my first thought.
Unfortunately it looks like the U.S. Treasury market is experiencing some forced selling. This may abate and we may get a rally where everyone thinks “Whew, that was close.” This happens almost always during a crash sequence. “The worst is over” and confidence briefly comes back, this would not surprise me at all. Don’t be fooled by this however as the detonation has already occurred and cannot be reversed.
I must confess that I had no idea that China’s banking system went into seizure mode until I woke up this morning. I mention this because as you know I believe that when this comes it will be a Monday morning event. Will it be China? Japan or Europe? Surely not the U.S.! Will it be the banks? Or will it be a broker, insurance company or even a sovereign govt. itself? I don’t know and it really doesn’t matter because the result will be the same no matter where “the chain breaks.”
Please ask yourself this question, “If I woke up this Monday morning, today, in retrospect, and the world had blown up financially over the weekend where the banks did not open for whatever reason…would I have been ready for it?” Maybe a bad question because NO ONE can ever really be ready for it but have you done everything that you think necessary? This is a very real question. What would you be doing right now if the banks didn’t open this morning? Would you go to work? Would you be going nuts and trying to scramble to figure out a way to buy food for the next week? Would you be calling your broker to see if they could cut you a check (which no bank could cash until “later”)? What would you be doing?
I could go on and on but you really do need to ask yourself this question now because the threat is not only real, mathematically this is what will come…whether you are ready or not.