InvestorsInsight Publishing

Where Do We Go From Here?

John Mauldin — Sat, 11 Oct 2008 03:20:20 GMT

Construction Lending: The Next Shoe to Drop
Lehman at the Center
Iceland Guarantees What?
Letters of Credit: Going, Going Gone?
What to Do and Where Do We Go from Here?
London, Stockholm, and California

I have been writing for almost a year that the next shoe to drop on US banks would be commercial construction lending. Today we look at some hard numbers. We look across the pond to sort out the problems in Europe. We look at the consequences of the losses stemming from Lehman. Then we look at one of the more serious consequences of the banking crisis, one that will bring the crisis home to you. Finally, we look at what the various governments of the world must do in response. It may not be fun, but it should be interesting. And it is important. Feel free to forward this letter to anyone who asks why we not only need the bailout but will need even more coordinated government action.

But first, let me offer a note of optimism before I serve up the not so good news. This is not the end of the world. There are a lot of very positive things happening in the US and the world. Companies are creating new inventions. Much of the economy, including health care, is moving along fine. I have lived through two serious recessions (1973-74 and 1980-82), and the point is that a free-market economy will find a way to eventually get back to solid growth. Recessions are simply part of the business cycle. Congress cannot repeal the business cycle. This will not be the last recession of my life. I hope to live long enough to go through 4 or 5 more.

Depressions are caused by governments making major policy mistakes. And we have made some in the areas of not regulating mortgage lending, allowing the five large investment banks to increase their leverage to 30 or 40 to one in 2004 (what was the SEC thinking?), and failing to oversee the rating agencies. That is behind us. It will make a normal recession deeper and the recovery longer, as I have been forecasting for some time.

But as I argue below, immediate actions must be taken by the government to avoid a much deeper problem. To not take actions to stem the credit crisis would be that major policy mistake which would compound all the other mistakes. I think everyone knows the seriousness of the problem and will act. Let's pray they do.

But whatever happens, there will be plenty of opportunity for investors and entrepreneurs to exploit. The world is on the cusp of a remarkable explosion of new technology of all sorts that will transform our lives. This march of progress went on unchecked last century, through two world wars, major depressions, numerous smaller wars, recessions, financial crises all over the world, famines and natural disasters, not to mention a lot of man-made ones.

The current crisis will pass. None of us will want to go back to the "good old days" in 20 years, for we will be living in the best of times. Just make sure you keep your powder dry so that you can enjoy it. And now, let's look at some less than uplifting news.

Construction Lending: The Next Shoe to Drop

The Bank Credit Analyst is one of the more reliable sources I know for information. They estimate that total losses from the current debt crisis could be anywhere from $1.1 trillion to $1.7 trillion. They estimate roughly half to be in the banking sector, or around $750 billion, and almost $590 billion of that has already been written off. That means that the $700 billion from the TARP (government bailout) program may actually be enough to handle the losses and inject some actual capital into the banks. Maybe.

The losses from subprime and other mortgage-related loans are well known. Most of those losses are in the larger banks, as smaller banks simply could not participate to any great extent. What is less well understood are the potential losses which smaller banks are in fact exposed to in the area of construction lending. Lisa Marquis Jackson, now writing for John Burns Real Estate Consulting (one of the best sources for hard real estate data), gives us some answers to the question of "how much?"

Outside of the large home builders and developers, most of the lending for construction of homes and commercial property comes from regional and local banks. A local home builder may finance 5-10 homes, or a developer a small strip mall or apartment complex, from their local bank. Look at the graph below. Since 2001, delinquencies had been rather small and well-contained. Then starting 18 months ago, the delinquency rates started rising.

Again, note that these are delinquency rates for business loans from banks and not for individual mortgages.

Over 16% of loans made for condominium construction are now delinquent. Loans made for single-family home construction are only slightly more than 12% overdue. But that masks a much bigger problem. Single-family loans account for 86% of all for-sale residential construction loans outstanding.

The good news is that for the top 100 banks by size, single-family loans make up only 2% of the total. But that small portion totals $245 billion. And condos add another $41 billion. That puts almost $40 billion at risk of default at today's delinquency levels.

It will be worse for many smaller banks, as they have larger commercial construction loan portfolios. As noted below, this may require some proactive action on the part of regulators.

Lehman at the Center

Now we know the consequences of allowing Lehman to fail. The severity of the credit crisis was deeply, severely worsened by the failure of Lehman. Based on the results of the credit auction today, sellers of protection will need to make cash payments of more than $270 billion, BNP Paribas SA strategist Andrea Cicione said in London. Some funds may be forced to dump assets to meet the payment demands if they haven't hedged.

How much of that debt will eventually have to be absorbed by various government programs or direct capital infusions? It is too soon to say, but you can bet it will be a lot.

If there is any good news to this, it is that much of the write-downs have already been made. It now looks like the Lehman CDS market sorted itself out with no failures, according to the International Swaps and Derivatives Association.

We have dodged a huge bullet. But the anguish this has put the credit markets through the past month was avoidable. The CDS markets MUST be made to migrate to a regulated clearing entity like the Chicago Mercantile Exchange. Next week would be a good time. While there have been serious losses by various players in other exchange-traded markets, there was no systemic risk, as everyone knew the value of their various securities, whether futures or options or other derivatives, and knew they would get their full value when sold.

With Lehman, no one really knew until late today. Thus banks and hedge funds had to sell anything they could in order to meet possible payments or losses, which caused wildly swinging prices in every market.

It is my bet that future memoirs of the various main actors and books on the credit crisis will look back at the failure of Lehman as the proverbial "last straw" for the unregulated CDS markets.

Iceland Guarantees What?

Let's get this straight. Iceland is a country of 300,000 people. I've never met an Icelander I didn't like. They are an extraordinary people. A few decades ago, they made their money on fishing, farming, and trading. Then they discovered banking and started to take deposits from anywhere and everywhere and make loans outside the country. Soon, the various banks' assets were over $140 billion, about 10 times the total GDP of the country, and they had far more foreign depositors than citizens. With foreign reserves of just 2 billion euros, what could the government do if there was a crisis?

Now Iceland has had to take over the banks and guarantee deposits. They also had to turn to Russia for a loan. Does anyone think Putin would hand out a no-strings-attached loan? Russia needs a refueling station for its Navy and will likely get it.

Note that Iceland gave its citizens the ability to withdraw money but did not extend that same privilege to the citizens of other countries. England and the Netherlands have already gone to court.

As noted by good friend Dennis Gartman this morning, "Since then, things have only gotten worse, with the UK government moving to freeze the assets of Icelandic companies in the UK, and Her Majesty's government has said that it will take whatever further actions it deems necessary to protect the assets of British companies and citizens currently held in Iceland, doing 'whatever is necessary to recover [our] money.'

"Thus, not only are banks fearful of lending money to banks; and not only are banks fearful of lending money to individuals and/or companies; and not only are individuals and/or companies fearful of lending money to the banks, but now nations are fearful of lending to other nations. This is Smoot-Hawley writ large, and of all of the circumstances that have prevailed in the course of the past several days, this is the worst; this is the most difficult to deal with. This is madness."

As noted last week, Ireland set off a feeding frenzy when it guaranteed all deposits in its banking institutions. Five billion euros poured in over the last week. One by one, European governments are having to guarantee their loans to keep money from leaving their institutions.

Let's look at the Irish guarantee on the face of it. There are six Irish banks, holding assets of $576 billion. That works out to three times Ireland's gross domestic product, or about $200,000 for every working person in the country. (Bedlam Asset Management) Yet depositors flooded them with money in just a few days.

This is a sign of panic. One goes where one can, trying to protect what one has. On the face of it, how could Ireland really guarantee all the deposits? Yes, there are real assets against the loans, but at what price? Could Ireland borrow enough to make good on even a portion of those assets, should they decide to walk? This is sheer panic.

Letters of Credit: Going, Going Gone?

Just as the business world is dependent upon commercial paper as its life blood, the world of global trade depends on letters of credit (LOC). Without LOCs, the world of trade quickly freezes up.

If you are a manufacturer of a product and want to sell to someone outside your borders, you typically require a letter of credit from the buyer before you load any cargo at a port. A letter of credit from a prime bank is considered to be proof of your ability to pay. It not only can be a source of ultimate payment, it can be a source of inventory financing while goods are in transit.

And if you are a business which is buying a product, you do not want to release money until you know the product is on the way. There are buyer's and seller's agents who make sure these things happen seamlessly, and world commerce had grown because of it.

Now we are starting to get anecdotal evidence that this extremely vital market is also freezing up. If you think the problems stemming from a meltdown with the commercial paper markets are threatening to the world economy, they are small potatoes when compared to a seizure in the letter of credit markets.

I had been thinking about this for a few weeks. Then an article posted on Naked Capitalist caught my eye. Quoting:

"At the end of the day, if every counterparty is bad then you don't have a market and you don't have an economy. I spoke to another friend of mine this afternoon, whose father has been in the shipping business forever. Pristine credit rating, rock solid balance sheet. He says if he takes his BNP Paribas letter of credit to Citi today for short term funding for his vessels, they won't give it to him. That means he can't ship goods, which means that within the next 2 weeks, physical shortages of commodities begin to show up. THE CENTRAL BANKS CAN'T LET THAT HAPPEN OR WE HAVE NO ECONOMY, LET ALONE A CREDIT SYSTEM."

And they quote the following story from The Financial Post of Canada:

"The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.

"Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.

"'There are all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit,' said Bill Gary, president of Commodity Information Systems in Oklahoma City. 'The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy.'

"So far the problem is mostly being felt in U.S. and South American ports, but observers say it is only a matter of time before it hits Canada. 'We've got a nightmare in front of us and a lot of people are concerned it's going to get a lot worse,' said Anthony Temple, a grain marketing expert based in Vancouver.

"Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world's trade by volume goes by ship. 'The credit crisis has made banks nervous and the last thing on their minds is making fresh loans,' Omar Nokta, an analyst at investment bank Dahlman Rose, said in an interview with Reuters.

"While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before."

If banks are refusing to go into the LIBOR market and lend to each other, then why would they want to take a letter of credit either? At first, it will be a small trickle, which is how the commercial paper meltdown started. Then it will be a flood.

The one good sector in the US is its export sector. Start slowing that down due to a lack of ability to ship or receive payments and see what happens to an already shrinking economy. If anyone wants to see how the credit crisis can affect Main Street, look no further.

It is hard to overstate the problem and the potential for it to create a true economic meltdown. It must be dealt with, and soon. See more below.

What to Do and Where Do We Go from Here?

The credit markets are frozen. Period. The chart below shows one week LIBOR going back for four years. Notice the gradual rise into 2005? It was a lock-step move with the Fed funds rate. And the less smooth drop was also in concert with the Fed funds rate. The recent spike is not responding to this week's Fed funds cut. The spreads are wider than ever. The problem is not just the price of LIBOR. There is no trading at any price. The LIBOR market is a fiction today. And left unchecked, this lack of dealing with other banks will spread to letters of credit and the international trade markets.

The G-7 group of nations is holding an emergency meeting this weekend. As I write this, reports are coming in that there are serious disagreements as to what to do. They cannot even agree on a press release.

Former Federal Reserve Chairman Paul Volcker urged that "all of them [the G-7 nations] now admit or all of them own up to the fact their own banks are going to need support," in an interview on PBS Television's Charlie Rose Show yesterday.

The real leadership and innovation in the banking crisis seems to be coming from London. UK Chancellor of the Exchequer Alistair Darling told Bloomberg Television that "It is absolutely essential that the world's largest economies act together, and act together now." Darling wants countries to guarantee lending between banks, either by turning central banks into clearing houses for the loans or having governments back them. (Bloomberg)

Sadly, he is right. It has come to that. We are close to the point of no return. Now, we are not talking about bailing out financial institutions. We are literally talking about saving the world economic system. Failed bank lending and a large decrease in letters of credit would guarantee a deep world recession. The last depression produced severe political backlash and a world war.

Frankly, it is simply not worth the risk to say that we should sit back and let the markets work. They are not working, and there are no signs they will. As with a patient whose heart has stopped, it is time to apply the shock treatment.

What should we do? We must simply guarantee LIBOR (interbank) lending worldwide for some period of time (say 3-6 months) or until banks can trust each other's balance sheets. With the Lehman crisis going on, with more mortgage credit problems being revealed, no one knows what their own exposure is, let alone what the exposures of other banks are. Until that dust settles, the LIBOR market will remain frozen. The longer this is allowed to continue, the worse the problems will be. And it needs to be handled on a coordinated basis.

Banking is truly global. The system cannot just be guaranteed by England or the US. It must be done in concert with all major nations contributing their share. Businesses must be able to trade across borders through banks that will accept one another's letters of credit.

Second, we must consider direct investment in some banks. This should be done as preferred shares, with the view to eventually selling the paper back into the market. To make sure that money is not invested poorly or on bad terms, the various governments should invest alongside private investors, on the same terms. If a bank cannot find private investors willing to invest alongside the government, then they should be quietly assisted into the arms of stronger banks. Banks that are too big to fail must be taken over.

Businesses must have access to credit as well. They cannot get it from banks with impaired balance sheets. This is critical to world trade as well as local commerce.

Third, for a short period of time, all bank deposits in the US must be guaranteed. Weak banks must be absorbed into stronger banks as soon as possible. There are banks with large construction loan books in the hardest-hit parts of the US housing crisis, and they need to be put down as quickly as possible. We are already seeing deposits leave banks, many of them small, due to depositor concerns that small banks will not be seen as too big to fail. This must stop. A blanket guarantee will help.

Fourth, mark-to-market rules must be reconsidered. A blanket one-size-fits-all rule clearly does not work and is part of the problem. As I have documented for the last month, there are numerous assets that have a market price far below their intrinsic value. That is because there are simply no buyers. If everyone is selling in order to raise capital, then that will drive down prices to bargain levels below intrinsic value. That does not mean the asset in question would not have a higher value in a market not in crisis.

These are extraordinary times. I know there will be those who believe the markets should be allowed to work or simply want those who created the crisis to pay. I do understand the anger. I too am angry, and have been for a long time. Those of us who saw this crisis coming are frustrated that no one bothered to pay attention.

But now that we are in it the midst of the crisis, there is no going back. We must look forward and do what we can to avoid an even worse crisis and potential depression. I believe we can do so if governments act promptly.

We are already in what will prove to be one of the longer recessions on record. If we look at the Leading Economic Indicators, which have about a 9-month forward-looking view, it will be late next year before we start to grow once again. Given that everything peaked last October through January (sales, employment, etc.), it is likely that the recession will be dated from the beginning of this year.

Long-time readers know I have been wary of the stock market for several years, suggesting that investors either avoid stocks or have close stop losses. No one taking my advice is long-only this market. Not that I have been perfect, but as it turns out, I was right on this one.

I have been fielding calls all week asking me if I think we are close to a bottom in the stock market. And my answer is, we are close to a short-term bottom, but I think we will trade lower over time due to what I think are going to be poor earnings for the next few quarters. If you are a trader (and that means you have been doing it for some time - not the time to get on the job training!), then maybe you can catch a rebound, which is overdue. But (and here is the big caveat) if there is no global coordination on some or all of the recommendations I made above, this is not going to be pretty. It will end in tears. Let's hope the authorities can get their collective act together.

The next two weeks I'll send a two-part letter on the longer-term investment view and how you should position your portfolios. Stay tuned.

London, Stockholm, and California

Next Thursday and Friday I am in Southern California, speaking at two financial planning conferences. Saturday I leave for London to meet with my London partners, Absolute Return Partners, and clients. Then on to Stockholm, where I will speak for the now-Swedish-government-backed bank Kaupthing. The government took the bank over last Monday (it was affiliated with the Icelandic bank of the same name). That conference will be on investing in an age of scarcity. I will be speaking and chairing the panels, and good friend Marc Faber will be there as well. It will be an interesting time to be in London and Europe. A quick trip to Malta, and then I will make my way back to Dallas.

Tomorrow night all seven of my kids and family will gather to celebrate my son Chad's birthday and mine as well (it was last week). It will be nice to have them all under the roof, if only for a day or two. And a pleasant reminder of what is really important.

It is time to hit the send button. My friend Jack Harrod has front-row seats on the glass for the Dallas Stars. I don't understand hockey, but it is exciting sitting that close. All the best, and have a great week - and here's hoping for a bounce in the markets.

Your hoping we see some positive news this weekend analyst,

John Mauldin

Who Owes Who?

Chuck Butler — Fri, 10 Oct 2008 14:09:05 GMT

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In This Issue….

* Trading theme pushes yen higher...
* Settlement day for Lehman CDO's...
* Oil price fall hurts loonies...
* Gold climbs back above $900...

And Now... Today's Pfennig!

Who Owes Who?

Good day... And a Happy Friday to one and all! It certainly doesn't look as though it will be a Fantastico Friday in stocks, as yesterday was a bloodletting, and overnight the Japanese stock market sold off 11%, and Europe is down about 9% at this point. UGH! This is getting quite ugly...

But remember what I've been saying this week about the currency trading theme... When things look bleak, the dollar goes up... And when it looks as though all the stimulus might work, the dollar sells off... This has been quite evident in Japanese yen overnight, as stocks sold off 11%, the currency rallied to a 98 handle from 101 yesterday... And... Then in dollar trading, other than yen, the dollar is stronger this morning, pushing the euro back to the 1.35 handle. The high yielders, which enjoyed a day in the sun yesterday before U.S. stocks took a turn on the slippery slope, got whacked hard overnight! UGH!

When I told you the other day that this is darndest thing in the financial markets that I've ever seen, and that I had begun my career in the brokerage industry in 1973, I wasn't kidding... I was dead serious... And I started tracking currencies in 1985 when we began the WorldCurrency desk at the old Mark Twain Bank. The reason I take you on this journey back in time is to illustrate the fact that the Aussie and kiwi dollars have fallen so much this week, that you have to go back 25 years to find another week like this one for these two currencies. 25 years! 1/4 of a century! 1 score and 5 years! Simply unbelievable that strong countries like Australia and New Zealand, full of natural resources and located near China, would go through these daily beatings...

When I arrived this morning, the TV was on, and Bill O'Reilly was talking about that crazy Jim Cramer, and how he told everyone earlier this week to get out of stocks.... O'Reilly said something to the affect of: you shouldn't pay attention to Market Analysts' advice on TV... And then he said, "and those stupid newsletters"... I thought for a minute... And then said, "it's OK Chuck, he said "giving advice"... You don't give advice, just opinions!" Whew! I thought for a minute he was calling the Pfennig "stupid"!

OK, back to the task at hand... And that is reporting on this financial market meltdown... I don't mean to sound flippant there, this is serious stuff folks! Looks to me as though the Fed is going to have to round up the posse once again and get another coordinated rate cut, because the one they made earlier this week, hasn't produced the W-2 they need to unlock the seized up credit markets.

The Wall Street Journal reported that the U.S. Government is considering following the UK’s lead by guaranteeing billions in bank debt and temporarily insuring all US bank deposits. This did little to appease the markets. What is going to appease the markets? The Fed and Gov. has turned over a lot of rocks, but the credit markets are still locked / seized up...

There are rumors going around this morning that today will be the "settlement" of the Lehman Brothers default... And while normally this wouldn't cause problems, it has this time, because of those darn Credit Default Swaps (CDS)! Here's something to think about folks... a CDS allows the holder of some debt (e.g. a portfolio of subprime mortgages) to get insurance on the risk of default of that debt from a third party such as a bank, insurance company or other entity. In this case, buyers of Lehman Brothers bonds and other debt securities are looking for the payoff of credit default swaps they purchased.

In this case... Banks are hoarding cash in expectation of pay-outs on up to $400 Billion of defaulted credit derivatives linked to Lehman Brothers and other institutions, according to analysts and dealers. This is when, we'll find out "who owes who" and if they have the cash to pay their obligations should they fall into the category of a "who that owes who"!

The Fannie and Freddie settlement went off at 98-99 cents, thus not a "default" and didn't cause as much of a ripple in the markets as first feared... But this Lehman thing is a horse of the different color, folks... We'll have to see how the markets deal with this today... Could add more fuel to the trading theme of: if it's bad for the U.S. buy the dollar, and if things get better in the U.S., sell the dollar... Strange, I know, but I've seen this before back in the 90's...

Have you been tracking the fall in the price of Oil? This is just as amazing as the run-up in the Oil. Could we actually see the return of less than $3 gas? Now that would be amazing as far as I'm concerned. It has fallen almost $5 overnight! This has led to the sell off in Canadian dollars / loonies. The loonie has fallen to an 18-month low of 86-cents! UGH!

The fall in the price of Oil also is probably going to help the Trade Deficit, which prints this morning. The August Trade Deficit is expected to narrow from $62.2 Billion in July, to $59 Billion. This would be a huge indicator that not only 1. the price of oil has fallen dramatically, but 2. the U.S. consumer is finally spent! And that my friends is another nail in the coffin of a long painful recession...

Yesterday, I read this in the Wall Street Journal... "The U.S. economy has sunk into a recession and government action is critical to stem the damage, according to economists in the latest Wall Street Journal forecasting survey. On average, the 52 economists surveyed now expect gross domestic product to contract in the third and fourth quarters of this year, as well as the first quarter of 2009. If those predictions bear out, it would mark the first time U.S. GDP -- the total value of goods and services produced -- has contracted for three consecutive quarters in more than a half century."

I don't mean to say I told them so... But if those knuckleheads had listened for the past year, they would not be surprised now to say the U.S. is in a recession! It's been staring us in the face since January... But those that the U.S. consumer depend on to lead them told them there was no recession, and that everything was just peachy!

Gold is back above $900 again this morning... I find Gold's performance in the face of a falling Oil price and a stronger dollar to be very impressive indeed! But, in reality, I'm still scratching my head over why Gold isn't soaring, given the lack of supply of the physical metal... Someday, this will all be very clear to everyone what went on... But for now, we scratch our heads and wonder...

And in my, what now is required due to the severity of the situation, daily update of what's going on in Iceland... Yesterday, I was thinking about the white knight for Iceland, and I began to wonder where the heck the IMF is during all this? What are they doing? The should be there to iron out the problems and provide a streamlined clearing mechanism. But they are no where to be found! Well, the Netherlands has provided 20 Billion euros to Iceland financial institutions... That news came through last night. There still doesn't seem to be a "quote" available in krona, and that's very concerning to me. Maybe the Netherlands' 20 Billion euros will get the bank operations going again...

The U.K. is all mixed up in this Iceland mess, and has frozen Icelandic assets in the U.K. in hopes of getting some their U.K. depositors' funds out of Icelandic banks... This problem with Iceland has really caused some problems for pound sterling, as if pound sterling didn't already have enough problems of its own, now it has Iceland weighing on it too!

OK... Here I am again, getting close to going to the Big Finish, and I've been nothing but gloom and doom all morning, and that's not how I like to go into a Friday! So... Let's see... Oh! Japanese yen is trading with a 98 handle! This has been long overdue, and held back by the Carry Trades... But now the Carry Trade is dead (for yen), but who knows... Maybe if the U.S. Fed keeps cutting interest rates to deal with the recession, the dollar might end up taking the yen's place as the funding currency of the Carry Trade!

Currencies today 10/10/08: A$ .66, kiwi .5950, C$ .8635, euro 1.3555, sterling 1.6965, Swiss .8970, ISK (no quote), rand 9.3350, krone 6.2090, SEK 7.12, forint 195.50, zloty 2.6350, koruna 18.4910, yen 98.90, baht 34.40, sing 1.48, HKD 7.7580, INR 48.29, China 6.8359, pesos 13.60, BRL 2.2825, dollar index 81.65, Oil $81.50, Silver $11.75, and Gold... $916

That's it for today... Well... This is it for me for almost 2 weeks! I head out on the Currency Tour on Monday morning, and then finish up in Jacksonville a week later. I'm then staying in Jacksonville for a couple of days to meet with the "BIG GUYS" at EverBank. I haven't been to the headquarters since before I was sick in June 2007, so it's long overdue. Chris will have the conn on the Pfennig, right after he finishes the Chicago marathon this weekend! I head out to Columbia MO tomorrow, after my little buddy Alex plays football in the morning, to see my beloved Missouri Tigers play Oklahoma State... This will be a tough game for the Tigers... I'm worried... And... It's another night game so you can tune in and watch them play! That's all... I hope you have a Fantastico Friday, and a Wonderful Weekend, I'll talk to you in two weeks!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Lehman Credit Default Swaps Announcements Today

Vinny Catalano, CFA — Fri, 10 Oct 2008 08:35:00 GMT

If you are looking for a reason why stocks are plunging, here's one major reason.

Today, at 10:30 AM and then again at 2 PM (both eastern time) announcements re settlement of the massive Lehman Bros. credit default swaps will occur. According to one trading desk source of mine, the equity markets are far more concerned on this point than are the debt markets. Earlier this week, the settlement of Fannie and Freddie CDS' were announced.

While the settlement of the Fannie and Freddie loans was enormous, the CDS settlement prices were more than 90 cents on the dollar making the CDS losses far more manageable (less than 10 cents on the dollar). However, as the Financial Times noted last week, "In the Lehman case, numerous banks and investors have already made losses due to exposure to Lehman as a counterparty on numerous derivatives trades. The auctions next week are for credit derivatives which have Lehman as a reference entity. There are likely to be fewer contracts outstanding than for Fannie Mae and Freddie Mac because Lehman was not included in many of the benchmark credit derivatives. However, exposure remains unclear,..."

Expectations for Lehman CDS' settlements are in the 10 to 20 cents on the dollar range.

Investment Strategy Implications

The equity markets are pressured on multiple levels. One of them is the forced liquidations due to client redemptions, including mutual funds and hedge funds. In the case of hedge funds, it is unknowable at the moment but can be reasonably assumed that despite having an estimated 1/3 of their assets ($600B) in cash, many have exposure to credit default swaps and may incur huge losses as a result. Hence, forced equity liquidations.

By the end of day investors should have a far better idea just how extensive the counterparty damage is. Additionally, knowledge of the credit crisis process and the methods by which it will work its way toward resolution along with the interconnected dynamics of and impact to the real economy will advance. However, the psychological damage to confused equity investors may be far more long lasting.

Fear is feeding upon itself. And the greatest aspect of this fear is ignorance. Tragically, a leadership vacuum is evident with the failure to explain to the American public (and the world audience) what is happening and why. And in the process, panic in all its ugly forms is running rampant and time will show that many equity values being posted today do not reflect their true intrinsic value. In other words, we are clearly at the point where, just as with many credit instruments, mark-to-market in many equities do not reflect their fundamental realities.

To view the Lehman auction results, click here

To learn more about the credit default swaps settlement process, click here

Week of 10/09/2008

Research & Editorial Staff — Thu, 09 Oct 2008 14:47:00 GMT

Bargains Are Starting To Appear
A Bottom Fishing Check List
The Bear Isn't Finished Yet
Big Drops Lead To Big Rebounds
Financial Stocks Attract More Attention
There Is One More Shoe To Fall
The Biggest Question: Will The Bailout Work?
The Bottom Line This Week

Wall Street's thrill ride continued over the past week as investors made king-sized moves after every drop in the economic outlook. By the time the closing bell rang on Friday, the Dow and the Nasdaq were down 7.3% and 10.8% respectively. A good time was definitely not enjoyed by all.

Once again, investors saved their biggest gyrations for the following Monday when the market plunged some 800 points. Fortunately, the market regained 430 points before the end of the day. Stocks resumed their slide on Tuesday and Wednesday when they fell a total of 689 points.

Bargains Are Starting To Appear

It is encouraging to see that most of the big market drops are starting to attract bargain hunters, including big hitters such as Warren Buffett. That's not surprising since many stocks are clearly oversold when measured against their long-term potential.

We were delighted to see that one of the stocks Mr. Buffett picked for a multi-billion dollar investment was General Electric, a company we started to accumulate in February. Other stocks the value investors are buying include Burlington Northern, Cisco Systems, Coca-Cola, IBM, Kraft Foods, Hewlett-Packard, Intel, Procter & Gamble, and Pfizer – all of which have been recommended in The AIA Advocate.

A Bottom Fishing Check List

In times like these when the bear is still raging, successful bargain hunters don't take undue risks. Although they venture into the storm, they only buy stocks when the odds of winning appear to be solidly in their favor.

The first thing the bottom fishers look for is lots of cash and very little debt. With a strong balance sheet, a company can make it through a tough period even if it lasts quite a bit longer than expected.

The odds of success rise higher if the companies provide products and services that people need even when times are bad. Food, drug, and basic retailers are favorite choices.

Of course, stock fundamentals must also be right. A good rule of thumb is to find companies with price to earnings ratios that are close to their historic lows. For example, the P/E for SuperValu (SVU) is currently an attractive 7.3. By contrast, the P/E for Amazon.com (AMZN) is a stratospheric 42.6.

It's also highly desirable to get some income while waiting for the big payoff. Comparing SuperValu and Amazon again we find a 3.3% dividend and none at all, respectively.

The Bear Isn't Finished Yet

With all the fear we see in the market today, we doubt that stocks will turn around any time soon. First there needs to be a stomach churning washout, an ugly process Wall Street calls capitulation. It occurs when investors become so discouraged they keep selling stocks no matter how cheap they are becoming. When the last of the stragglers are out of the market, stocks will finally stop sinking.

Once a floor has been reached, smart money will begin to come in from the sidelines where it was waiting patiently for months. The influx of cash will solidify the market bottom and lay the groundwork for a recovery.

Currently, the market's partial rebounds after every drop indicate that the capitulation phase of the downturn is still to come. When it finally arrives, we hope you look beyond the carnage and remember the event marks the end of the bear market.

Big Drops Lead To Big Rebounds

Although the final stock market shakeout is still on the way, we continue to think you should begin to do some cautious value buying. Dr. Steve Sjuggerud of DailyWealth (www.dailywealth.com) looked at 150 years of stock data and found that over the past 70 years, there was only one time that the market turned in a worse 12-month performance than the period that's currently ending. (Assuming that stocks finish October about where they are now.)

Dr. Sjuggerud also found that when stocks had a terrible 12 months, they usually followed up by having 12 very good months. The only exceptions were after the dot-com bust and the Great Depression. However, stocks were at record highs during those two times, which is certainly not the case today.

There is one caveat: the relationship between year-long declines and recoveries only applies for the worst 12 months in a bear market. We may not be there yet.

Financial Stocks Attract More Attention

We were pleased to see the article, Financial Stocks, Yes Financial Stocks, To Consider in Barron's this week. As you undoubtedly recall, we have been recommending the group since the meltdown slashed their prices over the summer.

The only place we would differ with the Barron's article is with the stocks that were mentioned. Since many additional banks and S&L's are likely to fail before the blood bath is over --and it is impossible to know with certainty which ones they will be-- we think picking individual issues is not the best way to proceed.

Instead, we continue to recommend the Fidelity Select Financial Services Fund (FIDSX). http://finance.yahoo.com/q/bc?s=FIDSX When the sector rebounds, so will the fund, no matter how many firms don't make it through the shakeout.

There Is One More Shoe To Fall

Right now, the world is understandably focused on the financial service industry. In its shadow, however, another giant sector is starting to look weak: consumer spending. Because consumers account for about 2/3 of our economic growth, if they curtail their spending significantly the downturn will intensify.

Unfortunately, Joe and Sally MidAmerica are starting to grip their pocketbooks more tightly. The big three automakers saw their sales decline about 30% last month. Most shopping malls are also seeing sharp reductions. If the trend continues through the winter holidays, we could see the first quarterly drop in consumer spending in nearly two decades.

The bright spot in the consumer picture is most Americans are being frugal because they are scared, not because they don't have the means to buy what they want. If the federal rescue program appears to be working, millions of Americans will breathe a sigh of relief and go shopping again.

The Biggest Question: Will The Bailout Work?

We believe the government's efforts to turn the credit crisis around can work, but only if it is greatly expanded. Here's what most economists think should be done:

First, the big banks aren't the only financial service firms that are in trouble. Many regional banks, credit unions, savings & loans, and hedge funds are also on shaky ground. Collectively, they are worth more than the giant firms that are in the news every day, and they also need a lifeline.

In addition, the collapse of subprime, no-document, and ninja (no income, no job, no assets) mortgages started the credit crisis, but they aren't its only problem. Also at risk are countless short term loans that individuals and businesses make to each other. Bank to bank loans are also drying up. All these sources of capital are essential to the smooth functioning of our economy, and must resume.

It appears the government is starting to include additional financial service firms and types of loans in its rescue program. On Tuesday, Fed Chairman Bernanke announced a plan to buy large amounts of short-term debt in an effort to get lenders to make credit available again. On Wednesday, the Fed also lowered interest rates ½ point. Other measures are undoubtedly on the way.

The final bailout cost, of course, will be well above the initial $700 billion allocated for the rescue effort. In fact, the language in the law clearly states that $700 billion is the limit that can be spent "at any one time." Some economists think the total bill could be three times the initial figure. By this time next year we should know what the final tally is likely to be, and whether the massive spending is having the desired effect. Keep your fingers crossed.

The Bottom Line This Week

The financial service crisis appears to be moving faster than the government can keep up. One analyst referred to the rescue program as a "whack a mole" strategy. However, the money that Washington is spending should begin to take effect within a few weeks.

Meanwhile, some stock bargains are appearing. We think investors should start to make some cautious purchases over the next several months. Financial, food, drug, and basic retailers look the most attractive now.

A New Trading Theme...

Chuck Butler — Thu, 09 Oct 2008 14:27:17 GMT

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In This Issue..

* Coordinated rate cuts...

* Did the Fed reignite soaring inflation?

* More pain in Iceland...

* Revisiting the 90's in Japan...

And Now... Today's Pfennig!

A New Trading Theme...

Good day... And a Tub Thumpin' Thursday to you! Well... How about those wily veteran Central Bankers? They all got together and decided to cut rates... The Reserve Bank of Australia (RBA) went first with their 100 BPS cut, and opened the rate cut sea for the rest of the Central Banks around the world. The European Central Bank, The Riksbank (Sweden), Swiss National Bank, Bank of Canada, Bank of England, and the Bank of China all lined up at the rate cut table... The Bank of Japan, The Norges Bank (Norway), and Reserve Bank of New Zealand did not participate.

The Bank of Japan doesn't have any rate to cut, The Norges Bank will wait until their regularly scheduled meeting on 10/15, and the RBNZ believes that they have taken their toxic waste bond flu shot...

RBNZ Gov. Bollard said last night... "New Zealand banks have high-quality assets. Fortunately they do not have the poor quality assets that have proved so damaging overseas." Boy... Given what happened after the European Union's Finance Minister put his foot in his mouth, pointing a blaming finger at the U.S. and putting the EU's fortunes above the U.S. only to see the walls crumble down all around him, RBNZ Gov. Bollard, might want to talk low, talk slow, and don't talk much at all!

That's a famous John Wayne line... Just had to use that when I saw it on the Bloomie this morning!

So... The currency traders around the world, stopped when the rate announcements were made, to check the pulse of the markets... At first, we saw calm... But then, traders and investors began to say, "Uh-oh!, maybe things are worse than we imagined if Central Banks around the world are cutting rates"... So, getting back to the theme I talked about yesterday, where if it looks bad for the U.S., buy the dollar, and if it looks good, sell the dollar, we saw the currencies go back and forth... But overnight, calm seems to have settled in, and keeping with the "theme", that means a weaker dollar.

The stock markets of Asia and Europe have generally been stronger, which could lead to a tourniquet being applied to the U.S. stocks... And again... Keeping with the "theme" that would spell a further weakening of the dollar.

This isn't rocket science, it's just what I see happening in the currencies right now... It's like looking into the mirror, as everything is opposite, but that's what's happening right here, right now!

G-7 ministers meet this week, starting tomorrow, I believe... U.S. Treasury Sec. King Henry Paulson, held a press conference yesterday afternoon, and in my opinion, effectively kicked off the G-7 meeting. King Henry was particularly focusing on the coordinated policy moves... I would think we could expect more of this kind of Global policy maneuvers going forward.

I'll tell you this... It's my opinion that... The coordinated rate cuts didn't do what the Central Bankers had hoped it would do. And that is, unlock the seized up credit markets... But, you can't blame them, the Central Bankers are doing what every they have at their disposal to deal with this global mess.

Speaking of messes... It was reported this morning that Kaupthing Bank, the largest Bank in Iceland, has fallen, as control was seized by the Gov't. The currency CAN'T EVEN TRADE AT SPOT! That means immediate cash isn't available, folks! This is very serious stuff! Somebody expressed dissatisfaction with the price we received in the market the other day at 171... Yesterday, the last spot trades were done at 259! UGH! A foreign exchange dealer at Nordea in Copenhagen said, "Effectively the krona can't be traded at the moment because there are no banks to clear the trade."

Hopefully, that situation will be fixed quickly, and currency transactions can be cleared again, at least for spot... Oh... And that peg to the euro that the Gov. announced on Tuesday? It was dropped yesterday, because the peg to the euro at 131 could not be defended... Trades were going off at 340 krona per euro... It's a bad situation, hopefully, a white knight will step in to help here... Unfortunately, banks around the world (except the few mentioned above) have their own problems to deal with right now. Russia made a big loan the other day, and with Russia swimming in cash from oil, maybe they could be the white knight...

Aussie and New Zealand dollars saw some love last night for the first time in what seems to be a month of Sundays. I wouldn't put too much into a one night stand for these two... Yes, it's true that they have been beaten up too much and look oversold to me, but that doesn't mean the markets see it that way... We'll have to see if more than a one night stand is in the cards for these two.

One thing keeping a lid on any big time rally for these two, especially New Zealand, is the fact that Japanese appetite for anything offshore has gone away... Recall... That I told you several times over the years that the Japanese loved to sell their currency and buy kiwi (and Aussie), shoot Rudy, they would even issue Japanese bonds issued in kiwi!

With the Japanese appetite for anything offshore going away (for now at least) the financing of the U.S. Current Account Deficit comes back into the worry picture. Recall, that the Current Account Deficit needs about $2 Billion per day in foreign investments to keep it properly financed. And if the Japanese are slowing their offshore investments, that means the U.S. too, not just New Zealand and Australia!

Another country with a currency crisis going on is Mexico... For the last month, the currency has teetered, and yesterday it fell off the cliff, on rumors that Citibank and Chase were pulling up stakes in Mexico. There was nothing to confirm those rumors, but the damage had been done. The pesos slipped to a 14 handle... Recall that 2 months ago, it was all seashells and balloons for pesos as they almost moved to a multi-year high. But that's in the rear view mirror now... UGH!

The Mexican President, Calderon, has proposed a stimulus package worth 1% of GDP to help the economy... But the real problem here is that the cow has already left the barn... And that is the economy which showed signs of slowing, but got caught in the mud after all the hurricanes this year, need a rate cut... And how many times have I told you that Mexico needs high interest rates to attract foreign investment... Foreign investors use the high interest rates as sort of an insurance policy, risk policy, whatever, to pad their investments in case of problems that have existed in Mexico in the past. Well... When the economy slowed, and it looked like the Central Bank may need to cut rates, the investors began to leave. And then with the rumors yesterday, the you know what hit the fan in Mexico. At this point, it's nothing more than a currency problem... This is not Iceland! Oh, and the peso has "recovered" back to a 12 handle...

One country that I was surprised to see on the list of rate cutters yesterday was Canada... I've written about the surprising strength of the Canadian economy the past couple of months, and even yesterday they saw Housing Starts at a pace that was stronger than forecast... But the Bank of Canada (BOC) joined the rate cut party anyway... Why you go out and debase your currency just to keep your neighbor to the south happy is beyond me! The loonie has taken the rate cut hard... The currency slipped 2 cents yesterday, from 90-cents to 88-cents... (rounded) It was just a few weeks ago that the loonie was trending toward parity again...

OK, this morning, I turned on the screens and saw the euro trading 1.3750, and said, "OK... That's better"... But now, I look up, after all this furious typing, and see that the single unit has slipped back below 1.37, to 1.3675... I don't know why it has to play these games with me! Trust me, I don't need any more stress! But... It is what it is... There's nothing I can do about, so no reason to bang my head against the wall, and throw things... Well, maybe the throwing, it always makes me feel better! HA!

Well... Gold didn't gain yesterday for the first day in 4... Gold continues to outperform Oil though, and that in itself is a major victory for Gold! With the coordinated rate cuts yesterday, I thought to myself, Chuck, this is going to reignite the inflation story, and that should be good for Gold.

Oh, and one other thing, and this is BIG! Who was right and who was wrong on the Fed's next rate move? Chuck, or the big banks? I told you months and months ago that the Fed's next move would be down before moving rates up again... Now, I didn't foresee the coordinated rate cuts coming then, but I did see the Fed cutting rates to reignite the economy, that they kept saying was strong... And I kept saying they were wrong! Any way... Rate cuts should get inflation roaring again, and again... That should... Be... Good... For... Gold!

Yesterday afternoon I got a minute to read a newsletter that brought something back to my mind that I had talked about in July and early August, and that is the Huge Dollar Short Covering we saw in July while I was in Vancouver... At that time, it appeared very suspicious, and I said it was Gov't intervention... Well, it may have been some of that, but it now appears to be a widely known fact that the Gov't gave the "heads up" to several large banks, and allowed them to cover their dollar shorts and sell Gold... Hmmm... Don't you think it would have been nice for them to give all us investors the "heads up" too? This just ticks me off to no end folks... You can't believe how angry I get when I begin to think about this stuff!

Any way... Back at the ranch... Now their rate cuts will reignite inflation, and Gold should look to rebound, maybe back to previous highs? Who knows... But... The Gov.'s and Fed's moves in the end, will have caused a lot of pain, and achieved nothing but to keep the dollar from circling the bowl...

And in an attempt to bring this home with a happy story... The Japanese yen continues to bask in the "no carry trade" sun... We saw yen trade with a 98 handle yesterday... I hadn't seen that since around 1995 or so... I would have to go back and check, but in the mid 90's we saw yen trade to the mid 80's... And they were in such a mess economically... I've said it before many times, but this mess we're in here in the U.S. has very familiar ring tones to what happened in Japan in the 90's... And, come to think of it, had the same currency trading theme that I believe is going on in the dollar right now. The worse off Japan's economy got, the better the currency did... Just like the U.S. right here, right now! WOW!

Currencies today 10/9/08: A$ .7030, kiwi .6205, C$ .8895, euro 1.37, sterling 1.7330, Swiss .8850, ISK no quote, rand 9.0575, krone 6.1010, SEK 7.0475, forint 183.50, zloty 2.5130, koruna 2.5125, yen 100.70, baht 34.34, sing 1.4680, HKD 7.7650, INR 48, China 6.82, pesos 12.11, BRL 2.3325, dollar index 80.79, Oil $88.80, Silver $11.62, and Gold... $888 (this has just slipped here, as it was $912 as I was writing about Gold above)

That's it for today... The League Championship games for baseball begin tonight... You've just got to love those Tampa Bay Rays don't you? They had never won more than 70 games in a year prior to this year, and now they're in the American League Championship! I love underdog stories like that! Sort of like my beloved Cardinals in 2006! Man! That seems like so long ago now! The Dodgers are in the National League Championship, and every time I see or hear about the Dodgers, I think about Rick Monday, and how he made the greatest play ever in baseball... You should Google it if you don't know what I'm talking about... Forever ingrained in my mind, and brings chills to my spine every time I watch it... OK... Things haven't calmed down here on the trading desk, and I'm leaving for almost two weeks! I sure hope things do calm down while I'm gone... Until then, I going to try to have a Tub Thumpin' Thursday and hope you do too!

Chuck Butler

President

EverBank World Markets

1-800-926-4922

1-314-647-3837

Coordinated Rate Cuts!

Chuck Butler — Wed, 08 Oct 2008 14:15:59 GMT

.........But First, A Word From Our Sponsor..........

The FX University Seminar Series. Learn from foreign currency experts-then invest like one.

Coming to a location near you:

. 10/13 - Chicago

. 10/14 - St. Louis

. 10/16 - Philadelphia

. 10/18 - Ft. Lauderdale

. 10/20 - Jacksonville

Don't miss this exclusive event-you owe it to your portfolio. Visit http://www.sovereignsociety.com/Portals/0/landing/pfennig.html to find out more and register.

EverBank is a Member FDIC and Equal Housing Lender.

......................................................

In This Issue..

* Yen trades to 98!

* Carry Trades unwinding hurt high yielders...

* Gold rallies back to $900!

* Central Bank rate cuts....

And Now... Today's Pfennig!

Coordinated Rate Cuts!

Good day... And a Wonderful Wednesday to you! Well... There's a ton of stuff to talk about today, one of which is the amazing run that Japanese yen has had in the past month, but particularly the last week! No need to sneak a peak at the currency round-up, Japanese yen is trading 98.80! WOW! I could be acting like a contortionist and trying to slap myself on the back, but that would unprofessional... And besides, the rest of the currencies are taking shots to the mid-section. Anyway... Blow the horn, the Carry Trade (for yen) is dead, may it rest in peace!

OK... The currencies tried like all get out yesterday to rally VS the dollar, the euro did end the day 1% higher on the day, which after the bloodshed of the past month, I'll take that any old time! I would love to go back to 2005 (not really, but for this conversation's sake I will) and pull out some old Pfennigs where I talked about all the naysayers talking about a break up of the euro... We had the NO votes from France and Denmark on accepting the European Union's (EU) Constitution, we had riots in the streets of France, we had rising interest rates in the U.S. and dozens and dozens of naysayers called out the euro and said it would collapse under the weight. I said then, and I'll say now... HOGWASH!

Shoot Rudy! If this had all played out like the EU Finance Minister bragged about just two weeks ago, the U.S. economy would be drowning without a life preserver, and Europe would be pointing their finger saying neener, neener, neener... But the Finance Minister misspoke and didn't get the memo that Europe had toxic waste bonds too! So, the euro which should be basking in the sunlight is being tarred with same brush as was used on the dollar, when the markets thought it was just a "U.S. problem"...

Front and Center this morning, we have news that the U.K. Gov. has unveiled plans to partially nationalize major banks, with taxpayers taking a share stake in a bid to restore stability to the banking industry. Eight banks have signed up for the recapitalization plan, which isn't a marker on who's doing bad and who's doing OK... These banks, Abbey, Barclays, HBOS, HSBC, Lloyds, Nationwide Building Society, Royal Bank of Scotland, and Standard Chartered, see a chance to shore up their balance sheets... Who wouldn't sign up of that these days?

I don't really know what to make of this plan, I like it because taxpayers get a share of what they paid for... But I don't like it because once again the Gov. has gotten involved!

Well... The DOW fell another 500 points yesterday... I read something last night that reported U.S. retirement assets are down $2 Trillion dollars in the past 15 months! I guess the markets are calling for "more" from Big Ben Bernanke... The "more" they are asking for now is an interest rate cut, and not some measly 25 BPS... Hey, use the Reserve Bank of Australia (RBA) as your guide... They felt the need to jump start their economy with a rate cut and came out with a 100 BPS cut! No sense in messing around, eh? I mean, if you believe you will need to cut 100 BPS over a period of time, why not go for the gusto and get it over with?

That's how I've always worked on things... If I had things to do at work or home, don't stop until it's done, and then take a break...

So, anyway, back at the ranch... Big Ben is getting pelted with requests for rate cuts... I wonder if he has the intestinal fortitude to do a Saturday Night Special? (a rate move, out of meeting, and on a Saturday night, like Paul Volcker did back in the 80's) If Big Ben's speech yesterday is any indication of what he might do, then the "fix" is in for a rate cut... You see, he gave a strong indication that interest rates may need to be lowered... He has this to say... "The combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased."

WOW! He finally sees the downside risks to growth have increased! A round of Applause for the Fed Chairman! Don't ask me what they heck he's been looking at if he's just now come around to seeing downside risks to growth increasing!

Even sadder news than the Fed Chairman just now waking up to smell the coffee, is the unwinding of the Carry Trades for Aussie, kiwi, Brazil, and any other high yielding currency that was purchased in the Carry Trade... Yes, it's all seashells and balloons for Japanese yen, but the currencies of Australia, New Zealand, Brazil, South Africa and others are getting hammered with the unwind going on. The Aussie and kiwi currencies have fallen to 5-year lows VS the dollar... What took 5-years to build, has been knocked down... I can't believe it with my own 4 eyes!

The Brazilian real, which had been the belle of the ball for the last two years, has really fallen on a sword... And it all comes back to the unwinding of Carry Trades folks... Should "risk" return to the markets, we could see these trades come back in a hurry... But I wouldn't hang my hat on the thought that "risk" will return to the markets any time soon... This is the worst period of time in the financial markets that I have even seen... And just so you know... I began my career in the Brokerage business in 1973! So... That covers some time, eh? And I'm not just saying this because these currencies have fallen so badly... This IS the worst period of time that I have seen in the financial markets, period.

Shoot Rudy, the stock market crash of 1987 is like a party compared to this mess!

Stocks are circling the bowl, the high yielders are too, you are lucky if you can get 50 BPS yield on a 3 month T-Bill, and so on... But Gold... Gold is back above $900 this morning, and has rallied 3 days in a row, after dipping to $859 on Monday.

There's been a lot said recently about Gold and Silver for that matter too, and the theories on why they have not soared to the moon, given the shortage of Gold and Silver... Swiss Asia Capital CEO Jurg Kiener was on CNBC the other day to talk about gold, and he noted the disparity between the explosive physical market price and the sluggish paper market price, blamed the speculation of Wall Street banks for the latter, and predicted the failure of the paper market and the quick doubling of the gold price.

That's some aggressive talk and move there Mr. Kiener... While I'm a big Gold fan, I can't get all caught up in aggressive talk like that... Got to stay steady Eddie...

You know... One would have thought that the Fed's announcement on Monday that they were going to begin paying interest on reserve balances at the Fed would have given the markets some room to breathe... Then follow that announcement up with the Fed's announcement yesterday that they plan to purchase commercial paper directly from issuers, would have really gotten the market's attention... It got mine! This is huge folks... Those Corporations that depended on Commercial Paper issuance as a part of their financing, had seen this market dry up and wilt away since last August (2007)...

Of all the things the Fed has done and I have ripped them for, this is one that makes some sense... But again, why is the Fed having to step in to deal with this? Who gave them the authority to do this? Is that part of the Federal Reserve Act of 1934? Or whatever year it was they became a power!

But nooooooooo! The markets don't care right now, they have focused strictly on unlocking the seized up credit markets. I was asked during a radio interview yesterday whether this credit market seizing up was the "real" culprit in all this... I said, "well, it is now! Obviously, there have been other culprits, subprime, toxic waste bonds, FASB accounting rules, etc., but right here, right now, it's all about unlocking the seized up credit market"...

As I look at the currencies right now I see a massive overbought U.S. dollar... (that's my opinion, as I see it) It has gotten in this overbought position based on a flight to safety into U.S. Treasuries... But what happens when / if all the plans of the Fed and Treasury do work, and brighter days are ahead for the U.S. credit market and financial institutions? Will we see massive amounts of U.S. Treasury purchases that were made this year, sold, and a repatriation to the base currency of the investors? Now that would certainly lead to a weaker dollar once again, and the fundamentals would come shining through, eh? Well, that's the way I see it... But I hear you asking... Hey, Chuck... What happens if the un-dynamic duo's (Paulson and Bernanke) plans don't spell relief like Rolaids? What then, Big Guy? Hmmm... I guess you would still see the Treasuries being bought, and a stronger dollar... The dollar / currencies trades could end up being strictly tied to if the U.S. is in trouble or not...

Speaking of being in trouble or not... Yesterday, I told you about the Icelandic krona being pegged to the euro at 131... Well, I called a dealer yesterday to see where he was quoting krona, and he had it pegged at 255 euro, which would be $187 in dollars... And... Our foreign bonds trader, Don Ries, came to me yesterday and said he thought his clearing broker would deal in krona... I said, "get him on the phone and make certain of that." Soon, Don came back to say that clearing broker withdrew his bid/ offer on krona. I know it wasn't a popular decision on Monday to have to sell the krona we had due, since there was no longer a forward market, but it sure looks like it was the best one we could have made!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

OK>>> THIS JUST CAME ACROSS THE SCREENS FOLKS>>>

The Fed, European Central Bank, Bank of England and the Bank of Canada have all cut interest rates in a coordinated rate cut move before the markets in the U.S. open! The Fed cut rates 50 BPS to 1.50%! I'm looking all over the board for the size of the other Central Bank cuts... The Fed made the announcement, and said the other banks would announce their rate cuts...

I saw a blip that the ECB said that "inflation risks had weakened"... Since when? I guess when Big Brother (the Fed) calls and says they need a rate cut from them, they say, "how big?" I'm shaking my head in disbelief... The ECB has allowed the Fed to dictate rate policy...

OK... I now see that the ECB also cut 50 BPS... So... You see, the Fed needed a cut, like I said earlier today, and to keep the markets from jumping all over the dollar for lack of rate differentials, the Fed got the ECB to keep in line, to keep the differentials the same, etc.

The yen has lost ground since this move was announced, and the euro has gained 1/2 cent... So, the crosses to yen are causing problems! So... Earlier I talked about yen moving to 98... Well it's back to 100... So much for all that!

I could go on all morning about this move, but I have to tell you it has really lit a fire under the euro, and it's now up one full cent since the announcement!

I'll have more on this tomorrow, you can bet your sweet bippee!

Currencies today 10/8/08: A$ .6675, kiwi .6010, C$ .9050, euro 1.3720, sterling 1.7550, Swiss .8840, ISK 187, rand 9.20, krone 6.1150, SEK 7.0640, forint 184.10, zloty 2.5225, koruna 17.9850, yen 100, baht 34.40, sing 1.4640, HKD 7.7625, INR 48, China 6.8175, pesos 12.84, BRL 2.3110, dollar index 80.62, Oil $87.45, Silver $11.86, and Gold... $912.25

That's it for today... So... The rumored coordinated rate cuts came to fruition... Very interesting, eh? I'm enjoying a morning of listening to Carlos Santana as I write the Pfennig today... He's my fave guitar player of all time... Him, Joe Satriani, Eric Clapton, Stevie Ray Vaughn, and too many others to name... My little buddy Alex, is quickly becoming one of my fave guitar players, he has the gift. I hope he keeps at it... Because, unless he begins taking some growth hormones, his football playing days will end about the same time mine did! Well... Mary Owens just came in... So, that means I'm late out the door again today! The last two days have been pretty crazy on the trading desk, I have little time to even look up and see what's going on around me, but I can hear it, and it's crazy! I have to cut back the long days though, I promised myself, my beautiful bride and doctor that I would not return to 14 hour days, and I'm going to keep that promise! Besides, my beautiful bride reminds me every time I stay late! Our little Christine does the same, always calling out the time of day, etc. So, I have help in keeping that promise! I hope you have a Wonderful Wednesday! Now, on to reading more about these coordinated cuts!

Chuck Butler

President

EverBank World Markets

1-800-926-4922

1-314-647-3837

Beyond the Sound Bite: My Interview on NPR

Vinny Catalano, CFA — Wed, 08 Oct 2008 10:27:00 GMT

The folks over at National Public Radio noticed my blog posting of yesterday re the credit markets, Treasury yields, LIBOR, and the TED spread and did an interview with me on the topic, which you can listen to by clicking on the following link.

To listen to the 20 minute interview, click here.

Note: To track the all-important TED spread, click here

Finding Higher Returns with Low Risks

Bob Carlson — Tue, 07 Oct 2008 23:22:00 GMT

Market volatility and uncertainty spur the search for investment alternatives. Index fund investors broke even or lost money the last 10 years, depending on what the markets did in the latest volatile week. The index fund investors did worse than simply owning treasury bills or a money market fund. Investors need their portfolios to grow after inflation and taxes if they are to meet retirement goals, but many investors want to avoid the risks and volatility of traditional growth assets such as stocks.

Investors seeking growth with lower risk and volatility can turn to "structured products" such as equity-indexed annuities. EIAs offered by insurers are the big sellers, but banks and other financial institutions offer similar investments. These can be good additions to the portfolios of some investors—if they understand the details and costs of the products and their limits.

An EIA first promises safety of principal and often a guaranteed minimum return of 1% to 3% annually, depending on the insurer and current interest rates. An EIA also offers the potential for a higher return based on a stock market index. The account will receive the stock-based return when the index has positive returns but will not share losses when the indexes decline. Because of the guarantee the account can earn a positive return when stocks lose money.

Here are the key provisions to understand when considering an EIA or similar structured investment. Understanding these points ensures you understand the investment and will not be surprised by results over the years if you choose to buy it.

Index. The insurer determines the index used to determine the account’s returns. The index is stated in the contract, but in most EIAs the index can be changed. Shortly you will see that the insurer does not pay the return of the index but a return based on a formula that is based on the index’s return.

Participation rate. Some EIAs credit the policy owner with the full return for the year as determined by the return formula; others have a ceiling participation rate. For example, the credited return might be 75% of the return computed under the formula.

Return ceiling. An additional way of limiting the return in EIAs is an explicit limit on one year’s return. Ceilings generally are 7% to 10%. For example, an EIA might say the account earns 75% of the return under the formula, up to a maximum return of 8% each year.

Return formula. The annuity is not invested in stocks, and the investor is not earning stock returns. The account is credited with interest, and the amount of interest is based on stock market returns. The combination of the index’s returns and the return formula determine the interest credited. There are over 30 different formulas used for computing interest for EIAs. Many investors assume that an index's return for the year will be credited to their accounts. That point-to-point valuation is rare. Most EIAs use some kind of averaging method. Because stock returns for a year tend to be bunched in a few days, credited returns under the formulas can be far less than the index's return for the year. Here are a couple of examples of formulas.

Averaging. Under this method, the ending values of the index for each period used in the formula (usually days or months) are added. The total is divided by the number of periods. The difference between the index's beginning value and the average value is the return for the year. Insurance analysts estimate that in a bull market, this method credits the account with about half of the index's actual gains.

The averaging method tends to be offered with higher annual caps and participation rates. It also reduces the damage from funding an account a few days before a major market drop. Also, if the index rose for much of the year but suffered a major decline near the end, the averaging method credits those early gains.

Point to Point. This is the method most people assume is used. The difference between the beginning and ending values of the index over the period are used to credit the account. Point to Point likely will give a higher return in a bull market than the other methods, but it exposes the owner to more risk in a declining market and also higher volatility than the other methods. It also is likely to be accompanied by lower caps, participation rates, and other limits than some of the other methods.

The EIA also might contain a couple of protections that prevent a bear market from severely restricting interest credited to the account.

Annual Reset. The annual reset method prevents bad years from taking away gains. The gains from one year establish a new account floor. Future losses cannot bring the account value below that level.

Suppose Max Profits put $100,000 into an EIA. After five years, the account value is $150,000. The sixth year the index declines 10%. The account value still is $150,000 at the end of the sixth year.

The annuity owner might be able to select the reset period. An annual reset method can be good in trading range markets but likely will be accompanied by lower annual caps on returns and lower participation rates.

High Water Look Back. This method is being offered more frequently. It provides that the account value credited at the end of the contract will be the highest of the values on the contract’s anniversary dates. For example, suppose an EIA is owned for 10 years. The index rose steadily during the first nine years, giving a rising account value. The index tumbles the last year. When the contract is terminated, the account is credited with the value on the second-to-last anniversary date instead of the lower value on the last anniversary date. Note that the credited value is not the highest value during the 10 years but the highest on the anniversary dates.

Investors also should look at two other key points in the formula. Some formulas look at only changes in the index value and do not count dividends paid during the year. Also, some measure returns over the years as simple interest instead of compound interest.

Tradeoffs. The return formula, participation rate, and return ceiling need to be considered together. Generally, insurers make trade offs between the three. EIAs with less than 100% participation and with restrictive valuation formulas tend to have higher return ceilings of 10% or so. Typically an EIA that allows 100% participation will have an annual return ceiling of 7% to 8%. If an insurer or broker is focusing on one of the features, be sure to study the others.

The trade offs require some consideration. The combination that intuitively seems the most attractive often isn't. Suppose the index returns 10% one year. One EIA has 100% participation rate but a 7% cap. That EIA's investors get credited with a 7% return. Another EIA has 75% participation rate but a 10% cap. Those investors get 7.5% credited to their accounts for the year.

Based on past market return patterns, an investor is likely to earn a higher return over time with a higher cap and a lower participation rate. That's because an index's returns each year tend to be far from the averages. Good years in the market tend to be very good years. If this pattern of returns continues in the future, the lower participation rate/higher cap EIA is likely to be the better choice.

Some EIAs also have multi-year caps. For example, a policy might say that the return over two years will not exceed 15%, regardless of any other policy provisions.

Fees. After the return for the year is calculated, fees are subtracted and the net-of-fees return is credited to the account. Most EIAs charge fees only when returns are positive. But the more generous the EIA's policy of crediting returns is, the higher the fees tend to be. An EIA with 100% participation and a high or no ceiling likely will have annual fees of 2% or more. That could be great if the index returns 20%. But when the market returns 10% or less, an EIA with a less generous crediting policy and lower fees would generate a higher net return.

Again, it pays to look at the interplay of fees, ceilings, valuation formulas, and participation rates under different return patterns. A period of steady, low returns would favor an EIA with low fees. A pattern of widely varying returns with the positive returns above 10% would be rewarded by 100% participation and no ceiling with higher fees.

Many EIAs allow fees and charges to be changed, and the maximum fees that can be imposed are quite high. Be sure to ask what current policy holders are charged. Also check surrender charges and minimum holding periods. The EIAs with the most attractive initial terms tend to be those with the highest penalties for withdrawing from the EIA.

Changes. Most EIAs retain the right to change any of these provisions. There might be a limit to the potential amendments, but the insurer can review the terms each year. A 100% participation rate can become 75%, or a 10% cap could decline to 8%. There's not much the policy holder can do except realize terms that are more attractive than those on other EIAs can change at any time.

Commissions. Most EIAs offer the selling agent or broker generous commissions of 5% to 9%. The higher commissions usually are on policies with high surrender charges or more restrictive terms. The commissions usually are paid directly by the insurance company.

Investment bonuses. Some EIAs offer bonuses. For example, an EIA might credit an extra 10% to the policy holder's account for purchasing the annuity. Or 1% annually might be credited for each year the policy is owned. Such bonuses almost always come with higher surrender charges, longer required holding periods, and other restrictions.

Withdrawal phase. An EIA usually imposes a surrender charge if the investor withdraws all or some of the money before a minimum period has passed. An investor should know the surrender charge and surrender period before investing. An investor who is sure the money will not be needed for seven years or more often can find an annuity with generous terms that has a long "lock up" period or a high surrender charge. Other investors want a minimal surrender period and low charge in case their cash or investment needs change.

Also, even after the lock up period has passed, some annuities do not allow the investor to withdraw the account in a lump sum. They might require annuitization—a stream of fixed for life payments from the insurer. Others allow only a maximum amount of 10% or so to be withdrawn in any one year. Most EIAs, however, allow the entire account to be withdrawn or rolled over to another annuity. Don't be dazzled by generous front-end terms that are taken away by limits on how money can be withdrawn.

Insurer safety. The only guarantee behind the annuity is the promise of the insurer to make the payments. Dealing with one or more insurers that have been around a long time and are in strong financial condition is important.

An EIA is neither a stock market investment nor a traditional fixed annuity. It can be appropriate for someone who wants something more conservative than the stock market but wants to try for higher returns than are available from interest-based vehicles such as fixed annuities, bonds, and certificates of deposit. The returns of an EIA will vary considerably from year to year. The good news is that, unlike a stock market investment, the return any year will not be less than zero in most EIAs. On the other hand, an investor won't know until after the year what, if anything, the return for the year is. In addition, in years of strong stock market returns, the investor likely will be credited with a fraction of those returns.

A potential EIA investor needs to review different EIAs, study the contract terms, and understand the trade offs. Different EIAs are appropriate to different types of investors, and many investors will find all EIAs to be inappropriate for them. Also compare an EIA to a diversified portfolio of low fee mutual funds or to a balanced fund.

InvestorsInsight Publishing

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Week of 10/09/2008

Bargains Are Starting To AppearA Bottom Fishing Check ListThe Bear Isn't Finished YetBig Drops Lead To Big ReboundsFinancial Stocks Attract More AttentionThere Is One More Shoe To FallThe Biggest Question: Will The Bailout Work?The Bottom Line This Week

Bargains Are Starting To Appear

A Bottom Fishing Check List

The Bear Isn't Finished Yet

Big Drops Lead To Big Rebounds

Financial Stocks Attract More Attention

There Is One More Shoe To Fall

The Biggest Question: Will The Bailout Work?

The Bottom Line This Week

A New Trading Theme...

Coordinated Rate Cuts!

Beyond the Sound Bite: My Interview on NPR

Finding Higher Returns with Low Risks

Bargains Are Starting To Appear
A Bottom Fishing Check List
The Bear Isn't Finished Yet
Big Drops Lead To Big Rebounds
Financial Stocks Attract More Attention
There Is One More Shoe To Fall
The Biggest Question: Will The Bailout Work?
The Bottom Line This Week