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In the marbled halls of this nation’s leading banks … and the wood-paneled boardrooms of top investment firms …
They’re facing the biggest credit meltdown since the Savings and Loan Crisis of the late 1980s and early 1990s!
Back then, interest rate fluctuations and bum commercial real estate loans bankrupted S&L after S&L. The sagging banking sector – and the credit crunch it engendered – kneecapped the U.S. economy. The result: Economic recession.
In this report , I want to delve into the causes and consequences of the last major banking crisis – and why the current meltdown is similar. Then, I’m going to tell you what it means for our nation’s economy and your finances.
The Scary Parallels
Between Then and Now
The original S&L crisis stemmed from several factors. Three of the most important ones:
#1. Interest rate gyrations caught many institutions borrowing money at high rates and lending at relatively low ones. This mismatch between borrowing and lending rates wreaked havoc on bank earnings and net worth.
#2. Banks overextended themselves in the commercial real estate sector. They made too many risky loans to too many high-risk borrowers, and when the economy slowed, losses surged. The oil price bust of the mid-1980s made a bad problem worse, helping wipe out scores of S&Ls in Texas.
#3. Weak regulation and disturbingly low capital levels made S&Ls vulnerable to failure. The use of brokered deposits – where S&Ls chased “hot money” depositors by offering high interest rates – caused its own set of problems.
Ultimately, more than 1,000 S&Ls failed, and the U.S. government was forced to step in with a bailout totaling an estimated $150 billion. It took years for the agency established to help resolve bad loans – the Resolution Trust Corporation – to finally work through the morass of impaired assets.
These days, interest rates are still relatively low and banks are better capitalized than they were in the 1980s. That’s an important difference.
But this time around, the bubble in residential mortgage lending and the underlying housing industry was also much bigger – and much more widespread – than the commercial real estate boom was back then.
This time around, home prices surged much faster than incomes. Real estate speculation soared. Lending standards were flushed down the toilet.
Moreover, some of the most complex, hard-to-value, mortgage-related securities and derivatives ever invented were foisted on the financial markets. They were snapped up by eager investors who, it turns out, had no real idea what they were buying.
And now, the list of casualties is expanding by the day …
Banks, Brokers, and Insurers Are Losing
Money Hand Over Fist, Fueling the Risk
Of a Large-Scale “Credit Crunch”
In October 2007, I covered some of the biggest losers. I told you how Citigroup’s profits plunged 57% … Washington Mutual’s earnings tanked 72% … Bank of America took a $4 billion hit … while Merrill Lynch suffered a $7.9 billion whacking.
Since then, things have gotten WORSE, not better! Shares of the bond and mortgage insurance firms I told you about (Ambac Financial Group, MBIA, and the like) continue their swan dives amid fears over credit losses related to complex mortgage securities.
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Meanwhile, the mortgage giants are among the vulnerable. For example, on November 20, 2007, Freddie Mac shares dropped as much as 35%, the biggest drop since it went public in 1988. While on the same day, shares of Fannie Mae plunged the most since the 1987 stock market crash.
You can see why the estimates of the final fallout keep getting ratcheted higher and higher:
- Egan-Jones Ratings went so far as to predict “massive losses” – $4.3 billion at Ambac … $7.25 billion at MGIC Investment … and up to $20.2 billion at MBIA.
- Royal Bank of Scotland weighed in with a forecast of $100 billion in write-downs for banks and brokers loaded up with so-called “Level 3” assets. Those are assets whose value is essentially based on theoretical estimates, not actual market transactions.
- Lehman Brothers was even more aggressive. It said the credit meltdown could ultimately cost firms $250 billion.
- Deutsche Bank weighed in with a $300 billion to $400 billion estimate.
- And fasten your seatbelts – the chief economist at Goldman Sachs said these huge losses could force lenders to cut lending activity by a whopping $2 trillion!
Why Should You Care About All These
Losses Piling Up in the Financial Sector?
In a nutshell, if banks get hit with too many losses, their capital levels get impaired. They face increased oversight from federal regulators. And they get nervous and cut back on making new loans.
That’s what leads to a credit crunch – when even good borrowers can’t obtain car loans, or mortgages, or small business financing.
In fact, it’s already happening!
As Martin told you on November 19, 2007, lenders aren’t just tightening standards on subprime mortgages – they’re tightening them on prime mortgages as well. They’re getting stingier with commercial and industrial loans. And they’re clamping down on commercial real estate lending excesses.
Plus, if past is prologue, and this truly is an S&L-type credit crunch that’s brewing, here’s what you’re going to see:
More bank failures. These are just now starting to happen after a period of extraordinary calm where NO banks failed. In 2007 alone, we saw a pair of small banks in Pennsylvania and Ohio fail, as well as NetBank of Alpharetta, Georgia – an institution with $2.5 billion in assets.
But the number of “problem” institutions identified by the Federal Deposit Insurance Corp. (FDIC) climbed to 61 in the second quarter of 2007 from 53 a quarter earlier. Those firms had $23.1 billion in assets, up from $21.5 billion. That’s low by historical standards, but the direction – higher – is clear.
More write-downs on Wall Street. I’ve already told you about many of the biggest blowups. But it’s worth noting that other firms are suffering, too. For example, Morgan Stanley lost $3.7 billion in just two months during the fall of 2007 due to the crumbling price of home-loan related securities. And as I mentioned earlier, the estimates of future write-downs keep spiraling higher.
There’s another key risk: The ratings agencies like Moody’s and S&P may finally do their job and cut the official ratings on many of these junky securities that banks are lugging on their balance sheets. If they do, it could trigger more “forced selling” from investors and firms who can’t hold debt rated below certain levels.
If the S&L crisis is any guide, you can bet the total losses from the housing and mortgage crisis will keep rising. It’s just the nature of the beast. The farther home prices fall, and the longer the crisis drags on, the higher the losses will climb.
More government bailout proposals. No way, no how is Congress, the Federal Reserve, or the administration going to sit around and watch as the housing and mortgage markets implode. You’re going to see a full-court press!
The Federal Reserve is slashing interest rates like crazy. It cut the federal funds rate 100 basis points in 2007 and another 125 points in January 2008. More cuts are on deck.
Meanwhile, the Treasury Department has abandoned its so-called “Super SIV” rescue fund. The idea was that the fund would buy up a bunch of crummy debt securities, including mortgage-related ones, from various smaller funds and banks and dump them into one place. That was supposed to prevent widespread selling of impaired debt and allow investment firms to avoid billions of dollars more in losses.
Federal Housing Administration reform is another approach the government is using to refinance borrowers out of toxic subprime loans. We’re also seeing regulators bring tons of pressure to bear on mortgage lenders and servicers. They want them to modify existing loans to stem the foreclosure wave.
More economic fallout. Look, if it was just a bunch of rich Wall Street bankers who were being forced to trade down from Bentleys to BMWs, none of us would have a reason to care about this crunch. But it’s not.
The spreading housing and mortgage meltdown is now slowing the REAL economy by hurting consumer confidence and causing job gains to slow. And that’s hurting corporate America.
Here’s What I Suggest You
Do to Protect Yourself…
First, keep a large chunk of your money in safe investments like short-term Treasuries or Treasury-only money market funds. They’re your ultimate insurance against “S&L Crisis II.”
Second, protect yourself further by continuing to avoid vulnerable sectors of the market – home builders, lenders, construction suppliers, and the like.
Third, stick with contra-dollar investments like precious metals and foreign stocks and bonds. The Fed will be forced to keep monetary policy easy to cushion the pain of the housing crisis. That, in turn, should hurt the dollar.
Fourth, consider hedging your portfolio with inverse ETFs – special ETFs that are designed to go up when the market or index they track goes down. To learn how to use these unique investments to protect your wealth and profit from market declines, be sure to read our special report, How to Protect Your Stock Portfolio From the Spreading Credit Crunch.
