Sunday, November 23, 2008

The Weekend Huddle

About a month ago we began what has now become the weekend huddle. It usually starts on a Tuesday or Wednesday during the week when a CEO makes a statement to the media that:

1. Their balance sheet is strong
2. They are confident moving ahead in the future

When you hear these two statements from a CEO of a major investment bank you can immediately know that they are in serious, serious trouble. Citigroup has been all over the news this week with these announcements and I told a few people that I would be ready for some bail out news as early as this weekend.

I even guessed the time the news would be released. 1:00 PM on Sunday. How did I know?

It happens the same way every time. I was even joking that maybe they pick the time because they are hoping people will be distracted with football and will be less likely to notice.

A few weeks ago I said that both Citigroup and Wells Fargo were in a war to acquire Wachovia because taking their bad debt on their books would make them too big to fail. They had this mind set because the government had let Lehman fail because they thought their impact would be minimal to the markets. They were wrong.

Wells Fargo ended up taking on the bad Wachovia debt and Bank of America then acquired all the bad Merrill Lynch debt. This now made them too "big to fail", or nationalized. Fortunately for Citigroup, Lehman's failure and market consequences has now made it clear to the government that they will not let ANYONE fail under any circumstances. All the banks have now been nationalized, and all would be insolvent without the new government guarantee.

They will now get an unlimited amount of dollars to keep their bad operations running. The same is true for the auto manufacturers, but not for the reason that many are talking about. The auto manufacturers failure would trigger massive losses in the credit default swaps market on their corporate debt, which would in turn trigger additional massive losses onto the banks balance sheets, which would trigger additional bail outs.

As the losses pour in hour by hour, we move closer to the point when the United States debt will be downgraded. Right now our treasuries are trading at AAA credit, just like subprime debt was trading at AAA in the fall of 2007. The similarities are eerie, and the outcome will be the same. The United States is currently on life support from foreign countries just as the investment banks are on life support from the United State government.

When the rest of the world figures out that the "AAA" treasuries they are holding are actually junk bonds, the bubble will explode and its impact will be deafening.

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