Saturday, December 10, 2011

MF Global Opens The Door To Systemic Collapse

A few weeks ago a clearing house named MF Global went bankrupt.  It was a large firm run by John Corzine, formally of Goldman Sacs and formally in charge of the state of New Jersey. 

We found out after the firm went down that Corzine and his traders had placed enormous bets on European debt with leverage and as European bonds imploded over the past few months they did not have enough capital to keep their doors open.

Financial institutions have failed on a regular basis for hundreds of years (up until 2008 when.....oh, don't get me started) so the bankruptcy was initially not seen as a major event.  However, after the bankruptcy news began to spread that some of the clients were unable to access their accounts and get their capital back.  It turns out that MF Global was betting on European bonds with clients money on deposit and now billions of dollars have gone "missing."  Corzine testified yesterday saying simply, "I do not know where the money is."

Many of these contracts were for commodities purchased through the CME.  It was always implied that in an event such as this the CME would immediately step in and make the accounts whole to keep trust in the system.  However, when it came time for the CME to step up they went silent and turned their back on the customers. 

For more information on these events I would strongly urge you listen to this interview with Gerald Celente, a client who lost a considerable amount of money, and this interview with Ann Barnhardt who has shut down her commodities firm because she can no longer trust the exchanges.  She does not feel comfortable investing her client's funds in the financial system and she is closing her doors.

I discuss this now not only because I feel bad for the customers that lost their funds but because we have an entire financial system that is based on trust.  Everything is interconnected like a massive spider web around the world and if one small portion of the web breaks or even if the other members believe a portion of the web cannot pay you have the possibility of "systemic risk."  This means the entire financial system can implode.

We are moving into a time where things are going to get worse in the short term.  It is important to understand that as an investor, employee, or business owner.  We have gone on a 40 year global credit binge in consumer, business, and government debt and now the bill is due. There is not enough capital on the planet to even come close to covering the bill.  It is similar to someone who runs a massive credit card balance for 40 years.  Now the bill is due and the credit is cut off.  In general do you think things will be better for that person in the short term or worse?

The question is how will this period play out?  There are endless discussions which I follow closely regarding an inflationary or deflationary outcome.  There are discussions that a global depression will lead us to war, as it has done every other time in history.  Now with the MF Global bankruptcy there is a third option back on the table, one that we have not seen since the week after Lehman Brothers failed and confidence left the financial system completely.

That is of the financial system itself imploding.  Global systemic risk as if the entire system had a heart attack.  Everyone is now looking over their shoulder wondering who may be the next MF Global.  Banks, hedge funds, pensions, insurance companies, governments, and sovereign wealth funds all have their money spread across multiple institutions.  They must all now worry that one could fail and an entity such as the CME may turn their back on the implicit guarantee on their funds. The scenario is similar to the concerns around the world that the United States would not step in and guarantee or nationalize the bonds of Fannie Mae and Freddie Mac during the summer of 2008.

Back in March of this year, when the tsunami hit Japan, the Japanese Yen (their currency) began moving violently higher in the FOREX (currency exchange) markets.  For reasons I don't have time to get into here this had the possibility of creating a meltdown in the derivatives market due to something called the "carry trade." 

That night on my way home from work I stopped at the grocery store and I bought water and enough food to last 3 to 4 weeks and I took some cash out of the bank.  I called my immediate family and a small handful of people that have a strong understanding of the financial markets and advised that they did the same.

Now, at this point in the conversation I probably will have lost credibility with 95% of readers and have become "one of those people."  However, at the time, while the world was casually going on with their business, we were hours away from a meltdown.  There was a global central bank intervention of massive proportion to get the situation under control.  Sound familiar?  I'll get to that in a second.

So what happened next?  Nothing.  I went back to the bank to deposit the cash, and I drank clean water and excellent food for the next 3 weeks. 

This past week many believe we were close to another one of those moments.  We had a global central bank intervention where the Chinese central bank and the European central bank both cut interest rates.  The Federal Reserve cut rates on their "swap lines" which means they will lend dollars overseas at a reduced rates to funnel liquidity into European banks.

With the MF Global situation handled the way it was, many of the most intelligent market participants who have a strong understanding of derivatives now have no idea what comes next.  The financial system shutting down is now back on the table.  If that happens, what does it mean?  It means for a period of time there will be civil unrest, little cash available at ATM's, empty grocery stores, and no gas at the stations. 

In terms of your savings and capital, I would review the following article which discusses how to protect yourself from waking up one morning with your money "gone" like the customers who worked with MF Global.  The article is titled The Logic and Logistics Of Market Flight and Repatriation.  The author discusses the article this week in an audio interview, which can be heard here.  Her segment begins 37:15 into the program.

I do not believe a systemic collapse is the most likely scenario or even a likely scenario, but with the option back on the table it would be wise to stay stocked up moving forward on food, water, and take some cash out of the ATM.  What happens if nothing happens?  Nothing.  You just have some extra food, water, and cash.

I spend most of my time discussing how this scenario is going to play out under the regular course of action (a deflationary deleveraging or an inflationary deleveraging) of the global debt bubble we now face.  I do my best to get your portfolio prepared for both scenarios and monitor the situation daily to determine which direction we are headed.  At this point it is still impossible to know because the direction of global markets are exclusively in the hands of our politicians and central banks.

A truly terrifying thought indeed.

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