Tuesday, January 3, 2012

2012 Outlook: How We Got Here

2012 Outlook Part 1: Introduction
2012 Outlook Part 2: How We Got Here
2012 Outlook Part 3: Sovereign Debt Review
2012 Outlook Part 4: Global Butterfly Effect
2012 Outlook Part 5: Japan's Debt Crisis
2012 Outlook Part 6: United States Stock Market
2012 Outlook Part 7: United States Bond Market
2012 Outlook Part 8: Gold And Silver
2012 Outlook Part 9: How To Invest
2012 Outlook Bonus: Real Estate

We begin quickly with how we got here. The financial system collapsed in the fall of 2008 when real estate loans were held on bank balance sheets with no capital reserves to buffer against the possibility that home prices would fall or home owners would be unable to make the payments. Both happened, causing the banking system to become insolvent (their liabilities were greater than their assets), and the entire system froze after the collapse of Lehman Brothers.

It was a historical moment in history. Governments decided that instead of letting the system cleanse itself of the toxic debt and try and back the good debt, they would nationalize everything and the toxic debt became one with the government debt. Central Banks around the world flooded with system with liquidity purchasing and backstopping trillions in toxic debt with printed money.

Then governments around the world unleashed massive stimulus programs creating new mountains of government debt to pile on top of the original government debt and new private toxic debt. Central banks continued to ease the burden by purchasing additional trillions in government debt and mortgage securities.

In March of 2009, a major accounting rule (FASB 107) for US banks was changed, allowing banks to mark their assets at full price (mark to myth), instead of having to write their assets down when they fell in value. This was a landmark rule change that put a floor under bank shares and the stock market as a whole, and they took off to the upside with QE1 providing rocket fuel behind them.

This also ensured that these banks would live on as “zombie banks,” a program used by Japan when their market crashed in 1990. With banks assets underwater, they were not able to lend to the market. How would we now finance mortgages, student loans, auto loans, and the necessary credit to keep our country growing? The US government through deficit spending.

After these actions took place, all appeared to be well again. The stock market was roaring, economic indicators were soaring, consumer and business sentiment rose, and there was an overall calm back in the financial world.

Then in the fall of 2009 a small city name Dubai announced that they were going to have to delay payment on their government debt. Essentially they were announcing default.

While this was seen as a blip on the radar, to the astute market observer it rang the opening bell for the next round of the global financial crisis.

Next: 2012 Outlook: Sovereign Debt Review

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