Brace yourself…

The underlying economic issues I’ve been writing about are gaining publicity.  The following article from The Economist explains the latest problems:

All fall down?

Jan 18th 2008 | NEW YORK

Huge new problems in the capital markets?


AMERICA’S big bond insurers, which have underwritten some $2.4 trillion of private and public-sector bonds, usually go about their business largely unnoticed. But now they are looking distinctly wobbly they have started to attract attention. If one or more of them were to topple over, there will be a huge knock-on effect on banks and other financial institutions that rely on their guarantees. This in turn will further worsen the credit crunch and cause an even bigger headache for policymakers already grappling with a sharp slowdown in the American economy.

The threat of such a financial domino effect looms large. Moody’s, a credit-rating agency, has signalled that it might downgrade the AAA-ratings of two of the biggest bond insurers, MBIA and Ambac, in the near future. On Friday January 18th, Ambac said that it had dropped a plan to raise $1 billion of new equity capital to preserve its rating—making futher downgrades even likelier. In response, Fitch, another rating firm, cut Ambac’s rating.

MBIA, which recently managed to raise $1 billion of new capital on top of another billion that it received from Warburg Pincus, a private-equity firm, will almost certainly need even more money if it is to preserve its AAA-rating. ACA Financial Guaranty Corporation, another insurer, is in even direr straits. In December its single-A credit rating was cut to junk status. The firm begged its trading partners to give it more time to sort out its problems. But by Friday it had still not come up with a rescue plan. The state insurance regulator of Maryland, where ACA is incorporated, has already assumed responsibility for some of its operations.

Bond insurers in effect “lend” their top-notch ratings to lower-quality debt, raising its value in the eyes of investors. Any cut in those ratings may make it impossible for the bond insurers to take on new business and would reduce the value of the securities they have already underwritten. Such cuts are now a distinct possibility because the insurers have underwritten billions of dollars of mortgage-backed securities, including those notorious collateralised-debt obligations (CDOs) that have now gone sour…… 

In the Book of Daniel, The Lord gave Daniel, Hananiah, Mishael, and Azariah (Shadrach, Meshach, and Abednego) knowledge, skill, wisdom, and understanding.  The current economic problems stem from the fact that knowledge and skill were used to leverage investments against the market without wisdom and understanding.  Technical traders did not understand the fundamentals of investing and assumed that technical analysis was sufficient to beat the market returns.  The Derivative Instruments assumed theory to equal reality.  We are on the verge of a reality check!

I recently wrote about MBIA and Ambac.  As of this writing, the world markets are responding negatively concerning the subprime crisis.  Many markets lost over 5% in one day.  Volatility will continue to be the norm.  The world’s central banks are in uncharted territory.  If you are highly leveraged, reduce your leverage immediately.  Raise cash, cash is king!  If you own commodities, don’t get rid of them.  The central banks will flood the market with cash which in turn will be inflationary.  Hard assets will rise.  Food and energy costs will rise.  Brace yourself!

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