- The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts. The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer.
- Recent days' cascade of bad news, culminating in yesterday's bailout of Bear Stearns Cos., is accelerating the erosion of trust in the longevity of some brand-name U.S. financial institutions. The growing crisis of confidence now extends to the credit-worthiness of borrowers across the spectrum -- touching American homeowners, who are seeing the value of their bedrock asset decline, and raising questions about the capacity of the Federal Reserve and U.S. government to rapidly repair the problems.
- Global investors are pulling money from the U.S., steepening the decline of the U.S. dollar and sending it below 100 yen for the first time in a dozen years. Against a trade-weighted basket of major currencies, the dollar has fallen 14.3% over the past year, according to the Federal Reserve.
- Lenders and investors are pushing up the interest rates they demand from financial institutions seen as solid just a few months ago, or demanding that they sell assets and come up with cash. Banks and Wall Street firms are so wary about each other that they're pulling back. Financial markets, anticipating that the Fed will cut rates sharply on Tuesday to try to limit the depth of a possible recession, are questioning the central bank's commitment or ability to keep inflation from accelerating. (Thankfully, the CPI report shows inflation is dead!)
- "Clearly, the whole world is focused on the financial crisis and the U.S. is really the epicenter of the tension," says Carlos Asilis, chief investment officer at Glovista Investments, an advisory firm based in New Jersey. "As a result, we're seeing capital flow out of the U.S."
- That is a troubling prospect for a savings-short, debt-heavy economy that relies on $2 billion a day from abroad to finance investment. It is raising the specter of the long-feared crash in the dollar that could further rattle financial markets and boost U.S. interest rates.
- But while cash continues to pour into the U.S. from abroad, this flow has been slowing. In 2007, foreigners' net acquisition of long-term bonds and stocks in the U.S. was $596 billion, down from $722 billion in 2006, according to Treasury Department data. Americans, meanwhile, are investing more of their own money abroad.
- Bob Eisenbeis, a former executive vice president of the Federal Reserve Bank of Atlanta, says the problem is more than an inability to find ready buyers for assets. "It is time to step back and recognize that the current situation isn't a liquidity issue and hasn't been for some time now," said Mr. Eisenbeis, the chief monetary economist for Cumberland Advisers. "Rather, there is uncertainty about the underlying quality of assets -- which is a solvency issue, driven by a breakdown in highly leveraged positions." (Bingo!)
- The loss of confidence is now spreading beyond the biggest banks, with their well-publicized losses on subprime and other risky assets, to regional and small banks. (wait, you told me it was the kitchen sink quarter and to buy financials last fall? Did you lie to me again?)
- This couldn't come at a worse time for U.S. homeowners. American household debt has more than doubled in a decade to $13.8 trillion at the end of 2007 from $6.4 trillion in 1999, the vast majority of it in mortgages and home equity lines, according to Fed data. But the value of U.S. householders' biggest asset -- their homes -- is now falling.
- Kenneth Rogoff, a Harvard University economist, says the current difficulty has many mothers -- the housing bubble, the subprime problem and the fact that the value of U.S. imports has long outstripped the value of exports. The current account deficit -- the broadest measure of the trade deficit -- burgeoned, and the U.S. needed to borrow ever larger amounts of cash from abroad to fund it.
- Pressures in one market spread rapidly to other, often more distant markets. "The dollar and subprime -- they're two sides of the same coin," says Princeton University economist Hyun Song Shin. Many U.S. hedge funds and financial institutions were speculating in mortgage-related securities with money that was ultimately borrowed in Japan, where interest rates have been low for years. (google "Yen carry trade" if interested)
- The resulting blow to confidence threatens to further weaken lending, borrowing, spending and investment in the U.S. economy. "Hedge fund blowups have so far been one-off situations. One worry is that we'll cross some line and there'll be a systemic wave of fund failures. It's a reason why the market is so nervous," says John Tierney, credit derivatives strategist at Deutsche Bank.
- Now, many hedge fund managers say, access to borrowed money, essential for many of their investment strategies to work, has become virtually impossible.
- Mohamed El-Erian, co-chief executive officer of Allianz SE's Pacific Investment Management Co., says the hedge-fund community is unwinding its leverage. "This will push more of them into 'survival mode,' further accentuating distressed sales and nervousness among the prime brokers," he wrote to his colleagues Thursday morning. "In such a world, the quality of the assets matters less than whether you can finance them [or] how liquid they are."
And now you see why I have sounded like a worry wart since blog inception... the "realization" of the scope of the issue is now hitting the lemmings.
