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Central Banks

Written By Brian Hicks

Posted December 19, 2007

This market doesn’t need a Xanax. Whether they’re anxious or depressed, investors from Wall Street to Shanghai require real confidence, not artificial stimuli, to get their smiles back. So why are central banks throwing the liquidity pill down our throats?

Not to sound too much like Tom Cruise, but this market can’t be drugged out of the nuthouse.

The placebo didn’t work, of course. Last week’s quarter-point Fed rate cuts merely frustrated schizophrenic traders who had hoped for the Fed to tug the monetary policy lever harder with a half-point drop in the benchmark overnight and discount rates. Instead, a broader international strategy was unveiled, showing that "Helicopter" Ben Bernanke knows he’ll need more than a couple bags of money and a chopper to slake the global thirst for liquidity.

Now, the Bank of England, the European Central Bank, the Swiss National Bank, and the Bank of Canada are heaping another half-trillion or so onto the banking system in order to jumpstart short-term lending. But U.S. isn’t just the leader in remedying the problem, we led in creating the malady too.

The sub-prime plague has afflicted everyone, and even when the news seems good, it’s bad. Citigroup Inc. (NYSE:C) and Merrill Lynch & Co., Inc. (NYSE:MER) both said bye-bye to their CEOs after the banking giants got left holding shaky mortgage-backed securities when default rates skyrockted. Goldman Sachs could have come to the rescue with a spoonful of sugar on its Q4 earnings report this Tuesday, but the medicine was still sour.

Goldman Sachs announced earnings above Wall Street estimates, largely based on doubled revenue from merger advisory services and a one-time kick from the sale of energy assets. But the core businesses of fixed income and debt underwriting services took a big hit.

M&A counseling won’t buffer against declines in these businesses for long, even if the credit crunch lets up a bit.

Leverage had gotten out out of control before this year’s correction, and banks would do well to be skittish about slicing up debt too thinly in order to finance buyouts for the next couple years at least.

Goldman CFO David Viniar’s comments accompanying earnings cued us that the sub-prime fallout hasn’t yet come to a head. There won’t be any "mega public-to-private" deals in 2008, since the house of cards they were built on recently has toppled.

I like to look at things from the global point of view, and 2007’s market movements are no exception. In the springtime China knocked emerging markets and developed ones all for a loop, with developing country ETFs like the iShares MSCI Emerging Markets Index (NYSE:EEM) seeing both greater downside and greater rebounds than the Dow in each big correction this year.

However, the leader of the pack in the second half of ’07 has been the wobbly U.S. sub-prime mess and its exemplars like Goldman Sachs.

Here we see Goldman Sachs Group, Inc. (NYSE:GS) compared to the EEM fund and the S&P 500. Notice how the movements in GS overlap with major dips in the EEM? Emerging markets have tried to break out despite persistent downtrends in the mortgage-related sector. Lately, headwinds from GS and others have been too strong. Emerging market woes are the effect, not the cause, of this chain reaction.


The S&P 500 dips and rises in a more shallow fashion, but both GS and EEM have beta measures (deviation from the S&P 500) of around 1.7, which gives us an idea of the elastic nature of these market fluxes from start to finish.

So what will truly cure what ails us? Not an airlift of money, that’s for sure.

Central Banks May Yet Help

Amid the storm of financial news the market had to choke down this Tuesday (who can really know what information is priced-in these days?), the Fed introduced a new plan to protect sub-prime borrowers against predatory lending.

The most egregious and mind-bogglingly foolish of these credit practices is that of penalizing borrowers from paying off loans early. Discouraging solvency will of course beget a lifetime of debt, which is fine for modern-day sharecropping but no good for capital markets.

The Chicago Board Options Exchange Volatility Index (VIX) is still riding near its highest levels since 2003, and the Dow bears out traders’ nervousness.

Chicago Board Options Exchange

Nevertheless, there will be fortunes made and secured during these turbulent times. As inflation threatens paper money’s true value, we at Wealth Daily are holding gold. And anticipating a big U.S. slowdown, I am still bullish on overseas stocks and funds since they tend to recover higher than Wall Street.

We’ll keep you up to date on every market movement and what you need to do to keep yourself wealthy and financially healthy.



Sam Hopkins