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Friday, January 18, 2008

We are coming dangerously close to a money panic.

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Few Wall Street analysts are talking about this in public. Fewer still understand its potential consequences. Many don't even know what a money panic is. But historians do. They realize that ...

A money panic is a stampede from greed to fear, risk to safety, buying to selling. Once set into motion, it can spin out of control, feeding on itself, wrecking havoc in financial markets.

Moreover, the data I'll share with you in this in-depth issue shows that, if not averted, a money panic could ...

* Threaten the solvency of major Wall Street firms like Bear Sterns, Goldman Sachs, Lehman Brothers, Merrill Lynch or Morgan Stanley.
* Increase the risk of future failure among large banks like Bank of America, Citibank, HSBC, JPMorgan Chase or Wachovia.
* Even force certain kinds of money market funds to break their solemn process of preserving your capital.

No one can predict the future. But right now, the panic is already spreading from big brokers and banks to local governments and a few money market funds. Just last week, for example:

* Florida's Local Government Investment Pool , a fund for local Florida governments, was frozen to stop a rush of withdrawals by panicked investors. Until recently, the fund had $27 billion. Last month, it fell to $15 billion due to mortgage-related losses and mass withdrawals. And on Thursday morning alone, before Florida slapped the freeze on withdrawals, the fund lost $3.5 billion!
* Montana's school districts, cities and counties withdrew $247 million from the state's $2.4 billion investment fund after officials said the rating on one of the pool's holdings was lowered to "default" level.
* Countrywide Financial caused more shock waves. One week ago, I explained why I believe the company is on a collision course with bankruptcy. ( Click here for the details. ) Now, we learn that state funds like Florida's may have substantial investments in the company's banking subsidiary, downgraded in August and likely to be downgraded again.

Even certain money funds, thought to be safe from the turmoil, have felt repercussions. Bloomberg's David Evans puts it this way:

"Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt instruments in the world: collaterized debt obligations (CDOs) backed by subprime mortgage loans ...

"U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year."

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