Tuesday, December 25, 2007

Toilet Paper Money

With Christmas now behind us, and 2007 soon to be in the rear view mirror, we can begin to look forward to a new year of very bad news for the world financial community. Bad news, that "should" translate into good news for those that believe in the virtues of the Precious Metals. The imminent implosion of the commercial bond market may be just the spark to reignite Gold's run to $1000. For Gold is the truthsayer, and the light at the end of a very long and dark tunnel for bond investors...

The financial turmoil just keeps getting worse. This week S&P slashed the rating of small bond insurer ACA Capital from triple-A to junk, stating that mortgage-related losses could exceed its $650 million capital cushion by more than $2 billion. ACA has provided guarantees on billions of dollars of securities including $26 billion of CDOs. Since in almost all of these cases the triple A ratings of the guaranteed securities depends on the guarantees, these securities are likely to be subject to writedowns as well, leading to a new wave of additional writedowns at banks and other institutions.

But wait—there is more. While ACA is relatively small, S&P yesterday put two large bond insurers—MBIA and Ambac---on negative watch, meaning that it may downgrade their ratings in the near future, although it confirmed their triple A status for now. In addition MBIA, in a surprise move, indicated that it guarantees $8.1 billion of so-called CDOs-squared that have chances of losses. CDOs-squared repackage other CDOs and securities linked to subprime mortgages. If leading bond insurers were downgraded some $2 trillion of insured securities would lose their triple A rating, leading to another surge of massive writedowns at financial institutions throughout the globe along with additional severe credit problems in the world financial system. --Bob Chapman, The International Forecaster

Ratings Collapse
by Martin D. Weiss Ph.D.

...since lower-rated bonds are invariably lower-valued bonds, when they're downgraded, there will be an across-the-board downward adjustment in bond prices — a bond market crash.

...investors may begin to seriously question Wall Street's entire system for rating the nation's $2.6 trillion in municipal bonds ... $10.6 trillion in corporate bonds ... and $1.9 trillion of commercial paper and other money market instruments.

In short, this crisis could raise doubts about the true value of all non-Treasury securities — whether insured or uninsured, long term or short term, at risk or not at risk.

The net result:

An Unprecedented FlightFrom Risk to Safety

Investors will rush to sell any bond or money market instrument in doubt — not only the mortgage-backed securities and CDOs that are already pariahs of the investment world today, but also ...

  • Local and state tax-exempt bonds

  • A wide range of corporate bonds

  • Government-sponsored agencies like Fannie Mae and Freddie Mac

  • Commercial paper

  • Bond market mutual funds, and even ...

  • Certain money market funds, such as those that have invested heavily in commercial paper.

At the same time, investors will rush to buy ...

  • Treasury securities

  • Treasury-only money market funds

  • Safe-haven foreign currencies like the Japanese yen and the Swiss franc

  • Gold, gold ETFs and mining shares, plus ...

  • Virtually any investment perceived to be immune from the ratings collapse.

Needless to say, the Fed will respond with massive money pumping. And if MBIA can receive a massive capital infusion, a bond market panic may be avoided for now.

But any capital infusion is unlikely to be more than a temporary band-aid. No matter how the crisis is ultimately resolved, you're bound to see a substantial flight to safety. http://www.moneyandmarkets.com/Issues.aspx?NewsletterEntryId=1301

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