Gary North’s Economic Edge™
Twice-weekly economic insights and advice from a biblical worldview
Volume 1 Issue 21 • An Electronic Publication of The American Vision™
These words appeared at the bottom of the screen for the
entire morning segment on the stock market in the opening few
minutes of The Today Show on Monday morning, September 15. This
was the message conveyed to millions of housewives 80 minutes
before the New York Stock Exchange was scheduled to open. The
words were entirely appropriate. By the end of the day, the Dow
was down by over 500, and the S&P 500 was down by over 50.
At long last, the media are scared. I watched CNBC in the
afternoon. I tuned in to see the looks on their perma-bull
faces. They were visibly scared. I don’t blame them.
Anyone who has read what I have been writing since last
November knew this was coming. On November 5, 2007, I told
subscribers to my Website to short the stock market: the Standard
& Poor’s 500. The index was at 1500, down from 1550 a month
earlier. It is now under 1200. It lost over 50 points in one
day. Those subscribers who took my advice have done very well,
and I think they are going to do a lot better as the markets
continue to fall.
But the experts did not know. The Today Show brought on the
usual in-house experts from CNBC. These experts were Money Honey
(Maria Bartimoro) and Mad Money (Jim Cramer). Both of them
assured viewers that this is all temporary, that there is no
major problem, that it will soon be a buying opportunity, the
stock market will recover, yada yada yada.
This is what they have been saying, month after month, all
year, as the nightmare on Wall Street has unfolded. This has
been a nightmare ever since last October. Down, down, down have
gone the stock indexes, but especially the financial stocks.
Lehman Brothers Holdings has gone bankrupt. Here is a firm
that was founded in 1850. It survived the Civil War and the
Great Depression. It did not survive the current breakdown.
Anyone who thinks this crisis is some minor affair is not
On Sunday night, September 14, the attempted bailout by ten
major financial firms and banks fell apart when Barclays Bank
said “no deal” to the request by Treasury Secretary Paulson that
they each pony up $7 billion to bail out Lehman. That decision
certainly showed wisdom on the part of Barclays.
Less wisdom was shown by Bank of America, which agreed to
buy Merrill Lynch. On Monday morning, Standard & Poor’s, the
credit rating agency, downgraded Bank of America’s bond rating to
AA-, down from AA. This means that Bank of America will have to
pay higher interest to creditors. S&P announced that there may
be another downgrading. Why did S&P do this? Because of doubts
Merrill was one of the ten firms called together over the
weekend by Secretary Paulson. As to how Merrill was going to
pony up the $7 billion on Monday morning, when it did not even
survive as a separate firm on Monday morning, will be one of
those questions that curious historians of 2008’s nightmare on
Wall Street may want to chat about.
What the weekend showed is that the Treasury Secretary has
declining influence. He spent the whole weekend trying to get a
deal put together to save Lehman, and it fell apart at the last
On the Today Show, there were scenes of Lehman employees
walking out the door, carrying boxes of possessions or pulling
boxes behind them on what appeared to be luggage carts.
Lehman is in the hole $613 billion. It has assets of $639
billion. It will have to sell these assets to pay creditors.
This will put downward pressure on the prices of these assets.
Some of them are illiquid.
What do I mean by liquidity? This:
1. You can sell rapidly.
2. You can sell without a discount.
3. You can sell without advertising costs.
4. You can sell with low transaction fees.
The problem is this: the investing world does not know how
many of Lehman’s assets are illiquid. When Lehman sells in order
to pay creditors, this will put downward pressure on all the
markets, but especially the illiquid markets.
When it does, the dominoes will continue to fall. There
will be more bankruptcies, as Money Honey said on the Today Show.
In March, Bear Stearns was saved only by the weekend
pressure of the Federal Reserve System on J.P. Morgan, which
bought the shares at pennies on the dollar.
On Sunday, September 7, the Federal government, in the
person of Secretary Paulson, announced that the Federal
government was taking over the mortgage market in the United
States. Over the past year, Fannie Mae and Freddie Mac have
packaged 75% of all mortgage loans in the United States. The so-
called “conservatorship” is in fact nationalization.
Congress did not protest on Monday, September 8. The public
did not protest. This was a unilateral announcement by a
lame-duck Treasury Secretary, everybody in authority accepted it.
We have lost the free market in mortgages in the United
States, and nobody blinked.
It’s falling apart. The entire capital structure is being
hit, just as Austrian economic theory said it would.
“EVERTHING IS JES’ FINE”
One of The Today Show reporters said that Lehman’s employees
were disappointed because they had been told by senior management
everything was all right.
Of course that is what senior management said. All senior
managements lie in a crisis. Everyone knows senior managements
lie — except their employees. This is the Enron factor. Senior
managements lie about imminent bankruptcy in the same way that
politicians lie about virtually everything. If they did not lie
about the imminent bankruptcy of their firms, shareholders would
immediately sell the stock, which would immediately bankrupt the
firms. Senior managers hope for the best. They hope for a
miracle. They hope against hope.
Here were highly sophisticated employees who had spent a
year watching the financial markets disintegrate, and these old
hands sat in their offices, selling people investments that were
doomed to go down, on the assumption that nobody was lying to
them at the top. Talk about naive!
There are people who take seriously the recommendations of
brokers whose jobs are so close to oblivion but they are unlikely
to have a career in the industry in a month or two. Yet the poor
saps listen to these people, take their advice, and lose money.
Why would anybody believe a stock broker today? Merrill
Lynch, which was bullish on America, no longer exists as an
independent organization today. It took a bailout by Bank of
America to keep the organization alive.
Presumably, you know better if you have been reading my
warnings for over a year. Presumably, you are completely out of
the stock market. If you are wise, you shorted the market no
later than last November. But he if you are still in the stock
market, then you are in it because you have been listening to the
Now, finally, the mainstream media are frightened. This
fear will spread to the general public.
Think of the 24,000 ex-workers at ex-Lehman. They work in
New York City. They are in debt up to their ears. They are now
unemployed. They will probably lose their homes, if they own
their homes. They will not find a job in financial services.
The entire financial sector in New York City is in
contraction mode. In 2007, 140,000 jobs were lost in the
nation’s financial sector in the first ten months. Over 40,000
of these were in New York City. In a report last November, we
read the following.
Broker-dealers have been active in reducing their
workforces. Morgan Stanley (900), Bear Stearns (310),
Lehman Brothers (1,200), and Credit Suisse (320)
announced cuts in residential mortgages, banking and
leveraged finance. Those institutions with significant
losses, particularly UBS (1,500), Citigroup (15,000),
and Bank of America (3,000), are trimming their
workforces even further and issuing warnings that more
layoffs may be ahead. On October 26, Reuters reported
that Merrill Lynch is expected to issue pink slips
after a third-quarter net loss fueled by mortgage and
leverage loan losses.
Yet on Friday afternoon, September 12, there were 24,000
workers at Lehman who were still on the job, still hoping for the
best. They believed senior management. These people were slow
In late March, just after the Bear Stearns fiasco, London’s
“Guardian” reported on the estimate that 20,000 jobs on Wall
Street would disappear over the next two years.
In short, the experts in the financial industry were blind
to the magnitude of what was about to happen. They could not see
that the financial sector was about to get smashed.
People hope for the best. They hate to face unpleasant
reality. They stay on the job when it is clear that the job is
terminal. This is human nature. This is why people who own
stocks and mutual funds still hold them, and still take Jim
BERNANKE TO THE RESCUE!
The Federal Reserve is in panic mode. On Sunday, it
announced another lowering of its standards for making loans. It
used the usual bankers’ jargon. The following means “the markets
are falling apart. The collateral on loans is declining in value.
We are taking steps to loan money on sows’ ears at silk purse
“In close collaboration with the Treasury and the
Securities and Exchange Commission, we have been in
ongoing discussions with market participants, including
through the weekend, to identify potential market
vulnerabilities in the wake of an unwinding of a major
financial institution and to consider appropriate
official sector and private sector responses,” said
Federal Reserve Board Chairman Ben S. Bernanke. “The
steps we are announcing today, along with significant
commitments from the private sector, are intended to
mitigate the potential risks and disruptions to
I like this phrase: “potential market vulnerabilities.” It
means “capital market collapse.”
“We have been and remain in close contact with other
U.S. and international regulators, supervisory
authorities, and central banks to monitor and share
information on conditions in financial markets and
firms around the world,” Chairman Bernanke said.
This means: “Things are unraveling so fast that the
government’s entire regulatory structure is trying to figure out
what is happening. So far, nobody has a clue. But we’re working
The collateral eligible to be pledged at the Primary
Dealer Credit Facility (PDCF) has been broadened to
closely match the types of collateral that can be
pledged in the tri-party repo systems of the two major
clearing banks. Previously, PDCF collateral had been
limited to investment-grade debt securities.
The collateral for the Term Securities Lending Facility
(TSLF) also has been expanded; eligible collateral for
Schedule 2 auctions will now include all investment-
grade debt securities. Previously, only Treasury
securities, agency securities, and AAA-rated
mortgage-backed and asset-backed securities could be
Translation: “We are willing to loan freshly created money
to buy just about anything the cat brings in.”
These changes represent a significant broadening in the
collateral accepted under both programs and should
enhance the effectiveness of these facilities in
supporting the liquidity of primary dealers and
financial markets more generally.
AIG ON THEIR FACES
AIG is the largest insurance company in America. Most Wall
Street companies are connected to AIG in one way or another.
AIG has the signs of a company in its terminal stage.
Jim Cramer made one point that I agree with entirely. He
said that the real threat to the economy now is AIG. This giant
insurance company needed an infusion of capital something in the
range of $40 billion. That’s what Cramer said.
Before the market closed, AIG needed $75 billion.
If it goes under, who is large enough to bail it out? If
the Treasury Secretary could not put together a deal to save
Lehman, how could he reasonably expect to put together a deal to
save anything as big as AIG?
Cramer mentioned the possibility that the Federal Reserve
would have to intervene. He was not alone. My late afternoon,
when the Dow Jones Industrial Average had fallen over 400 points,
CNBC interviewed two experts. One looked grim. He spoke of the
need to preserve confidence in trying times like now. The other
one agreed, but said the FED may not intervene.
When the stock market opened on September 15, AIG’s share
price was down 41%, at $7. Last October, it was at $70. In
early August, it was at $30. It was under $6 by the afternoon.
This is a collapse. When a stock falls 90%, a financial
company is as good as finished. Potential clients will not
become clients. Old clients will flee.
By the end of the day, the Federal government had asked the
last two surviving investment banks, J. P. Morgan and Goldman
Sachs to intervene and put together a $75 billion package to bail
out AIG. (This was a “Wall Street Journal” story.)
Money Honey by 3:30 p.m. announced that AIG had lost $19
billion in capital in less than one trading day. The market
value of the stock was $14 billion. In less than one day, it
lost over half its value. The share price declined from $12 to
The guy she was interviewing, Win Smith, said AIG is too
important to fail. “AIG has to survive.” When some harried
looking guy on camera who looks bleak says that an outfit “really
has to survive,” it’s as good as gone. He said, “It must go
forward.” Don’t bank on it. Who is Mr. Smith? He is the former
chairman of Merrill Lynch International. He said everything is
fine at Merrill. The merger with Bank of America is great.
His former employer is gone. This is great, he says. Up is
down. Black is white. There is good news ahead.
The government is grasping at straws. There will be no
bailout from private firms without government guarantees against
losses. AIG is a huge pile of liabilities. Who wants them?
The experts did not see this coming. But they want us to
believe them when they tell us that the worst is behind us, so
don’t sell your shares, don’t panic, yada yada yada.
An insurance company holds lots of long-term debt. This
means bonds and mortgages. Lots and lots of mortgages. These
are liquid in normal times, but in a panic sell-off, they are
What happens if AIG declares bankruptcy and is forced to
unload its portfolio rapidly? Who will buy the toxic waste that
has led to the company’s precarious position?
The experts are scared. I could see it as they faced the
cameras. They are seeing a meltdown. Two icons of the industry
died over the weekend. A third is about to die.
Then there is Washington Mutual. It is close to the end.
Its stock went under $2 yesterday. It is almost a penny stock:
below $1. The 8th largest bank in the nation!
It’s going to get much, much worse.
© 2008 An Electronic Publication of The American Vision™
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