Please forgive the ‘rushed’ nature of this article but the very morning I posted this this article the Dow Industrial Average ended up closing down 311 Points, or 2.3% after recovering from a 450 point drop amid record volume. This is not good and I have no doubt that the Plunge Protection Team stepped in to “help” stop the decline.

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Although some would argue that “In the real world, efficient markets are not liquid and liquid markets are not efficient.” All pricing models used on Wall Street and every other major market assume that markets will be liquid and efficient. This is not always the case as was clearly demonstrated by the 1988 Long Term Capital Management meltdown and is proving not to be the case again now with the current, very serious sub-prime mortgage problems.

So here’s what we need to be worried about:

  1. Back in March 2003, Warren Buffet warned that “The rapidly growing trade in derivatives poses a “mega-catastrophic risk” for the economy… “
  2. Since that time: “Notional amounts of interest rate derivatives outstanding grew almost 14 percent to $285.7 trillion in the second half of 2006.”

So if Warren Buffet thought that derivatives were a “mega-catastrophic risk” for the economy four years ago, I wonder what he thinks now when the market for those instruments has grown by a mere 236% since he said that?

Don’t know the answer to that but we do know what he has been doing: “Warren Buffet has taken huge bets against the dollar, both by shorting the currency in futures contracts and by buying foreign stocks.”

What’s not hot today?

  1. Since late 2006 “161 major U.S. lenders have “imploded” and: “Right now things are starting to come unglued,” said Charles Gradante, co-founder of hedge-fund consultant Hennessee Group.”
  2. Wall Street firm Bear Stearns said two hedge funds it runs are now worth nearly nothing after a tumultuous June in which Bear had to promise the funds billions in rescue financing after subprime bets went bad. The net value of assets in Bear’s highly indebted fund, High-Grade Structured Credit Strategies Enhanced Leverage Fund, is wiped out, according to people familiar with the matter, who were briefed on the contents of a late-afternoon call with brokers. The net value of assets in its other larger, less-leveraged fund is roughly 9% of the value at the end of March, these people said.
  3. Just when it seemed like Wall Street’s top firms had weathered the subprime storm comes news that Bear Stearns’ High-Grade Structured Credit Strategies Enhanced Leverage Fund sank 23 percent as of the end of April 30. According to BusinessWeek Bear Stearns’ asset management group has suspended redemptions which has investors upset (to say the least). One apparently has been trying in vain to get his money back since February. The fund got caught on the losing end of a big bet on subprime mortgages. In a June 7 letter, Bear Stearns explained that redemptions were not possible because the “company will not have sufficient liquid assets to pay investors.”
  4. “Investors in the worse-hit of two stricken Bear Stearns hedge funds are offering to sell their holdings for as little as 11 cents on the dollar but still finding no buyers, according to unfilled trades on Hedgebay, a secondary market for funds.”

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  5. “The fund started less than a year ago with about $600 million in assets, but used leverage, or borrowed money, to expand its holdings to more than $6 billion, The Wall Street Journal reported. But subprime mortgage trades that went wrong left the fund down 23% in the first four months of 2007, the newspaper said.”
  6. “The risk of owning bonds of Wall Street firms soared as concerns escalated that investment banks will be hurt by deepening losses from subprime mortgages and waning demand for corporate debt.”
  7. “When creditors led by Merrill Lynch forced a fire-sale of assets, they inadvertently revealed that up to $2 trillion of debt linked to the crumbling US sub-prime and “Alt A” property market was falsely priced on books.”
  8. “If the higher-rated stuff is worth 85-90 per cent of face value at best, what is the value of the $750bn of mortgage-backed securities said to be held in US commercial banks’ balance sheets?”
  9. PIMCO’s Bill Gross – one of the world’s best fixed income managers said there are hundreds of billions of dollars of subprime residential mortgage-backed securities (RMBS), derivatives on subprime RMBS and collateralized debt obligations (CDOs) that buy subprime RMBS and/or the derivatives on the RMBS – all of which he considers “toxic waste.“
  10. Overall mortgage debt between 2000 and 2006 soared from $4.8 trillion to $9.5 trillion and: “As past marginal buyers are forced to sell their home to prevent foreclosures, so too will future marginal buyers be restricted from buying them.”

  1. China sold $5.8 billion in US Treasuries in May; the first time they have dumped US Treasuries on the market.
  2. This month, the U.S. dollar hit an ALL-TIME low against the Euro.
  3. This month, the U.S. dollar hit a TWENTY-SIX YEAR low against the British Pound.
  4. This month, the U.S. dollar hit an EIGHTEEN YEAR low against the Australian dollar.
  5. This month, the U.S. dollar index, which tracks a basket of world currencies, fell to a FIFTEEN YEAR low at 80.015
  6. The respected John Burns Real Estate Consulting company stated that the information for new and existing home sales, is “misleading and covering up a deep plunge of the housing sector.” The housing market is free-falling. Existing-home sales are down 22% in May and mortgage applications have fallen 18%….In Florida home sales are down 34%, not 28% as NAR reported; Arizona sales are down 38%, not 28%; and California’s down 37%, not 24% as NAR reports.”
  7. “The slump in home prices from the end of 2005 to the end of 2006 was the biggest year over year drop since the National Association of Realtors started keeping track in 1982.” (New York Times) The Commerce Dept announced that the construction of new homes fell in January by a whopping 14.3%. Prices fell in half of the nation’s major markets and “existing home sales declined in 40 states”. Arizona, Florida, California, and Virginia have seen precipitous drops in sales. The Commerce Department also reported that “the number of vacant homes increased by 34% in 2006 to 2.1 million at the end of the year, nearly double the long-term vacancy rate.” (Marketwatch)

All of this is enough to make you worried but there’s more from one of our VIP Members Brad Bard:

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  1. “7th July 2007 – Senator Rick Santorum: “Confronting Iran in the Middle East as an absolute linchpin for our success in that region…. And while it may not be a popular thing to talk about right now, and I know public sentiment is against it [namely, the war in Iraq and expanding the conflict to Iran] … between now and November, a lot of things are going to happen, and I believe that by this time next year, the American public’s going to have a very different view of this war, and it will be because, I think, of some unfortunate events, that like we’re seeing unfold in the UK. But I think the American public’s going to have a very different view….”
  2. Arkansas Republican chairman Dennis Milligan, who describes himself as “150 percent” behind Bush and his Iraq war, said in an on-the-record interview with the Arkansas Democrat-Gazette: “At the end of the day, I believe fully the president is doing the right thing, and I think all we need is some attacks on American soil like we had on [Sept. 11, 2001], and the naysayers will come around very quickly to appreciate not only the commitment for President Bush, but the sacrifice that has been made by men and women to protect this country.”
  3. 10th July 2007 – Although the US Intelligence community spends $100+ billion per year on “intelligence,” Homeland Security Secretary Michael Chertoff prefers to rely on his “gut feeling”. He told the editorial board of the Chicago Tribune that he had a “gut feeling” about a new period of increased risk. Saying that “Summertime seems to be appealing to them,” Chertoff said in his discussion with the newspaper about terrorists. “We worry that they are rebuilding their activities.”
  4. The US national intelligence chief and other intelligence spokesmen confirmed that strikes against “terrorist targets” in Pakistan’s tribal belt are increasingly possible.
  5. The US now has a formidable strike force in the Gulf with two carrier groups, 50 or more warships with nuclear weapons, hundreds of planes and contingents of Marines and Navy personnel.

They’re not there for a social visit and …

Because “The US wants to place ten interceptor missiles in Poland and a radar station in the Czech Republic to counter possible rocket attacks from “rogue states” such as Iran.”

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So is anybody really surprised that:

“Russia threatened to deploy rockets in the European Union’s backyard yesterday in retaliation for American plans to install a missile defence shield.”

“It’s obvious that if part of the strategic nuclear potential of the US is located in Europe, which in the opinion of our military experts represents a threat, we will take the corresponding steps in response,” said Mr Putin,

So apart from facing some catastrophic financial problems, while 47 million Americans go without health insurance, the US is spending $255 million per day at ‘war’ with Iraq, the US is threatening Iran with nuclear weapons and now threatening to attack another Muslim nation – Pakistan, a military dictatorship who is also allegedly a US ally.

A ‘perfect storm’ is a “a critical or disastrous situation created by a powerful concurrence of factors” which is most definitely what we are seeing today but apart from this, there’s very little to worry about.

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Written by Scott Oliver, author of How To Buy Costa Rica Real Estate Without Losing Your Camisa and Costa Rica’s Guide To Making Money Offshore.


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