European Debt Crisis right around the Corner?

I must admit folks that I am in awe of what I see each day in the financial markets. It's also very hard to make any sense of any it when it comes to investing.

Things that would have been considered tinfoil 4 years ago now have become reality. I mean heck: If anyone would have told me three months ago that Goldman Sachs would be accused of fraud I would have laughed in their face.

Yet(minus yesterday's hiccup), the market continues to march higher despite being surrounded by seemingly endless economic landmines that threaten to destroy our financial system.

I mean take your pick: Greece? The consequences of the Goldman Sachs trial on the TBTF banks? Portugal? Spain? Massive unemployment? Housing Collapse? Financial Reform? US National Debt? Derivatives? Inflation(I know they keep telling us there isn't any but just take a look at oil)?

All of these problems have fuses that could potentially take us all down if they get lit. The reason this is the case is because the world is all now interconnected financially. It doesn't matter whether or not the crisis is here or in Europe: If the European banks go down as a result of soveirgn defaults, the USA's banks will be right behind them.

That's why we must focus on the European debt crisis. The ramifications of a Greek debt default would be devastating despite it's small size.

Greece and Portugal alone are a half a trillion dollar problem:

2y Greek bonds hit 20% today which is unbelievably bad. Greece is rapidly becoming an Argentina 2001 on steroids. Spain was also downgraded today and their economy is over $1 trillion. Our banks basically avoided the two bullets above but the big bankers in Europe. This puts us at risk as a result.

For awhile it appeared that Greece would get bailed out and I still lean towards this theory, but I am starting to hedge as I watch the credit spreads blow out on the rest of the PIIGS. Making matters worse if the fact that it is beginning to put pressure on the debt of the other Euro countries.

This is rapidly becoming a situation where if you bail out one PIIG you need to bailout them all. The problem is the money simply isn't there to do it.

What's happened to Euro bond market this week is flat out stunning. The bond vigilantes in the USA must have hopped on a plane and flew over to Europe this week in order to have a little fun.

I don't see how this ends well. The only answer to this crisis IMO is to have the PIIGS leave the Euro and go back to their old currencies where they can then devalue them and inflate out of their fiscal disasters. The results of this would be catastrophic from a social chaos standpoint but I see no other way out.

Housing Collapse Part 2?

I may be early but I think it's unavoidable as we watch the homebuyer tax credit end this Friday.

The only part of the housing market that was really recovering since the bubble burst was the lower end of the market where buyers were taking advantage of the government's gift.

Making matters worse is the fact that these new loans were also done using more horrible lending standards via FHA. I spoke to one of my Wall St friends this week who had an interesting take on this: "FHA will go down just like Fannie/Freddie did because the lending standards haven't really changed".

I totally agree with him. Allowing a buyer with a 620 credit score to buy a house with only 3% down is a recipe for disaster! Why do we continue to make the same mistakes over and over again?????? 20% down with a DTI of 36% is the only way any financial institution should be lending. If housing prices have to collapse as a result so be it. It's the ONLY answer.

Making matters even worse for the housing market is the fact that the TBTF banks are preparing to dump massive amounts of foreclosures into the market. I have read one report where Bank of America is preparing to dump 600,000 foreclosures just by themselves!

I guess they must be getting tired of the millions of squatters who stopped paying their mortgages 2 years ago. The reality here is the banks can't afford to play this game anymore.

They also probably recognize that the economy is getting worse(despite what CNBC tells you), and they may be better off trying to dump them now versus dumping them later as unemployment continues to rise.

The Bottom Line

Hold onto your hats. Stocks and bonds in the USA may do well in the short term as a result of the chaos in Europe. There is a massive "flight to safety" going on over there and we will be the beneficiaries of it. This is also why you saw such a spike in gold this week.

Over the long term I expect the debt crisis to eventually end up over here as well. We are in no better shape than anyone else. However: Risk is relative and the perception by the markets for now is the USA is safer than Europe.

For now I agree. Europe is heading rapidly into a serious debt crisis. It will be interesting to see how it plays out. Be careful if you are short treasuries. Bonds over here should do OK for awhile.

I shifted some more of my portfolio out of treasuries and into cash this week despite my belief that bonds may do well over the next few weeks. I did this because I am afraid that the Euro debt crisis could potentially come over here in a heartbeat if things really start to unravel in Europe.

Be very very careful and keep a close eye on Europe. As for the Goldman debacle, I will get to that another day.

Disclosure: Sold US treasuries and government bonds.

Dylan Ratigan on Goldman Sachs

Dylan does an awesome job explaining the Goldman Sachs debacle. I was going to write something about this today, but I think Dylan's take is as good as it gets so I figured I would just let him do the talking.

The bottom line is Goldman Sachs is pure evil and needs to rot in hell as far as I am concerned. Wall Streets obsession around making money is going to destroy this country if these large banks are not stopped.

Lets hope the SEC charges are the beginning of the end for the pigmen!

Great job Dylan!:




Part 2

The Fed's Newest Bubble

Well it looks like the Fed has done it again.

They have successfully created another bubble. You can call this one the Equity Bubble. Once again it was done using the same toolbox of low interest rates.

It's amazes me when I watch this country keep making the same mistakes over and over again. Greenspan has been vilified post housing bust for keeping rates too low for too long in response to the last recession at the beginning of the decade.

Yet me have managed to do the same exact thing all over again before we have even fully recovered from the last time we made the same stupid mistake.

Any reputable economist will tell you that keeping interest rates too low for too long creates the perfect environment to create bubbles. The massive amounts of money created by such policy eventually begins to flow somewhere. This time it landed in stocks.

When looking at our previous bubbles created by our two decade old Ponzi finance system(tech, housing, and now stocks) they all had one thing in common: The ability to borrow money at extremely low rates.

So Why Stocks This Time?

In my opinion its multi faceted.

Firstly:

The banks have basically found their version of heaven:

- Hide their losses via fraudulent accounting

- borrow at practically zero.

As a bank in this environment you are going to make a fortune when you borrow at zero and lend to a home buyer at 5% or buy 30 year bonds that pay a 4.6% yield. It's almost impossible to lose money in such a rate environment when you are allowed to hide your losses with "hide the sausage" accounting.

Eventually, a large piece of this newly created money then inevitably begins to flow into stocks.

This got the stock bubble started. Then(like any other successful bubble) you need to suck everyone else in.

How do you orchestrate this if you are the Fed? Take away all other investment options.

Investors(especially senior citizens) are desperate for yield. Many of the elderly depend on it. By dropping rates to zero, the Fed has wiped out CD's, money markets, and treasuries as solid yielding investment options.

This essentially forces both the public and fund managers into buying stocks and junk bonds in a desperate chase for yield because the "safe" investments pay them nothing.

Just like the housing bubble: The higher the market goes the more people get sucked in like any other Ponzi scheme.

Eventually, the bubble turns into a euphoria where investors can't get enough until the music stops(which it always does)..

I am not sure if we are into the euphoria stage yet but one thing is for sure: Bubbles never end well.

I find at sad that investors are forced to throw their retirement portfolio into a bipolar market that soars and crashes ever few years.

Just look at the s&p 500 over the past decade or so:

My Take:

Markets aren't supposed to look like this! I believe the rally we have seen in 2009 wouldn't have been nearly as strong if CD rates were at 5% like they have been historically.

Investing in a zero interest rate environment has now changed the whole game. It turns the market essentially into a speculative casino where investors desperately try to find returns.

I bet if you took a poll: 80% would tell you that they hate investing in an environment like this where they are forced to take huge risk in order to find return.

I know it aggrevates the heck out of me.

Who in the hell wants to work all their lives and put their life savings into something that resembles Space Mountain at Disney World? The average person in this country doesn't want to invest in a roller coaster ride that gives them nothing but a couple heart attacks and zero returns when it is all said and done.

The Fed's policies however tell you that they could care less about the average person in this country. It's all about taking care of their Wall St. buddies.

The Bottom Line

I don't know where we are in this bubble but one thing I do know is this:

Buying stocks because there are no other options versus buying them based on valuations is a recipe for disaster.

When was the last time you heard about P/E values on CNBC? Been weeks since I have heard them talk about it. Hell, they probably can't even figure out the real P/E valuations because their is so much crap that's sitting on so many corporate balance sheets that's not being accounted for because of fictitious accounting rules.

God only knows how many worthless bad loans remain valued at 100% on Bank of America's balance sheet.

Don't be fooled folks: Markets that are made ignoring fundamentals eventually end up getting torched.

To be fair and balanced are earnings up? Of course, but look what they are being compared to. The economy virtually stopped from Sept. 2008-March 2009. If you are an average company you should be beating earnings after downsizing and increasing productivity in response to the great recession!

The question is can it be maintained? The answer is No Way Jose IMO.

What's scary is the quarterly earnings are probably going to look good which is going to throw even more investors onto the train we like to call the stock market.

Like any other bubble, this one will blow too and when it does there will be no place to hide because the Fed has used all of it's ammo to create the currentequity bubble.

The way it will blow will be two fold:

- The mark to fantasy game ends and losses are realized.

- Interest rates march higher as the risk of default rises as we continue to play "hide the losses" from the Ponzi finance game that peaked with the housing bubble.

If you are long enjoy the ride but watch out for that cliff that lies straight ahead.

Disclosure: No new positions at the time of publishing