US and European central banks inject billions in cash to stanch market meltdown - 10-Aug-07 - Generational Dynamics

The big trigger early on Thursday was an announcement by the the French group BNP Paribas Investment Partners, indicating that they were following in the footsteps of Bear Stearns. They would freeze three of their hedge funds that had invested in mortgage-backed securities.

The reaction that followed this announcement was enormous. But before getting to the details, let's step back and look at the big picture.

What almost no one understands is how different people are today than they were, say, ten years ago. During the 1990s, the people who survived the Great Depression were disappearing (retiring or dying), all at once. Those people were like the man described in the above paragraph. My own mother, incidentally, was exactly the same. The people who survived the Great Depression instinctively knew how dangerous credit was.

The investors of the last few years are very different. Their entire lives have been in relative luxury, with no little or no fear of homelessness, bankruptcy or starvation. They believe that they can take almost any risk with credit and get away with it.

But there's always been a little voice nagging at them -- perhaps the ghosts of their own parents or grandparents -- saying, "Be very careful. Don't go into debt. We could have another Depression at any time." And although investors scoffed at such warnings, they never completely forgot them.

So when things start looking bad, and they realize that all their assumptions are wrong, they panic, and they overreact. Today's investors are capable of panicking in a way that investors would NOT have panicked in the 1990s.

We didn't see a full-fledged panic on Thursday, but the smell of panic was definitely in the air.

"BNP Paribas Investment Partners temporarily suspends the calculation of the Net Asset Value of the following funds : Parvest Dynamic ABS, BNP Paribas ABS EURIBOR and BNP Paribas ABS EONIA

Paris, 9th Aug. 2007

The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating. The situation is such that it is no longer possible to value fairly the underlying US ABS assets in the three above-mentioned funds. We are therefore unable to calculate a reliable net asset value (“NAV”) for the funds.

In order to protect the interests and ensure the equal treatment of our investors, during these exceptional times, BNP Paribas Investment Partners has decided to temporarily suspend the calculation of the net asset value as well as subscriptions/redemptions, in strict compliance with regulations, for the following funds: ...

The valuation of these funds and the issue/redemption process will resume as soon as liquidity returns to the market allowing NAV to be calculated.

In the continued absence of liquidity, additional information on the envisaged measures will be communicated to investors in these funds within one month of today."

Note the sentence: "The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating."

This means that there's been a coverup going on, similar to one that occurred with Bear Stearns. The assets owned by the hedge funds are collateralized debt obligations (CDOs), or other mortgage-based credit derivatives. Since these CDOs can't be bought or sold on the open, as stocks are traded in a stock exchange, the value of these CDOs cannot be determined except by estimates (known as "mark-to-model," because the assigned value is determined by a computer software economic modeling program.)

Normally, BNP Paribas should be able to sell these CDOs to other investors, or investment firms. But the "complete evaporation of liquidity" means that nobody was willing to buy them at any reasonable price. As a result, BNP Paribas stopped investors from redeeming their shares in the hedge funds.

The hedge funds are supposed to be worth $2.2 billion, but it's possible that, like the Bear Stearns hedge funds, they'll turn out to be totally worthless, and the investors will lose everything.

This reaction by investors and central banks alike is illustrating increasing anxiety -- not yet panic, but getting closer. And the anxiety begets more anxiety: As an article in The Independent pointed out, the action by the ECB only served to spark "panic selling in stock markets around the world.

Related Articles

Macroeconomics
Understanding deflation: Why there's less money in the world today than a month ago.: As the markets continue to fall, the Fed is increasingly in a big bind.... (10-Sep-07)

Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)

Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
How to compute the "real value" of the stock market. : And some additional speculations about stock market crashes. (20-Aug-2007)

Ben Bernanke's Great Historic Experiment: Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.... (18-Aug-07)

Redemptions of money market funds now fully in doubt: Wednesday is the deadline for 3Q redemption of many hedge fund shares.... (15-Aug-07)

Alan Greenspan defends his Fed policies, as people blame him for the subprime crisis: Greenspan never ceases to amaze, and he did so again on Monday.... (8-Aug-07)

Nouriel Roubini says: "Worry about systemic risk." Whoo hoo!: His arguments show what's wrong with mainstream macroeconomics.... (6-Aug-07)

Robert Shiller compares stock market to 1929: He says the recent fall was caused by "market psychology," but is puzzled why.... (20-Mar-07)

A conundrum: How increases in 'risk aversion' lead to higher stock prices: Maybe because the global financial markets are increasingly "accident-prone."... (12-Mar-07)

Pundits are suddenly talking about (gasp!) "risk aversion": Fearing full-scale panic in the mortgage loan marketplace,... (6-Mar-07)

Alan Greenspan blames the housing bubble on the fall of the Berlin Wall: Meanwhile, the stock market keeps skyrocketing and appears unstoppable to many investors.... (25-Oct-06)
System Dynamics and the Failure of Macroeconomics Theory : Mainstream macroeconomic theory, invented by Maynard Keynes in the 1930s, has failed to predict or explain anything that's happened since the bubble started, including the bubble itself. We need a new "Dynamic Macroeconomics" theory. (25-Oct-2006)

Alan Greenspan gives another harsh doom and gloom speech: Saying that "the consequences for the U.S. economy of doing nothing could be severe,"... (4-Dec-05)
Ben S. Bernanke: The man without agony : Bernanke and Greenspan are as different as night and day, despite what the pundits say. (29-Oct-2005)

Fed Chairman Alan Greenspan says that the deficit is out of control: France's Finance Minister Thierry Breton quoted Greenspan... (25-Sep-05)

Fed Governor Ben Bernanke blames America's sky-high public debt on other nations: I'm normally wary of applying specific generational archetypes to individuals, but Bernanke is acting like a Baby Boomer.... (14-Mar-05)

Greenspan's testimony further repudiates his earlier stock bubble reasoning: The Fed Chairman has now completely reversed his previous position on the stock market bubble... (17-Feb-05)
Alan Greenspan warns that global economic dangers are without historical precedent : In a speech on Friday, Greenspan buried a major change of position in a speech admitting that his assumptions about the economy for the last decade were wrong. (6-Feb-2005)

Almost everyone seems to be totally oblivious to what's going on.

A Reuters article says, "Relative value opportunities are emerging in asset classes tainted by the U.S. subprime mortgage crisis."

In other words, investors formerly would invest in anything. Now they're stopping to look at which opportunities are better than others.

This is a theme that I focus on frequently: What is the value of the stock market?

Suppose that you want to purchase a pound of apples. You go the grocery and discover that one kind of apple sells for $100 per pound, while another kind of apple sells for $200 per pound. So you focus on "relative value," and pay $100 for a pound of apples.

But do you say to yourself, "Huh? Forget relative value. BOTH of those prices are way too high."

That's the problem. Even now, investors are not thinking of "value," but only "relative value," which is ridiculous.

And then, here's another article describing investors' strategy in setting up hedge funds: "Others are so-called statistical arbitrage funds, which analyze the historical relationships between related securities and trade when those relationships get out of whack."

Now, Dear Reader, do you know what they mean by "historical relationships"? In many cases, they mean last year. The hot shots may go back as far as ten years. They never go back farther than that; everyone knows that the world didn't even exist more than ten years ago.

So these people are totally oblivious to what's coming, but the readers of this web site have a great advantage over most investors and other Very Important People, because you know something that they don't know: That a new 1930s style Great Depression is coming with absolute certainty. I said this in 2002, and said that I expected a stock market crash by the 2006-2007 time frame. We still don't know exactly when it's coming, but we know with certainty that it IS coming.

The Generational Dynamics forecasting methodology, as usual, tells you where you're going to end up, but doesn't tell you how you'll get there. In 2002, I knew nothing about CDOs or a housing bubble. All I knew was the final destination, and it's only now that we're learning the path that we'll be taking to get there.

The question is: When will a full-on generational panic occur, similar to "Black Monday" in 1929?

Let's do some speculating. Last year I wrote an article "Speculations about a stock market panic and crash," to discuss what might happen leading up to a stock market panic if one occurred at that time. That didn't happen, but let's speculate on whether we might be close to one now.

Let me repeat: This is speculation, not a prediction. We know that a generational stock market panic MUST occur, and must occur soon, but short-term predictions are impossible. Still, it's hard to resist speculating.

This data is taken from my Dow Jones historical page. On September 3, 1929, the market peaked at Dow 381.17. By November 15, it had fallen 40% to 228.73.

This year (so far), the market peaked on July 19 at 14000. In the three weeks since then, it's been following a similar pattern.

The following table compares 1929 and 2007, following the respective peaks:

    1929   % of peak (381.17)
    -------------------------
    Tue 09-03 ( +0.22%) 100%              2007   % of peak (14000)
    Wed 09-04 ( -0.41%)  99%              ------------------------
    Thu 09-05 ( -2.59%)  97%              Thu 07-19 ( +0.59%) 100%
    Fri 09-06 ( +1.76%)  98%              Fri 07-20 ( -1.07%)  98%
    ------------------------              ------------------------
    Mon 09-09 ( -0.36%)  98%              Mon 07-23 ( +0.67%)  99%
    Tue 09-10 ( -2.04%)  96%              Tue 07-24 ( -1.62%)  97%
    Wed 09-11 ( +0.99%)  97%              Wed 07-25 ( +0.50%)  98%
    Thu 09-12 ( -1.23%)  96%              Thu 07-26 ( -2.26%)  96%
    Fri 09-13 ( +0.14%)  96%              Fri 07-27 ( -1.54%)  94%
    ------------------------              ------------------------
    Mon 09-16 ( +1.51%)  97%              Mon 07-30 ( +0.70%)  95%
    Tue 09-17 ( -1.04%)  96%              Tue 07-31 ( -1.10%)  94%
    Wed 09-18 ( +0.65%)  97%              Wed 08-01 ( +1.14%)  95%
    Thu 09-19 ( -0.25%)  97%              Thu 08-02 ( +0.76%)  96%
    Fri 09-20 ( -2.14%)  94%              Fri 08-03 ( -2.09%)  94%
    ------------------------              ------------------------
    Mon 09-23 ( -0.84%)  94%              Mon 08-06 ( +2.18%)  96%
    Tue 09-24 ( -1.78%)  92%              Tue 08-07 ( +0.26%)  96%
    Wed 09-25 ( -0.01%)  92%              Wed 08-08 ( +1.14%)  97%
    Thu 09-26 ( +0.96%)  93%              Thu 08-09 ( -2.83%)  94%
    Fri 09-27 ( -3.11%)  90%
    ------------------------
    Mon 09-30 ( -0.41%)  90%
    Tue 10-01 ( -0.26%)  89%
    Wed 10-02 ( +0.56%)  90%
    Thu 10-03 ( -4.22%)  86%
    Fri 10-04 ( -1.45%)  85%
    ------------------------
    Mon 10-07 ( +6.32%)  90%
    Tue 10-08 ( -0.21%)  90%
    Wed 10-09 ( +0.48%)  90%
    Thu 10-10 ( +1.79%)  92%
    Fri 10-11 ( -0.05%)  92%
    ------------------------
    Mon 10-14 ( -0.49%)  92%
    Tue 10-15 ( -1.06%)  91%
    Wed 10-16 ( -3.20%)  88%
    Thu 10-17 ( +1.70%)  89%
    Fri 10-18 ( -2.51%)  87%
    ------------------ -----
    Mon 10-21 ( -3.71%)  84%
    Tue 10-22 ( +1.75%)  85%
    Wed 10-23 ( -6.33%)  80%
    Thu 10-24 ( -2.09%)  78% Black Thursday
    Fri 10-25 ( +0.58%)  79%
    ------------------------
    Mon 10-28 (-13.47%)  68% Black Monday
    Tue 10-29 (-11.73%)  60%
    Wed 10-30 (+12.34%)  67%
    Thu 10-31 ( +5.82%)  71%
    Fri 11-01  (Closed)
    -----------------------
    Mon 11-04 ( -5.79%)  67%
    Tue 11-05  (Closed)
    Wed 11-06 ( -9.92%)  60%
    Thu 11-07 ( +2.61%)  62%
    Fri 11-08 ( -0.70%)  62%
    ------------------------
    Mon 11-11 ( -6.82%)  57%
    Tue 11-12 ( -4.83%)  55%
    Wed 11-13 ( -5.27%)  52%
    Thu 11-14 ( +9.36%)  57%
    Fri 11-15 ( +5.27%)  60%
    -----------------

If we follow the same pattern as in 1929, then we'll continue to have enormous ups and downs, with a big panic occurring about a month from now.

Generational Dynamics Web Log for 10-Aug-07
US and European central banks inject billions in cash to stanch market meltdown

Web Log Pages

	Generational Dynamics
	Forecasting America's Destiny ... and the World's

\| HOME \| WEB LOG \| COUNTRY WIKI \| COMMENT \| FORUM \| DOWNLOADS \| ABOUT \|

Generational Dynamics Web Log for 10-Aug-07 US and European central banks inject billions in cash to stanch market meltdown

Web Log Pages

Generational Dynamics Web Log for 10-Aug-07
US and European central banks inject billions in cash to stanch market meltdown