The Sixth Day
Sunday, March 02, 2008
  Rising Risk - Final Installment
Ninth, the shadow banking system, made up of non-bank financial institutions, will soon be in trouble. Like banks, they borrow short-term money (for a bank this is taking deposits) and lend the money to longer term borrowers. They can have a liquidity crises if the short-term money is withdrawn and they cannot immediately call in their long-term loans. Banks can borrow from the Federal Reserve to meet this type of liquidity crises but the financial institutions in the shadow banking system cannot.

Tenth, stock markets in the U.S. and worldwide will fall further if it becomes clear that there will be a severe recession in the U.S. rather than a mild recession such as the two we had in the last fifteen years. In a typical U.S. recession the S&P 500 falls 28%. A fall of that magnitude or larger could cause hedge fund bankruptcies as well as possible failures of other financial firms.

Eleventh, the credit crunch can cause financial markets that are normally very liquid, such as derivatives, to freeze up. This is what happens if institutions loose confidence in each other and are unwilling to make the normal day-to-day transactions that keep money and goods moving around the world.

Twelfth, the cycle of illiquidity, credit contraction, and losses can force more fire-sales of assets at below their fundamental values. If this cycle begins to spiral down, then losses will multiply and the situation will become increasingly severe. This could become the worst financial crises of the last twenty-five years.

The ability to avoid such a scenario is dependent primarily on the U.S. Federal Reserve to have a coherent, timely, and credible response. This is a tall order. Because of the risk involved, one should be prepared for the worst.

Once again, this is a summary of Twelve Steps to Financial Disaster by Professor Nouriel Roubini. More information is available at http://www.rgemonitor.com/

My advice to everyone reading this summary is to maximize your own liquidity. That is, pay down debt and maximize your holdings of cash and bank deposits. Do not hold ownership investments in financial firms. Favor investments in natural resources and inflation hedges such as gold or silver.

While a financial crises is not a good thing, it can cleanse the financial system of past mistakes and lead to a better tomorrow. Do not panic. If your trust is in the Lord, you can weather any crises knowing that ultimately, He is in control!

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Commentary about all things human; life, the Christian religion, ethics, politics, economics, sociology, art, anything to do with twenty-first century American culture. Perhaps I will inform, perhaps I will anger and frustrate, but I hope always to make you think!

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I grew up in Kansas in the 1950's - 60's. I attended Kansas State (B.S. in Soc. Science) and Washburn Law School (J.D.). My wife and I have been married for over thirty years and are the parents of three grown sons.

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