More Evidence That We're In a Second Credit Crisis

The tech-heavy Nasdaq and small cap Russell 2000 crashed again yesterday, August 18th. Nasdaq was down 131 points or 5.22% and the Russell 2000 was down 42 points or 5.90%. This is the third crash for both of them since the beginning of the month. Repeating crashes (drops of 5% or more in one day) were common during the Credit Crisis in the fall of 2008 and indicate severe stress in the global financial system. 

As in the fall of 2008, bank stocks are leading the way down. The only difference now is that bank stocks in Europe are getting hit the hardest, whereas it was U.S. and UK banks three years ago. So far, U.S. markets are holding up better than those in the EU. The Dow and S&P 500 have had only one mini-crash so far. The German DAX has had several. While continental European markets have been hit the hardest, Asian markets have continued to suffer the least from the current turmoil. The Hong Kong markets are being more impacted than those in Japan. 

While U.S. banks Morgan Stanley and Wells Fargo were down somewhat more than 4.5% yesterday and Bank of America and Citigroup 6.0%. This was much better than the 10% drop in Germany’s Commerzbank, the 11.5% drop in the Britain’s Barclays and the 12% drop in France’s Société Générale. As of August 18th, the EURO STOXX Financials index was down 38% from earlier this year. 

Just last week, French banks were supposedly in trouble, but this was denied by them and one major French news outlet retracted a story that claimed this was the case. Yesterday, the ECB (European Central Bank) said one bank, which it didn’t identify, had paid above-market rates to borrow $500 million a day for seven days. Today, it was reported that the U.S. Fed supplied $200 million of liquidity to the Swiss National Bank in the form of forex swaps. These are two separate issues. Switzerland is suffering from a skyrocketing currency (which is going to cause massive loan defaults in Eastern Europe if it continues since many loans there are denominated in Swiss francs), whereas the ECB is trying to keep banks afloat despite the fallout from the Greek debt crisis.

The chances of a full Greek default (a selective default with bondholders taking a 21% haircut was already part of the second bailout deal reached in July) intensified on Thursday. Finland insisted that Greece provide a cash deposit equivalent to its share of the second bailout guarantees. Four other countries then made similar demands. This of course undermines the bailout by taking away money with one hand that the bailout is providing with the other. 

Financial crisis behavior was also evident in the U.S. treasury markets. The yield on the 10-year fell as low as 1.9872 on Thursday, taking out the low from 2008. The two-year treasury has been hitting a series of new lows and has been significantly below its Credit Crisis bottom for some time now. One thing that is different from the 2008 Credit Crisis is that gold is rallying strongly and is in a blow off. The December gold futures contract hit another all-time high at $1881.40 this morning before U.S. stocks opened. Gold has always been a safe haven throughout history and despite claims to the contrary, it will remain so.

 
Daryl Montgomery
Author, “Inflation Investing – A Guide for the 2010s”

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.Investing is risky and if you don’t fell capable of handling it yourself, seek professional advice.