HyperInflation Coming But Financial Crisis Not Over Yet

Ben Bernanke is indeed a man of his words. He not only stepped into a helicopter to drop money, he virtually flew a B-52 bomber and carpet bombed the skittish financial system with a trillion dollar payload.

The Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

In a single day, this “shock and awe” maneuver ramped up Treasury prices while driving down corresponding yields. The US dollar tumbled while gold spiked to $958, an impressive run considering its last traded price of $882 on Wednesday. Crude oil also rallied above $50 per barrel. Bonds and equities market also enjoyed a brisk rally.

However, I remain tentative of any sustainable momentum to turn around the major downtrend in stock markets. US economic conditions are not encouraging with the leading indicator index falling 0.4% and the number of Americans collecting unemployment benefits surging to a record. The US recession is deepening and when the US is in the doldrums, the rest of the world suffers.

IMF confirmed this view on Thursday with a grim warning: “The world economy is set to contract for the first time in 60 years, as the deepening financial crisis would lead to the global GDP shrinking by up to 1 per cent in 2009.”

On the bright side, there is cause for celebration if our greatest enemy happens to be deflation. The US CPI data indicates that inflation is on the rise and trade gap has narrowed sharply. Spectre of deflation has faded with the rise in prices and considering all the money being minted at epic proportions, inflation will surely catch up with us in a massive way by 2010 or 2011. The dire impact on curriences makes gold a superior investment but I will not discuss gold any further today.

Meanwhile, the financial sector could be in for more punishment from short sellers. Moody’s is set to cut ratings on $241 billion jumbo mortgage debt. These are not subprime loans (our dear friend which wrecked havoc on global financial institutions and claimed the scalps of Countrywide and Bear Stearns) but prime-quality U.S. residential mortgages which are above $417,000 and only available to good-credit applicants.

The fact that they are also on the verge of defaulting shows that unemployment is a malaise that takes no prisoners. A credit-worthy person without a job (and hence income) cannot afford his monthly housing payments, goes into default for several months and subsequently foreclosure beckons. The financial sector has to brace for more write-downs with all these delinquent loans and profits seem to be a distant dream.

By the way, overpriced residential property in dubious hands is no longer the only disaster for banks. The US commercial property is very much of a black hole. With $4 trillion of debts involved (nearly half in America), the cost of saving irresponsible banks may be grossly underestimated if this sector goes into a tailspin.

Then, there is a credit cards time-bomb which any day now, could blow up in a nasty manner. US credit cards default rose to a 20 year high with losses particularly severe at American Express Co and Citigroup. Credit card chargeoffs could reach 10 percent this year (from 6-7% in 2008) and racked up losses of $75 billion.

Credit card lenders are trying to cushion losses by tightening credit limits, slashing rewards, raising interest rates and increasing fees to cushion further losses. American Express has even resorted to paying $300 to close accounts. Whether such measures are effective in averting this crisis is unclear but credit card comapnies only have themselves to blame for gouging subprime borrowers with attractive offers.

As a sideshow, a bill to impose steep taxes on employee bonuses at AIG and other TARP recipients has been passed quickly in Congress. 90% tax will be levied on bonuses paid to employees of companies that received at least $5 billion in federal bailout funds.

While the fury over bonuses is appropriate, the real issue is the money which AIG has paid out to counterparties. Eliot Spitzer, former New York Attorney General who was disgraced in a high class prostitution scandal, says the AIG bonus issue is “penny ante” compared to the billions of the insurer’s bailout money funneled to bad banks.

Spitzers’s initial probes came from AIG’s effort from the very top to gin up returns whenever, wherever possible and to push the boundaries in a way that would garner returns almost regardless of risk. He described it succintly that AIG is the center of the web.

Many people are incredulous that AIG can take money from taxpayers on one hand to shore up balance sheet while rewarding their cronies with $165 million dollars on the other hand after reporting a $61 billion loss in a single quarter. I don’t blame Ben Bernanke, a normally stately and composed man, who blasted AIG for their reckless behavior.

AIG is a revered insurance company which we naturally assumed to be conservative but they betrayed our trust by behaving like a hedge fund and putting millions of insurance policy holders at risk. The “leaked” 22 page dossier by AIG to the Senate is breathtaking in its audacity. A company, granted it is big, holding the United States of America to ransom. With financial institutions like these, the United States doesn’t need enemies, or terrorists to be exact.

The Sept 11 terrorism took down the New York twin towers, causing global stock markets to be battered but none the worse once the shock wears off. Yet, the US and the world is staring at financial Armageddon because of the collapse of a single corporation. This makes Osama bin Laden looks like a convention nun and his devious plans looks like child’s play.

At least, the US can launch retaliatory attacks on terrorists for their inhumane actions but with AIG, nothing can be done. The US government and taxpayers can only submit meekly to their ravages. Maybe Osama bin Laden should invite all the derivative traders on Wall Street for lunch and then plan the next attack on the US. It should be easy since nobody wants to seriously regulate this industry, especially derivatives and credit default swaps.

That is all for my rant today. There could be a bear rally in the coming weeks and if you are nimble enough, this could be an opportunity to make money in the stock market. However, if you intend to hold for the mid to long term, I think it is wiser to conserve your cash. Stay tuned for more updates.