(From MIR of September 19, 2007)

—We have all learned now how much tolerance central bankers and more important politicians have for a financial market mess to be allowed to continue, especially when it involves voters.  The U.K government and BOE have guaranteed the depositors at Northern Rock they will get all their money back, a figure which is well above the limits of their deposit guarantee.  Where will the money come from to pay for this financial largesse?  Presumably the cash from the printing press.  What is most interesting and instructive in the Northern Rock tale is their business model was broken weeks ago, management knew it and after days of consulting with the U.K government along with potential buyers, no one, other than the government, showed up.

It is an odd thing that the root cause of the current credit crisis is excessive money printing and interest rates which were too low for too long, resulting in poorly thought out lending practices, yet the medicine being administered by central banks and governments is to do more of the same.  More money printing, more bailouts, and lower interest rates seem to be on the way, at least for now.  The sums which are necessary to reflate the financial system are fantastic.  CDO issuance topped $1 trillion since 2005.  Where all those CDO’s landed will be another interesting tale.  Over the next few months, I would look for disclosure of CDO holdings in some unlikely places—at companies rich in cash, in corporate pension funds, insurers offering guaranteed investment products and I think we’ll find those holdings all over the world.

How much are they worth?  Several weeks ago, I saw a news story on Bloomberg which noted Deutsche Bank thought A-rated CDO’s were trading at 25¢-50¢ on the Dollar.  If that turns out to be approximately where the market is, there are pension fund trustees who are going to have heartburn at the Q4 asset allocation meetings.  What will they do?  My guess is they will begin to jettison the positions which took on those CDO holdings. 

Anecdotally, in client meetings, I am hearing quite frequently that some hedge fund redemptions are being planned and I think CDO holdings along with the leverage employed in some hedge funds are the underlying reasons why.  Where will the money go?  I believe it will go to equities and to commodities.  At the margin, gold and silver are the commodities which are the principal beneficiaries of a money printing operation.  Commodities are likely to be the big winners as the bailouts grow geometrically.  Bernanke basically signaled today that we should buy risky assets and sell long-term bonds.  The gun just went off.  Our Dow Jones target for the next high is 15,800.  Charts of gold, silver, and the long-term view on oil are shown today.