Financial Crisis in Summary

A Summary of What's Been Going On The Past Week

The last few days and weeks have been truly extraordinary. In short, we have seen events that none of us thought we would see in our generation:
• A bank run in the UK.
• The central bank of the most powerful country of this planet offering help to households on the first page of its webpage.
• A dramatic change in this central bank’s balance sheet now filled with repackaged mortgages at the expense of government bonds.
• Financial authorities who explored new paths in search of the best market support
• Repurchase agreements of huge proportions.

Things that were unthinkable have happened:
• A central bank going out of jurisdiction to bail out an investment bank.

In the last three weeks, we saw:
• The two biggest mortgage providers of this planet becoming nationalized
• Followed one week later by the largest insurer
• The disappearance of a 150 year old financial institution, meanwhile its competitor was taken over by a bank.

And last week:
• A major shortage of dollars on a worldwide basis.
• A money market fund’s NAV dropped below $1.00 (a situation known as "broken the buck"), prompting huge redemptions and forcing other MMFs to suspend redemptions.
• Commercial paper yields rose from 3% to 5% in one day, the result of MMF sales.
• The US central bank directly injected a whopping $245bn into financial institutions.
• Other foreign central banks injected $247bn in financial markets for their part.
(Pictet)

The reflief rally following the promised $700 billion clean-up of Wall Street's toxic waste lasted barely more than a trading day. One day!! Foreign investors finally realising that they are bailing out Uncle Sam.

For most of September, Treasury bond prices rose on the theory that, in the midst of a crisis, they were a safe haven. But, as Hank Paulson and Ben Bernanke have approved a bewildering array of ever more far-rearching bailouts, investors started adding up the numbers.

Depending how you account for the quasi-nationalisations of Fannie Mae and Freddie Mac, the total cost is now well over $1 trillion - and possible several trillion dollars.

If Uncle Sam was rich, this might not matter too much. But the government's deficit is already yawning as the result of a slowing economy. On conservative estimates, it will reach $450bn next year. It doesn't take a dire assumption to think it could top $1tr by 2010.

What's more, the country as a whole is still relying on funds from abroad to finance its trade gap. The current account deficit is running at $60bn a month, a cool $720bn annually

From an international investor's perspective, this is beginning to look worrying. Last week they were receiving a yield of only 3.4% for holding US government paper for 10 years. Even if inflation comes back under control and hovers around 3%, that doesn't look like much compensation. Something more like 5%-6% would be reasonable. If inflation starts to take off - and Monday's astonishing 12% spike in oil prices is not a comforting omen - a reasonable bond yield would be still higher.

In the past week, the dollar has fallen by 3% on a trade-weighted index while the price of 10-year Treasuries have dropped 4%. Put these together and foreign buyers of have suffered a 7% loss. The real worry is that there could be a stampede for the exits as they try to cash out before suffering even bigger losses. The Federal Reserve might then be forced into the unpleasant task of pushing up interest rates in the midst of a crisis.

In short, we're £u<*#&!