Dow Jones has downgraded $37.2B Of collateralized debt obligations (CDOs). Of the $37.2 B, $14 billion worth of the highest rated CDOs were reduced from the highest rating of AAA to junk status. This follows nearly $20 billion worth of transactions which were reduced to junk status, while another 60 CDO transactions are still on watch for potential downgrade.
CDOs are risky mortgages which were bundled together and sold as less risky financial instruments because the bond rating agencies assumed that they would not all go bad at once, so the overall security should be safer than the individual mortgages.
This is another symptom of the fact that there are More mortgage loan problems.
What's behind the reports on this.
The Fed Chief has already reported that he is pessimistic about the further of the economy. When he suggests bad news for the future, he will always downplay the severity because if he ever said that the problems were going to be severe, his very announcement would set off troubles in the market that would make things economically more severe.
Combine the credit market problems with the dropping dollar and the increasing price of oil with the inability of the Federal Reserve to effect the problems by either increasing or reducing the interest rate, The American economy is looking at a tough period. The two questions remaining unanswered are how tough and how long.
The biased reporters
There is no clear answer to those questions, but keep in mind that the Fed Chief, Ben Bernanke, cannot announce any prediction that is not already common wisdom in the financial markets which are already built into market prices. So his prediction that there will be a recession in 2008 is common market wisdom already.
The only problem is, the market-makers themselves make a living by selling their services brokering the buying and selling of credit securities. If they as a group claim to be pessimistic about the future of the market, all orders will be to sell and no one will buy. That shuts down the markets and puts them out of business, so they will be uniformly biased towards predicting mild market shifts rather than extreme ones. So Bernanke is restricted to announcing the common wisdom of the market makers, and the market makers are biased towards expecting minor changes in the market.
No one is going to stand up and say that the future of the American economy and economic markets is bleak.
My reaction
Neither am I. I am no professional economic pundit. The best (or worst) that I will say is that no one is going to tell us how bad things are going to get, because that message, delivered from someone who might really know, would be a self-fulfilling prophesy.
I will say that now it s probably a good idea not to have any debt that comes due in the next two or three years, avoid debts in foreign currencies that you depend on dollar revenue to pay, buy foreign assets and currencies, and consider real assets rather than dollar-dominated financial assets in your portfolio. Oh, and switch your IRAs into foreign investments. Don't let a mild increase in transaction costs keep you from making those financial moves.
Oh, and don't pay off your fixed interest rate mortgage now, since you may be able to repay it with depreciated dollars in the relatively near future. That's if you don't depend on a dollar-based pension that is not increased for inflation.
My expectations
My bet is that the U.S. can expect to conduct an Argentine-style financial collapse. But it may not be as bad for us as it was for Argentina because the U.S. has had the international reserve currency, and the American economy has been the engine of international growth. So many nations have very large Dollar debt holdings that they will fight to keep the dollar from dropping too badly, and those nations (cough *China* cough) who have used exports to the U.S. to keep their economy working are likely to want to avoid a collapse of American buying. So the U.S. has advantages that Argentina did not have. Still, the near future for the American economy is not going to be a good period.
So get ready for Inflation, a lot of foreclosures, more bankruptcies (in spite of the credit card company friendly bankruptcy bill), a slower economy and a rapid increase in inflation. That's the near future.
Blame Bush as well as Greenspan who manipulated the economy to reelect Bush.
How bad will it really get?
By the way, I do expect an extremely severe recession. (Bad, but not disastrous.) I don't know how long the Recession will last, but I do NOT expect a Depression. Our economists do not even yet fully understand what happened in the 1930's, but they have learned a whole lot. No one in government is going to wait on the economy to fix itself, the federal reserve understands that bank failures reduce the money supply so we have bank insurance as well as the Federal Reserve, and we do not have the Gold Standard which transmitted the Depression from America to the rest of the Industrialized world.
Still, the credit crisis is currently really bad an getting worse. It is one bad element of a simultaneous set of economic problems. 2008 is not going to be an economically pleasant period.
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