Global Stock Market BLOG - Mike Burnick

Is Santa Clause Coming to Town?

U.S. stocks turned in their best two-day performance in over five-years on Tuesday and Wednesday, with yesterday’s 2.6% advance by the Dow Industrials the best percentage gain this year. Is this the start of the Santa Clause rally?

This year, the jolly old elf may come to town the week after next, dressed like Ben Bernanke, and bearing the gift of another Fed rate cut.

According to the talking heads on CNBC, the prospect of more easy money to come when the Fed next meets in less than two-weeks is the main catalyst driving the rally in stocks. Fed fund futures are showing a 100% chance that the Fed will lower its benchmark rate by at least another quarter-point on December 11.

Federal Reserve Vice Chairman Donald Kohn spread some holiday cheer on Wall Street yesterday, saying in a speech that the “uncertainties” about the economy are “unusually high” and that the Fed would be “flexible and pragmatic” in response.

Investors interpreted Kohn’s remarks favorably, indicating the Fed will indeed continue to cut rates in response to the credit crunch market shock that’s still gripping Wall Street.

Credit Markets Still Crunched

According to Bloomberg, “The London interbank offered rate that banks charge each other for euro loans due after the end of the year jumped 64 basis points to 4.81 percent, the highest since May 2001.”

Meanwhile the Libor rate for borrowing in U.S. dollars also jumped 40 basis points to 5.23% – the biggest move in more than a decade.”

This key lending rate that banks charge each other for routine short-term funding is once again going through the roof, as happened in August and September, before the Fed began easing interest rates.

The reason Libor rates are shooting higher this time around is being attributed to high levels of cash demand going into year-end, when financial market activity will slow down considerably.  But there’s something more sinister at work here.

Averting a New Year’s Credit Crisis

A money manager interviewed by Bloomberg put it best: “The increases we've seen in borrowing costs cannot be simply explained away by year-end pressures; this is a full-on credit crisis.” Indeed, with the New Year less than five weeks away, banks are hunkering down with as much cold-hard cash as they can get their hands on in this uncertain environment.

Add in the fact that investors are terrified to have too many long positions going into the holidays, and you've got the recipe for an intensified credit crunch.

This is why Fed officials seem to be going out of their way to sound sympathetic, or “dovish” in recent remarks. It’s also the reason that central banks around the world, led by the fed, are busy injecting plenty of extra-credit into the global financial system right now.

All of this cheap money seems to be having the desired effect so far, as witnessed by big gains in U.S. stocks recently.

But it’s not just the U.S. that’s partying like its 1999 all over again. Markets in Asia, particularly beaten down Japanese shares are surging higher too.

Will Global Stocks Continue Enjoying a Year-end Bounce?

In fact, The MSCI Asia Pacific Index climbed 2.5% today, Japan's Nikkei 225 Stock Average jumped 2.4%, and Hong Kong's Hang Seng China Enterprises Index surged over 4% higher, on top of a 5%-plus move yesterday, bringing its two-day gains to nearly 10%.

Even mainland China is rallying yet again, with the Shanghai-Shenzhen CSI 300 index adding 5% overnight.

China’s A-shares have had a rough ride in recent weeks. In fact, the CSI 300 declined 21% from its October 16th peak, before the recent bounce. Not to worry you China bulls – it’s still the world’s best performing stock index this year – up about 130% year to date.

Meanwhile, the China Enterprises Index of H-share listings has continued its out performance over mainland listed A-shares, as it has since mid-year. The H-share index has gained nearly 50% in value, just since mid-August, even after the recent global market correction.

Considering the region's robust economic growth, soaring business profitability, and relatively attractive share prices, the Asia-Pacific region has far more reason to rally than U.S. stocks do this holiday season.

So keep a sharp eye on Asia during this Santa Clause rally.

Korean Firm Forges Ahead in Asia

I have often commented on how the entire Asia Pacific region that surrounds China and India are booming, thanks to robust growth in these two emerging Asian giants. That’s why a recent story in the Financial Times caught my attention, since it shows this global dynamic at work, from one steel company’s point of view.

South Korea’s largest steelmaker Posco (PKX) made headlines earlier this year when it was revealed that Warren Buffett owned a 4% stake in the company. Posco has been growing by leaps and bounds in recent years, thanks to booming economic growth at home, and across the entire Asian region.

Ambitious Global Expansion Plans to Include China

In fact, Posco today is the world’s 4th largest steel producer, and is rapidly closing in on Japanese rival Nippon Steel for the #3 spot. According to the article “the steelmaker has enjoyed annual sales growth of 12 per cent over the past decade,” tripling its total sales of steel since 1997. Posco is in the midst of an aggressive expansion plan as “it aims to triple sales” over the next 10-years!

Posco is opening state-of-the-art steel plants all around the region including Vietnam and India. Now, Posco is looking to invest directly in the booming Chinese market – the world’s largest consumer of steel. The company is in talks with Beijing to partner up with China by taking a minority stake in local Chinese steel companies.

The attraction for China is obvious: an increased supply of a key basic resource it needs to sustain the country’s expansion. Posco also has superior technology to offer, and that’s the real icing on top.

Posco’s Cutting Edge Steelmaking Technology is a Competitive Edge

Posco has developed a cutting-edge steel making technology called Finex that allows “the production of molten iron directly from iron ore and non-coking coal, the process cuts out the processing needed for blast furnaces. Finex facilities are also about 20 per cent cheaper to build than traditional blast furnaces and they produce steel for about 15 per cent less.”

A cheaper, more cost effective steel making technology is exactly what the Chinese need, as officials in Beijing grow wary of rising inflation at home.

For Posco this deal makes a lot of since too, because China is the company’s fastest growing export market. In fact, China accounted for 25.3% of Posco’s export sales last year, while Japan gobbled up nearly 20%, and the rest of Asia 19%. North America accounts for just 9.6% of sales.

This means that Posco is very well dialed in to the epicenter of global growth... Asia, and is relatively insulated from the slowing U.S. economy. Warren Buffett strikes again!

So Now It’s Official: U.S. Stocks in “Correction”

Don’t blame international markets for yesterday’s sharp reversal of fortune in U.S. stocks. Equity markets in Asia moved sharply higher on Monday, but the U.S. failed to follow through on the upside.

Instead U.S. indexes fell to new correction lows – down over 10% from record highs achieved on October 9th – just seven short weeks ago. 

Domestic stocks opened higher in the morning, but quickly succumbed to another strong bout of selling; thanks to more worries about the ongoing credit-crunch market shock that’s impacting the financial sector. In the end, the Dow Jones Industrial Average suffered another triple-digit decline (-237 points, -1.8%) while the S&P 500 Index shed a still more bearish 2.3%.

Asian Markets Turn in Strong Rally

Markets in Asia, and to a lesser extent in Europe, tried to get Wall Street kick-started to the upside this week. The MSCI Asia Pacific Index jumped 2.7% overnight on Monday – the biggest advance since mid-September. Japan’s Topix index jumped 2%, South Korea’s Kospi index surged 4.7%, and in Hong Kong the China Enterprises Index soared 5.4%.

But it didn’t help Wall Street much.  The culprit was an old familiar tune: the credit-crunch blues, which have been impacting the financial sector since the summer. Yesterday HSBC, a leading bank in the U.K. suffering from U.S. sub-prime problems, dropped another bomb on investors. Here’s how Bloomberg described it (emphasis mine):

“Banks and brokerages declined after HSBC, Europe's largest bank, said it will bail out two structured investment vehicles by taking on $45 billion of assets to avoid a fire sale of bond holdings. Banks are trying to prevent SIVs, companies that borrow short-term to invest in higher-yielding securities, from collapsing and forcing fund managers to sell their $320 billion of assets. Bank of America, Citigroup and JPMorgan are trying to persuade competitors to help finance an $80 billion ``SuperSIV'' fund to bail out the companies.”

Too Many “Unknowns” Still Have Investors Fearful

I wish Wall Street, and its front-man: U.S. Treasury Secretary Hank Paulson, all the best luck in getting the proposed super-SIV up and running in time to bail-out... er that is relieve the Wall Street credit crunch.

The reality is that there are still just too many “unknowns” out there. It’s not yet known what the financial sector’s true exposure is to toxic sub-prime paper that’s defaulting at an accelerating rate. And how could it be known? Sub-prime mortgage resets will continue to RISE into the spring of 2008.

This will trigger a still “unknown” number of additional loan delinquencies on Main Street. Nationwide, foreclosures have surged to the highest level in 50-years, and are still climbing. We are certain to see a growing number of asset-backed loan defaults on Wall Street as a result. But just how much: that’s the great “unknown.”

During the depths of the last “great” U.S. housing depression in the 1930’s, President Franklin D. Roosevelt said “we have nothing to fear but fear itself.” On Wall Street however, the reverse is true. Financial markets fear EVERYTHING – and especially the unknown.

Fear is Feeding on Itself in Financial Sector Now

As banks and brokers go careening headlong toward year-end – just six-weeks away – they are once again growing fearful to loan cash to each other, even on a short term basis.

Bloomberg reports that 3-month Libor rates -- a key inter-bank lending rate – “rose for a ninth day to 5.05 percent” in London yesterday. “That's 55 basis points more than the Fed's benchmark rate, the widest gap since the Fed cut its benchmark rate for the first time in 4 1/2 years on Sept. 18.”

Fear among investors tends to feed on itself until a full-blown panic is reached. Are we there yet? NO; but we may be getting close.

Watch to see if Asian markets can hang on to yesterday’s gains, or will follow Wall Street lower yet again. This morning these markets closed slightly lower in “sympathy” with Wall Streets drubbing on Monday. Stay tuned.

Black Friday Gives Consumer and Market Sentiment a Boost

The all important post-Thanksgiving holiday shopping season began with mixed results last week. There were more shoppers on the prowl at malls and stores across the nation in search of deals; but they spent less on average than a year ago.

According to the National Retail Federation (NRF), 147 million Americans performed their economic duty by visiting stores on “black Friday”, the day after Thanksgiving. That’s a 4.8% increase in “traffic” from a year ago.

This is often the busiest day of the year for retailers with some opening in the wee hours of the morning to accommodate the onslaught of shoppers. It is said that retailers, after loosing money on average over the first ten-months of the year, can make it all back and go into “the black” (turning profitable) in the frenzied days after Thanksgiving.

Thrifty Shoppers Holding Out for Bargains

The bad news on black Friday was that the average “ticket” was lower than expected. In fact, shoppers spent 3.5% less than last year on their purchases. The mixed results so far seem to confirm industry forecasts of a rather lackluster holiday shopping season. The NRF for its part predicts the “slowest increase in sales in five years.”

Consumers are clearly cutting back on spending. With home prices falling more than 5% from their peak, oil prices sky-rocketing to $100 per barrel, and the average American household already drowning in debt... who can blame consumers for being thrifty?

However shares of beleaguered U.S. retailers got a boost in Friday’s shortened trading session amid relief that the post-Thanksgiving sales results weren’t even worse than expected. Wal-Mart shares rose nearly 2% Friday, while Target jumped almost 6% and Macy’s surged over 5% higher.

Stocks are Beginning to Offer Bargains Amid Global Correction

Retailers weren’t the only stocks to bounce on Friday. In fact, global stock markets have been undergoing a steady correction since October, as I pointed out in my previous blog (Are Global Stocks Heading for a Bear Market?).

The U.S. S&P 500 Index had declined nearly 9% prior to Friday’s bounce, while the MSCI Emerging Market Index had pulled back about 12% from its October peak.

Global markets look overdue for a relief rally of some kind. The character and strength of such a rally should reveal valuable clues about the market’s primary trend over the next several months.

More good news about the U.S. consumer should help sustain such a bounce, at least in the short run. More negative news on the health of the consumer; especially another housing-related market shock, and all bets are off.

Are Global Stocks Heading for a Bear Market?

Well it’s official. One of the world’s largest stock markets has now “officially” entered bear-market territory.

Last week, Japan became the first of the world’s 10 biggest stock markets to enter a bear market,” according to Bloomberg news. Japan’s benchmark Topix index, which is a broad gauge of stock prices in the land of the rising sun, has now fallen 21% from it’s highs reached early this year. That was before the U.S. credit-crunch began to shock financial markets around the world.

The commonly used rule-of-thumb for gauging bear markets is a decline of 20% or more from a previous peak. While a stock market “correction” is in place once an index has declined over 10%. Japan’s other major benchmark, the Nikkei 225 Index, is closing in on “bear market” territory with a decline of 18.3% from its 2007 peak.

Japan has Lagged for Years as Attractive Values Get Cheaper Still

Of course Japan has been a troubled market for years; decades in fact. The nation has been plagued by uneven economic growth as it struggles with the aftershocks of a deflationary spiral that lasted throughout the 1990’s, The Topix Index enjoyed a nice bull-run from 2003 to early 2006, more than doubling in value over that stretch.

However the bull market rally seemed to loose its steam that year, finishing little changed in 2006. The Topix then toped-out just above the 1,800 level in February of this year. A fund manager quoted by Bloomberg put it this way; “Japan hasn't been an area of stellar growth for 10 years.”

However Japan is an area of compelling value at this point. The world’s worst performing major index is now trading at just 17.5 times earnings, which is just HALF of its average value over the past four years. The index is even cheaper than the S&P 500, which is valued at about 17.7 times earnings.

Japan’s Topix Index is home to many of the world’s most undervalued banks too, including Mitsubishi UFJ and Mizuho, both of which have warned of profit declines this year due to shrinking loan demand and fallout from the U.S. sub-prime market shock. There are certainly some bargains on sale in the land of the rising sun – unfortunately for early investors (including yours truly) stocks that already appeared undervalued earlier this year have gotten even cheaper since then.

Global Markets in “Correction Mode”

But it’s not just Japan’s equity markets that have been suffering declines lately. In fact, the month of November, which has historically been kind to stock market investors, has instead been a particularly cruel month this year.  Most global markets have fallen this month.

In the U.S. the S&P 500 Index is down 8.6% from its recent high, and is rapidly closing in on “correction” territory. The blue-chip U.S. index has given up all its early year gains and is now about flat on a year-to-date basis, after suffering its worst monthly decline in November, since September 2002.

The selling hasn’t been confined to the U.S. and Japan however. The MSCI World Index of developed global stock markets has fallen about 8% from its record high reached on Halloween. Meanwhile, the MSCI Emerging Market index has declined 12% from its October peak. Global stock markets are in the midst of an across the board “correction.” Only time will tell if other major markets go the way of the Topix, entering bear-market territory next year.

Right now, I’m betting on just a “correction” which should result in some very attractive buying opportunities for global investors – especially in Japan.

Sub-prime Crisis Keeps Pulling Me Back In

Writing as frequently as I have in recent months about the ongoing Wall Street credit crunch saga makes me feel a bit like the “Godfather”, Michael Corleone: Just when I thought that I was done they pull me back in!

But the fact that the sub-prime induced credit crunch is perhaps the biggest financial story in decades helps provide lots of material for me. Also, the standard Wall Street/Washington approach to this crisis has followed the usual pattern: First, ignore the problem; second, dismiss the problem as largely irrelevant; third, deny the problem will have any lasting impact on the economy.

Treasury’s Paulson Provides Dire Sub-prime Forecast for 2008

It’s deliciously entertaining in such circumstances to point out the truth; that the sub-prime crisis has become much worse than anyone thought just a few months ago, and it will continue to impact financial markets for quite some time to come.

Just in the past few days in fact, Wall Street firms have begun to turn on each other, as I mentioned in yesterday’s blog (The Sharks are Circling on Wall Street... Looking for a Year-End Meal). After first denying that the credit crunch would have any meaningful impact on banks’ bottom line profits, analysts are now stumbling over one another to issue the direst forecasts of expected sub-prime loan losses and assets write-offs.

In a recent interview with the Wall Street Journal, even Treasury Secretary (and former Goldman Sachs alum) Henry Paulson had a somber outlook on sub-prime, the emphasis is mine: “We'll watch carefully mortgages that will be reset. The quality [of the 2008 resets] will be lower, when you think about it. Of the 2005 ones, roughly 10% of those end in default; the others refinance. The nature of the problem will be significantly bigger next year because 2006 [mortgages] had lower underwriting standards, no amortization, and no down payments.” Yikes!

Industry Bellwether Freddie Mac Takes a $2 Billion Hit

I have been writing for some time about the peak in overall sub-prime mortgage resets won’t even be reached until the spring of 2008. And we will not see a significant decline in reset activity until late next year and moving into 2009. Meanwhile, the process for Wall Street to clear all of these bad loans off their books will last even longer; well into 2009 and perhaps not until 2010.

Yesterday, mortgage giant Freddie Mac reported a much larger than expected $2 billion loss related to credit crunch fallout. The government-charted Freddie, along with it’s twin Fannie Mae are expected to provide stability to the home mortgage market in times of crisis, buying and guaranteeing mortgages against default.

Instead, Freddie revealed yesterday that it has recently “been forced to sell mortgages to ease its financial woes,” according to the Wall Street Journal. The company actually sold off about $20 billion of mortgage loans in September, followed by another $25 billion in October. Freddie says it was forced to take such actions due to its dwindling capital margins, but the effect is to destabilize the mortgage market, rather than providing a backstop.

Freddie’s Outlook: Expect Loan Losses to Triple in 2008 and Brace for a Dividend Cut

In fact, losses at Freddie Mac and expectations for more red-ink this quarter “put the company in jeopardy of falling below minimum capital levels” as required by regulators.  As a result, Freddie is seriously considering the unthinkable possibility (for a blue-chip financial firm) of slashing its dividend by 50% in the fourth-quarter to preserve about $646 million in cash.

Even worse was Freddie’s outlook. Since the firm is such an industry bellwether, it’s forward-looking guidance can be a key barometer for where the entire financial sector is headed. And the forecast from Freddie was NOT reassuring.

“Freddie estimated that its losses related to defaults on single-family homes will grow to $1.5 billion in 2008 and $2.1 billion in 2009 from an estimated $493 million for all of 2007. That forecast assumed that home prices at the depth of the downturn would be down 5% from their peak.”

So by Freddie Mac’s own estimates, loan losses will triple next year from 2007 levels – and quadruple in 2009! But Freddie may still be far underestimating the depth of its troubles assuming only a 5% slide in home prices. On a nationwide basis, home prices are already down about 5% over the past 12 months, with many economists predicting declines of 15% to 20% before it’s over.

The Sharks are Circling on Wall Street... Looking for a Year-End Meal

Yesterday was another sub-prime related wipe-out on Wall Street as big banks and brokers tumbled again, due to ratings downgrades from their own kind. This is a sure sign that the credit-crunch market shock is entering a new and more dangerous phase.

Citigroup, the largest bank in the U.S. as measured by assets, dropped to fresh four-year lows after its Wall Street “colleague” Goldman Sachs downgraded the stock. Goldman said that credit-market losses may cause Citi to report $15 billion in additional losses and asset write-offs over the next two quarters.

But Goldman was on the warpath for scalps from more than just Citigroup. Merrill Lynch and Morgan Stanley also slumped toward new lows after a Goldman analyst cut the share-price estimate on both stocks, sighting more sub-prime fallout ahead for these two brokers as well.

Blood in the Water on Wall Street Won’t Affect Year-End Bonuses

When Wall Street’s elite firms begin attacking their own like a pack of hungry sharks smelling blood in the water; you just know that the credit crunch is taking a turn for the worse. I expect more market shocks dead ahead.

Now contrast that story with this reported by Bloomberg news yesterday; the headline says it all: “Wall Street Plans $38 Billion of Bonuses as Shareholders Lose.”

Investors in the financial sector are taking it on the chin this year, with big banks and brokers slumping the most since 2002. In fact, firms in the securities industry have lost $74 billion of their combined stock market value this year, according to Bloomberg. But that “won't prevent Wall Street from paying record bonuses, totaling almost $38 billion” this year.

Yes, you read that right. Wall Street fat-cats will still enjoy huge bonuses this year; despite growing sub-prime related losses!

Bonuses Equal Four-Times the Average American’s Income

In fact, the “average” bonus paid on Wall Street this Holiday season is likely to be about $201,500 per person – “more than four times the $48,201 median household income in the U.S. last year, according to U.S. Census Bureau statistics.” 

Wall Street is swimming in red-ink thanks to nearly $50 billion (and counting) in losses and asset write-offs so far due to the credit crunch. Ah, but booming M&A activity earlier this year should provide plenty of year-end bonus money for the Wall Street fat-cats.

But don’t be fooled. Once the books are finally closed on 2007, and those hefty year end bonuses are paid and cashed in – that’s when you’ll begin seeing the real financial damage caused by the credit crunch. Just as soon as this year’s bonuses are safely paid, that’ll be the signal to clear-the-decks with even more asset charge-offs and losses in early ’08.

Whatever you do; please don’t pity the Wall Street investment bankers this time next year when you read about skimpy 2008 bonus awards. Just remember the fat paychecks they cashed in December 2007 – on the backs of billions in investor losses – and still growing!

The Buck Stops Here...

Ministers from the Organization of Petroleum Exporting Countries (OPEC) gathered last week and over the weekend in Riyadh, Saudi Arabia with much to celebrate as oil prices move ever closer to $100 per barrel.

OPEC is set to reach $685 billion in total crude oil export revenue this year, a jump of nearly 10% from 2006 levels. And next year, OPEC’s oil riches should surge past $760 billion up another 16%, according to estimates from the U.S. Energy Information Administration. Oil revenues are up 19% this year for Saudi Arabia, OPEC’s biggest exporter. Kuwait’s oil export sales are up nearly 27%, and in the UAE crude oil revenue is soaring 32.6% over a year ago.

One of the byproducts of OPEC’s oil riches is a newfound desire among members to decouple themselves from the sinking fortunes of the U.S. dollar. Many oil-rich OPEC states in the Middle East have had their own currencies pegged to the U.S. dollar for some time. And nearly all OPEC members price their oil exports in dollars in the global marketplace. But that may not be the case for long.

The Sinking Dollar is a Drag on Gulf States

The U.S. Dollar Index traded recently at a record low against a basket of other major currencies, “the weakest level since the index started in 1973,” according to Bloomberg. The historic slide in the greenback has triggered talk that the Persian Gulf states may consider dropping their peg to the dollar.

Bloomberg news reported yesterday that “the six member countries of the Gulf Cooperation Council (GCC) that includes Saudi Arabia and Kuwait will discuss a proposal next month to revalue their currencies.

In fact, a proposal “to change the value of the currencies of the Arab nations” is on the docket for a meeting of the Gulf Cooperation Council scheduled for early December.

Saudi Arabia, OPECs biggest producer with historic political ties to the U.S. has long resisted such a move, but it may be just a matter of time. As the dollar falls further, even the Saudi royal family is feeling the heat.

Imported Inflation Thanks to the Dollar Peg

The falling value of the dollar is sparking inflation concerns in countries that maintain a peg to the buck. “Saudi Arabia's consumer prices rose at a record 4.9 percent pace in August, after averaging less than 1 percent over the last decade” according to Bloomberg. In fact, this process of diversifying away from the dollar is already underway.

“United Arab Emirates central bank Governor Sultan Bin Nasser al-Suwaidi said his bank has a target of moving 10 percent of its currency reserves into euros and has ``already diversified to some extent.'' The $50 billion Qatar Investment Authority said Sept. 4 it was looking to buy assets in Asia to counter a weak dollar.” Even global guru Jim Rogers, who has recently advocated moving assets out of the buck, has said “the dollar peg is doomed.”

In fact, GCC members have already broken ranks from the dollar club with Kuwait now linking its currency to a basket of foreign currencies including the dollar.  With a high probability of more Fed rate cuts to come, pressure will only increase inside OPEC for a landmark break from the buck.

When and if this happens, it will be an historic event in the history of global finance, and may mean the beginning of the end for the U.S. dollar as the world’s reserve currency.

And it may also give quite a boost to the GCC economy, which have been enjoying robust growth, but are struggling with inflation as a consequence of the falling dollar. Cutting the dollar peg should help cut back on imported inflation in the Middle East.

Money Market Funds Suffering a Sub-Prime Squeeze

Money market mutual funds used to be considered among the safest investments by holding short-term U.S. Treasury and agency debt in order to minimize risk.

Only rarely in the history of modern finance have money market funds “broken the buck” – trading below the $1 per share net asset value that all such funds seek to maintain. But that was before this year’s credit crunch…

The ongoing trauma of the U.S. sub-prime crisis is revealing plenty of risky assets in some of the biggest money market funds in the nation. In fact, both Legg Mason and SunTrust Banks recently propped-up shaky “money-market funds to cushion them from possible losses on debt issued by structured investment vehicles” or SIVs, according to Bloomberg news.

Will Bad Debts from Leaky SIVs Drown Money Market Funds?

To recap, SIVs are off balance sheet entities set up by banks and brokers to buy other securities, typically risky sub-prime mortgage debt, way too much of it as it turns out. Most of the cash needed to purchase theses securities is raised by issuing commercial paper, which usually matures in 270 days or less.

As I have commented before (The Credit Crunch Rolls On in CP Market), when the crisis intensified this summer, the market for asset-backed commercial paper crashed 30% in value – falling from $1.2 trillion in early August to less than $850 billion now. This means that SIVs are stuck in a real cash-crunch, unable to roll-over and repay billions in outstanding commercial paper.

OK, so how does this relate to money market mutual funds, you ask?

Well, it seems that quite a few funds, hungry to boost yields in a low-return environment, gobbled up a bit too much of the most toxic asset backed commercial paper. Now, after the market crashed 30% in value, money funds are bracing for big potential losses on the commercial paper investments they hold.

“U.S. money funds have $50 billion in SIV debt”

According to Bloomberg, “Legg Mason invested $100 million in one of its money funds and arranged $238 million in credit for two others. Funds run by Legg Mason held about $10 billion of SIV debt, accounting for 6 percent of the company's money-market assets at the end of October, according to its filing with the SEC.”

Meanwhile, SunTrust has petitioned the SEC to bail-out two of its money market funds that purchased $115 million in notes issued by a SIV called Cheyne Plc, that’s now in big trouble and facing liquidation.

Last month, Wachovia reported a $40 million loss on asset-backed commercial paper it bought from its Evergreen Investment Management division. One of Evergreen’s money market funds had nearly $3 billion in asset-backed paper at the end of March, but has since cut back it’s holdings to $1.76 billion at the end of September.

And there’s a lot more of this toxic sub-prime paper floating around in the financial system. In fact, the 10 largest managers of U.S. money funds have $50 billion in SIV debt,” according to Bloomberg.

Don’t be surprised to find even more sub-prime mortgage losses surfacing in the most unlikely places.

What’s in your money-market fund's wallet?

Can You Top This Write-Off...

In a game of "can you top this" banking analysts in the U.S. and around the world are desperately trying to get a handle on the full extent of losses from the sub-prime credit crunch. Each day the estimates get more sobering.

According to an article today in Bloomberg, a Deutsche Bank analyst is predicting that "losses from the falling value of subprime mortgage assets may reach $300 billion to $400 billion worldwide.

Wall Street's largest banks and brokers will be forced to write down as much as $130 billion," as a result of the sup-prime credit crunch. That figure tops a similarly dire forecast floated last week by the Royal Bank of Scotland, which I reported on Friday (U.S. Banks, Brokers May Face $100 Billion in Additional Write-offs ).

Deutsche Bank's analysis reckons that 30% to 40% of the approximately $1.2 trillion in sub-prime mortgage loans outstanding will eventually default, while so far default rates are running in the mid-teens. "Banks and brokers may have to write off $60 billion to $70 billion this year," according to the report.

Over the past several months, big Wall Street firms have so far acknowledged about $40 billion in sub-prime related losses or asset write-offs. Presumably then we can expect a very sharp increase between now and year end.

The next big issue for investors to grapple with is pending re-valuation of billions in Level 3 assets sitting on the books of big Wall Street firms.

Jim Grant, of Grant's Interest Rate Observer worries about the lurking dangers posed by difficult to price Level 3 assets, "the valuation of which is very subjective." According to Grant, "if one were to mark these Level 3 assets to zero, then many of our leading financial institutions would be broke."

He's quick to point out that not all Level 3 assets may need to be written-down to such an extend, but the problem is that Wall Street hasn't been very forthcoming as yet in disclosing the full extent of losses, leaving investors to speculate, and fear for the worse.

The lack of disclosure about the true extent of sub-prime problems is perhaps because even Wall Street's masters-of-the-universe simply do not know just how bad things may get out there. And that's the really scary part!