Wednesday, February 13, 2008

Liquidity Crisis --> Bank Failures --> Hard Times

The credit and liquidity mess in the US is going to get worse.

Bond insurers (eg Ambac) protect bondholders from the credit risk associated with their holdings. But if the insurer fails, then the real risk associated with the bond has to be accounted for. This real risk is so serious that what currently counts as capital will no longer qualify as capital in many cases.

Ambac and its peers are in trouble. This means that banks who rely on bond insurance are exposed. A lot of dominoes are poised to fall. Read this analysis if you want a supporting analysis of the gathering storm.

Gold, as always, appears to be a safe haven if the outcome of the mess is rampant inflation. Debts will become less onerous as they can be repaid using devalued dollars. But if the outcome turns out to be Deflation (see Japan in the 1990s after THEIR bubble burst), then assets like gold will not be attractive. In deflation, cash is attractive, commodities lose their dollar value and debt is absolutely crippling as the obligations must be repaid with higher value dollars.

What turmoil may lie ahead! Fortunes will be made or lost. And for every family and investor, a dose of harsh reality, perhaps overdue. Debts are always covered, either by the borrower or the lender.

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