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Flash Crash II

By Paul Lamont

June 30th, 2010



Finally, the mainstream is realizing that we are “in the early stages of a third depression.” As we stated in April: “the illusion that a government can prop up a systemic credit bubble is now deflating along with the credit ratings of the sovereigns.”


In Ben Bernanke Fails His Own ‘Two Lessons Learned’ From The Great Depression, we learned that the Federal Reserve Chairman regarded the Creditanstalt as the “most critical failure” of the Great Depression. According to Murray Rothbard in America’s Great Depression, the Creditanstalt collapsed when “the Bank of France and lesser French banks suddenly insisted on redemption of their short term debts from Germany and Austria.“ Interesting to note; in late June Spanish bankers are in a rage because the German controlled European Central Bank is reducing its support for Spanish banks. According to the Financial Times: “One senior bank executive said: ‘Any central bank has to have the obligation to supply liquidity. But this is not the policy of the ECB. We are fighting them every day on this. It's absurd.’” As we stated back in April: “We expect Spain to meet the same fate as Greece, causing massive bank failures throughout Europe.” In Europe, the cross border debts are too large.


Flash Crash II

In “Stash Cash for Next Flash Crash”, we explained how the Flash Crash of May 6th was due to “the lack of liquidity (buyers AND sellers) in the stock market.” We are still having this problem. Citigroup was halted on June 29th due to a 17% plunge after only 8,820 shares were sold. Similarly, the Washington Post was halted when shares doubled on a 400 share trade.


In addition to these structural troubles, according to a detailed analysis of the Flash Crash by Nanex, in some instances high frequency traders are purposefully jamming up exchange computers with orders to fake out other high frequency traders.


We expect a Flash Crash II and then a time out. From the NYSE site:




Running Out of Money For Bailouts

In July 2007, we cited the Bank of International Settlements (BIS), the central bank of central banks: “…years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.” Now the BIS is warning in a new report:


"Events coming out of Greece highlight the possibility that highly indebted governments may not be able to act as a buyer of last resort to save banks in a crisis. That is, in late 2008 and early 2009, governments provided the backstop when banks began to fail. But if the debts of the government itself become unmarketable, any future bailout of the banking system would have to rely on external help."


As we stated in April, we have reached the ‘Debt Limit’ as “central bankers fear Europe is running out of ‘external backstops’ that could step in, other than the US and the International Monetary Fund.” The report “implies that governments may not be able to repeat such a bailout in the event of a second crisis, which some commentators fear could be triggered by another economic shock.”


The U.S. tried to bail out Europe in the 1930s. It failed back then as well. According to Rothbard: “throughout the crisis, the Federal Reserve, particularly the New York Bank, tried its best to aid the European governments and to prop up unsound credit positions… As a result, much frozen assets were shifted, to become burdens to the United States.”


He continues: “In the meanwhile, the depression grew worse in the United States, and not because of the European situation.” The reason? “… a growing loss of confidence by Americans in their banking system - caused by the bank failures abroad and the growing number of failures at home.”


Looking forward, “banks around the world must refinance more than $5 trillion of debts in the coming three years, a massive rollover that poses threats to financial stability and growth.” After warning of this large rollover, James Saft of Reuters then dismisses any worries with “unless there is a profound sovereign debt crisis, we can count on governments taking the needed steps to see that the banking system does not fall over for lack of funding.” Obviously, he isn’t aware of the BIS report cited previously.


How To Protect Your Cash In A Double Dip Depression

With systemic risk rising, it is time to double check that even your cash reserves are protected. A form of cash equivalent that we have recently come across is the “guaranteed investment contract.” These are insurance contracts that are touted as cash but are only as good as the insurer. Obviously with the failure of AIG, insurance companies should be looked at with much skepticism. But as we dug further, we found this:


In 1991, the Executive Life Insurance Company, California’s largest insurance company failed. In 1996, employee retirement plan participants of Unisys Corp. were still trying to get their money. “Among the several investment choices in the plan were guaranteed investment contracts issued by the Executive Life Insurance Company of California. The contracts are similar to certificates of deposit, paying an interest rate on the principal invested.” So after a 5+ year delay (and likely with a discount), your cash was finally delivered to you. Not exactly ready money.


As we stated on November 19th, 2007 (and repeated on September 17, 2008); “When we state 'cash' we specifically mean U.S. Treasury Bills.”



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***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.


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