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The Smart Profits Report: Issue #454
Monday, September 10, 2007
The Bank of England: How To Profit From The Credit Crunch And Subprime Woes
By Martin Denholm
Senior Analyst, Mt. Vernon Research
Picture the scene… a majestic-looking, wood-soaked boardroom at the “Old Lady” at Threadneedle Street, headquarters of the Bank of England in London.
On the table… a rainforest of paper, with a mass of numbers that would give John Nash’s “Beautiful Mind” a seriously ugly workout. Computer screens with mind-boggling spreadsheets, charts and tables - enough to make most regular folks go cross-eyed before sobbing like a little girl. And nine people diligently poring over it all. Poor saps, eh?
Not really. The people in this room aren’t your average Joes. They’re central bankers. They love this stuff! They live for numbers. And this is the scene that played out at the Bank of England this week - following similar scenes in Washington and Frankfurt.
Yep, the Bank of England has not-so-boldly gone where the Federal Reserve and European Central Bank have gone before and pumped a ton of money into the market to help relieve the “credit crunch” (are you as tired of this phrase now as me?)
But will it actually help? The jury is out…
The Bank of England Provides Sweet £17.6 Billion Relief
It took them a while to catch up to their counterparts in the U.S. and continental Europe (perhaps they were finishing their tea or something), but Governor Mervyn King and his band of bankers decided to toss some money at British banks on Wednesday.
£17.6 billion ($35.4 billion), to be exact, in order to “relieve some pressure on interest rates for overnight borrowing, which have been unusually high.” Remarkably, it was the Bank of England’s first public statement on the credit crisis since it rocked the markets a few weeks ago.
The problem is that banks are nervous about lending to each other over a longer period and have charged higher interest rates to provide a measure of security. That’s led to less credit. But the Bank of England’s move means banks can save money on their loans.
A $31.25 Billion Game Of Market Tag
Not to be outdone, however, the Fed responded yesterday by injecting a further $31.25 billion into the markets. Since August 9, the central bank has poured $200 billion into the markets to prevent liquidity from drying up.
As if that weren’t enough, the Fed and the Bush administration recently promised to introduce measures to tackle the current problem to prevent it from really getting out of hand. Excuse me for not doing cartwheels, but once you get bankers and bureaucrats meddling too much, it can become counter-productive. Investors suddenly come to expect them to ride to the rescue, but all it does is artificially prop up stocks, rather than just letting market forces deal with it. The result is that it could make investors even more nervous and leave the market more susceptible to wild, unpredictable moves.
As former Fed chairman Alan Greenspan said today, “The human race has never found a way to confront bubbles.” But he then went even further in his speech to economists, comparing the current situation to the stock market crash of 1987 and the meltdown of the Long-Term Capital Management hedge fund in 1998. The Wall Street Journal quotes Greenspan’s assertion that “… bubbles cannot be defused until the fever breaks.”
The question is: Can the Fed help “break the fever?”
The Fed’s Power To Deflate Bubbles Is Limited
According to Greenspan, the Fed’s powers to deflate bubbles and save stocks are limited. In his speech, Greenspan cited the bank’s two efforts to put the brakes on the massive stock bubble in the mid 1990s and in 1997 by raising interest rates - neither of which worked.
The old adage that fear and greed are the only two forces that move the markets is never truer right now. Fear is driving this wagon, folks - a concept that Greenspan notes “is more important than euphoria.” Banks are fearful of lending to each other and investors’ nerves are frazzled, wondering which way the market is going to lurch next, taking their money with it.
With the Fed saying that the subprime losses could hit $100 billion, the bankers are facing increasing pressure to help out the little guys, not just the big boys (banks and hedge funds), by following up their cut to the discount rate with a cut to the Fed Funds interest rate.
But that’s unlikely.
- Not with oil prices bouncing higher again,
- Other inflationary pressures still present,
- And second-quarter GDP growth rebounding to a 4% annual rate - the fastest in five quarters.
So if you’re hoping for a Bernanke bailout, don’t get too excited. The Fed’s white horse is headed for the glue factory…
Will Interest Rates Change on September 18th, 2007?
When the Fed’s monetary policy board meets again on September 18, it’s expected to leave interest rates unchanged. Cue groans and disappointment from investors looking for a bailout - and more market pressure.
In any event, the Fed’s recent moves to relieve the pressure on the market are likely to have a limited and temporary impact. As my colleague Marc Lichtenfeld noted in Issue #452, Recent Home Sales, the real estate market is a mess, with ugly recent data and a shift in buying and selling sentiment. It’s all very well for the Fed and Bush administration to want to reduce the soaring number of foreclosures, but how? Supply and demand is out of whack, with the largest number of homes on the market in 16 years. Sellers are struggling to dump their houses, prices are slumping and owners are strapped for cash. It’s unrealistic to think the bureaucrats can save the day.
With credit drying up, consumers under pressure (as seen in the recent weak retail sales) and the subprime mess sucker-punching an already weak real estate market, it’s possible that the fallout could affect corporate sales and earnings growth and business and consumer spending. This is one situation that is likely to play out over months, not weeks.
But there is a way you can profit from all this, while the Bank of England waits to see what the Fed will do.
Have a great weekend,
Martin Denholm
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Today’s Smart Profits Action Center
- This week, the Bank of England and European Central Bank left interest rates unchanged (at 5.75% and 4% respectively). Canada and Australia followed suit. With the Bank of England stating that its recent interest rate hikes are “starting to bite,” it seems they’re all hanging around, waiting to see what pans out from here and the Fed does and says on September 18.
- But some economists in London expect U.K. interest rates to peak at 6% in November, citing strong economic growth, continued inflationary pressures and only “tentative signs of a slowing in consumer spending” (according to the bank’s statement this week). If the bank does raise rates a final time, expect the British pound to strengthen further. So if you want to diversify your portfolio and take advantage of an already strong pound against the U.S. dollar (with the potential for more), take a look at Everbank’s World Currency CD. In addition to grabbing an annual interest rate of up to 4.5%, you also benefit from further currency appreciation. The CD has flexible maturity terms, has no monthly account fees, and is FDIC insured. For full details, please click this link.(Disclaimer: The publisher of the Smart Profits Report has a marketing relationship with EverBank, but that’s because we believe it has the most competitive products on offer).
- I just asked my Mt. Vernon Research colleagues what ideas and picks they’re thinking about for the October Xcelerated Profits Report issue. And talk about intriguing… here’s the reply I received from Investment Director Karim Rahemtulla: “Good ideas? Hell, yes - I have the anti-subprime cure on deck for the next issue.” The last time Karim made a trend-busting, contrarian pick, he not only scooped the rest of the market - but some excellent gains, too. Profits between 40% and 112%, in fact - in just five weeks. You don’t want to miss this one. To make sure you don’t, simply visit this link.
Related Articles:
- The Real Estate Market: Four Ways To Protect Yourself As The Housing Bubble Bursts
- Bear Market Investing: Don’t Get Burned By Bears… Here’s Your Five Point Plan
- Global Investing: Legendary Investor Predicts Triple Bubble… Here’s Four Ways To Beat It
