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Is the US credit crisis over?

By Dan Denning
January 30, 2008 14:05 IST
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One clue comes from the inter-bank lending market, and the interest rates that banks charge for lending money to each other.

Commonly known as LIBOR (the "London interbank offered rate" - London still being capital of the world's money markets), the interbank rates say the credit crisis is over, according to our colleague Steve Sjuggerud.

How does he know? The rate banks charge each other for overnight loans has gone down, notes Steve, and even briefly went under the Fed funds target rate last week.

If that trend holds, it would be a sign that the crisis in confidence in the banking sector is easing. Banks in Europe and America have taken substantial losses both in their proprietary trading departments and in their loan portfolios.

They've had to go hat-in-hand to creditors (mostly Sovereign Wealth Funds) in the Middle East and Far East to recapitalise their balance sheets.

Where was the adult supervision? Where were the boards charged with protecting shareholder capital? Where were the masters of the universe this whole time? Do they all work for hedge funds? And most importantly, why should we assume that the financial sector's ability to manage risk has improved with billions in losses? Does shame make us more prudent?

The temptation to buy the banks for an expected earnings bounce is obvious. On a year-over-year basis, 2008's fourth quarter should look a lot better than 2007's fourth quarter. The banks should see a big earnings bounce. But you have to wonder who the banks will be lending to this year. Earnings will look comparatively better, yes. But absolutely, will the business of borrowing and lending money be as good as it was anytime soon?

This is the other factor affecting the long-term prospects of the financial sector. Money center banks and investment banks simply never had it as good as they did in the last ten years. We reckon they'll never have it so good again. The market for financial products is going to undergo a contraction. This means, we think, lower long-term profits for financial institutions.

Besides, if the banks were so bad at judging risk in the sub-prime market, how can we be sure they did any better in the option-ARM market, the credit default swap market, and the bond insurer market? "Bond insurer woes carry major risks for banks as well," reports CNNMoney.com.

Last week, American regulators tried to put together a bailout in which banks recapitalise the bond insurers and prevent a downgrade by the ratings agencies, which would in turn force the sale of billions in bonds held by institutions, which can only buy AAA rated debt.

"If no new capital is forthcoming for bond insurers," CNN reports, 'lenders and other policyholders could end up swallowing heavy losses...Citigroup, Merrill Lynch, Bank of America and Wachovia are among the most exposed."

Sound familiar? January 2008 has already been a memorable month, and it's not over yet. The last few days might offer a welcome respite from the credit crisis. But the unwinding of leverage and the deflating of the credit bubble is likely to continue, whether we like it or not.

And not everyone likes it, that's for sure. Hence the surging gold price.

The immediate cause of gold's latest surge has been the national electricity crisis in South Africa, the world's second-largest gold producer. "Several major mining companies, including AngloGold, Harmony and Gold Fields Ltd., suspended all but emergency operations at some of the world's largest mines because of a national electricity emergency", reports the Associated Press.

"Mining operations in the country were suspended Friday on fears that power interruptions would trap workers underground. Gold fields said it halted all its South African operations, including in the world's largest gold mine, which produces 7,000 ounces per day. When adjusted for inflation, gold remains well below its all-time highs in 1980. An ounce of gold at $925 then would be worth about $2,360 today."

That's right, a mere $2,360 per ounce...a mere 150% above the current gold price.

As it is, only gold bugs are choosing to buy gold right now - and they're buying it for the very same reasons we think financial stocks are a long way from safe. And for as long as the US Fed and its friends around the world choose to destroy money in the hope of supporting financial asset prices, gold prices look sure to keep rising.

The real bull market will start when dishwashers, taxi drivers, and Wayne Swan start talking about it. All the advice we have received suggests that by then gold will be a bubble.

But not yet.

Formerly editor of Strategic Investment with Lord William Rees-Mogg, Dan Denning is an independent investment analyst now based in Melbourne, from where he edits the Australian edition of The Daily Reckoning. He is also author of the best-selling The Bull Hunter (Wiley & Sons).

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