APOCALYPSE NOW? IMPLODE

A picture of the Apocalypse
September 28, 2008 – 12:27 pm
Average Americans may be forgiven for not understanding why Congress is moving so quickly to pass this massive bailout package. Sure the economy isn’t great—gas prices are still high, it’s harder to get a home loan, some folks have lost jobs—but why are guys close to Paulson saying things like this (from the Times of London):

“the economy is dropping into the john. We could see falls of 3,000 or 4,000 points on the Dow [it's at 11,000 currently]. That could happen in just a couple of days.

“What’s being put around behind the scenes is that we’re looking at 1930s stuff. We’re looking at catastrophe, huge, amazing catastrophe. Everybody is extraordinarily scared. It’s going to be really, really nasty.”

Whoa! Didn’t the economy grow last quarter? We haven’t even determined that we’re in a recession. You’re telling me we’re going to skip right over that and go straight into a Depression?! In a matter of weeks!?!?!

I’m here to tell you they’re not kidding. It could be that bad. And it could happen VERY quickly. Indeed, the scariest thing about this crisis is that those who really know what’s going on are the most frightened.

What is an economic catastrophe? Besides a precipitous fall in the price of stocks and other assets, we may also see a global run on banks.

Here’s a very famous movie scene to help us understand what we’re potentially facing…..




What we have here is a typical bank run. When Jimmy Stewart goes in the back, you hear his associate say that they have no money to give customers, which is why he closed the doors. This caused an immediate loss of confidence in the bank and Stewart’s depositors panic. They literally run to the bank to withdraw everything they can before it’s too late. But there isn’t enough on hand, so they take what little they can get.

When people lose confidence in their bank, they panic. Ask yourself what you would do if you thought your bank was going out of business. Perhaps you’d run to the bank as quickly as possible in order to take all your money out. If everybody does this at once, the bank goes out of business very quickly.

That’s because banks never have ALL your money. In a fractional reserve banking system, banks only keep a fraction of your deposits in reserve. The rest is lent out. If the bank has given loans to people who don’t pay them back, the money is gone.

This happens all the time. Foreclosures, failed land deals, defaulted car loans, these aren’t rare. And banks (are supposed to) keep sufficient reserves to protect themselves.

But over the last five years, lending standards got so bad that banks lost an extraordinary amount of your money. And confidence across the whole system has been shaken. We’ve already seen bank runs all over the world. Some have looked like the movie scene above—IndyMac in CA, Northern Rock in the UK, Bank of East Asia in Hong Kong. While there were no pictures on TV, WaMu had its own bank run as depositors withdrew $16.7 billion in the nine days leading up to September 25th. The bank failed and was sold to JP Morgan.

There have been far larger bank runs, however. Fannie and Freddie were put out of business when creditors stopped lending to them, the five investment banks and AIG disappeared because they lost access to capital.

The next dominoes to fall may be National City and Wachovia here in the U.S., Bradford and Bingley in the UK, and Fortis in Belgium. Wachovia’s balance sheet is larger than WaMu’s, itself 8x larger than the previously largest bank failure. At $871 billion, Fortis’s balance sheet is larger than the two countries in which it is based (Belgium GDP = $343 billion; Netherlands GDP = $529 billion).

If WaMu can fail, and Wachovia is next, can Citigroup be so far behind?

My point is, it may only be a matter of time before YOU lose confidence in your bank and decide it’s safer to keep your money under your mattress. FDIC insurance is comforting, sure. But if I think my bank is going out of business, I’ll have my money now thank you very much. If everyone decides to do this simultaneously, the worldwide financial system literally ceases to function. You lose access to whatever money you’ve saved in the bank. Companies everywhere fail to make payroll.

Economic activity doesn’t just slow down. It stops.

That’s why everyone in Washington is panicking. They see bank runs spreading everywhere, from “Wall Street to Main Street” so to speak.

And they hope that passing a massive bailout will arrest the confidence contagion spreading through the banking system.

As regular readers know, I’ve been pessimistic for some time. And I don’t see this government bailout as a solution. The government may have to spend a nearly unlimited amount of money to bail out “the system.” We’re talking well north of a trillion dollars. That’s money the Feds don’t actually have. They have to borrow it. What if they can’t? What if they borrow so much that interest rates spike and they have to resort to printing money in order to bail out depositors? Now we’re talking higher inflation…..

Either way YOU could lose a lot of money, as your assets/deposits fall in value or disappear when your bank fails or as your purchasing power disappears when hyperinflation destroys the value of American currency.

This is the situation everyone’s facing. And it’s why people at the highest levels of government and finance are panicking.

It’s also why I’ve published contingency plans.