Category Archives: S&L Crisis

Krugman: Right or Wrong?

Source

Krugman, Paul R. "Mexicans Send Message with Votes, but the Results may Not be what they Hope." Los Angeles Times. Jul 24, 1988, page 2.

Claims

  • "Dragged down by a massive burden of foreign debt, buffeted by declining oil prices and given an earthquake as a final insult, Mexico had shown little economic growth since 1982."
  • "The standard of living of ordinary workers had fallen by half."
  • "The sinking peso had fed an inflationary spiral that had taken the inflation rate in a country once proud of its price stability into triple digits."
  • "Salinas and his team must succeed in controlling inflation; they must translate that inflationary success into political success that gives them the power to pursue economic liberalization; they must then fairly quickly deliver results in terms of economic growth that validate their economic program."

Prediction

"Is anyone in the U.S. government prepared to take the lead? Or will we drift, hoping that Mexico's problems will go away, or at least wait until January [1989]? If we do, we risk a foreign policy disaster that will make our Central American worries look trivial."

Outcome

  1. “In its largest loan ever made to a debt-pressed nation, the United States said today that it would grant Mexico up to $3.5 billion to help it cope with reduced revenues resulting from the plunge in oil prices. The short-term loan is intended to tide over Mexico, which depends heavily on oil exports, for a few months until it can get longer loans of similar magnitude from the big multinational lending agencies, the World Bank and the International Monetary Fund. (Kilborn, Peter T. “Mexico to receive up to $3.5 Billion as loan from U.S.” New York Times. Oct 18, 1988. page A1.).

see also: Mexican Peso Crisis

2015 Reprint: Consequences of Falling Oil Prices

It was merely an observation at the time.  However, we find it necessary to reprint a piece from 2015 on the outcome of falling oil prices and our thoughts about it at the time.  Please click on the image or the following link: Consequences of Falling Oil Prices

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Consequences of Falling Oil Prices

Economic events never occur in a vacuum.  Usually there is a string of events that leads from one event to another. One big event can lead to an even bigger event that overshadows the prior calamities that triggered “The Big” event.  The February 9, 1983 issue of Richard Russell’s Dow Theory Letters covers  one market event that led to two major crises that happened at different periods in time.  The two events are joined at the hip based on the decline of oil prices.  This led two separate major bailouts that resulted in the structural shift in the way our brand of capitalism works.

The first event resulted in the Savings and Loan Crisis (S&L Crisis) and is thought to have begun in 1986 due to the Tax Reform Act of 1986 culminating in the bailout of many banks and the eventual bankruptcy of the Federal Savings and Loan Insurance Corporation (FSLIC).

The second event resulted in the Mexican Peso Crisis with the outcome that major banking institutions like Citibank and Goldman Sachs needed to be bailed out.  It is important to note that the Peso Crisis is considered to be as a result of the peso devaluation in 1994.

The true roots of both the S&L Crisis and the Peso Crisis is the decline of oil prices after the inflationary peak in 1980-1981.  Richard Russell’s Dow Theory Letter Issue 854 highlights the seeds of destruction that were going to be much larger than even Russell could have imagined. However, if anyone wishes to understand how the snowball got rolling then this issue highlights the beginning.

The very first quote is an amazing insight of the American dependence of the high price of oil, Richard Russell says the following:

“We’re facing a situation (ironically) where the US is all for holding oil prices at a high level. The banks have lent huge sums of money both to private corporations and to oil producing nations-loans based on rising oil prices. If the oil price cracks badly,  the banks are going to have major problems. On top of that, the US depends on oil taxes (so called “excess profits” tax) for huge chunks of tax income. If oil prices crack then the profits for the oil companies will dive (which they are already doing) and the tax short-fall will be horrendous. (page 1)”

This commentary is staggering in the fact that it was so prescient.  The cracks in the armor of the American oil industry began in Texas when the easy money stopped raining down on oil dependent cities like Houston and Dallas.  In a 1988 issue of Dow Theory Letters, Russell had the following to say:

“With oil prices caving in, Texas now has more people leaving the state than coming in.( Dow Theory Letters. March 9, 1988. page 6.)”

The decline in oil prices led to a decline of jobs for that industry which resulted in a decline in real estate prices as people left the state of Texas.  Loans made by savings and loan institutions in the southwest U.S., to businesses and real estate investors, all went bad at the same time leading to the Savings and Loan Crisis (S&L Crisis).  The S&L Crisis cost several hundreds of billions of dollars and still exist as an off-budget item as part of our national debt.

The decline in the price of oil also crushed foreign economies dependent on the commodity.  The Mexican Peso Crisis, although officially listed as beginning in 1994, had its roots in the early 1980’s.  The natural outcome of this crisis was the bailout of large banking institutions like Citibank and Goldman Sachs when the government stepped in and bought the bad debt held by the bank’s all in gamble.

Likewise, the current boom in commodity rich countries (although somewhat cooler at present) like Australia, Brazil, Russia, China and India could experience significant shocks to their system depending on the level of loans made as “investments” by foreign banking institutions based on the potential of future growth.

Few understood or believed the impact and importance of high oil prices to the American economy at the time.  Even fewer understood the direct reliance of the U.S. government to high oil prices.  Investors should watch for the potential fallout that may arise from the recent precipitous decline in the price of oil.  The troubles afflicting Russia and Brazil’s Petrobras may be early indications of where the pain may be felt.

Review: Bank of Montreal

Contributor C. Cheng Asks:

“What are your concerns regarding the housing bubble forming in Canada and it’s potentially adverse effects on BMO?”

Our Response:

The timeliness of this comment regarding Bank of Montreal (BMO) is critical.  On June 7, 2012 (found here), we posted an Investment Observation on Bank of Montreal which was one of our leading considerations as an investment opportunity.  Keep in mind that our interest in BMO came after a 14-month declining trend in the stock’s price.

At that time we said the following of BMO:

“We are reticent to recommend any kind of banking institution due to the many unexpected risks that occur outside of the purview of regulators and accountants.  However, Bank of Montreal is a reasonable banking investment if bought at the right price.  We believe that the right price begins at $51.80 and below.”

Unfortunately, BMO never fell below $51.80.  In fact, the day that were did our write up on BMO it only fell below the $53.57 price on the five subsequent trading days immediately afterwards, with the lowest price being $52.15 on June 11, 2012.

At the moment, BMO’s stock price has retested the previous high set in November 2013.

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If there is a concern that Canadian real estate is in a bubble then it would be wise to sell only the principal in BMO while leaving the profits to compound.  This would eliminate the guesswork associated with determining if there is a bubble.  The remaining funds would be allowed to compound at a 5.50% rate until BMO has sustain a similar decline in price from April 2011 to June 2012.

Continue reading

Richard Russell Review: Letter 854

Richard Russell’s Dow Theory Letter Issue 854 was published on February 9, 1983.  At the time, the Dow Jones Industrial Average was at the 1,067.42 level.

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Economic events never occur in a vacuum.  Usually there is a string of events that leads from one event to another. One big event can lead to an even bigger event that overshadows the prior calamities that triggered the “big” event.  This issue of Richard Russell’s Dow Theory Letters covers  one market event that led to major crises that happened at different periods in time.  The two events are joined at the hip based on the decline of oil prices.  This led two separate major bailouts that resulted in structural shift in the way our brand of capitalism works.

Also, this Russell review will cover the topic of cycles in corporate cash and corporate indebtedness. We'll discuss, in brief, where we might be in this cycle.

The first event resulted in the Savings and Loan Crisis and is thought to have begun in 1986 due to the Tax Reform Act of 1986 culminating in the bailout of many banks and the eventual bankruptcy of the Federal Savings and Loan Insurance Corporation (FSLIC).

The second event resulted in the Mexican Peso Crisis with the outcome that major banking institutions like Citibank and Goldman Sachs needed to be bailed out.  It is important to note that the Peso Crisis is considered to be as a result of the peso devaluation in 1994.

The true roots of both the S&L Crisis and the Peso Crisis is the decline of oil prices after the inflationary peak in 1980-1981.  Richard Russell’s Dow Theory Letter Issue 854 highlights the seeds of destruction that were going to be much larger than even Russell could have imagined. However, if anyone wishes to understand how the snowball got rolling then this issue highlights the beginning.

The very first quote is an amazing insight of the American dependence of the high price of oil, Richard Russell says the following:

“We’re facing a situation (ironically) where the US is all for holding oil prices at a high level. The banks have lent huge sums of money both to private corporations and to oil producing nations-loans based on rising oil prices. If the oil price cracks badly,  the banks are going to have major problems. On top of that, the US depends on oil taxes (so called “excess profits” tax) for huge chunks of tax income. If oil prices crack then the profits for the oil companies will dive (which they are already doing) and the tax short-fall will be horrendous. (page 1)”

This commentary is staggering in the fact that it was so prescient.  The cracks in the armor of the American oil industry began in Texas when the easy money stopped raining down on oil dependent cities like Houston and Dallas.  In a 1988 issue of Dow Theory Letters, Russell had the following to say:

“With oil prices caving in, Texas now has more people leaving the state than coming in.( Dow Theory Letters. March 9, 1988. page 6.)”

The decline in oil prices led to a decline of jobs for that industry which resulted in a decline in real estate prices as people left the state of Texas.  Loans made by savings and loan institutions in the southwest U.S., to businesses and real estate investors, all went bad at the same time leading to the Savings and Loan Crisis (S&L Crisis).  The S&L Crisis cost several hundreds of billions of dollars and still exist as an off-budget item as part of our national debt.

The decline in the price of oil also crushed foreign economies dependent on the commodity.  The Mexican Peso Crisis, although officially listed as beginning in 1994, had its roots in the early 1980’s.  The natural outcome of this crisis was the bailout of large banking institutions like Citibank and Goldman Sachs when the government stepped in and bought the bad debt held by the bank’s all in gamble.

Likewise, the current boom in commodity rich countries (although somewhat cooler at present) like Australia, Brazil, Russia, China and India could experience significant shocks to their system depending on the level of loans made as “investments” by foreign banking institutions based on the potential of future growth.

Few understood or believed the impact and importance of high oil prices to the American economy at the time.  Even fewer understood the direct reliance of the U.S. government to high oil prices.  Then as now, the elevated level of the price of gold is being wagered on by the U.S. government in a similar way that it was done when we had high prices in oil.  The excessive printing of money through quantitative easing and other accommodative policies by the Federal Reserve is based on the elevated level in gold prices.

If the price of gold were to collapse then all bets are off.  Unfortunately, many believe that a collapse in gold couldn’t happen while the government is bent on printing money out of thin air.  However, the problem is that commodities like gold are prone to dramatic declines, especially when all bets are that it can’t or won’t happen.

Many die-hard gold investors/speculators are not making the connection between the government’s reliance and expectation of higher prices in gold.  Worse still, gold investors mistakenly believe that the U.S. government wants to see a lower price in gold and that the only direction is up due to accommodative policies.  This is far from the reality, as found out the hard way by the likes of billionaire money manager John Paulson.  Waiting in the wings are other big-time money managers who will likely get bailed out of their money losing bets on gold’s elevated levels.  Those that have leveraged their bets on gold and other commodities will be bailed out using taxpayers money and hidden as an off-budget items as part of the national debt.  Suffice to say, despite all the carnage in the period from 1980 to 2007, the stock market managed to climb over 12 times.

Next up is a comment on how U.S. corporations were strapped with debt. Russell says the following:

“In the shorter term, the argument for holding stocks is that a low rate of inflation will be bullish for stocks. But that argument was never used in a situation like the current one - a situation in which corporations are loaded with debt.  Whether these corporations can survive with debt ridden structure during a period of deflation remains to be seen. (page 3)”

This commentary is interesting because it was at the early stages of a secular bull market when the Dow Jones Industrial Average went from 1,000 to the peak of 14,164, an increase of over 12 times in 24 years (and this was just the “average”).  Now, we seem to be in the early stages of a secular bear market with just the opposite scenario.  Today, we’re being told of the immense cash hoard that corporations happen to be sitting on (WSJ article here).  Furthermore, interest rates are at or near zero and likely to rise as opposed to rates falling from double digit heights in 1980.

We’re not impressed with the claims of corporate strength based on off-shore cash hoards. We believe that what we’re witness to is the corporate equivalent of high tide which is inevitably going to be followed by low tide.  It is only a matter of time that it will be revealed that the idle cash of today will be the debt-laden corporation of tomorrow.  Those that are clamoring (in some cases suing) for companies to disgorge their coffers of excess cash in the form of “special” dividends will not think twice, twenty years from now, that they had unwittingly contributed to the decline of the company that they’ve targeted.