If history is our guide, then the rally we’ve seen in U.S. stocks in recent weeks is more than just a periodic run-up in share prices – it’s the initial stage of a prolonged bull market.

The 13-week rally the Dow Jones Industrial Average has experienced off its March lows is the most powerful surge that index has seen since the Great Depression. If we look to history, stocks should continue to rally over the next three months.

“I say this with the utmost confidence and my fingers tightly crossed: This is the start of a new bull run,” Hugh Johnson, chairman of Johnson Illington Advisors, told MarketWatch.com.

The 13-week stretch from March 9 through May 29, which saw the Dow soar 28.3%, has been bested only once – by the 40.8% run-up the Dow enjoyed in the 13 weeks that followed its hitting a bottom in May 1932. The Dow surged an additional 3.1% last week.

Going back to 1900 – in any given quarter (13 weeks) – there have been 18 cases in which the market surged 20% or more, Johnson said.

Looking at the trends, the odds are strong that the Dow will be higher three weeks from now, and that means the odds are strong that the index will be higher three months from now.

“Based on history, who knows where we’re going to be four weeks from now? But in 12 weeks, the odds are we’ll be 3.8% higher,” Johnson said.
That can’t be guaranteed, however, since there has been at least case where stocks had a huge quarter, only to plunge afterward: In May 1929, the Dow zoomed 26% in 13 weeks – only to plunge 38.9% in the 12 weeks that followed.

Market Matters

General Motors Corp. (OTC: GMGMQ) officially filed for Chapter 11 bankruptcy protection and another U.S. icon has been laid to rest (until the “new” GM emerges better than ever).  With another $30 billion in government aid in hand, GM quickly moved forward by financing the acquisition of supplier Delphi Corp. (OTC: DPHIQ) by a buyout firm that will help it emerge from its own bankruptcy; reaching an agreement to sell Saturn to Penske Automotive Group Inc. (NYSE: PAG); and entering into a deal to unload Hummer to China’s Sichuan Tengzhong Heavy Industrial Machinery Corp. (though regulatory “challenges” are sure to hold up that one).  Meanwhile, Chrysler LLC progressed with its own restructuring Fiat SpA (OTC ADR: FIATY), much to the chagrin of about 800 dealers; and Ford Motor Co. (NYSE: F) plans to increase production to take advantage of the misfortunes of its primary competitors.

Shifting to a more “stable” industry, the Federal Deposit Insurance Corp. and FDIC Chairman Sheila Bair seem to be targeting Citigroup Inc. (NYSE: C) for a management shake-up, a move that could give regulators greater control of the one-time financial behemoth.  Smith Barney brokers found their new homes as a significant joint venture between Citi and Morgan Stanley (NYSE: C) was completed.  Citi also attempted to save face from the prior American International Group Inc. (NYSE: AIG) embarrassment by announcing plans to withhold millions in previously promised severance packages to former execs. On the Troubled Asset Relief Program (TARP) front, JPMorgan Chase & Co. (NYSE: JPM), Morgan Stanley, and American ExpressCo. (NYSE: AXP) each revealed plans for stock offerings as they race to become the first major bank to repay “bailout” moneys.  With GM now in bankruptcy and Citi struggling to overcome its own problems, theDow Jones Industrial Average is replacing them with Cisco SystemsInc. (Nasdaq: CSCO) and The Travelers Cos. Inc. (NYSE: TRV)effective June 8.

Energy prices resumed their higher trek, as crude spiked above $70 a barrel for the first time since last October, despite reports that showed demand at its lowest level in 10 years.  Goldman Sachs Group Inc. (NYSE: GS) analysts upwardly revised their projections for future global demand and warned of a “likely return to energy shortages” in 2010.  As gas prices have skyrocketed about 50 cents above last month’s levels, consumers are facing pressures at the pumps that threaten to hinder some of next year’s anticipated growth in the economy.

Economically Speaking

It looks like fixed-income traders are not the only ones concerned about the expanding debt position in this country.  U.S. Federal Reserve Chairman Ben S. Bernanke warned that the government “can’t borrow indefinitely” and politicos need to take crucial steps to reduce a budget deficit that is rapidly approaching $2 trillion.   Bernanke again confirmed his belief that the economy will move beyond recession by late 2009, though he also warned that the weak jobs market (among other conditions) will restrict future expansion.

Speaking of labor, the unemployment data highlighted the week’s releases and the jobless rate surged to 9.4%, a new 25-year high, as 345,000 nonfarm jobs were lost from the economy.  However, even bad news becomes good news these days as economists had predicted a far more substantial loss (525,000 jobs), and the May decline was the smallest since October 2008.  Still, more than six million folks have seen their jobs disappear since the recession began in December 2007 and May represents the seventeenth consecutive month of labor contraction.

In other news, the manufacturing sector appears to be on the verge of recovery (though ever-so-slightly) as the ISM index reported its best showing since September 2008.  On the housing front, construction spending jumped for the second straight month and pending home sales experienced its biggest increase in eight years.  Personal income surprisingly rose in April, a positive sign for future consumer activity.  Though retailers reported weaker-than-expected same-store sales for May, analysts were quick to point out that Wal-Mart Stores Inc. (NYSE: WMT) is no longer participating in these reports, a decision that should skew the numbers lower because the world’s largest retailer accounts for about 10% of total retail sales.  Luxury chains and department stores were among the worst performers last month, while The Gap Inc. (NYSE: GPS) benefited from a nice increase in activity at its Old Navy chain.

U.S. Treasury Secretary Timothy Geithner ventured over to China during the week where he praised it leaders for past stimulus measures (a tad different tact than used by his predecessor).  Recently, China has complained about the ballooning U.S. debt and analysts remain worried about its continued participation in our Treasury auctions.  The domestic powers-that-be have long criticized China about unfair trade practices and currency issues.

While the respective leaders have reservations about each other’s policies, Geithner’s remarks may be seen as smoothing over relations as our combined efforts will be imperative to securing an effective and long-lasting global recovery.

Weekly Economic Calendar

Source: History Hints that Current Stock Market Rally May Be the Leading Edge of a New Bull Market

The largest U.S. automaker will cut its global salaried workforce from 73,000 to 63,000 by the end of 2009. GM will eliminate 3,400 of its 29,500 U.S. jobs by May 1, and its U.S. executives will see a pay cut of 10%. Many other salaried employees will take a temporary 3% to 7% pay cut.

“These difficult actions are necessitated by a severe drop in vehicle sales worldwide and by the need to restructure GM for long-term viability,” GM said in a release on its Web site.

Nearly every day it seems, GM’s turnaround efforts have been making gigantic waves.

GM and Chrysler LLC have until Feb. 17 demonstrate their viability to the U.S. government, or risk being forced into bankruptcy.

GM has received $9.4 billion and expects to get $4 billion more, while Chrysler has received $4 billion and is hoping to get another $3 billion. But in order to secure these funds, they must first prove they are able to repay the federal loans that are currently keeping the companies afloat in the worst U.S. auto sales climate in 26 years.

Source: GM Chopping 10,000 Jobs, Executive Pay

And in a separate story yesterday – which underscores that the auto sector’s woes are going global – Nissan Motor Corp. (ADR:NSANY) said it would cut 20,000 jobs by the end of 2010 and expects to book a net loss for the year ended March 31, which would be its first loss in 14 years.

But the outlook for Detroit’s “Big Three” is clearly worse, right now. From the time U.S. carmakers first approached Congress about obtaining bailout money for the American auto industry, GM and Chrysler have adamantly opposed bankruptcy. Indeed, as far back as their first visit to Washington – when the CEOs caused a firestorm of controversy by flying to the meeting in their corporate jets – the automakers’ top executives said the bankruptcy labels would weaken their companies’ reputations by pushing potential customers to other brands.

However, the government could force bankruptcy by applying the debtor-in-possession status to the loans, which would make debts owed to the government the top priority, Don Workman, a partner at Baker & Hostetler LLP and bankruptcy expert, told Bloomberg News.

GM and Chrysler have until next Tuesday (Feb 17) to demonstrate progress on their plans – reducing labor costs and showing how they’ll begin repaying loans – enacted in order to receive loans from the Troubled Asset Relief Program (TARP).

GM said it plans to close dealerships and continue cutting union retirement benefits. Chrysler’s CEO Robert Nardelli previously said the company would try reducing debt, Bloomberg reported.

GM is talking with parts maker and supplier Delphi Corp. (DPHIQ) – which was spun off from GM 10 years ago – about buying back assets, which will shore up GM’s supply chain, Reuters reported.

The bottom: The government wants more cost-cutting and income-generating measures from the carmakers. And if GM and Chrysler can’t do it themselves, their loans will be yanked.

Nissan Announces 20,000 Job Cuts

Across the Pacific, Nissan said it must cut jobs because of lackluster sales – including its first loss in nearly a decade and a half.

“In every planning scenario we built, our worst assumptions on the state of the global economy have been met or exceeded, with the continuing grip on credit and declining consumer confidence being the most damaging factors,” Nissan President and CEO Carlos Ghosn said in a statement. “Looking forward, our priority remains on protecting our free cash flow and taking swift, adequate and impactful actions to improve our business performance.”

The 20,000 job cuts equate to 8.5% of Japan’s No. 3 automaker, Reuters reported, and is just one of several recovery actions the company outlined in a news release. Others include:

• Launching an average of 10 new vehicles every year from 2009 to 2012.
• Reducing labor costs in line with decreased revenues. Labor costs will be cut 20% in fiscal 2009.
• Eliminate bonus payments to its board of directors for 2008 and reduce board and corporate salaries by 10% starting in March and lasting “until the situation clearly improves.”
• Negotiate and hopefully implement a work-sharing scheme for staff workers.

Source: Bankruptcy Looks Increasingly Likely for GM and Chrysler; Nissan to Slash 20,000 Jobs

Private equity is an asset class consisting of equity securities in operating companies that are not publicly traded.  The name “private equity”is the rechristened, kinder and more gentile label for what used to be known as leveraged buyouts, or LBOs. But make no mistake about it, while leverage may not be part of the name any more, it remains a big part of every private equity deal.

LBO firms, or “franchises”, as Henry Kravis, co-founder of Kohlberg Kravis Roberts & Co. (KKR), likes to call his shop, acquire publicly traded operating companies. Then they streamline management and operations to increase profitability and hope to cash out through a merger, an outright sale of the company, or by taking the company public again through an initial public offering, or IPO.

Private equity firms are the debutante sisters of hedge funds. They raise huge pools of capital from pension funds, endowment funds, sovereign wealth funds, institutional investors and wealthy entrepreneurs. But while hedge funds buy and sell the stocks of companies they hope to profit from, private equity shops buy whole companies.

Generally, once a target is identified, an offer is made to buy a majority, or all of the stock of the company. The trick of the deal is to pay for the target by using as little equity capital as possible, and raising the remainder by actually having the target company borrow the required funds. Except for the private equity firm’s initial equity investment, the target company is essentially buying itself.

And if that isn’t enough of a trick, very often when the target is privatized, their new masters have the company borrow even more money so they can then pay themselves a dividend as a bonus for the good job they did in leveraging the company to the hilt so they can streamline it.

The leveraged buyout business has been around for a long time and it has worked very well for investors and the private investment bankers who make an extravagant living with other people’s money. In fact, the business was so successful it eventually led to its now very problematic fork in the road. The problem facing private equity is that their leveraged deals were at one time in such great demand that it became too easy to borrow too much money.

The result was that they chased too many deals, paid too much for targets, paid themselves too many dividends and fees, and now their portfolio companies are straining and collapsing under the weight of too much debt.

Act I: The Two Big Mistakes that Made Leveraging Possible

There are two elements that made massive borrowing possible.

The first was a ready supply of capital courtesy of the U.S. Federal Reserve’s easy money policy and low interest rates. The second was the ability of banks that lend money to acquired companies to pool those loans into securities called  collateralized loan obligations, or CLOs, and sell them off to investors. Banks and investors refer to this asset class as “leveraged loans.”

Since banks were able to sell off their leverage loans to investors they had plenty of recycled money to lend out again and again. Competition to lend out all that money put borrowers in an advantageous position, which they exploited.

Banks and non-bank lenders attach covenants to the loans they make. Typically, covenants dictate to borrowers what specific balance sheet requirements must be met and include debt-to-cash flow leverage ratios, limitations on the total amount of debt a company can carry, minimum equity provisions and other dictates that serve to secure collateral that is relied upon by lenders.

But, banks were so flush with money and so eager to lend that privately acquired companies, driven by their new private equity masters, proposed that the money they borrowed should not be encumbered by the protective covenants lenders are used to demanding. Hence the birth of “covenant-lite” loans.

Covenant-lite loans included insane “reverse covenants” that benefited the borrowers not the lenders.

Among other things, some borrowers demanded and got rights to:

• Increase debt-to-EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) levels to 10:1.
• Freely substitute collateral.
• Have collateral “released” outright.
• Issue unsecured debt equal to the total amount of existing debt (if they hedged or effected swaps.
• Employ PIK (payment-in-kind) options, where instead of paying interest in cash they could substitute more debt.
• Employ PIK toggles, sometimes called “extendibles.”

PIK toggles (think of a toggle switch which is used to turn something on or off) let the borrower can roll interest payments into principal and extend the maturity, instead of making twice yearly cash payments. If that sounds like an option ARM mortgage, where borrowers can choose whether to pay the interest due, some part of it, or none of it, and roll unpaid interest into principal, it’s because it is the exact same borrower covenant.

It’s like déjà vu all over again.

Act II: With No Leverage Private Equity Deals Fall Apart

Junk, junk and more junk. When the music stopped and the credit crisis began last August, money and credit evaporated. Only then did it bother leveraged loan investors that the private equity guys were leveraging their private companies to pay themselves huge dividends – enough in many cases to repay the entire initial cash equity investment used to underpin the leveraged buyout of their targets. And only then did they realize that all the debt heaped onto these companies was going to drag many of them into bankruptcy.

At that point, investors simply stopped buying leveraged loans. And the net result is that banks may be sitting on over $150 billion of junk leveraged loans that they can’t place. They are taking hits to their balance sheets as they have to mark down these loans which were securitized and subject to mark-to-market accounting. And they are terrified that the recession will drive more of these leveraged companies into bankruptcy.

Thomson Reuters recently reported that 40 private equity companies have sought bankruptcy this year. According to Standard & Poor’s, of 86 S&P rated companies that defaulted this year, 53 of them were private equity related transactions. Linens ‘n Things which was taken private by Apollo Group Inc. went bankrupt. Sharper Image, Wickes Furniture and catalogue company Lillian Vernon, were all taken private by Sun Capital Partners Inc., all of them are bankrupt. Mervyn’s which was taken private by Sun Capital and Cerberus Capital Management LP. is bankrupt.

Also in the clutches of the three-headed-dog from Hades, Cerberus, is Chrysler LLC; Chrysler Financial, GMAC LLC (General Motors Acceptance Corporation) (GMA) – 51% owned by Cerberus – and Residential Capital LLC, a GMAC company. By most accounting standards, all of these companies are, if not already, close to insolvent.

GateHouse Media Inc. (OTC: GHS), 40% owned by Fortress Investment Group LLC (FIG), is at risk of debt default and may likely be headed for bankruptcy. Former Lazard Ltd. (LAZ) deputy chairman and  media honcho Steve Rattner’s Quadrangle Capital Partners may lose control of American Media Inc., publisher of The National Enquirer and Star magazine, as he battles with bondholders and may also lose portfolio company Alpha Media Group Inc., publisher of Maxim magazine. These few examples of failures are just the tip of the iceberg.

Then, of course, there’s the pure genius of PE firms coming to the rescue of troubled banks. But, TPG Capital (formerly Texas Pacific Group) doesn’t look so genius with its $7 billion investment in Washington Mutual Inc. (OTC: WAMUQ) which was wiped out in a matter of five months.

It’s understandable that bankrupt target companies are suing. Mervyn’s, for example, filed a 57 page suit against its lead dog master Cerberus, alleging fraud among other charges. But what is not as easily understandable is that some other lawsuits have the potential to turn the game viciously against the private equity firms and all the major bank lenders. I’m not talking about the deals that got done; I’m talking about the deals that didn’t get done because private equity firms walked away or otherwise tried to dissolve pending deals.

Apollo Management asked a Delaware Court of Chancery to kill a transaction it had entered into to have one of its portfolio companies, Hexion Specialty Chemicals Inc., buy NYSE listed Huntsman Corp.(HUN) for $6.5 billion. Huntsman sued and won. The judge issued a ruling that Hexion “knowingly and intentionally” breached parts of the merger agreement and ordered the company to complete the deal. Not only is Apollo being forced to go through with the deal, the ruling allows Huntsman to seek damages from Apollo. Apollo is now suing the banks it had lined up to provide debt financing for the deal.

There are hundreds of billions of dollars of abandoned deals that may now be re-visited in courts around the country. The implication for private equity firms and banks is potentially staggering.

Here are a few of the larger failed deals that resulted from a lack of debt investor interest:

• Cerberus’ failed  deal for United Rentals Inc. (URI).
• The Blackstone Group LP’s (BX) failed deal for Alliance Data Systems Corp. (ADS).
• J.C. Flowers’ failed deal for SLM Corp. (SLM), also known as Sallie Mae.
• And Appaloosa Management in conjunction with Harbinger Capital Partners, Merrill Lynch & Co. Inc. (MER), Goldman Sachs Group Inc. (GS), and UBS Securities LLC’s failed financing of Delphi Corp. (OTC: DPHIQ) to take it out of bankruptcy, for which they are being sued for fraud and conspiracy to “derail” the bankruptcy plan; a serious situation because interfering with a bankruptcy is a federal crime.

The amount of leverage involved in private equity deals is a problem if banks aren’t eager, or able, to supply needed loans. But that alone isn’t scary. What is scary is the effort private equity firms are making to actually get into the banking business themselves.

Act III: Private Equity Seeks to Corrupt Banking System

There’s a lot of pressure on banks to raise capital and there’s a lot of pressure being exerted by the private equity guys to lean on the Fed and U.S. Treasury to bend the rules to let them play in that sandbox. Pushing hard from the private equity camp are Randall Quarles, Managing Director of Carlyle Group Ltd. and a former senior Treasury official and none other than the former Treasury Secretary himself, Chairman of Cerberus Capital Management, John Snow.

What the private equity guys want is the ability to buy into banks and control them. If they get their hands on the low cost deposit-based capital at commercial banks, they’ll be unstoppable. How about having the piggy-bank, backed by taxpayers to leverage at will?

The prospect is frightening.

Right now there’s a limitation imposed on investors in Federal Deposit Insurance Company insured commercial banks. Once an investment exceeds 9.9% there must be an agreement with regulators to not “control or influence” management. If an investment exceeds 24.9% the investing entity must register as a Bank Holding Company, and subject itself to all necessary transparencies called for by regulators and the Fed. In addition, the holding company is forced to serve as a “source of strength”, meaning its capital will be called upon to support its bank.

Private equity guys do not want any part of either of those restrictions. They don’t want their business looked through nor do they want their capital encumbered. The private equity firms are sitting on hundreds of billions of dollars of fresh money raised recently. While it may seem reasonable and expedient to allow private equity capital to be infused into ailing banks, any compromise of existing regulations would result in the creation of the mother of all moral hazard enablers.

There’s no doubt that if the recession is as deep and as long as feared,, the continuing failure and bankruptcy of leveraged private equity portfolio companies will result in far greater unemployment, and in and of itself, has the potential to deepen the recession on an inordinate scale.

There’s too much greed and far too much power in the form of private equity firms. Their greed has encumbered American banks with significant CLO and leveraged loan exposure and encumbered American companies with too much debt. Now, they threaten to undermine sound banking (wait a minute, that’s already been done by the banks themselves) by investing capital into them in order to control them.

Until concrete underpinnings replace the glue and duct tape that’s holding together the banking system, and until leverage is wrung out of companies, investment vehicles and households, banks and private equity firms will both be on a slippery slope.

Source: Overly Leveraged Private Equity Deals Add to Unemployment and Deepen Recession

Unfortunately, when a series of vicious insurance losses hit the world’s insurance market through the early ’90s, many Lloyds members lost absolutely everything – houses, furniture and indeed their lives. Many of today’s professional money managers engage in a similar practice when they sell credit default swaps (CDS).

CDSs, CDOs and all the other credit derivatives that populate the global financial markets present a new and uncertain risk for investors. Let’s dig a little deeper…

CDOs, as we explained in last Friday’s edition of the Rude Awakening, are new-fangled credit derivatives – i.e. they are bond-like instruments that are derived from pools of loans, usually mortgages. Through the wizardry of modern financial engineering, a pool of sub-prime mortgages, for example, can become an array of CDOs, some rated as high as AAA, others rated much lower. Industry insiders sometimes refer to the lower-rated CDOs as “toxic waste.”…

Institutional investors have been gobbling up these high-yielding – but very risky – CDOs because they are able to buy default insurance – otherwise known as a credit default swap (CDS).

For example, the buyer of a particular CDO could simultaneously buy a CDS to protect against a default. The investor would, effectively, pay an insurance premium to another investment institution for underwriting the risk of the underlying home-loans defaulting. Apart from a bit of legal drafting, that’s all there is to a Credit Default Swap. In return for a cash payment, you swap the risk of default.

These insurance premiums, paid to the underwriter of the CDS, appear to the receiver as income – just like the insurance premiums that any insurance company would receive. You are being paid for accepting risk, not for lending money.

So you see, the investment bankers have been very clever. They have said there are two components in a bond-interest payment: a fee for the use of your money, and a fee for the risk of default. The CDS simply separates out the [fee] for the risk of default.

The investment bank can have still more fun with this. Just like the boring mortgage streams that we started with, these CDS streams can be aggregated into a pool…then divided into tranches with different risk profiles…producing the magic of higher credit ratings for lower-risk tranches…plus concentrated risk in new toxic waste.

If you can get a credit rating agency to assess the tranches you have created, then you have something that looks like a CDO – and smells like a CDO – but which is not now based on cash flows deriving from borrowed money. Instead, it is based on cash flows deriving exclusively from insurance premiums that are paid to cover the risk of mortgage default.

That’s how CDSs get packaged into what is known as a “synthetic CDO,” and the investment banks can sell them for what appear to be fantastic yields. It’s a really neat deal…for the investment banks, which are selling to the highest bidder the right to receive their mortgage default insurance premiums in exchange for assuming the risks of default – so the buyer is just another “investment landfill”. He ends up with what’s called a “contingent liability.”

Why would any investment fund possibly fall for this scheme? The modern fund manager has a powerful short-term incentive to get a strong performance out of your invested savings. If he gets 2% more than the next guy he is a genius, and he will get more money under his management and much larger performance fees. As long as defaults occur rarely, synthetic CDOs can provide a pretty neat deal for the investors. They earn a steady income stream, simply by promising to stump up if there’s a default.

So you can see now how through the use of synthetic CDOs, fund managers can underwrite credit default risk and increase their income accordingly, without outlaying any fund capital. Importantly, however, they are placing their fund capital at risk. Your fund manager is a genius while there are no claims. But if it goes wrong, your fund gets hammered.

But the CDO story does not end here…

It was not long before the investment banking industry had a “Eureka” moment…They started insuring against the default of securities they didn’t even own! It’s like noticing your friend is looking a bit ragged and taking out insurance on his life for your benefit, without him having anything to do with it. And as long as there is demand for “easy income,” there’s no limit to how many of [CDS, the investment banks may create.]

When Delphi Corp (DPHIQ), a large motor parts spin-off from General Motors (GM) , got into serious trouble last year, its bonds fell into default. Incredibly, more than 10 times the nominal value of its bonds were then claimed from investment institution underwriters, by bankers who had insured against the default of bonds they didn’t own by issuing Delphi CDSs.

This isolated incident suggests that the mushrooming growth of credit-derivative issuance imparts an unknown and untested threat to the global financial system….

Long Term Capital Management failed in 1998. It was the last truly serious financial collapse which threatened the U.S. financial system. When LTCM went under, the bail-out fund required was $3.65 billion. The [LTCM] fund itself was leveraged to about $125 billion of assets…

Back in 1998 LTCM was plowing a lonely furrow. Its investment view was something to do with Russian bonds and the Japanese Yen. It was off the main investment spectrum, and there were few copy-cats putting the same market view into action in the same way.

That is where things are very different this time…Many banks and funds are involved…This makes the size of the problem potentially much larger, and of much greater risk to the whole financial system.

How large?…Depending upon who’s counting, the world’s investors now hold somewhere around $1 trillion worth of credit derivatives, at market value. But since the notional value of these arcane financial instruments exceeds $25 trillion, no one really knows how large the potential losses could become during a panic.

Now you can see the difference in scale between LTCM and the subprime bust. This may be 20 times worse than LTCM. And it’s getting worse – daily.

At a time like this, we should not underestimate the skill of people like Ben Bernanke at the US Federal Reserve in underpinning the financial system. They have been remarkably effective at organizing the lifeboats over many years and many crises….[But] Here at BullionVault we think the Bernankes of this world will one day fail.

The result will be a credit squeeze. Bond issues will be pulled, bank loans recalled, and business activity will sharply decline for lack of funding. The first two of these have certainly started – with a rash of failed issues at the end of June. Will these risks be contained? We don’t know…

Clearly we’re biased against excessive leverage, and against too much financial ingenuity, too. That’s why we’re in the physical gold bullion business. We believe that real physical gold is a sensible insurance against today’s increasingly weird financial system. It has been astonishingly reliable in that role in the past.

But this time, who knows?

Source: Investment Landfill, Revisited