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John Lee, CFA

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Romeo Must Die, Holding dollars? - "That was a mistake"

By John Lee, CFA      Printer Friendly Version
Nov 2 2007 4:40PM

In my October 4th article titled: “Depression, Debt Implosion, Gold, and Prosperity� (, I argued that:

“In the last four weeks (September), we have witnessed the worst financial event in the US over the last 50 years. The subprime mess shook the US financial system to the core, as it directly affected the marketability of the $30 trillion+ US debt market.

  1. The worst possible event that could trigger debt implosion has already occurred, with demand for the multi-trillion US mortgage debt market suddenly and completely dried up. Yet the world has gone on with business as usual.

Would you touch beef (US debts) again knowing there is a significant quantity of mad cow disease (subprime) going around?�

According to, AAA mortgages are now selling at 80cents on the dollar, whereas BBB (Subprime) mortgage are selling at 20 cents on the dollar.

According to Mr. Gillian Tett of The Financial Times, quoting an anonymous trader,

“…as he has embarked on this sordid task, he has discovered that the only effective way to get rid of these distressed assets is to avoid putting any tangible price on the trade.

“Barter is the only thing that works right,� he chuckles grimly. “It is like the Dark Ages.�

Indeed, in some arenas, such as mortgage-linked securities, sentiment now seems to be getting worse, not better. And that raises the prospect that we are now moving into an entire new phase of this year’s credit squeeze.

Take the ABX index, the basket of derivatives linked to subprime securities. As financial tools go, this index is far from perfect, since it is barely two years old, and tends to be thinly traded.

But right now it has the unfortunate distinction of being the only tool easily available to measure sentiment in the opaque subprime securities world. And in the past couple of weeks, the message emerging from this measure has started to look utterly dire.

The experience of living through the Enron scandals earlier this decade means that the audit industry is now terrified that it could face lawsuits if it is perceived to be too lax towards its clients. So some now appear to be demanding that their banking clients reprice their mortgage assets according to the only visible market tool – namely the ABX. It is thus little wonder that some banks have suddenly been forced to increase their writedowns in recent weeks. Indeed, I would wager that the pernicious combination of ABX and the “Enron factor� is a key reason for the recent shocks emanating from Merrill Lynch.

However, the rub is that while auditors at some Wall Street banks are becoming quasi-evangelical about the need to reprice subprime assets, there are still other, vast swathes of the financial system which have not been touched by the full blast of transparency yet. Moreover, many financiers outside the world of Wall Street banks remain very wary of rewriting their mortgage assets to current ABX price levels, due to a lingering hope that the recent ABX slump will remain temporary.�

I have long said the inflation vs. deflation debate is over and the central bankers have told you loud and clear they will print their way out of trouble, and there is no other way. The Fed injected (printed) $41 billion on November 1st, the largest amount in a single day post 9-11.  However neither this nor the $70 billion superfund will solve this mad cow problem, as trillions of dollars of mortgage positions need to be unwounded. Nor is adjusting interest rates going to make a difference now.

In public and privately, the Fed needs to redeem any and all mortgage debts with new paper. It needs to catch up and print $billions more until the government officials took off by helicopters Argentine style.  Don’t anticipate a crash in the stock market.

The Dow is selling at a discount measured in a free falling currency.


The dollar has dropped 17% in 2 years and 37% in 6 years.

The dollar’s free fall will continue, while gold and RMB’s rise will accelerate in pace. We will look back and kick ourselves for not buying gold below $850. For those who hold dollar savings, to borrow from the classic line from the movie “Romeo Must Die� by the Kung Fu master Jet Li to his brother who betrayed him – “That was a mistake.�

John Lee,CFA



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