Carnegie Management Group

and crude oil between now and late-2009. The Dow Industrial Average could rebound to around 12,000 by mid-2009.

LEVERAGED DEBT WILL HAUNT THE
FINANCIAL MARKETS FOR YEARS!

The banks and the brokerage firms have already written-off $600 billion in various Structured Debt Obligations (SDOs).

However, Bridgewater Associates, one of the world’s largest hedge funds, just released a study revealing that total credit losses will amount to $1.6 trillion worldwide, or four times greater than what has already been written-off. The bean counters at Bridgewater estimate that the financials handle around $26.6 trillion in debt-based assets.

If such assets were valued at today’s market rates, an astounding $1.6 trillion would be instantly lost! But there’s more: This credit crisis is not even close to a bottom, nor to a resolution. The problem for the stock market is sobering.

Analysts worry that the banking system is encumbered by off-balance-sheet debt that amounts to more than the net capital of our banking system. Each quarter, financial firms decide how much debt they can write-off. After that amount is determined—let’s say $6 billion—then that $6 billion in off-balance-sheet debt is moved to the banks balance sheet and written-off.

Bridgewater Associates says we’re only 25 percent through the write-off process. Hence, we can expect more write-off announcements that could destabilize the banking and financial sectors in the future.

I am continually amazed that trillions in SDOs were created without the approval of or registration with some regulatory agency. Bill Gross, founder and Chief Investment Officer of Pimco, the world’s largest bond fund, made these observations in Fortune magazine:

“’Skim milk masquerades as cream,’ warned Gilbert and Sullivan over a century ago. Sure enough, today’s subprimes, packaged into financial conduits, with monikers such as SIVs and CDOs, pretended to be AAA-rated cubes of butter. Financial institutions fell for the ruse, and now we all suffer the consequences.

“Defaults are rising, the dollar’s sinking, and even Google’s stock price is going down. Something must really be wrong. It is. What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so difficult to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August 2007.

“My Pimco colleague, Paul McCully, has labeled it the ‘shadow banking system’ because it has remained hidden for years. It’s untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain. It is certainly true that this shadow system, with its derivatives circling the globe, has democratized credit.

“Yet, we overdid a good thing, and the subprime skim milk has soured. As the commercial-paper market shrinks by hundreds of billions of dollars a month, central banks worldwide are facing a giant stress test of the shadow banking system. The publicized and photographed overnight ‘runs’ on Countrywide and Britain’s Northern Rock in mid-August 2007 were nothing compared to what’s taking place in the shadows of the real banking system.”

The $1.6 trillion in SDOs is a continual threat to the stability of the banking sector and the financial markets. But it doesn’t end there! How will the Fed deal with $62 trillion in credit default swaps when that market begins to unravel? Or the $600 trillion in derivatives debt that former Fed Chairman Greenspan said was too big to regulate? And, if we did decide to regulate this problem, it would just move offshore to London or Hong Kong. The size of these problems is breathtaking!

The GDP of the U.S. is $14 trillion annually. Derivatives debt is 43 times larger than the U.S. economy. Global GDP is $53 trillion. A financial meltdown would produce something far worse than the Great Depression of the 1930s.

Going forward, the short side of the market will be far more profitable!