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Financial Planning > Behavioral Finance

Credit-Crisi Fallout and Financials

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Financials are the home of the country’s scariest roller coaster ride. Furious down days are followed by hope filled rallies. The government has tried everything to stop the down ward spiral. The much anticipated $700 billion bailout failed the first time around and is poised for a second try. The question is this: Will a bailout make a huge difference? It doubtlessly would have lifted the spirits of Wall Street for a while, but what about long term?

The government’s bailout of Fannie Mae and Freddie Mac did not result in relief. The $85 billion credit line for AIG failed to lift financials. The ban of short selling did nothing to buoy the markets. The ban on short selling did however cause problems for financial short ETFs, like the popular UltraShort Financial ProShares (SKF) and their unleveraged brothers, Short Financial ProShares (SEF). In addition, by banning short sales on entire industry sectors, the SEC may get an opposite effect when the ban expires; accelerated panic selling.

After everything is said and done, financials represented by the Vanguard Financial ETF (VFH) are still down close to 40 percent. Based on this track record, the positive effects of the bailout may be questionable of the performance of this group.

As for the future, just look at Japan, where there was loose credit and a struggling economy despite a dozen of stimulus packages. The problem is that Japanese banks are hording their money to protect from a “run on the bank”. U.S. banks might do the same.

A nagging issue that remains unresolved is credit default swaps (CDS). How big is this problem? It is a $50 to $60 trillion problem. How big is $50 trillion? If there was such a thing as a million dollar bill, it would take 5,000,000 one million dollar bills to get $50 trillion. In comparison, the gross domestic product or GDP, which represents the total value of all goods and services produced within a country, is $12 trillion for the United States. If you could earn one dollar per second, it would take you 1,585,500 years to earn $50 trillion.

The SEC has now promised to crack down on this “new” problem. But, if the SEC is about ready to tackle credit default swaps, conventional wisdom would lead one to conclude that the organization is late to the party.


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