Sunday, December 23, 2018

Liquidity Is Often The First Casualty In A Financial Crisis

Liquidity Is The First Casualty In A Financial Crisis
Banks have a way of failing us when we need them most and that is why liquidity is generally the first casualty in a financial crisis. A huge part of the problem is the same massive gains leverage brings, also showers us with huge losses that paralyze both individuals and financial institutions. This means that high yield bonds suffer, and anything, person or group with less than stellar credit finds they are unable to get new money and are forced to watch as even existing credit-lines are cut. Just the minor market pullback so far means it is very likely that new loan issuance will grind to a complete halt in 2019. The bottom-line is banks do not like to loan money to those that need it but prefer to line the pockets of those who dwell in their inner circle.

Many of the credit-lines that existed prior to 2008 have gone the way of the dinosaurs with banks claiming new government regulations are to blame for the way they do business today, this is especially clear in the commercial real estate market. CEO Chris Maher of New Jersey’s Ocean First Bank has already pulled back on refinancing transactions that let customers cash out on their debt, and has started reducing exposure to industrial loans,  told Reuters.
“In a downturn, industrial property is extremely illiquid,” he said. “If you don’t want it and it’s not needed it could be almost valueless.”
This is why even if we do not know what the future will bring in a financial crisis when liquidity drys up cash rapidly becomes king. To anyone doing a great deal of negotiating the one-word people wanting to reach an agreement don't want to hear is "IF"! This is why I will never call the holder of cash stupid unless it is during a long period of massive inflation. With this in mind, how well banks fare if assets retrench will depend a great deal on the collateral they have glommed onto. Falling oil prices are already putting pressure on a slew of oil patch loans and bonds and it is also important to remember historically banks have been poor managers of any tangible assets that require day to day care.

For years investors have been rather complacent to the risk they faced and because of this, leverage has slowly built up within the system. It is only in the last week that we have seen panic start to set in as traders began to realize the long-awaited Santa Claus rally was not going to occur and indeed the Fed and the plunge protection team were not going to or unable to stem the tide of selling in many markets. This, of course, does not mean a vicious rally is off the table in the near future but when and how high it will go has yet to be determined and if it does occur many traders will see it as an opportunity to sell. For those many bulls crushed this week in the rush to the exits, it is too late, which brings up the question of how long the current downtrend will last.

Much Of The "Smart Money" Has Already Exited
As usual, it is the slow movers and common folks that will suffer the brunt of a falling market. If the chart off to the left is correct, it seems much of the "smart money" has already exited the stock market in recent months. The biggest problem the bulls face is the carnage may be far from over this is exacerbated by the fact many shorts got out of the market long ago and today many traders are playing on borrowed money so the margin calls will be fierce.

In a recent article, I questioned whether we have entered the period that may someday be referred to as "The Great Reset" where values might be shaken to their core. In this particular case, it means that assets such as stocks could take it hard on the chin and not recover for decades when adjusted for inflation. The market surge since 2008 has reinforced the myth that stocks move upward and always recover if you ride out market tantrums, however, this is not true. All those owning shares of GE, GM, and a slew of other companies caught up in the last crisis will confirm that holding on to an investment does not always make you whole. Now that the markets have crossed into bear-market territory by retreating more than 20% from their peak market psychology has begun to change and "worry" is the word of the day.

The five FAANG stocks. Facebook,, Apple, Netflix, and Google/Alphabet together accounting for more than two-thirds of the Nasdaq-100's loss and when such high-flyers that are always being hyped in the news get whacked traders take notice. With liquidity on the wane and traders rather nervous this might be a bad time to try and catch a falling knife" a market axiom for trying to pick the bottom in a falling market, remember the market has climbed a long way in the last nine years without a major correction. While the idea of buying stocks when the market is out of favor sounds great pulling the trigger is difficult in an unstable market which causes many investors to alter their plans. Be careful out there, and remember capital preservation is job one!

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  1. How come there are rarely any comments here?

  2. Good question, I have often wondered the same. I can only speculate that many people are not inclined to comment unless someone else has already placed a comment, I see this on many websites. Another possibility is the readers on this site are just not prone to comment.
    I have noticed that when my articles are picked up by Seeking Alpha or another group which places them in a format where comments can be made the comment area can become very active. Having said that, good quality comments and ideas are always welcome.

  3. I am a regular reader of your blog and find your articles very educational and thought provoking. As for the comment, since you cover the topic thoroughly there is not much left to add from my side. Perhaps you could start making some deliberate mistakes giving readers chance to add their 2cents

  4. You do have readers, clearly and I am one who comments if there is something odd, peculiar, untrue or needs clarification. None of that applies here. This was a well-written article.