Wednesday, January 14, 2009

A Second Shoe

Roubini is right. There is yet another shoe to drop. Not a small part of the problem is that the world has become globalized: the banking system has become homogenized; there is no systemic division between brokerage houses, banks, and insurance companies. Government meddling, in the form of social engineering, has not helped the financial world. Not too long ago banks were local institutions; not even interstate let alone international. Regulation dealt primarily with reserves and reach. Additionally the risk assessment criteria used by large investment institutions has become homogenized - with every institution measuring risk against the same yardstick. A single "miss" can wipe-out the whole system. It's like a gene-pool that has been reduced to a single set of reproducing individuals where one "bad" gene can surface to destroy the entire species.

Deleveraging of the system is wreaking havoc with every government and every major industry, due in no small part to overlapping and interlocking of financial activities. Globalization has failed to act as a buffer; has instead created one giant world-wide system, subject to a case of flu that could be deadly. There are no alternate players to put in the game. There are no firewalls protecting one institution from another. Take a look at General Electric, just as a single example. GE stock and bonds is held in large quantities by every major financial institution. GE is primarily a financial institution. 60% of GE's revenue comes from financial investment deals.... loans. GEF holds the paper on commercial properties around the world. As retail contraction spreads, shopping centers and malls and strip centers are sick; they have holes in them (even vaunted anchor tenants are folding tent), vacancy ratios are terrific and cash-flow to GE's portfolio is in trouble. GE could well go under taking additional institutions with it. Think about this: In 40 years the S&P 500 has lost 425 of its members. There are only 75 original members in the current S&P 500.

When that second shoe drops there will be an earthquake. This is the kind of stress to a system that leads to war. The world's population has left the farm. The industrialized cities have too much capacity, and people and industry have combined to put severe strain on energy and other natural resources. In Roubini's words, "The worst is yet to come." I still believe that oil (DXO)and agriculture (DBA) will be winners. Oil is not being made as fast as we use it and people continue to eat. Speaking of food.... the world's ag industry looks a lot like the financial one: intertwined, globalized, homogenized.