It only took a few hours for most stock and bond market investors to realize that increasing interest rates, as outlined yesterday by Fed Chairman Powell, would not be good for stock or bond markets.
Yesterday’s short covering rally, was based on hope that it would only take a little more adjustment to interest rates to bring inflation back to the previous “acceptable” level of prior years.
Wishful thinking, I believe. The mass amount of money that has been injected into the stock & bond markets and the economy, these past years, is only now showing up in inflation reports. Inflation will be a very significant part of the 2022 financial story.
All of this reminds me of the sad saga of Long Term Capital Management, LTCM, covered in that delightful book, “When Genius Failed: The Rise and Fall of Long-Term Capital” by Roger Lowenstein.
The often repeated story of Wall Street Greed, and Hubris, which is being replayed this cycle by many crypto geniuses, like Michael Saylor, CEO of MicroStrategy and maybe, Elon Musk, CEO of Tesla.
Anyway, to just give our readers the short version, the geniuses at LTCM were so successful, in the early years, that they decided to buy out all of the outside investors and just concentrate on making money for themselves. Of course, their approach required large sums of investment funds which they were able to borrow easily from all of the major investment banks on Wall Street.
It all came crashing down one week when one of their very big bets went against them and they had a giant margin call. It turned out that none of the Banks bothered to check how many loans they had outstanding with all of the other banks. With a margin call, banks would normally sell the collateral they held to secure the loans, but it turned out LTCM had borrowed against the same collateral with many different banks. Also, since LTCM had been the major buyer of that collateral, when someone turned around to sell it, there wasn’t any real market value.
The situation was so serious it looked like the entire American banking system could shut down under the weight of this forced selling. To salvage the financial system, the Federal Reserve stepped in and told the 10 major U.S. Banks: “You Guys caused this problem, so figure out a way to solve it, and each take his share of the losses.”
Very worth reading the entire story, but I would mention one other interesting fact. Of the 10 Banks called in by the Fed, all but one, was willing to step up and take on their share of the losses. Only one refused. That Bank was Bear Stearns & Co, which refused to go along with the Federal Reserves’ 1998 LTCM bail out program.
Guess What? When the 2008 financial crisis hit several years later, guess which bank The Federal Reserve refused to bail-out? Of course, it was Bear Stearns, which was finally forced into a $10/share buyout by J.P. Morgan. But that is a story for another column.
What all of the above suggests is that it is possible that if a major company like MicroStrategy gets a margin call because they have leveraged their purchases of Bitcoin with loans, as some analysts who follow the company, have suggested, we might see forced selling of both Bitcoin and MSTR.
If history was to rhyme and if Bitcoin were to continue its decline, could we see another LTCM type moment, in financial history, in the coming weeks?
Of course, it is possible, that the Fed could step in to prevent panic, and could cause a sharp short covering rally.
As Warren Buffett has said: “You don’t know who is swimming naked, until the Tide goes out.”