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The MLK Day Panic of 2008
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(January 28th, 2008) Without a doubt, what we just saw was this century's most memorable week in world financial history. It included official recognition of a US recession, a pre-dawn rate cut by the Fed, a series of massive swings in equities and precious metals markets, and the return of the ‘rogue trader.‘
All in all, world financial markets were put to the test during this unsettling, gut-churning five-day period. It started with the US markets closed for MLK Day while, unbeknownst to the world, the French bank Societe Generale dumped unwanted European stock positions with both hands, leading to a massive decline in Euro equity markets and a free-fall in precious metals prices.

,p> Gold fell to the $850s level amidst the European market carnage on Monday. At weeks’ end, it would rally to over $920.00 during Friday’s session.

On Tuesday, anticipation ran high as to how US stocks would react when markets re-opened in the US, with futures index trading giving indications that stocks would open enormously lower in sympathy with Monday’s losses in Europe. Ben Bernanke conferred on the eve of the crisis-to-be, and decided to take dramatic steps before markets opened on Tuesday.

At approximately 8AM Tuesday the Fed announced a ¾% cut in the fed funds rate, an unprecedented move. It had been common understanding that a half-point cut would most likely be announced at next week’s Fed meeting, but making the cut 75 basis points ahead of the market’s opening after a long US weekend was certainly a dramatic move. Whether the cut was necessary to avert panic, or was a sign of panic itself, is a question that will long be argued.

Tuesday saw slight losses in US stocks, but the 75-point rate cut certainly prevented a true rout from occurring. Gold also regained its footing, trading up into the $880s. European stocks lost more ground. Asian and Indian markets suffered losses greater than on Monday. Hong Kong had its worst trading day ever, and the Mumbai market had to be shut down with losses exceeding 10% and no stability in sight.

On Wednesday US officials were apprised by the French that one Jerome Kerviel, a junior trader with the bank Societe Generale, had somehow evaded limit controls and amassed a $75 billion long position in European stock indexes without the bank’s knowledge, and that the bank was some $7.2 billion in the hole from Mr. Kerviel’s antics. Further, the bank had been frantically selling out this position in Euro stocks all week, no doubt weakening that market to an unknowable degree.

Yet US stocks rallied on Wednesday, partially due to a scheme to rescue troubled bond insurer Ambac. The turn-around was swift and dramatic, with the S&P rallying 5% before day’s end.

On Thursday the cat was out of the bag, and the world learned of the existence of yet another example of that modern archetype known as ‘rogue trader,’ this time SocGen employee Jerome Kerviel. The revelation brought up an interesting point about the Fed action: If the unwinding of Mr. Kerviel’s surreptitiously accumulated positions caused SocGen to sell heavily in to the European markets on Monday, thus causing a Euro stock rout, followed by Ben Bernanke’s dawn announcement on Tuesday of a surprise 75-point Fed funds rate cut, then could it be said that the Fed was panicked by the actions of junior trader in France?

The idea that the Fed was ‘flummoxed’ by the actions of a 31-year old Frenchman that no one had ever heard of made for a great story on Thursday and Friday. Editorialists and commentators had a field day. The truth is that the Fed did not know of Mr Kievel’s existence when they (read: Ben Bernanke) decided on the emergency rate cut.

What the Fed did know before dawn on Tuesday was that world stocks had gotten hammered over the previous 36 hours, and that US stocks were set up for a big-time fall on Tuesday. Fifteen minutes before the US markets opened, the rate cut was announced.

However you spin it, it wouldn’t have happened were it not for Jerome Kerviel, heretofore unknown junior trader at a French bank.

Meanwhile, back at the precious metals markets, gold rallied some 8% from Monday’s trough to Friday’s peak. Friday also brought news of extensive mine closings in South Africa due to a power shortage. Propelled by the news, platinum gained some $70 on Friday to a new record price, and rhodium topped $7,000 for the first time ever. Authorities say it may be weeks before production is restored.

Gold closed on Monday 1/28/08 at $927.10, completing the trifecta of all-time record high precious metals prices for that day. In Washington, a stimulus package involving free money for every person and corporation through the generosity of the Treasury is receiving bipartisan support, and a Presidential race is providing daily entertainment.

And in local Arizona news, there’s a football game scheduled this Sunday in Glendale.

 

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