This is an excerpt from the April 13, 2012 blog for Decision Point subscribers.
A major issue with which investors are having to deal is the global debt crisis. While it is currently centered in Europe, we should be clear that Europe is merely the location where the first dominoes are likely to fall. My purpose here is not to conduct a complete dissection of the issue, only to offer a quick "bottom line" for future reference, a handy template with which to measure the credibility of future news on this subject.
The sad fact is that major banks are choking on bad sovereign debt, some of which they hold with leverage of 30:1 or greater. This debt is non-performing and at some point must be written off. Unfortunately, such action will bankrupt these banks, so, in order to keep the plates spinning, all manner of effort is being made to "restructure" this debt -- that is to change the terms of the loan so that it can be imagined that the debt will actually be repaid. Now they can pretend that the loan is a performing loan, a healthy asset instead of a rotting hole in their portfolio.
Unfortunately, these restructurings are really a temporary measure that are not going to fix the problem long term (the borrowers will eventually default), but they do briefly allow for a "suspension of disbelief" among investors. Like when you go to a movie and for a few hours you can pretend that there really is a Superman.
The end result is that one day there will be news that encourages people to believe (pretend) that the problems will be fixed. Then the next day there is news that reveals just how hopeless the situation really is. How do we cope with this insanity? Well, I suggest that we recognize that everything is not going to be okay, and take it from there. So the news may swing from one extreme to another, but we can stay anchored in the reality of knowing that things are eventually going to go south. This doesn't sound like much fun, but it is a base from which to plan a realistic strategy.
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