Wild Ride Ahead

There are multiple reasons for the strength of the dollar and yen increasing while all of the markets worldwide are tanking. The dawning reality that there is going to be a global recession is one of the big ones, but another major problem is weakness among the insurance companies.

When people issue bonds they normally have insurance backing the value of the bonds. When the insurance companies that back the bonds get in trouble the bondholders normally have the right to redeem the bonds immediately. When AIG fell a lot people who had their bonds guaranteed by AIG had to sell assets to redeem their bonds, and they had to do it quickly. When large blocks of stock are sold, the market drops.

A lot of the sell off had nothing to do with the companies that issued to the stock. They were unfortunate enough to have had their stock purchased by institutions that needed cash quickly and couldn’t sell blocks in an orderly manner. Add to that the “programmed trading”, computer programs designed to buy or sell stock based on moves in the pricing among many criteria, and you have the mess you saw on Friday.

The other thing that was happening was “margin calls”. When people own stock on borrowed money and the price drops to a certain level, they have to repay the loans for the stock. That normally means more selling, and more downward pressure.

Things degenerated into an automatic process, with every sale requiring someone else to sell. Welcome to the global economy, where the pain is worldwide and computers are making many of the crucial decisions.