The financial crisis of 2014

Dec 31, 2013

Faced with a faster drop in the unemployment rate than expected (we are already at 7% ahead of schedule) ...

... the Federal Reserve will be forced to back off its stimulus efforts ...

... causing interest rates to spike, up three percentage points in less than a month.

The nation's five largest banks, which hold lots of bonds, will lose $55 billion. That alone wouldn't push us into a financial crisis. Bank of America (bac), for instance, would still have a capital ratio of 7.4%, just south of the required 7.5%.

But you know what will? The blow up of a large credit hedge fund, which had made a leveraged bet on collateralized debt obligations through repo-to-maturity trades using Treasuries as collateral. (Yes, Wall Street still does those deals.)

Already nervous investors will run from financial markets ...

... causing a credit crunch.

Banks nursing their recent capital losses will be forced to turn to the Fed for what Wall Street calls short-term funding and the rest of us call a bailout. It will work, but all of it will come as a surprise to investors who have bid bank stocks up 30% in the past year. Next year won't be as good.

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