By Stephen Gandel
December 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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