For the week, the S&P500 rallied 2.1% (down 8.1% y-t-d), and the Dow gained 1.7% (down 4.1%). The broader market was strong. The S&P 400 Mid-Caps rose 2.3% (down 11.9%), and the small cap Russell 2000 gained 1.9% (down 16.3%). The Morgan Stanley Cyclicals rallied 4.4% (down 23.4%), and the Transports jumped 4.1% (down 14.6%). The Banks increased 0.6% (down 3.19%), and the Broker/Dealers gained 0.7% (down 33.7%). The Nasdaq100 jumped 3.0% (down 0.7%), and the Morgan Stanley High Tech index surged 5.5% (down 11.5%). The Semiconductors spiked 5.3% (down 13.4%). The InteractiveWeek Internet index rose 4.8% (down 11.0%). The Biotechs rallied 1.2% (down 13.9%). The Morgan Stanley Consumer index gained 1.3% (down 7.7%), while the Utilities slipped 0.8% (up 6.1%). Although bullion recovered $14, the HUI gold index was little changed (down 8.3%).
One month Treasury bill rates ended the week at zero and 3-month bills closed at a half basis point. Two-year government yields were up 4.5 bps at 0.29%. Five-year T-note yields ended the week up 13 bps to 1.08%. Ten-year yields jumped 16 bps to 2.07%. Long bond yields rose 10 bps to 3.01%. Benchmark Fannie MBS yields surged 22 bps to 3.18%. The spread between 10-year Treasury yields and benchmark MBS yields widened 6 to 111 bps. Agency 10-yr debt spreads narrowed 5 to 3 bps. The implied yield on December 2012 eurodollar futures jumped 13.5 bps to 0.72%. The 10-year dollar swap spread was one wider to 20 bps. The 30-year swap spread declined 2 to negative 24 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 5 bps to 139 bps. An index of junk bond risk dropped 22 bps to 807 bps.
Investment-grade issuance this week included John Deere $1.0bn, Nordstrom $500 million, Joy Global $500 million, Darden Restaurant $400 million, Public Service of New Mexico $160 million and Southern California Edison $150 million.
Junk bond funds saw outflows of $363 million (from Lipper). Junk issuance included American Tower $500 million.
I saw no convertible debt issued.
International dollar bond issuers included BG Energy $3.0bn, Network Rail $1.75bn and BAE Systems $1.25bn.
Greek two-year yields ended the week up 450 bps to 63.52% (up 5,128bps y-t-d). Greek 10-year yields rose 75 bps to 22.53% (up 1,007bps). German bund yields jumped 12 bps to 1.885% (down 96bps), and U.K. 10-year gilt yields gained 4 bps this week to 2.47% (down 104bps). Italian 10-yr yields declined 2 bps to 5.51% (up 69bps), and Spain's 10-year yields fell 15 bps to 4.97% (down 47bps). Ten-year Portuguese yields rose 27 bps to 10.94% (up 436bps). Irish yields jumped 9 bps to 7.55% (down 150bps). The German DAX equities index rallied 3.2% (down 17.9% y-t-d). Japanese 10-year "JGB" yields declined 4 bps to 0.98% (down 14bps). Japan's Nikkei declined 1.1% (down 15.9%). Emerging markets were mostly lower. For the week, Brazil's Bovespa equities index declined 2.1% (down 26.1%), and Mexico's Bolsa fell 1.5% (down 14.4%). South Korea's Kospi index slipped 0.6% (down 14.1%). India’s equities index declined 1.4% (down 20.9%). China’s Shanghai Exchange was closed for holiday (down 16%). Brazil’s benchmark dollar bond yields dropped 16 bps to 3.87%, while Mexico's benchmark bond yields jumped 20 bps to 3.83%.
Freddie Mac 30-year fixed mortgage rates were down 7 bps to 3.94% (down 33bps y-o-y). Fifteen-year fixed rates declined 2 bps to 3.26% (down 46bps y-o-y). One-year ARMs jumped 12 bps to 2.95% (down 45bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.82% (down 42bps y-o-y).
Federal Reserve Credit declined $2.7bn to $2.836 TN. Fed Credit was up $428bn y-t-d and $551bn from a year ago, or 24%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/5) dropped $11.4bn to $3.425 TN (3-wk decline of $50.5bn). "Custody holdings" were up $74.3bn y-t-d and $173.5bn from a year ago, or 5.3%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $1.489 TN y-o-y, or 17.1% to $10.219 TN. Over two years, reserves were $2.961 TN higher, for 41% growth.
M2 (narrow) "money" supply jumped $33.8bn to $9.604 TN. "Narrow money" has expanded at a 11.6% pace y-t-d and 10.1% over the past year. For the week, Currency was unchanged. Demand and Checkable Deposits rose $31.3bn, and Savings Deposits added $0.7bn. Small Denominated Deposits declined $2.5bn. Retail Money Funds increased $4.5bn.
Total Money Fund assets added $4.9bn last week to $2.639 TN. Money Fund assets were down $171bn y-t-d and $166bn over the past year, or 5.9%.
Total Commercial Paper outstanding dropped another $22.2bn (12-wk decline of $251bn) to $985.4 Trillion. CP was up $13.9bn y-t-d, although it was down $137bn over the past year.
Global Credit Market Watch:
October 7 – Bloomberg (Lorenzo Totaro and Emma Ross-Thomas): “Spain and Italy, the euro region’s fourth- and third-largest economies, were downgraded by Fitch Ratings on concern they will struggle to improve their finances as Europe’s debt crisis intensifies… The downgrades reflect ‘the intensification of the euro zone crisis,’ which ‘constitutes a significant financial and economic shock,’ Fitch said… ‘A credible and comprehensive solution to the crisis is politically and technically complex and will take time to put in place and to earn the trust of investors.’”
October 7 – Bloomberg (Tim Catts): “Corporate borrowers are pulling back from markets for everything from overnight commercial paper to the longest-maturity bonds as global economic growth is threatened while Europe struggles to contain its fiscal crisis. The market for short-term IOUs in the U.S. slipped below $1 trillion for the first time since February in the week ended Oct. 5… Bond… issuance worldwide fell 47% to $21.5 billion this week…”
October 5 – Bloomberg (Gavin Finch, Liam Vaughan and Anne-Sylvaine Chassany): “Less than three months after Dexia SA got a clean bill of health in European Union stress tests, France and Belgium are considering a second bailout, moving the banking crisis from the continent’s periphery to its heartland. ‘We’re seeing a practical example of contagion playing out,’ said Jean-Pierre Lambert, an analyst at Keefe Bruyette & Woods… referring to Dexia’s ‘material exposure’ to the debt of countries on the EU’s rim. ‘Investors aren’t quite sure what the sovereign debt losses will be, nor where the share price should be. They are concerned about the risks and reduce their funding.’”
October 5 – Bloomberg (Anne-Sylvaine Chassany and Jacqueline Simmons): “Dexia SA may be left with the lender’s worst assets under plans that would allow the French and Belgian governments to avoid injecting more capital into the bank, two people with knowledge of the talks said. Under the option most favored by the French, the two governments would guarantee Dexia’s borrowings before splitting up the lender… Belgium may then assume Dexia’s assets in that country, while France’s state-owned La Banque Postale and Caisse des Depots et Consignations would buy Dexia’s French municipal-lending unit, leaving Dexia as the ‘bad bank,’ the people said.”
October 5 – Wall Street Journal (Michael Corkery): “Dexia SA's troubles in Europe have extended to the U.S. in recent months, lifting borrowing costs for many cities and towns. When times were good, the Belgian-French bank gave governments across the U.S. easy access to cheap financing by agreeing to ‘backstop,’ or purchase unsold bonds, in the $2.9 trillion municipal-debt market… as investors grew concerned about Dexia's ability to make good on the municipal guarantees, the bonds' interest rates rose.”
October 7 – Bloomberg (Greg Chang): “Belgium had its Aa1 local and foreign currency government bond ratings placed on review for possible downgrade by Moody’s…, which cited the financing environment for euro sovereigns and increasing risks to economic growth.”
October 7 – Bloomberg (Howard Mustoe and Michelle E. Frazer): “Moody’s… cut the senior debt and deposit ratings of 12 British lenders including Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, saying the government would be less likely to provide support in the event of failure.”
October 4 – Bloomberg (Liam Vaughan and Fabio Benedetti-Valentini): “Dexia SA, BNP Paribas SA and Societe Generale SA are resisting pressure from regulators to accept more losses on their holdings of Greek government debt amid criticism they haven’t written down the bonds sufficiently. While most banks have marked their Hellenic debt to market prices, a decline of as much as 51%, France’s two biggest lenders and Belgium’s largest cut the value of some holdings by 21%. The practice, which doesn’t violate accounting rules, may leave them vulnerable to bigger impairments in the event of a default…”
October 3 – Bloomberg (Richard Bravo): “Leveraged-loan issuance in the U.S. dropped 57.5% in the third quarter with losses mounting amid a faltering economy. New issue sales fell to $50.6 billion from $119 billion in the three-month period ended June 30… Year-to-date issuance of $310.8 billion outpaces last year’s $233.4 billion figure.”
October 7 – Bloomberg (Sapna Maheshwari): “Kinetic Concepts… that’s being bought by Apax Partners Inc., is proposing the biggest speculative-grade bond offering in 10 weeks as banks seek to offload acquisition financing promised before credit markets weakened in August. Kinetic is offering $2.55 billion of eight-year notes… Junk bonds have lost 8.6% since July…”
Global Bubble Watch:
October 3 – Bloomberg (Boris Groendahl and Gabi Thesing): “Bank for International Settlements General Manager Jaime Caruana urged European leaders to step up efforts to solve the region’s sovereign-debt crisis to prevent a further deterioration of the banking system. ‘We need to urgently and forcefully regain fiscal credibility and take the necessary actions to restore the risk- free status of sovereigns,’ Caruana said… ‘The implications of not having sovereigns as risk-free are very severe, they will materialize in many areas,’ including banks’ capital requirements.”
October 6 – Bloomberg (Jennifer Ryan): “The Bank of England expanded its bond-purchase plan for the first time in almost two years as government budget cuts and Europe’s debt crisis jeopardize Britain’s economic recovery. The nine-member Monetary Policy Committee led by Mervyn King raised the ceiling for so-called quantitative easing to 275 billion pounds from 200 billion pounds.”
October 3 – Bloomberg (Thomas Penny): “U.K. Chancellor of the Exchequer George Osborne said British bank practices before 2008 resembled ‘Ponzi schemes,’ contributing to the market crash. The crisis was caused ‘by the mistakes of human beings,’ Osborne told delegates… He blamed excessive borrowing by the previous Labour government, the creation of the euro and bankers’ risk-taking for the economic problems the U.K. faces. ‘The banks and those regulating them believed that the bubble would never stop growing, that markets were always self- correcting, that greed was always good, that their Ponzi schemes would never collapse, and that none of the debts would ever turn bad,’ Osborne said. ‘They let down their customers, they let down their shareholders, and they let down their country.’”
October 6 – Bloomberg (John Glover): “Investors are losing money on bonds sold by Europe’s bailout fund as optimism ebbs about policy makers’ ability to contain the economic crisis. The 440 billion-euro ($588bn) European Financial Stability Facility has sold 13 billion euros of bonds and all are underperforming relative to alternative investments such as debt of Germany and France… ‘That’s telling you that global investors are losing confidence in the whole EFSF apparatus,’ said Michael Riddell, a… fund manager at M&G Investments, which oversees about $323 billion of assets.”
October 6 – Bloomberg (Shannon D. Harrington and Sarah Mulhollan): “Europe’s crisis of confidence is crippling credit-market trading as banks shrink bond inventories to the least since the depths of the last recession. Federal Reserve data show U.S. primary dealers cut their holdings of corporate debt by 33% to $63.5 billion since May, bringing stockpiles to within $4 billion of the five-year low reached in April 2009. Trading in investment-grade company bonds has dropped 27% since February… Evaporating liquidity is contributing to the biggest junk- bond losses since the failure of Lehman Brothers…”
October 5 – Bloomberg (Daryna Krasnolutska): “Nassim Nicholas Taleb, author of the best-selling book ‘The Black Swan,’ said the current global market turmoil is worse than it was in 2008 because countries such as the U.S. have larger sovereign-debt loads. ‘Definitely, we face a bigger problem now and we will pay a higher price,’ Taleb… said… ‘The structure of the problem has still not been understood. We haven’t done anything constructive in three and a half years. Nobody wants to do anything drastic now.’”
Currency Watch:
October 7 – Bloomberg (Allison Bennett and Ye Xie): “The worst declines since at least 2008 for emerging-market currencies may have further to go as the debt and banking crisis in Europe buffets economies once resistant to the global slowdown. European lending of $3.4 trillion to developing nations is almost triple that from U.S. and Japanese institutions combined, according to Bank for International Settlements data through March 2011. This leaves emerging countries more vulnerable to Europe’s sovereign debt crisis than they were to the global credit meltdown in 2008, according to Royal Bank of Canada.
October 6 – Bloomberg (Denis Maternovsky): “Russia’s international gold and currency reserves declined for a fourth week, plunging $9.2 billion, the most since May, as Bank Rossii bought rubles, stepping up its defense of the currency. The country’s reserves tumbled to a four-month low of $516.8 billion…”
The U.S. dollar index added 0.3% this week to 78.75 (down 0.3% y-t-d). For the week on the upside, the Brazilian real increased 6.1%, the Mexican peso 3.3%, the South African rand 1.2%, the New Zealand dollar 1.1%, the Australian dollar 1.1%, the Canadian dollar 1.0%, the Swedish krona 1.0%, the Singapore dollar 0.8%, the Norwegian krone 0.6%, and the Japanese yen 0.4%. On the downside, the Swiss franc declined 2.1%, the British pound 0.1%, and the euro 0.1%.
Commodities and Food Watch:
The CRB index rallied 1.8% this week (down 8.8% y-t-d). The Goldman Sachs Commodities Index jumped 2.6% (down 4.0%). Spot Gold increased 0.9% to $1,638 (up 15.3%). Silver recovered 3.0% to $30.993 (up 0.3%). November Crude gained $3.78 to $82.98 (down 9%). November Gasoline jumped 4.3% (up 8%), while November Natural Gas dropped 5.0% (down 21%). December Copper gained 3.9% (down 26%). December Wheat was little changed (down 23%), while December Corn rallied 1.3% (down 5%).
China Bubble Watch:
October 6 – Bloomberg (Jasmine Wang): “China’s air travel grew at less than half the pace of capacity in the first four days of the weeklong National Day holiday, adding to signs that the world’s second- largest economy may be slowing down. The number of passengers rose 5.7% to 3.37 million in the Golden Week holiday… The number of seats available expanded by 12%. Growth in passenger numbers slowed from a 24% jump for the entire Golden Week vacation last year…”
India Watch:
October 7 – Bloomberg (Jeanette Rodrigues and Anto Antony): “The risk of holding India’s debt is rising the most in a year amid concern higher borrowing costs will spur an increase in bad loans… The cost of insuring the notes of State Bank of India… has climbed 34 bps since Sept. 30 to 387 bps.”
Asia Watch:
October 4 – Bloomberg (Katrina Nicholas and Wendy Mock): “Asian loans slumped to the lowest level in two quarters as Europe’s sovereign debt crisis pushed up banks’ funding costs and lenders under pressure in home markets retreated. Syndicated loans in the Asia-Pacific region outside of Japan fell to $104.7 billion in the third quarter, the least since the three months ended March 31, when they totaled $96.8 billion…”
Latin America Watch:
October 7 – Bloomberg (Alexander Ragir and Ye Xie): “Brazilian business owners are boosting prices on the widest range of products since March, a sign that above-target inflation is becoming entrenched. Bondholders are seeking protection…”
October 6 – Bloomberg (Ben Bain): “Foreigners are cutting holdings of the shortest-term Mexican government bills to a three-month low as the peso’s plunge erodes dollar-based returns. International investors owned 26% of the securities, known as Cetes, on Sept. 26, down from a record high of 37% in March… The peso has tumbled 14.2% in the past three months… the biggest slump among Latin American currencies after the Brazilian real. Foreigners who piled into Cetes to profit from gains in the peso earlier this year are now shunning all but the safest assets as Europe’s debt crisis fuels a global sell-off in emerging-market currencies.”
October 6 – Bloomberg (Camila Russo): “The cost to insure Argentine debt against default is soaring relative to Venezuela, the world’s riskiest credit after Greece, on concern the country will struggle to weather a worsening global economic crisis after defaulting on $95 billion of bonds in 2001. The cost of five-year credit-default swaps on Argentine bonds has more than doubled from Aug. 1 through yesterday to 1,200 bps…”
Unbalanced Global Economy Watch:
October 4 – Bloomberg (Sophie Leung and William McQuillen): “China said that the U.S. risks triggering a trade war with legislation being considered by the Senate to punish the nation for what lawmakers say is the undervaluation of the yuan. The People’s Bank of China said it ‘regrets’ the Senate voting yesterday to consider the bill, while the Foreign Ministry said the measure would violate World Trade Organization rules…”
October 3 – Bloomberg (Monika Rozlal and Piotr Skolimowski): “Poland, a bond-market darling in the second quarter, is leaving foreign investors with the third biggest losses worldwide as the euro region’s debt crisis slows growth in eastern Europe’s biggest economy. Polish bonds… tumbled 15.7% in dollar terms during the third quarter…”
U.S. Bubble Economy Watch:
October 6 – Bloomberg (Joshua Zumbrun): “When regulators come knocking at the Bank of Newman Grove, Nebraska, inquiring about loan risks, Chairman Jeffrey Gerhart has a ‘stress test’ ready to show how his portfolio would fare if rural land prices dropped 25%. Or 50%. Or 75%... Farmland prices in Nebraska rose 30 percent in the second quarter from a year earlier, according to a survey by the Kansas City Fed, driven by soaring farm income from elevated agriculture commodity prices and record-low interest rates.”
Central Bank Watch:
October 6 – Bloomberg (Gabi Thesing and Jeff Black): “The European Central Bank’s move to keep euro-area banks afloat is buying governments more time to recapitalize them as Greece edges closer to default. The ECB said… it will reintroduce year-long loans, giving banks access to unlimited cash through January 2013, and resume purchases of covered bonds to encourage lending. At the same time, the European Commission is pushing for a coordinated capital injection into banks and German Chancellor Angela Merkel said policy makers ‘shouldn’t hesitate’ if it turns out financial institutions are undercapitalized”
October 4 – UK Telegraph (Richard Blackden): “Federal Reserve chairman Ben Bernanke has said that US authorities are ‘innocent bystanders’ as European leaders grapple with a debt crisis that is now damaging confidence in the world's biggest economy. ‘We’re kind of innocent bystanders,’ Mr Bernanke told Congress's Joint Economic Committee… ‘Even the current situation – which is ongoing uncertainty – has been a negative for our economy.’”
October 4 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Richmond President Jeffrey Lacker said last month’s move to reduce long- term interest rates is unlikely to spur a job market hampered by uncertainty over fiscal policy and government regulation. ‘I tend to think it would cause higher inflation and have only a transitory or fleeting effect on growth,’ Lacker said…”
Muni Watch:
October 7 – Bloomberg (Andrea Riquier): “Municipal-bond rating downgrades exceeded upgrades for the 10th consecutive quarter, the longest such streak in more than a decade, Fitch Ratings said. Fitch cut 84 U.S. public-finance credits representing $29.2 billion in par value in the second quarter… It was the most ratings cuts in eight years.”
Tuesday:
Tuesday morning was the type of market moment that leaves a sick feeling. Ten-year U.S. Treasury yields were collapsing below 1.75% (ended today at 2.07%). The “developing” currencies, notably the Brazilian real and Mexican peso, were under heavy selling pressure. The Dollar index was surging higher, trading to the highest level since early January. Crude had sunk below $76 and commodities in general were under liquidation. Italian Credit default swap (CDS) prices had jumped back to almost 500 bps. At 206 bps, France’s CDS had returned to recent near-record highs. CDS in Brazil and Mexico were trading up at almost 230 bps, while China jumped above 200 bps. U.S. corporate CDS index prices were surging to levels not seen in more than two years, with high-yield CDS prices almost reaching 900 basis points.
Even more dramatic, financial company risk premiums were blowing out to levels last experienced during the fall of 2008’s “Lehman Moment.” European banking stocks were, after last week’s rally attempt, again getting hammered, as French banking goliaths Societe Generale (738 bps) and BNP Paribas (592 bps) saw their CDS prices in virtual melt-up. Goldman Sachs CDS traded to 410 bps, up 80 bps in two sessions (ended July at 150 bps). And after capturing the market’s attention with Monday’s big spread widening, an alarming headline went across the tape: “Morgan Stanley Swaps Add 62.6 Basis Points…” Perhaps the most market troubling headline came out of Europe: “Dexia Shares Now Down 24%.” The wheels were coming off.
The S&P 500 rallied from 1,080 to 1,125, or almost 4.2%, in the final hour of Tuesday’s trading session. Market commentators generally credited the announcement of Belgian and French government support (and the creation of a “bad bank”) for (top-25 European bank) Dexia as the spark for the dramatic market reversal. From its intraday low of $11.58, Morgan Stanley’s stock rallied 21% to close above $14 – most of the gain coming in the last hour. The Bank stock index rallied 8% intraday to end the day up 4.5%.
From the Wall Street Journal’s Wednesday “Heard on the Street” column (Matthew Curtin): “It’s deja vu all over again for Dexia. Just like in 2008, Franco-Belgian municipal lender Dexia is in need of a bailout. Except this time, the support looks like a stop-gap to allow an orderly wind up. The question becomes whether this means taxpayers will be called on to take losses so that bondholders can be spared. The French and Belgian governments, both part-owners of Dexia thanks to the previous bailout, committed Tuesday to safeguarding the bank's depositors and creditors.”
The markets have been trained over the years to recognize “market low” when risk asset prices are flashing “financial meltdown now in progress…” The buy signal, I suppose, is when the highly-intertwined global markets turn sufficiently disorderly to ensure immediate and undivided policymaker attention. Tuesday fit the bill. The move towards French and Belgian government support for Dexia was taken as a signal that European governments were indeed moving aggressively to support their rapidly faltering banking sector. Markets were also heartened by the prospect of more powerful responses from worried central bankers.
After surprising the markets with the announcement of another round ($116bn) of quantitative easing, Bank of England (BOE) governor Mervyn King commented: “This is the most serious financial crisis we’ve seen - at least since the 1930s if not ever. We’re having to deal with very unusual circumstances, but to act calmly to this and to do the right thing.” Meanwhile, in testimony before Congress’s Joint Economic Committee, chairman Bernanke signaled that the Fed was also on the case: Pricing pressures “have begun to moderate” and the Federal Reserve “is prepared to take further action as appropriate.”
From the degree of tumult apparent in the markets on Tuesday, de-leveraging and de-risking dynamics were in full force. And from the markets’ perspective, QE3 had rather quickly moved from appropriate to necessary - and it better be big. Markets were relieved to know policymakers have gotten the message.
The ECB further heartened markets with its move to purchase $53bn of bank (“covered”/backed by assets) loans and to re-open long-term bank funding facilities. An analyst was quoted by the Wall Street Journal: “They’ve opened the floodgates with liquidity…” With central bankers in full crisis management mode and European policymakers said to be working diligently on a plan to recapitalize euro zone financial institutions, markets were in the mood to hope that there was finally sufficient resolve to contain the crisis.
I was struck by a further comment from the BOE’s Mervyn King: “We’re creating money because there’s not enough money in the economy.” Dr. Bernanke has over the years used similar analysis in describing a central cause of the Great Depression. He is convinced that the Fed during that period was derelict in its responsibilities for failing to expand the money supply. It is his view that had the Fed only “printed” sufficient money and recapitalized the banking system much of the pain of the depression would have been avoided. The markets will now watch anxiously as participants try to gauge the efficacy of money printing and bank recapitalizations in arresting the global sovereign debt crisis.
I have posited that conventional analysis has it wrong: a paucity of “money” during the Great Depression was not a cause - but only a consequence. The Fed was not so much derelict in its duties in the early-thirties as much as it was from accommodating the “Roaring Twenties” Bubble episode. Yes, the Fed could have “cut a check” and recapitalized the banking system in the early-thirties, but it would have made little difference. A fateful post-WWI Credit inflation had inflated price levels throughout what had become a badly maladjusted “Bubble Economy” structure. The U.S. and global economies had been so distorted by Credit and speculative excess – and through the Bubble process had become hooked on ongoing Credit expansion and speculative leveraging. When the speculative Bubble burst, fragile systems could not withstand de-leveraging dynamics. The financial apparatus buckled and dragged economies down with it. The critical issue was not a lack of money, but a collapse in confidence in Credit instruments and faith in financial intermediaries and policymaking.
Bernanke and others have over the years argued that bank recapitalization in the early-thirties would have had a profound systemic impact. Some have argued that an operation by the Federal Reserve to create $4bn of additional capital would have been sufficient to stem collapse. These days, analysts make estimates of the amount of additional capital required to stabilize the European banking system.
It’s been my long-held view that, in the grand scheme of major Credit busts, calculations of necessary additions to depleted bank capital basically become meaningless. The critical issue is not some quantifiable (and “plugable”) hole in banking system capital but, instead, the overall Credit needs of maladjusted Bubble economic structures and inflated system-wide prices levels and spending patterns. This is a critical distinction. In the U.S., for example, I have argued that a period of prolonged Credit excess created a financial and economic structure requiring in the neighborhood of $2.0 TN annual net non-financial Credit growth - to keep the economic wheels rotating and (speculative) asset markets levitating. Post-2008 crisis bailouts threw hundreds of billions (Trillions?) at the financial sector, although this changed little with respect to the economy’s requirement for massive Credit creation on an ongoing annual basis. This is an enormous festering problem that goes unnoticed with attention fixated on European carnage.
From the European experience, we now appreciate that the little, almost inconsequential Greek economy is quite an impressive financial black hole. And as things have progressed, critical Credit Bubble Dynamics have been illuminated for all who want to see. The market has witnessed how the “money” from Greek Bailout One was soon vaporized. Dexia’s 2008 bailout: vaporized. Greek Bailout II, when it arrives, will be similarly vaporized. European bank capital: poof. The potential amount of “money” to be vaporized if Italy succumbs to the highly contagious path of Greece, Portugal and Ireland: Unfathomable Black Hole. Well, everyone knows this is not an option. So incredible effort will be exerted to present the European crisis in terms of some quantifiable, manageable, solvable problem – some quantifiable cost that might, with the euro at risk, be tolerable to, say, the German voter.
The markets are somewhat relieved to see policymakers now completely engaged. Yet I don’t foresee an increasingly enlightened marketplace really buying into any notion that policymakers are getting their arms, minds or pocketbooks around the problem. Seeming at times in lonely isolation (and I’m not referring to either their AAA debt rating or manufacturing-based economy), the Germans appreciate the unfolding “financial black hole” and monetary “slippery slope” nature of how things are progressing. Meanwhile, on a more daily and hourly basis, market focus seems to be whether policy pronouncements are sufficient to engender another “rip your face off” short squeeze.
Despite stringent austerity measures, Greece will run a deficit this year of at least 8.5% of GDP. Without a massive and open-ended commitment from a rapidly depleting European “core,” the situation is utterly hopeless. In a microcosm of the predicament shared by other developed economies, Greece for too long depended on the creation of new financial claims (Credit) and consumption at the expense of investment in real wealth creation (is this type of analysis sounding any less archaic these days?). As much as policymakers will never admit it, impaired economic structures are at the heart of an unquantifiable global Credit crisis of confidence. And as de-risking and de-leveraging empowers contagion effects worldwide, the scope of the unquantifiable grows only more unfathomable. Perhaps this is what Sir Mervyn King, from the BOE, had in mind.
And it all seems to boil down to this: Credit cannot be stable within a backdrop of such extraordinary uncertainty. And, I would argue, no amount of central bank liquidity (“money”) and bank capital is going to engender sufficient certainty to stabilize global Credit, financial flows and asset markets. Not with the large number of dangerously maladjusted economies; not with such well-entrenched global economic and financial imbalances; and not with today’s unbelievable Credit, derivatives, and speculative leverage overhang. The issue is certainly not a lack of “money” - but rather a lack of confidence and trust – the bedrock of Credit.