Moral Hazard

As Soros Starts A Three Month Countdown To D(oom)-Day, Europe Plans A New Master Plan

What would the weekend be without at least one rumor that Europe is on the verge of fixing everything, or failing that, planning for a master fix, OR failing that, planning for a master plan to fix everything. Sure enough, we just got the latter, which considering nobody really believes anything out of Europe anymore, especially not something that has not been signed, stamped and approved by Merkel herself, is rather ballsy. Nonetheless, one can't blame them for trying: "The chiefs of four European institutions are in the process of creating a master plan for the euro zone, the daily Die Welt reports Saturday, in an advance release of an article to be published Sunday. Suggestions targeting a fiscal, banking, and political union, as well as structural reforms, are being worked out..." Less than credible sources report that Spiderman towels (which are now trading at negative repo rates) and cross-rehypothecated kitchen sinks are also key components of all future "master plans" which sadly are absolutely meaningless since the signature of Europe's paymaster - the Bundesrepublik - is as usual lacking. Which is why, "the plan may well mean that the euro zone adopts measures not immediately accepted by the whole of the European Union, the article adds." So... European sub-union? Hardly strange is that just as this latest desperate attempt at distraction from the complete chaos in Europe (which will only find a resolution once XO crosses 1000 as we and Citi suggested two weeks ago and when the world is truly on the verge of the abyss), none other than George Soros has just started a 3-month countdown to European the European D(oom)-Day.

Guest Post: Canada Oil Sands And The Precautionary Principle

The precautionary principle is typically defined as “if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific evidence that the action or policy is harmful, the burden of proof that it is not harmful falls on those taking the action.”  In practice, the principle is utilized by government policy makers to ensure technological advances don’t pose too dire of an effect on the surrounding environment.  This may appear a noble goal if one accepts the premise that the prime function of government is the protection of life and property.  History proves otherwise as easily corruptible politicians have tended to grant exceptions to wealthy business interests which look to dump their waste in public-owned natural resources such as waterways.  It is also clear judging by historical cases that socialization often results in environmental degradation.  One look at the pollution in once-communist nations such as China or the former Soviet Union reveals that a lack of private property results in a type of moral hazard en masse as there is little incentive to preserve what you don’t officially own.

Europe's Got 99 Problems And A Deposit Guarantee Scheme Is One

We have explained in the recent past just why the rotation from a professional European bond-run to a retail bank-run is critical to the euro-zone banking system - with deposit losses creating even more encumbered asset levels among European banks, which would then exaggerate contagion problems as funding pressures mount. The problem is existing deposit guarantee schemes are implemented at the national level and are not currently funded to handle a systemic crisis - this is why there has been so much chatter of a pan-Europe guarantee scheme. However, not only does a euro-wide guarantee rely on credible commitments from core European governments but it misses the redenomination risk - as unlike the US FDIC, it would need to explicitly guarantee the euro-value of deposits. Barclays shares our doubts on the implementation (short- and long-term) of such a solution, noting that Eurozone deposits are greater than eurozone GDP (as opposed to US deposits at ~68% of US GDP). Between operational difficulties, the size of redenomination losses, moral hazard, and the massive (deposit/GDP) contingent liability dependent on actual exit of a member state, we would urge any exuberance over 'talk' of a guarantee to be stymied once again by the dismal reality of implementation and agreement.

Guest Post: George W. Bush’s “Growth” Strategy

Here are a few prominent questions that George W. Bush might want to consider answering before slinking off back to Crawford:

  1. Why did you ignore the CIA’s warnings in the summer of 2001 that al-Qaeda could strike “imminently”?
  2. Why did you pledge in the 2000 election debates that you were against nation building, and then embark on not one but two nation-building programs in Iraq and Afghanistan?
  3. You increased the Federal debt by 86%; to what extent do you accept the blame for America’s debt troubles?
  4. You reappointed Alan Greenspan as the Fed Chairman;  to what extent do you accept that his easy money policies caused the bubble that burst in 2008?
  5. Were the 2008 bailouts of well-connected banks and financial corporations engineered by your administration compatible with a supposedly “free-market” “capitalist” system? Doesn’t bailing out banks create dangerous moral hazard?
  6. How can a nation simultaneously claim to be a liberator while also practising torture?
  7. You swore to uphold the Constitution, yet passed the PATRIOT Act that authorised warrantless wiretapping, and mass surveillance in contravention of the Fourth Amendment. Do you realise that you violated your oath of office?

Guest Post: Feedback, Unintended Consequences And Global Markets

All models of non-linear complex systems are crude because they attempt to model millions of interactions with a handful of variables. When it comes to global weather or global markets, our ability to predict non-linear complex systems with what amounts to mathematical tricks (algorithms, etc.) is proscribed by the fundamental limits of the tricks.  Projecting current trends is also an erratic and inaccurate method of prediction. The current trend may continue or it may weaken or reverse. "The Way of the Tao is reversal," but gaming life's propensity for reversal with contrarian thinking is not sure-fire, either. If it was that easy to predict the future of markets, we'd all be millionaires. Part of the intrinsic uncertainty of the future is visible in unintended consequences. The Federal Reserve, for example, predicted that lowering interest rates to zero and paying banks interest on their deposits at the Federal Reserve would rebuild bank reserves by slight-of-hand. Banks would then start lending to qualified borrowers, and the economy would recover strongly as a result.

They were wrong on every count.

LCH Hikes Margin Requirements On Spanish Bonds

A few days ago we suggested that this action by LCH.Clearnet was only a matter of time. Sure enough, as of minutes ago the bond clearer hiked margins on all Spanish bonds with a duration of more than 1.25 years. Net result: the Spanish Banks which by now are by far the largest single group holder of Spanish bonds, has to post even moire collateral beginning May 25. Only problem with that: it very well may not have the collateral.

Acknowledging The Arrival Of Peak Government

Most informed people are familiar with the concept of Peak Oil, but fewer are aware that we’re also entering the era of Peak Government. The central misconception of Peak Oil -- that it’s not about “running out of oil,” it’s about running out of cheap, easy-to-access oil -- can also be applied to Peak Government: It’s not about government disappearing, it’s about government shrinking. Central government -- the Central State -- has been in the expansion mode for so long that the process of contracting government is completely alien to the nation, to those who work for the State, and to those who are dependent on the State. Thus we have little recent historical experience of Peak Government and few if any conceptual guideposts to help us understand this contraction. Peak Government is not a reflection of government services or the millions of individuals who work in government; it is a reflection of four key systemic forces that drove State expansion are now either declining or reversing.

Guest Post: The New European Serfdom

If the establishment is to be believed — it’s in the interests of “long-term financial stability” that creditors who stupidly bought unrepayable debt don’t get a big haircut like they would in a free market.  And it’s in the interests of “long-term financial stability” that bad companies who made bad decisions don’t go out of business like they would in a free market, but instead become suckling zombies attached to the taxpayer teat. And apparently it is also in the interests of “long-term financial stability” that a broken market and broken system doesn’t liquidate, so that people learn their lesson. Apparently our “long-term financial stability” depends on producing even greater moral hazard by handing more money out to the negligent. The only real question is whether or not it will just be the IMF and the EU institutions, or whether Bernanke at the Fed will get involved beyond the inevitable QE3 (please do it Bernanke! I have some crummy equities I want to offload to a greater fool!)

Guest Post: Can Banking Regulation Prevent Stupidity?

Anyone who worked in finance in the decade before Glass-Steagall was repealed knows that prior to Gramm-Leach-Bliley the megabanks just took their hyper-leveraged activities offshore (primarily to London where no such regulations existed). The big problem (at least in my mind) with Glass-Steagall is that it didn’t prevent the financial-industrial complex from gaining the power to loophole and lobby Glass-Steagall out of existence, and incorporate a new regime of hyper-leverage, convoluted shadow banking intermediation, and a multi-quadrillion-dollar derivatives web (and more importantly a taxpayer-funded safety net for when it all goes wrong: heads I win, tails you lose). I fear that the only answer to the dastardly combination of hyper-risk and huge bailouts is to let the junkies eat dirt the next time the system comes crashing down. You can’t keep bailing out hyper-fragile systems and expect them to just fix themselves. The answer to stupidity is not the moral hazard of bailouts, it is the educational lesson of failure. You screw up, you take more care next time. If you’re bailed out, you just don’t care. Corzine affirms it; Iksil affrims it; Adoboli affirms it. And there will be more names. Which chump is next?

Guest Post: Alan Greenspan Asked For Advice, Do People Ever Learn?

Unbelievable.

That is the only way to express this author’s utter bewilderment that former Federal Reserve chairman Alan Greenspan is still given an outlet to speak his mind.  Actually, I am surprised Mr. Greenspan has the audacity to show his face, let alone speak, in public after the economic destruction he is responsible for. It was because of Greenspan, of course, that the world economy is still muddling its way along with painfully high unemployment.  His decision to prop up the stock market with money printing under any and every threat of a downtick in growth, also known as the Greenspan Put, created an environment of easy credit, reckless spending, and along with the federal government’s initiatives to encourage home ownership, the foundation from which a housing bubble could emerge. It was moral hazard bolstering on a massive scale.  Wall Street quickly learned (and the lesson sadly continues today) that the Federal Reserve stands ready to inflate should the Dow begin to plummet by any significant amount.  Following his departure from the chairmanship and bursting of the housing bubble, Greenspan quickly took to the press and denied any responsibility for financial crisis which was a result in due part to the crash in home prices. 

Double or Nothing: How Wall Street is Destroying Itself

As Nassim Taleb described in The Black Swan these kinds of trades — betting large amounts for small frequent profits — is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen (and of course if you are betting big, losses will be big). If you are running your business on the basis of leverage, this is especially dangerous, because facing a margin call or a downgrade you may be left in a fire sale to raise collateral. This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).