Moral Hazard

Bear's execs say, "We didn't do it. It's not our fault. Evil speculators conspired against us, and investors irrationally made a run on us." They have no clue and they sound pathetic. Perhaps they should have read two little books.

Now that moral hazard has been adopted everywhere, and the fate of the entire western world is determined by the successful issuance of hundreds of billions of dollars each and every month (we have gotten to the Maginot line where even a hint of a failed US auction would immediately blow up the global capital markets), it is prudent to take a detailed look into a topic that few have covered previously, namely what does the auction demand curve imply. We refer to the distribution of the Low-Mid-High yield break points in each and every treasury auction and whether they can provide some addition insight into the demand picture behind US sovereign debt.

From Reuters:

German Fin Min: Crisis Largely Over In Europe and Germany
German Fin Min: If Greek Budget Consolidation Succeeds, No Tax Money Will Be Lost
German Fin Min: Without Consolidation In Greece We Will Have Unforeseeable Market Consequences

German Fin Min: Failure With Greece Would Put Euro In Question
German Fin Min: Cannot Throw Greece Out Of Eurozone

It's over - the excess debt/GDP terrorists have won, and Moral Hazard is now a global phenomenon. There will be no more failures anywhere. In other words, all your stock profits will come straight from your taxes.

Hands down, our favorite quote on investor’s lack of historical memory comes from Jeremy Grantham who said: “We will learn an enormous amount in the very short term, quite a bit in the medium term and absolutely nothing in the long term. That would be the historical precedent.” In this spirit, we highlight the lessons that should have been learned from the turmoil of 2008, complements of Seth Klarman. The excerpt below is from his annual letter. While most market participants have immediately forgotten these lessons, more prudent investors (who may still suffer from short term memory loss) should consider dusting this list off on an annual basis!

The ongoing Greek debt crisis has revived the old arguments that all national governments need monetary sovereignty. So, what if Greece had stayed with the Drachma, and never switched to the euro? Would this debt crisis be averted?

European central bankers and politicians have been as dumb as their American counterparts ...

"We are trapped in some horrendous Keynesian/monetarist nightmare, where policymakers, aided/abetted/advised by their buddies in the media, in the lobbyist cabal and in financial system, have YET AGAIN decided to go down the route which merely delays the problem/pushes it down the road, but which virtually guarantees that when the NEXT bubble collapses (I assume it will be the Global Government Debt/Bond Bubble and/or the Global Fiat Money/Paper Money/FX Bubble), there is NO pleasant way back. When this next bubble collapses, those of us living/working in these problem economies will realise, too late of course, that WE are the new emerging markets. And no, I don't mean the next China, instead my reference is to Argentina back in the late 90s/early 00s!. So if (as it seems to me) - even though we are agreed on the weak sustainable grwth outlook for the UK US Japan & Europe - that I WAS wrong and that Kevin is right on Austerity and the Reflation Trade, that policymakers will simply keep on behaving recklessly by loading on more debt and blowing more and bigger bubbles until the point of market and/or taxpayer revulsion, then this has some very clear 'asset allocation', and other implications" Bob Janjuah

Moore Capital, which was recently blamed for being a CDS "speculator" by Greece and the EU, discloses that it is in fact net long Greek duration (and its P&L is suffering as a result), according to a fund letter obtained by MarketWatch. It is thus not surprising that the fund is lamenting the botched Greek rescue, and the end of the EMU and hopes an effective bail out will soon be instituted. After all most leading hedge funds have been buying up Greek cash debt on the way down (and this certainly includes Paulson) without CDS hedging; they need it to avoid having the embarrassment of explaining to their LP how the only bet on global moral hazard so far this year has not panned out.

" in 2007 the liabilities of Barclays exceeded the UK’s GDP, the liabilities of Deutsche Bank stood at 80% of Germany’s GDP, and the liabilities of Fortis were several times larger than the GDP of its home country, Belgium ... such financial institutions may not just be “too big to fail”, but in fact “too big to exist” ... It was irrational to let Lehman Brothers fail, but it happened. Those who bet on that failure earned a substantial amount of money. So why not bet on a possible irrationality of European decision-making? "

"Somewhat paradoxically, the show of solidarity for Greece by other euro area members and the ECB raises the risk that the euro will break apart eventually. Seceding from the euro area to devalue is very costly and risky. But seceding to revalue and introduce a harder currency is easier. Germany might opt to do so one day. * The road to such a break-up scenario leads through even more fiscal profligacy and divergence in the euro area, a politicisation of monetary policy, and a weaker currency. Recent events suggest that the trip down this road has started." - Morgan Stanley

We are one step away from the full blown reincarnation of the entire CLO market. We read in Loanconnector that "LCDX14 and LCDX13 are better today on increased volume as accounts have found it increasingly difficult recently to take on exposure via the cash market, sources said. With sellers hard to come by in the cash loan space, investors are turning to synthetics to take on exposure." And there you have it: offer spigots everywhere are shut down as nobody sees any incentive to sell in a market where the Fed has taken away all the risk. And with sellers unwilling to offer product no matter what the cost, the scramble for derivatives and synthetic exposure is coming back with a vengeance. If this is any indication, we expect that the securitization market for corporate loans will be flying within a few weeks as investors needing to allocate capital to moral hazard strategies scramble to get Citi, Goldman, and Barclays to resecuritize all the same crap, and then some, that got us in this mess to begin with. With dividend deals, PIK toggles, no COC bonds, no downgrade trigger issues already a daily occurrence, corporate issuers hold all the cards. For all those companies which have opened restructuring practices over the past year in expectations of surging defaults, our condolences. You - 0, Moral Hazard - Infinity. As for the LCDX situtation: "Meanwhile, the Markit LCDX13 is hitting all time highs of 106.0625-106.1875 this afternoon."

The latest confirmation of the stock market bubble comes from Sentiment Trader which points out that yesterday's Nasdaq TICK almost passed an all time high, yet settled down...to 8 year high levels. As ST points out: "There were only three other dates that even come close to the current extreme: October 4, 2001: The NDX was coming off a major low, but still backed off for 3 days before rising again. May 2, 2002: The NDX dropped hard for the next 3 days. May 15, 2002: The NDX managed to rise a bit for the next 2 days, then rolled over into a major decline. Since then, the TICK hasn't managed to get above +4000 at any point, even intraday, much less to the +5300 level it closed at yesterday. Truly remarkable." Ben Bernanke has now succeeded at convincing virtually everyone that moral hazard is the right approach to dealing with an insolvent financial system. And for another indication of just how overbought the market is, Sentiment Trader also points out that the equity-only Put/Call ratio dropped to 0.32, the lowest reading since January 16, 2004, which on a relative basis is 45% below six-month average. The conclusion: " That, my friends, has never happened before (at least going back to 1997)."

And why not - after all it's all the rage among those waiting in line for iPads so they can be first to buy "The Steve Jobs Guide for Deadbeat Dummies Trying To Learn To Read Good." Now that Obama has given his blessing to an entire generation of Americans to tear up contracts (very appropriate coming from a contract law professor), the follow up to moral hazard is resulting in not just individuals and companies, but entire nations simply opting out of paying their dues. Evans-Pritchard reports that after today's ludicrous rates on 3 and 6 month Bills the tide may be turning in Greece, with both parties in the country finally realizing its creditors will do everything in their power to bleed it dry, at "usurious" rates. With economic growth negative for a decade and debt interests quite certainly positive, the marginal difference will destroy not only economic output, but sink Greece ever more in debt, as existing creditors fund capital shortfalls at maturity (or default) by ever increasing interest rates. Greece has the option to stop funneling domestic capital to Germany later (inevitable) or sooner (if it finally makes the right decision).

Nothing reall new here, just more confirmation from John Hussman, who tends to be somewhat more diplomatic than us, in highlighting what all those who care already know (the rest are buying AIG, Fannie and Freddie): the banking system is completely insolvent. And to make matters worse everyone in this administration from the very top, to the regulators, to the accountants, to the investors, and to the firms themselves, is in on it. The only thing that makes it palatable - the complete lack of any information about just how bankrupt America is and will continue to be for years, even as we hear every single day from the administration propaganda business stations how everything is doing great. Ignore all the talk about an economic recovery - with the cornerstone of the financial system still in default if it weren't for a variety of accounting gimmicks, not to mention the trillions in fiscal and monetary boosts, and the transfer of resurrection costs from the present to the future via the steep debt curve, real GDP would be down 10% or more, and all public financial firms would be undergoing liquidation (and their management teams likely in prison). Of course, public recognition of just how much of a ponzi the entire economy has become is never a good thing going into midterm elections. And with the Fed directly and indirectly monetizing, with Primary Dealers complicit in realizing full well their 4th Hamptons house would be on the block if they don't, with China forced to keep buying our debt as the alternative is a nor so glorious  revolution, we all not only live in Wonderland, but are fully aware of this sad reality, yet happily will continue to do so until the day this lie can not be rolled into tomorrow.

The VIX has just hit the lowest level since July of 2007 as Sentiment Trader reports that "speculation in the options market has spiked to its highest levels since the spring of 2000." The government's endorsed moral hazard policy has now lead to the worst of both the dot.com and the housing bubbles. There is nothing that can ever again default or lose money: Uncle Sam is there with your money to guarantee it. Ben Bernanke sees no bubble anywhere.