Moral Hazard

If we learn nothing, then we deserve to lose. This is not a popular concept in America at this point in its history, when monumental errors are denied, excused, rationalized or quickly absolved by those who committed them. As a small-fry investor, when I veer away from my discipline and system, I predictably lose money. As I sift the ashes of the trade, I always remind myself: if I learn nothing from my studies and experience, then I deserve to lose. What exactly has America learned since January 1, 1999, 13 years that included two stupendous financial/credit bubbles, two hot wars and an explosion in public and private debt? If we examine the policy changes and institutional changes since the 2008 global financial meltdown, then we have to conclude that we've learned a very few things...

Corporations are not people...

It has been a busy weekend for Wall Street, which has been doing all it can to spin the S&P downgrade in the best favorable light, although judging by the initial EURUSD and EURJPY reaction, so far not succeeding. Below we present a quick report written by Goldman's Lasse Nielsen on why in Goldman's view the downgrade's "impact is likely to be limited" and also the quick notes from an impromptu call MS organized for institutional clients (which had just two questions in the Q&A section, of which only one was answered - it appears virtually noboby believes that global moral hazard will allow anyone to fail at this point, so why bother even going out of bed).

All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.

Ben Bernanke's zero-interest rate policy (ZIRP) and command-economy efforts to maintain mispricing of risk, debt and assets are destroying capital and capitalism. No wonder his policies have failed so miserably. Bernanke's policy is to punish capital accumulation and reward leveraged debt expansion. Rather than enforce the market's discipline and transparent pricing of risk, debt and assets, Bernanke has explicitly set out to re-inflate a destructive, massively unproductive credit bubble. This is why Bernanke has failed so completely, and why he will continue to fail. He is not engaged in capitalism, he is engaged in the destruction of capital, investment discipline and the open pricing of risk, debt and assets.

Continuing our tradition of listing what according to Zero Hedge readers were the key news events of the year for the third year in a row (2009 and 2010 can be found here and here), we present, as is now customary, the most popular posts of the year as determined by the number of page views, or said otherwise - by the readers themselves. So without further ado, here are this year's top 20.

Just about 48 hours after it was duly noted as the greatest threat to the Eurozone in the post bailout world, Germany finally grasps the enormity of what global moral hazard truly means. As we said before, the biggest risk facing Europe, and by that we mean undercapitlized French banks (all of them) obviously, is not Greece or what haircut is applied to the meaningless €100 billion in Greek debt when all the exclusions are accounted for. It is what happens when everyone else understands they now have a carte blanche to pull a Greece at will. And while until now we had some glimmer of hope there was a behind the scenes agreement for this glaringly obvious deterioration to not manifest itself, Merkel just opened her mouth and proved our worst fears wrong. As Reuters reports, "Chancellor Angela Merkel said on Friday it was important to prevent others from seeking debt reductions after European Union leaders struck a deal with private banks to accept a nominal 50 percent cut on their Greek government debt holdings. "In Europe it must be prevented that others come seeking a haircut," she said." Too late, Angie, far, far too late. Because, just as expected, here comes Ireland and literally a few hours ago, launched the first warning shot that will imminently lead to what will be demands to pari passu treatment with Greece. Next up: Portugal, Spain, and, of course, Italy, which however won't be faking its own economic slow down.

While Fed's Lockhart earlier opined on his 'hope' that rates will drop under 'Twist' (and we remind him that all but the 30Y are now higher in yield than before Twist was announced) but expects its impact to be modest, Fed's Fisher just lost-the-plot with his truthful explanation on why he dissented. Speaking in Dallas, Bloomberg reports some rather refreshingly honest headlines from the outspoken Fed President:

*FISHER SAYS FED POLICY `HAS YET TO SHOW EVIDENCE OF WORKING'

*FISHER SAYS BENEFITS OF OPERATION TWIST DON’T OUTWEIGH COSTS

*FISHER SAYS RECENT FOMC POLICIES LIKELY TO BE INEFFECTIVE

*FISHER SAYS FOMC POLICIES MAY WORK AGAINST JOB CREATION

*FISHER SAYS OPERATION TWIST WILL INCREASE INCENTIVES TO SAVE

Tonight's feel-good story of our time is a desperate stroll through the reality of the US housing market for millions of individuals (as opposed to the hope-driven must-say-something-positive spin the home-builder CEOs have been spewing recently). Notices-of-default jumped 33% in August, a nine-month high and largest month-over-month increase since August 2007 and it is becoming increasingly acceptable to walk away from contractual agreements as strategic default becomes the New American Dream.

While we often pick on Morgan Stanley's Jim Caron (the same guy who year after year after year keeps predicting the yield on the 10 year will soar, and not just soar, but soar for all the wrong reasons, such as bull steepening and what not), has just diametrically changed his tune, by bringing us, drumroll please, Operation Torque. To wit: "Policy makers in both the US and Europe get back to work in September, and this month will be rife with deliberations on stimulus and market support policies. In our view, a duration extension to the Fed's SOMA portfolio is an optimal policy tool to engender easing. This can initially be done through extending the duration of reinvestments from MBS and agency holdings but may ultimately culminate in selling shorter-duration USTs in its SOMA portfolio in exchange for buying longer duration assets (‘Operation Torque’, as we at Morgan Stanley have dubbed it)." Why 2 Years? Because as per the August 9 FOMC statement, we know that there will no rate hike for the next 2 Years, and hence no duration risk. Which means that the Fed can sell an infinite amount of paper into a mid-2013 horizon without worrying about demand destruction. And by doing so it will, as we have been predicting since May, expand the duration of its portfolio, in the process pushing investors into risky assets for the third time in as many years. But there is a twist...

Since this chart from the WSJ sums up petty much everything about the "efficient market hypothesis" or whatever it is those wacky Chicago PhD's call their multi-variable, self-similar, Lorenzian "strange attractor" equations that describe human irrationality to the dot, there is little need for commentary (those who wish to do so, can read more about it at "Fed Faces Old Foe as Hazard Returns")

Shocker: the bank of Warren Buffett, that paragon of virtue and decency, busted by the capo di tutti ZIRP capi itself for lying to grandma? Surely WFC investors, who don't have to deal with their investment either admitting or denying wrongdoing, can "suck it in" and we can get Charlie Munger to preach some more fire and brimstone morality about the evils of gold and the miracles of taxpayer bailouts.

Identify the common characteristic of these three statements:

1. The Federal Reserve will never let the stock market decline, i.e. the "Bernanke put"

2. The Chinese government will never let property prices decline

3. The European Central Bank will never let Greece default

The answer of course is moral hazard: a person who is insulated from risk will have an insatiable appetite for risky bets because any gains will be theirs to keep but any losses will be covered by the central bank or government. The global financial authorities’ success in propping up assets (stocks in the U.S., real estate in China, banks in Europe, etc.) over the past three years has strengthened this asymmetric disregard for systemic risk into a dangerously quasi-religious faith that central banks and governments have essentially unlimited power to keep asset prices aloft via printing money, manipulation of markets and financialization of their economies.

The Maestro speaks at Jekyll Island ...

When a major mainstream media like Forbes compares BP with Goldman Sachs and recommends investors to buy Goldman stocks, you know the world is in total moral hazard and deserved to be doomed as Marc Faber always said.