Moral Hazard

Preliminary Thoughts On The European Downgrade From Goldman And Morgan Stanley

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).

The Real Dark Horse - S&P's Mass Downgrade FAQ May Have Just Hobbled The European Sovereign Debt Market

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.

Guest Post: Why Bernanke Has Failed, And Will Continue To Fail

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.

2011 Greatest Hits: Presenting The Most Popular Posts Of The Past Year

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.

"Black Swan" Fund Creator Explains Why Central Planning Has Doomed Us All

In a must read Op-Ed in the WSJ, Mark Spitznagel, founder of "fat tail" focused hedge fund Universa, where Nassim Taleb has been known to dabble on occasion, explains the fundamental flaw with central planning, and specifically why "moral hazard" or the attempt to avoid the destructive part of natural cycles, is the greatest unnatural abomination ever conceived by man. His visual explanation should be sufficient for even such grizzled academics who have no clue how the real world works, as the Chairsatan, to comprehend why what he is doing is an epic abomination of every law of nature: "Suppressing fire, creating the illusion of fire protection, leads to the wrong kind of growth, which then invites greater destruction. About 100 years ago, the U.S. Forest Service took a zero-tolerance approach to forest fires, stamping them out at the first blaze. Fast forward to 1988 when a massive wildfire at Yellowstone National Park wiped out more than 30 times the acreage of any previously recorded fire." Another way of calling this, is what we have been warning about for years: delaying mean reversion does nothing but that. And when the Fed finally fails to offset the inevitable, and it will - it is a 100% certainty - the collapse and destruction will be unprecedented. Ironically, the only way the system could have been saved would be by letting it fail in 2008. Now, we are sorry to say, it is too late.

The Fed vs The ECB - Presenting "The Correlation Of 2012" And What It Means For Gold

If there is one cross asset correlation that defined 2011 (and the greater part of 2010), it was that of the Euro-Dollar (EURUSD) currency pair and the S&P 500, which have correlated with near unison nearly all of the time. And yet, the stability of this correlation may be getting unglued, because as Goldman insinuated in its market roundup note from yesterday, it is "reasonable to think that the ... reflexive relationship between EURUSD and SPX...will take some time to break, but this correlation should start to fray." Why? Because, "like the FED before them, the ECB is aggressively expanding their balance sheet." Which brings us to the point of this article: much to the dismay of the armies of disgruntled bankers and investors demanding that the ECB print right now, the ECB has in fact been printing, as shown the other day. Only it has not done so in the conventional sense where it assumes an "asset" on its balance sheet while expanding a monetary liability, but indirectly through shadow conduits, such as repo and other liquidity backstops, also as shown yesterday, where no new currency actually enters the system, yet whereby the balance sheet expands just as efficiently (and in doing so, dilutes the underlying currency). It is well known that it has been our contention that in this centrally planned world the only thing that matters is the global provisioning of liquidity by the monetary authority, as the ultimate marginal determinant of Risk On behavior (and inversely Risk Off), is how much ZIRPy cash do speculators (and more importantly Prime Brokers) have at their possession (for outright and (re)hypothecated purchasing purposes). So here we would like to make a distinction: it is not so much how much cash one global monetary central planner will provide to markets, but how much the various standalone central banks will inject, in whole or in part. We contend that for 2012 the key qualifier will be "in part" with the ECB and the Fed printing (either outright or via repo) in staggered regimes, and thus the primary determinant of "risk", the EURUSD, will be the relative ratio of the two balance sheets. This can be seen on the charts below, the first of which shows just how dramatic the ECB expansion has been in the past 6 months, and the second showing the correlation between the EURUSD and the ratio of the Fed to the ECB.

ECB Liquidity: Back-Door Bazooka Or Suspension Of Democracy, BARCAP Opines

The market's reaction to Draghi's comments over the last week have been visceral in its schizophrenia. While his 'temporary' provisions, three-year LTROs specifically, provide a life-line of liquidity (a la TLGP - and how is that working out for the US banks having to roll now?), they hardly address the real underlying problem of the vicious circle between sovereign debt's now-risky nature and financial balance sheets bloated with zero-risk-weighted re-hypothecated peripheral bonds. The last week has seen a roller-coaster of Senior-Sub debt decompression and compression, liquidation-like drops in commodities, lower correlation across European sovereign debt, and significant dispersion in high- and low-beta equity and credit markets (notably as we have previously discussed, some of which will have been driven by index roll technicals). The issue comes down to whether this is the Bazooka (buy-buy-buy) or not enough (fade-the-rallies) and BARCAP's macro sales and European Banks' research team have, like the rest of the market, been exchanging views on this perspective. While their take on the liquidity explosion is that it doesn't solve the almost unsolvable solvency problem but it the deeper insight that perhaps it is not the actual mechanics of this liquidity bazooka but the perception that democracy itself has been suspended in favor of bank and sovereign survival that interests us more. Furthermore, they do an excellent job on breaking down the mythical carry trade potential of these LTROs and mutual sovereign financing benefits since near-term (carry-trade) profit potential would be offset by additional sovereign risk - meaning that funding markets could stay closed for longer. Once again the issue of collateralization, risk-weightings, and deleveraging are front-and-center as bank 'managers' and politicians may be at loggerheads on the carry-trade-savior potential and the ECB's status on the balance sheet only serves to further subordinate existing bondholders.

Guest Post: If Being Totally, Disastrously Wrong Were a Virtue, Bernanke and His Fed Mates Should Be Sainted

Since the market isn't able to price real estate, risk or credit transparently, then prudent investors would be forced to shun the market: how can you invest wisely when assets, debt and risk can't be priced by the market? Prudent lenders would withdraw from such a rigged, risky market, which is precisely what has happened. Literally 99% of the mortgage market is now guaranteed by the Federal fiefdoms, all of which are losing tens of billions of dollars and require monumental taxpayer bailouts to keep underwriting the banking sectors' private profits. The only way to restore trust and clear the market of uncollectable debt is to let the market transparently price, risk and credit--precisely what the Fed's policies are designed to stop. The Fed's knees are chafed from kow-towing to their banker masters, and worshipping the "magic" of their Keynesian Cargo Cult and Lenin ("destroying capitalism from within" should be stenciled on the Fed letterhead). Separate risk from gain, obliterate transparency and choke the market with zero interest rates, and you've not only destroyed capitalism, you've also destroyed the economy by rewarding the most venal, corrupt, fraudulent and capital-destroying players while stranding the prudent on an island of opacity where the true price of assets, credit and risk cannot be discovered.

Guest Post: Headwinds For Housing

It’s no secret that housing and employment are correlated, and the causation is intuitive. If more people have jobs, then more people have incomes that support the purchase of a home. In the other direction, the more houses that are built to meet rising demand, the more jobs will be created in construction and real estate. We can see the correlation in this chart from the St. Louis Federal Reserve displaying one measure of employment for workers age 45-54 and the index of home prices. As employment of those in their peak earning years rose, so did home prices. This is partly a function of basic supply and demand: Rising demand pushes prices higher. As employment fell, demand declined, and so did home prices. The Federal Reserve famously has a dual mandate: to maintain stable inflation and employment. The Fed attempts to pursue these goals with monetary tools such as setting interest rate targets, while the Federal government supports housing by subsidizing mortgage interest via tax policy and guaranteeing mortgages via the housing-lending agencies of Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). The Fed’s primary tool for stimulating demand for housing has been to lower mortgage interest rates, by buying the US Treasuries that set the baseline cost of long-term debt and also mortgage securities. Indeed, the Fed’s first quantitative easing (QE) program was to buy about $1 trillion in distressed mortgage debt outright. This removed the impaired debt from banks’ balance sheets and also served to lower mortgage rates.

The Ultimate "All-In" Trade

We have spent a great amount of time recently discussing both the re-hypothecation debacle and the 'odd' moves in CDS - most specifically basis (the difference between CDS and bonds) shifts and the local-sovereign-referencing protection writing. Peter Tchir, of TF Market Advisors, provides further color on the latter (as the 'Ultimate' trade) and in an unsurprising twist, how the former was much more critical during the Lehman 'moment' and will once again rear its ugly head. Exposing the underbelly of these two dark sides of the market must surely raise concerns at the fragility of the entire system - as we remarked earlier - but the lessons unlearned, on which Peter expounds, from the Lehman period are reflective of regulators so far behind the curve that it is no wonder the market's edge-of-a-cliff-like feeling persists.

Jump Risk Jumps After American Bankruptcy, Sends Junk Plunging As Major Debt Refi Cliff Approaches

A week ago, the reputation of legacy carrier American Airlines as being the only one to avoid bankruptcy is not the only thing that went pop. Along with it went the fervent optimism of high yield debt investors that moral hazard spreads not only to insolvent countries and insolvent banks, but to all insolvent corporates. On Wall Street, there is actually a technical name for perspective on insolvency optimism when viewed through the prism of CDS, where it is known as "Jump Risk", or the likelihood of a company to file tomorrow as opposed to a year from now. Until AMR, jump risk was not an issue. Now, it has come back with a vengeance. As Bloomberg LevFin magazine reports, "AMR’s bankruptcy is taking the corporate debt market by surprise, with investors losing 25 percent on bets in junk-bond derivatives that there wouldn’t be a jump in defaults this year. The Chapter 11 filing from the parent of American Airlines is helping to fuel a plunge in the value of credit-default swaps that  take outsized losses when companies in a benchmark index fail. The contracts, which back the debt of borrowers including ResCap and Radian, plunged to 64 percent of face value as of yesterday from 85 percent on Nov. 8. The derivatives were three weeks away from expiring with gains on Nov. 29, when AMR filed for protection." Oops. Alas, that's what happens every time unfounded optimism gets away from reality, especially when one is dealing with "junk", literally, which as the name implies is one TBTF if it is 99% unionized.

The Paradox Of Merkelism And ING's Not-So Grand Bargain

Despite another weekend of hope-driven chatter of a support-the-profligacy, print-til-we-die, mutually assured destruction game of chicken, we remain as far from the fiscal federalism, that we discussed earlier in the week (and the four critical questions that need to be answered) as ever. As we embark on yet another critical week in Europe's (and perhaps the world's future), ING addressed a critical aspect of the conundrum - that of Merkel's (read Germany's) reluctance to step on the gas and save the known universe. While attempting to quantify the price of break-up and the pay-now or pay-later perspective, they describe perfectly the 'Paradox of Merkelism' in that the core countries' attempts to limit their exposure have served only to increase it. They further worry that while a plan for a Grand Bargain may appear, this may rapidly give way to the recognition that the reality is not so grand - the bargain would still have to be delivered.