Moral Hazard

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Three Post-Mortems On China's Third Plenum





China's Third Plenum has come and now truly gone, following the second, 20000 word "decision" which followed the spares initial communique, which contains much more promises and pledges about the future with a 2020 event horizon, so it is a fair bet that nothing of what was resolved will be implemented in a world that will be a vastly different from the one today, but one has to digest current news regardless. So for the sake of those who analyze such things as promises out of a centrally-planned communist nation, here are three takes on the third plenum, courtesy of SocGen, Bank of America and Goldman Sachs.

 
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The Fed's 100-Year War Against Gold (And Economic Common Sense)





On December 23, 2013, the U.S. Federal Reserve (the Fed) will celebrate its 100th birthday, so we thought it was time to take a look at the Fed’s real accomplishment, and the practices and policies it has employed during this time to rob the public of its wealth. The criticism is directed not only at the world’s most powerful central bank - the Fed - but also at the concept of central banks in general, because they are the antithesis of fiscal responsibility and financial constraint as represented by gold and a gold standard. The Fed was sold to the public in much the same way as the Patriot Act was sold after 9/11 - as a sacrifice of personal freedom for the promise of greater government protection. Instead of providing protection, the Fed has robbed the public through the hidden tax of inflation brought about by currency devaluation.

 
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UBS Warns The Fed Is Trapped





The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fuelling asset price bubbles, which could burst eventually and do major damage. UBS' Beat Siegenthaler notes the September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer-term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, Siegenthaler explains it is now clear that the situation is much more binary; and as such, the hurdles for tapering might be substantially higher than originally thought.

 
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Because Of The Fed "Mortgage Market Liquidity Is As Bad As When Bear Stearns Failed"





Remember the main reason why the Fed should have tapered, namely the illiquidity in the bond market it is creating with its feverish pace of collateral extraction, and conversion of quality collateral into 500x fwd P/E dot com dot two stocks? Here to put it all in context is Scotiabank's Guy Haselmann: "Through its QE policy, the Fed buys $3 of mortgages for every $1 of origination.  The consequence is that secondary mortgage market liquidity has been decimated: it is as bad as when Bear Stearns failed." That's just MBS for now. However, since the Fed has refused and refuses to taper, the same liquidity collapse is coming to Treasury's first, then corporates, then ETFs, then REITs and everything else that the Fed will eventually monetize. Just like the BOJ.

 
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Busy, Lackluster Overnight Session Means More Delayed Taper Talk, More "Getting To Work" For Mr Yellen





It has been a busy overnight session starting off with stronger than expected food and energy inflation in Japan even though the trend is now one of decline while non-food, non-energy and certainly wage inflation is nowhere to be found (leading to a nearly 3% drop in the Nikkei225), another SHIBOR spike in China (leading to a 1.5% drop in the SHCOMP) coupled with the announcement of a new prime lending rate (a form a Chinese LIBOR equivalent which one knows will have a happy ending), even more weaker than expected corporate earnings out of Europe (leading to red markets across Europe), together with a German IFO Business Confidence miss and drop for the first time in 6 months, as well as the latest M3 and loan creation data out of the ECB which showed that Europe remains stuck in a lending vacuum in which banks refuse to give out loans, a UK GDP print which came in line with expectations of 0.8%, where however news that Goldman tentacle Mark Carney is finally starting to flex and is preparing to unleash a loan roll out collateralized by "assets" worse than Gree Feta and oilve oil. Of course, none of the above matters: only thing that drives markets is if AMZN burned enough cash in the quarter to send its stock up by another 10%, and, naturally, if today's Durable Goods data will be horrible enough to guarantee not only a delay of the taper through mid-2014, but potentially lend credence to the SocGen idea that the Yellen-Fed may even announce an increase in QE as recently as next week.

 
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Things That Make You Go Hmmm... Like Moral Hazard





A mere 24 hours before the US was going to run out of money and default on its obligations (in what Jack Lew described as a "catastrophe"), Grant Williams notes the S&P 500 was trading exactly 2.30% from its all-time high. Does that sound like anybody was worried about financial Armageddon? Nope, but as Williams detail sin his latest letter, the danger was very real, as a default by the US on its debt obligations would have gone to the very heart of the "plumbing" that underlies financial markets and caused havoc in the repo market and all kinds of problems with collateral... The key clue passed most people by a week ago; but it came from, of all places, Hong Kong...

 
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Central Banker "Confession" Of The Day





When it comes to Central Banks, there are doves and hawks - though in recent times, the two have become confused as to just what they think. However, it is becoming clear that in spite of their incessant need to print money (liquidity) into existence to maintain the status quo, some (but not all) are realizing there are very real costs to this insanity. Compare:

  • ECB - *COEURE: LIQUIDITY INTERVENTION CAN INTERFERE WITH PRICE STABILITY
  • ECB - *COEURE SAYS CRISIS SUPPORT CAN LATER HAVE "PERVERSE EFFECTS", GENERATE MORAL HAZARD

and

  • FED - *WILLIAMS SEES UNCONVENTIONAL STIMULUS FOR NEXT FEW YEARS
  • FED - *FED ZERO-RATE MOVE DIDN'T COMPROMISE POLICY

It seems central bankers believe what they want to believe.

 
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Guest Post: The Fed Gave Congress A Bottle Of Whiskey And The Car Keys





The irresponsibility of Congress and the rest of the political class cannot be understated. Underwriting this behavior is equivalent to the Fed providing a teenager with a bottle of whiskey and the keys to an automobile. In a context where the Fed could have done no harm by tapering, they instead created a huge moral hazard that will be exploited by politicians of all stripes.

 
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Breaking Bad News From The Fed’s Z1: Expansions Tend To Explode Near Current Leverage Multiples





breaking bad 2

While bubbling assets are a major part of the history of the Greenspan/Bernanke economy, so too is unsustainable borrowing. It seems wise to keep an eye out for another borrowing binge, especially as policymakers are encouraging all forms of financial risk-taking.  And one place to check is the Fed’s quarterly “Flow of Funds” report, which recently took the fancy new title, “Financial Accounts of the United States,” but still goes by the nickname “Z1.” There’s a cautionary note in comparisons of today’s leverage ratio to the last three expansions. The last three times the ratio jumped above the current reading of 7.2 were Q1 1990, Q1 1999 and Q2 2007. And from these points in time, the economy fell into recession about a year later, or less, in each case. (The respective times to recession were two, four and two quarters.)

 
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The Big-Picture Economy, Part 3: Scarcity, Risk And Debt





When skimming and speculation are more profitable than actually increasing the production of goods and services, the discipline and incentives of a market economy are distorted to the point of no return. The only way to restore natural market discipline is to let the cost of credit rise to a market-discovered price, force all speculators to absorb the losses resulting from their bad bets, and let the risk of losses discipline lenders to adjust loan portfolios and interest rates to reflect the risks of rising rates and defaults. "Growth" that depends on manipulated interest rates and easy credit is a sand castle awaiting the rising tide; its destruction is assured.

 
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Guest Post: The Trouble With Asset Bubbles: If You Stop Pumping, They Pop





Unfortunately for the bubble-blowing central banks, asset bubbles are a double-bind: you cannot inflate assets forever. At some unpredictable point, the risk and moral hazard that are part and parcel of all asset bubbles trigger an avalanche of selling that pops the bubble. This is another facet of The Fed's Double-Bind: if you stop pumping asset bubbles, they pop as participants realize the music has stopped, and if you keep pumping them, they expand to super-nova criticality and implode.

 
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