In a little under eight minutes, a plethora of today's more outspoken realists, economists, and journalists provide a simple yet clear path through the financial crisis to critically explain how the so-called equilibrium that so many mainstream analysts and economists trusted as fact has been proven as simple fiction. The hard-to-accept truth is that financial instability is in fact the natural state of our economic environments and that credit and banking lie at the very heart of that difference between Keynesian / Neo-classical dogma and the tough new reality that the world's major economies now face. The political and economic elite have "blind-sided themselves to the role of rising debt in funding what is really the biggest ponzi scheme in human history" and that the "blind-faith in institutions and mechanisms has cracked post-2007". From too-simple DSGE 'economic models' to 'representative agents' to the fact that financial systems are the cause of economic instability, a number of the new normal's best thinkers (including Stiglitz, Keen, Kinsella, and Bezemer), courtesy of INETeconomics, provide a very layman's guide to the (hopefully not so shocking to our readers) new reality of how critical credit and debt is in our brave new world and how entirely misrepresented it is in mainstream thinking. Must Watch, if for nothing else, the crushing conclusion for many neo-classicals that when you can't tweak your models any more, you need to move on to some next paradigm.
Tim Geithner Glitch In The Matrix Special: Will America Become Greece In Two Years - "No Risk Of That"Submitted by Tyler Durden on 04/15/2012 16:45 -0500
Geithner April 2011: Q: “Is there a risk that the United States could lose its AAA credit rating? Yes or no?” - Tim Geithner: “No risk of that.”
Geithner April 2012: Q: “If we don't deal with these debt problems we are going to be Greece in two years” - Tim Geithner: “No risk of that.”
When Bear Stearns hit the wall, there was no talk of a federal government bailout because of what Mr Paulson had stated in public. The other US banks refused to lend because Bear Stearns had refused to participate in the bailout of LTCM in 1998. Bear Stearns was left with two options. It could sell the “assets” in the hedge funds or it could bail them out with its own capital. For the one and only time in the GFC so far, a money centre bank tried to sell Collateralised Debt Obligations (CDOs) on an actual market. That attempt lasted hours. When the auction was closed, the bids were coming in at 30 percent of the face value of the paper. The jig was up, the valuation of the collateral underpinning the entire banking system was revealed as fictitious. Not much more than a year later, that collateral was transferred from the US banking SYSTEM to the Fed, which has maintained its fictitious “value” ever since. Europe dragged its feet, but at the end of 2011 it did the same thing in regard to its own banks.
Remember the look on one's face when one hears there is no Santa Claus, or tooth fairy? That, more or less, is what the visage on everyone's favorite CNBC anchors Becky Quick, Joe Kernen and Andrew Ross Sorkin was, when Chris Whalen matter of fact (because it is a fact) let a rare glimpse of reality on the NBC Universal distraction and entertainment show, when he said "There is no Chinese Wall. Please. Come on. This is Wall Street." Awkward silence follows. And why not: if the banks officially call frontrunning an "Asymmetric Information Initiative" to mask the simple illegality from the idiot regulators, why not call a spade a spade, and expose one more aspect of the lies and crime that is shoved down investors' throats every single day.
George Soros has been a busy man the last few days. Appearing at the INET Conference a number of times and penning detailed articles for the FT (and here at Project Syndicate) describing the terrible situation in which Europe finds itself - and furthermore offering a potential solution. Critically, he opines, the European crisis is complex since it is a vicious circle of competing crises: sovereign debt, balance of payments, banking, competitiveness, and structurally defective non-optimal currency union. The fact is 'we are very far from equilibrium...of the Maastricht criteria' with his very clear insight that the massive gap, or cognitive dissonance, between the 'official authorities' hope and the outside world who see how abnormal the situation is, is troublesome at best. Analogizing the periphery countries as third-world countries that are heavily indebted in a foreign currency (that they cannot print), his initial conclusion ends with the blunt statement that "the euro has really broken down" and the ensuing discussion of just what this means from both an economic and socially devastating perspective: the destruction of the common market and the European Union and how this will end in acrimonious recriminations with worse conflicts between European states than before.
The heaviest weekly loss (down 2%) in the S&P 500 since mid-December and largest two-week drop since the rally began in November was dominated by losses in financials (and energy). The major financials most notably have been crushed from the start of April (MS -13%, Citi/BofA -11%, GS -8.5% since the European close on 4/2). Credit broadly underperformed on the day (after ripping to pre-NFP levels yesterday) but HYG (the high-yield bond ETF) outperformed surprisingly but this appears to be related to an equity-credit (SPY-HYG) convergence trade as HYG looks very rich now once again to its NAV. The dismal close in ES (S&P futures) on significantly heavier volume and block size. VIX pushed back above 19.5% and we worry that the violent swings that we saw in credit and equity markets this week are very reminiscent of the beginning of the chaos mid-Summer last year - and perhaps rightfully so given the European situation that is escalating. FX markets were much more active today with EURUSD breaking back under 1.31 and AUD leaking lower after gapping down on China GDP news last night. Interestingly the USD ended basically unchanged from last week's close while Gold managed to hold onto its gains for the week (+1.5% at $1655) despite drops in Silver and Copper also today (Silver and Gold retracing the spike highs from yesterday). Copper kept sliding -4.7% on the week. Treasuries slipped lower in yield from late last night exaggerated by China's news with the entire complex notably lower (5-9bps on the week) in yield and flatter as the long-end outperformed. Stocks pulled back towards CONTEXT with broad risk assets at the close today though it remains rich to Treasuries and credit on a medium-term basis.
The link between government spending cuts and social unrest is highly non-linear and extremely troublesome. We first noted the must-read quantification of the relationship between so-called CHAOS of social unrest and spending cuts back in early January and this brief lecture reiterates some of the frightening conclusions. Critically, small spending cuts impact social unrest in very marginal ways but once the cuts begin to rise to 2-3% of GDP then the probability of considerable and painful social unrest becomes much higher. As Hans-Joachim Voth points out in this INET lecture, analogizing between a burning cigarette as a catalyst for a forest fire in an arid landscape, he suggests the rapid build up of combustible material caused by austerity (youth unemployment in Spain perhaps?) could be inflamed by a seemingly small catalyst that would otherwise be ignored in general (a poor immigrant being shot or motorist murdered in a bad part of town) when spending cuts are at the extremes we see across Europe currently. The frightening reality of the non-economic, real social costs of the Troika's handiwork look set to be tested going forward as the link between periods of very heavy unrest (clusters of rioting for instance) and austerity is very strong. His findings on the post-chaos fiscal policies, (what does the government do once social unrest explodes) are perhaps more worrisome in that governments will immediately withdraw from austerity patterns which leads to some tough game-theoretical perspectives on the endgame in Europe in a 'lose-lose proposition' for austerity as the uncertainty shock of these events cause dramatic drops in Industrial Production.
As Spanish CDS surge and bonds shrug off the very recent gloss of a 'successful' Italian debt auction, the sad reality we pointed out this morning is the increasing dependence between Spanish banks, the sovereign's ability to borrow, and the ECB. As ING rates strategist Padhraic Garvey notes this morning, the bulk of the LTRO2 proceeds were taken down by Italian (26%) and Spanish (36% of the total) and the latter is even more dramatic given the considerably smaller size of Spanish banking assets relative to Italy. The hollowing out of the Spanish banking system, via encumbrance (ECB liquidity now accounts for 8.6% of all Spanish banking assets), is a very high number - on par with Greek, Irish, and Portuguese levels around 10% where their systems are now fully dependent on the ECB for the viability of their banks. His bottom line, Spain is not looking good here and while plenty of chatter focuses on the ECB's ability to use its SMP (whose longer-term effectiveness is reduced due to scale at EUR214bn representing just 3% of Eurozone GDP), consider what happened in Greece! The ECB did not take a Greek haircut and so the greater the amount of Greek debt the ECB bought, the greater the eventual haircut the private sector was forced to take. By definition, every Spanish bond that the ECB buys in its SMP program increases the default risk that private sector holders are left with.
Get those rotten tomatos ready
I see no evidence that the economy is weakening.
"In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!" is how PIMCO's El-Erian introduces the game-theoretic catastrophe that is potentially occurring around us. In a lecture to the St.Louis Fed, the moustachioed maestro of monetary munificence states "let me say right here that the analysis will suggest that central banks can no longer – indeed, should no longer – carry the bulk of the policy burden" and "it is a recognition of the declining effectiveness of central banks’ tools in countering deleveraging forces amid impediments to growth that dominate the outlook. It is also about the growing risk of collateral damage and unintended circumstances." It appears that we have reached the legitimate point of – and the need for – much greater debate on whether the benefits of such unusual central bank activism sufficiently justify the costs and risks. This is not an issue of central banks’ desire to do good in a world facing an “unusually uncertain” outlook. Rather, it relates to questions about diminishing returns and the eroding potency of the current policy stances. The question is will investors remain "numb and sedated…. by the money sloshing around the system?" or will "the welfare of millions in the United States, if not billions of people around the world, will have suffered greatly if central banks end up in the unpleasant position of having to clean up after a parade of advanced nations that headed straight into a global recession and a disorderly debt deflation." Of course, it is a rhetorical question.
The latest consumer-credit data showed a slowing in the growth of the borrow-to-spend trend that had re-appeared through the holiday shopping period. This deceleration signals the deleveraging of the consumer is back and as the following charts from Morgan Stanley shows once people start saving historically, they have tended to remain saving; and that in the kind of low-/no-growth environment (or more specifically a balance sheet recession) we see a lack of credit demand even as credit availability is high. The momentum of saving and the correct focus on debt minimization as opposed to profit- (or living-standard) maximization will eventually outweigh the ever-increasing need for dollar-debasement money-printing flow to maintain the social market status quo. Add to this deleveraging concern the fact that Europe is seeing bank lending contract absolutely (notably weaker than in the US for now) amid tighter lending conditions and this is just another example of the cloggage in the Fed/ECB's transmission channels in this environment.
Bankruptcies, jobs, and the hoped-for deus ex machina....
Following today's disappointing jobs data, we thought it useful to reflect on the sad reality that is occurring under the eyes of AAPL Mr. Market. As BofAML notes this morning, their Economic Data Diffusion index (which tracks macro data surprises) has been trending lower for over a month (indicating a trend of data missing expectations to the downside) and, more importantly has turned absolutely negative (indicating a marginally negative bias to the overall economic data expectations). Following our lead, they note the weather's impact and that this is likely to be the third time in this recovery that the markets and economic consensus has over-reacted to positive news and become too optimistic about growth. Looking ahead, we expect this data downshift to continue. In the near term, both higher gasoline prices and the fading weather effect will likely weigh on growth and, over the course of the second half, we expect the looming fiscal cliff to undercut confidence and growth. Party's ending, a tough economic reality is looming and the punchbowl remains out of sight for now.