Things That Make You Go Hmmm... Like Moral Hazard
A mere 24 hours before the US (at least according to Jack Lew, who, as some of you may have known, is the Secretary of the Treasury of the United States of America) was going to run out of money and default on its obligations (the Lew-styled "catastrophe", which according to the great and the good would once again "bring the financial system to its knees" — how many MORE times are we going to have to listen to that, I wonder?), the S&P 500 was trading exactly 2.30% from its all-time high.
Sound like anybody was worried about financial Armageddon to you, dear reader? Not to me, either, but here's the thing:
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 (or at least, what little collateral is allowed amongst market participants once central banks have hoovered up their ever-expanding allotments).
The key clue passed most people by a week ago; but it came from, of all places, Hong Kong:
(FT): Hong Kong’s stock exchange decided the possibility of a US default had made some types of short-term Treasury bonds more risky, prompting it to force traders using the securities as collateral to provide extra backstops....
It came as the Asia Securities Industry & Financial Markets Association (Asifma), which represents banks, brokers and asset managers in the region, warned that any announcement by the US Treasury in advance of a default must arrive before the opening of the day’s trading in Asia to avoid “chaos”.
Japan’s clearing house, the Japan Securities Clearing Corporation (JSCC), said it was in “intensive discussions” to prepare for “anything that might happen”.
Hong Kong Exchanges & Clearing (HKEx) said on Thursday it had taken two measures designed to reflect the increased difficulty of valuing certain short-term US Treasuries amid the debt impasse.
First, its clearing house would apply an increased “haircut" to its valuation of US Treasuries held as collateral against futures trades. For bonds held with maturity of less than one year, that would be raised from 1 per cent to 3 per cent, effective immediately, HKEx said in a circular to members.
“This new haircut shall be applied on a daily basis to determine the value of the US Treasuries allowed to be used as cover for the margin requirements of HKCC [Hong Kong Clearing Corporation] participants,” HKEx said.
“Participants should make necessary funding arrangements to cover any shortfall to their margin requirements resulting from the increase in the US Treasuries haircut.”
Anyone posting US Treasuries with less than a year to maturity as collateral, would need to come up with three times their current posted margin.
Not good. Not good at all. The amount of liquidity this would suck out of a fragile market would be catastrophic very bad indeed, and any forced selling on behalf of those unable to post the additional collateral would be a catastrophe major problem, leading to falling prices and spiking rates — neither of which are allowed anymore. Now, if HKEx's move had become fashionable around the world (and it's safe to say that exchanges are very much pack animals), it would have been quite bad a catastrophe.
After a very subdued reaction to the can being kicked down the road until February debt ceiling being agreed, something rather strange happened on Thursday. See if you can identify at what point in the day it occurred:
(I should point out that the yellow overlay of the gold price looks green where it sits on top of the blue DXY chart. There are only two variables in this chart, the yellow gold price and the blue US dollar price.)
Now, there was already a clue as to what this event was, hidden away in an earlier chart, but (cue drum roll) the catalyst for the dollar's sudden drop and the sharp spike in the price of gold waaaaaaaaaaaas... THIS:
(Reuters): Chinese rating agency Dagong has downgraded the United States to A- from A and maintained a negative outlook on the sovereign's credit.
The agency suggested that, while a default has been averted by a last minute agreement in Congress, the fundamental situation of debt growth outpacing fiscal income and GDP remains unchanged.
"Hence the government is still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future," Dagong said in a press release.
Now those are the straight facts of the issue, but contained within the rest of what was a very short article are three fascinating sentences that speak to the very crux of the problem as things stand today. The first two constituted the very next paragraph:
(Reuters): Dagong's ratings are hardly followed outside of China. The agency also classifies most countries it follows very differently from major agencies such as Moody's, Standard & Poor's and Fitch.
Absolutely correct. Dagong's ratings are seen as something of a joke and very much inferior in nature to the Big Three — a poor man's Egan Jones, if you will.
...So here's where we get to the nub (finally!) of this week's philosophical wanderings.
The question I posed, all those charts ago, was this:
If something bad happens, but nobody reacts badly to it, did nothing bad happen?
Well, with each successfully navigated new crisis, the reaction of the market the next time a crisis flares up becomes more muted. We've seen the spectre of a Lehman-style collapse dealt with, and now the phrase "... could bring the global financial system to its knees..." is shrugged off with alacrity.
We've seen the spectre of a European fracture, a Grexit, a Spexit, and the end of the euro taken off the table by determined governments and central bankers; and now, each fresh outbreak of the European crisis is greeted with apathy and ennui. (I wonder if the French have a word for that.)
And now we've seen the extent of the reaction to the US debt-ceiling debacle the second time around. I would describe it as "quizzical interest" at best.
Because the Nannycrats are continually telling us that everything will be OK, that we shouldn't worry about things and ought instead to just Keep Calm and Carry On.
How bad has it gotten? Well, amidst the "hoo-ha on the Hill" recently, we saw one of the most bizarre things I've witnessed during the mayhem of recent years: Barack Obama's telling Wall Street that they SHOULD worry
Barack, let me explain something to you.
The reason Wall Street WASN'T worrying is that you and Bernanke and Geithner and Paulson (not you, John — Hank) and Yellen and the rest of the Crazy Crew have gone out of your way for five years to make absolutely certain that nothing bad ever happens again. Ever. Why the hell WOULD they worry?
It's YOUR fault that they're not. You just can't have it both ways.
That's what moral hazard looks like, I'm afraid...
Read Grant Williams' full letter below...
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