Feldkamp: The Grinch That's Stealing Investors' Christmas

rcwhalen's picture

Paris -- Here's another great post from my friend and co-author Fred Feldkamp that talks about why credit spreads are crucial to understanding our economic prospects. His comment also illustrates how the SEC handed the large banks a monopoly on short-term finance in 1998 by amending Rule 2a-7 and made the 2008 financial crisis inevitable.  Few significant players in "corporate finance land" are willing to take on the bank monopoly/monopsony over short-term funding for fear of being cut off. If this topic interests you, read our book: Financial Stability: Fraud, Confidence & the Wealth of Nations, which has a long treatment on credit spreads. I will be writing a longer research note on this issue for KBRA in the new year. -- Chris

 

The 2015 Grinch That's Stealing Investors' Christmas 

By Fred Feldkamp

December 22, 2015

Yesterday, the cost of credit intermediation ("CCI") for US growth firms (and, therefore, most of the world's, "emerging" nations) rose by more than 50 basis points.  That imputes a $1.25 trillion (PER ANNUM) decline, in just one day, of the ability of the worldwide economy to generate growth.  

In 1983, Ben Bernanke authored a widely-read article that showed how a 550 bp rise in CCI (between 1929 and 1933) accounted for all the damage associated with the Great Depression.  Due to factors explained in the comment I circulated Monday, there's been roughly a 350 bp rise in this measure of CCI since June 2014.  That equates to $8.75 trillion of annual decline in the generation of worldwide wealth (NEARLY FIVE TIMES THE ENTIRE NEW US BUDGET FOR THE FISCAL YEAR ENDING SEPTEMBER 30, 2016). 

As with the problems I described Monday, a major reason markets are struggling today is a repeat example of what Barbara Tuchman labeled "The March of Folly" in 1985.  The US SEC made a bi-partisan blunder, early in 1998, that a member of its staff arrogantly believed would forever prevent a "run" on US money market funds.  It created a market "glitch" that has ruined the ability of market participants to provide needed liquidity for short-term credit intermediation.  

For 17 years, nobody has been willing or able to admit and change that blunder.  As a result, a gigantic juvenile "Grinch" is decimating US corporate credit markets.   

By that 1998 rule, the SEC made a few large US banks monopolists (and "monopsonists") with respect to money market fund access.  In 1998, the rule destroyed many hedge funds, including Long Term Capital Management.  Bill Clinton's SEC, run by Arthur Levitt, adopted the rule as Clinton was seeking to avoid impeachment.  The SEC understood the problem they created by the fall of 1998, but refused to amend the rule, even after LTCM failed, because the staff said it was "too embarrassing" for the SEC to reverse course so soon after a rule was adopted.  

George W. Bush's administration was advised about the rule's disastrous consequences before taking office.  Yet, it did nothing to change the rule.  As a result, many large firms were forced to create their own banks in order to be able to compete with the monopolists. That trend was a contributor to the great market crisis of 2007-9.

The Obama team tried to fix the rule, but was stymied by the monopolists’ desire to preserve what they considered "their" domain.  As a result, 17 years later, major firms capable of creating new sound means for liquefying struggling markets for corporate bonds find they cannot do so, because banksters won't let the market work without being "in control."

Today, therefore, investors must still rely on the whims of a few very large US banks for the short-term intermediation of bond liquidity that is needed to cure the problems we all face.

Banksters, of course, blame "capital restraints."  What that really means is that they want the US to "let us run wild, AGAIN (with US taxpayers guarantying our liabilities), and we will fix the mess."  That's a total fool's game which the US must not play. 

If US leaders, ON ALL SIDES OF OUR POLITICAL DEBATES, do not get together soon and fix this "colossal muddle," there WILL, almost certainly, be a financial crisis in 2016.  Unlike 1929-33, the legal framework for resolving this mess is in place.  The solution will lead to more "disclosed" government debt--but doing that is necessary to slow the future growth of "total" government debt.

Fred

December 22, 2015

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dizzyfingers's picture

Assume no risk analysis anywhere. Hindsight rules.

 


moneybots's picture

"If US leaders, ON ALL SIDES OF OUR POLITICAL DEBATES, do not get together soon and fix this "colossal muddle," there WILL, almost certainly, be a financial crisis in 2016."

 

A financial crisis is already baked into the cake, 2a-7 or no 2a-7.  Timing is the only question.

moneybots's picture

"His comment also illustrates how the SEC handed the large banks a monopoly on short-term finance in 1998 by amending Rule 2a-7 and made the 2008 financial crisis inevitable."

 

The financial crisis was inevitable, anyway that it was sliced or diced. 

2a-7 was just an alpha-numeric.

What has happened to the FED interest rate since 1981?  It spent some 30 years bouncing down to ZERO. 2a-7 might be some cog in the process, the whole is the sum of its parts.

"In 1998, the rule destroyed many hedge funds, including Long Term Capital Management."

The market turned on LTCM, which turned exponential gains into exponential losses.  The Big Five investment banks had the same result after leveraging up over 30 to 1 during the housing bubble.  When markets turn, excessive leverage increases losses.  LTCM and the investment banks crashed for the same reason. 2a-7 or no 2a-7.

 


 

Ghordius's picture

interesting article. "a few large US banks monopolists (and "monopsonists")" i.e. the usual suspects