Yesterday, we laid out what according to Citi's Matt King, one of the most insightful and respected credit analysts in the world, is most surprising about the ongoing market selloff: the odd interplay between some asset classes which are declining in an orderly, almost boring fashion, and other assets which have crossed into and beyond a state of existential panic.
The reason for this ongoing paradox is still unclear but as Citi's King, BofA's Martin and Hartnett, and DB's Konstam and Reid have all hinted on numerous occasions, the fundamental driver of everything that is wrong with the market are the actions of the policy makers themselves, who in their feverish attempt to preserve the market in the post-Lehman devastation, have made the market into a "market", one where nothing makes sense any more. In other words, in order to save the market, central bankers broke it.
Which brings us to the conclusion from Matt King's most recent note, one which picks up on his observations of the all too clear dislocations and paradoxes in the market, those "things which, according to all the policymakers’ models of the world, are “not supposed to be happening”.
And yet they are, and as King adds, "it is increasingly clear that the world is not fixed – far from it."
The rest of King's conclusion is a must read for everyone, especially those who think that anything in the past 7 years has been fixed, or even partially resolved.
This, then, is the real implication of widespread market dislocations. It suggests that there was something about the entire narrative peddled after the crisis which was at best incomplete, and at worst downright wrong. As an FT article put it, either for the emerging markets, or indeed for what is rapidly becoming a much more broad-based sell-off, “There is no obvious high conspiracy between banks, the rating agencies and the government”. Nor is there simply a risk we might need to respond to “future adverse shocks”, as Yellen’s testimony to Congress yesterday maintains.
If the pre-crisis problem was not CDOs in and of themselves, or excessive bank lending and leverage, it must have been something else. The most obvious candidate is overly easy monetary policy stimulating unsustainable credit expansion and ultimately asset price bubbles. Banks were certainly an instrument through which this policy was enacted, but financial leverage itself – especially that behind relatively low-risk arbitrages within financial markets – was a very limited part of it. Had leverage not been available, easy money would have taken effect some other way, either by spreading to other banking systems which were less constrained, or through stimulating an expansion of credit via bond markets instead. The years since the crisis have of course seen both.
Which brings us to King at his most apocryphal.
Far from making the world safer, then, there is a risk that the post-crisis policy mix has simply suppressed problems, making markets stickier, and may even have added to them, by driving the global credit cycle far ahead of the current interest rate cycle. Recent market dislocations are a sign that that stickiness may be reaching breaking point. In the past, aggressive easing of monetary policy provided the solution to almost all recent crises – both those which did not lead to recessions, such as 1998 and 2011, and those which did, such as the tech bubble of 2000 and the real estate bubble of 2007-8. At this point we may start to question whether it can provide a similar solution this time round, not just because of the zero lower bound, but because the entire premise on which it has been based – inducing credit expansion and risk-taking in some other part of the global economy – seems to be reaching its limits.
In the property market, agents like to say that location is everything. When it comes to fixing current problems we are tempted to resort to the apocryphal story of the response given to tourists in Ireland when asking the way to Dublin: “If I were you, I wouldn’t start from here.”
Alas, 7 years into the fake "recovery" the option of "starting from some other place" is long gone.