Mr. Hyde’s Three Leaf Clover and the Russian Roulette

``Investors and lenders convinced themselves that financial alchemy would turn illiquid securities into liquid securities in all market conditions. But leverage and liquidity require two participants. A borrower needs a lender, and a buyer needs a seller. Otherwise each is just a ship at sea. Liquidity is a human phenomenon, a psychological phenomenon. Investors made the mistake of believing that financial technology had repealed the laws of human nature.” -Michael Lewitt, Hegemony Capital Management, Vectors of Credit

So markets have essentially been rising on the account of global rescue packages deemed as inflationary, but Mr. Hyde maintains his presence felt in the financial system amidst such perky expectations.

Here are some signs that Mr. Hyde still lurks in far corner waiting for the right opportunity to pounce:

A continued rise in interbank lending rates as shown in Figure 6…

``The London interbank offered rate that banks charge each other for overnight loans in pounds rose 20 basis points to 6 percent today, the highest in 10 days, British Bankers' Association figures showed. The corresponding rate for dollars rose 21 basis points to 5.30 percent, and the euro rate climbed 6 basis points to 4.23 percent.” September 27^th Bloomberg,

Figure 6: stockcharts.com: Widening spreads signs of tranquility?

While some semblance of restoration of order has been seen in the credit markets, widening spreads have not been encouraging signs of tranquility.

ECB Banks continue to tap emergency funds…

``The European Central Bank’s emergency lending fund, which attracts a penal interest rate, was tapped on Wednesday for €3.9bn, the largest sum since October 2004, the Frankfurt-based institution has revealed.

``The surge in demand for the ECB’s “marginal lending facility” points to the difficulties still being faced by European banks as a result of the global credit squeeze.” September 27^th Financial Times

Again from Dr. Hussman’s perspective, the amount broadcasted by media as accessed by banks is basically miniscule compared to the overall securities affected by the recent credit gridlock.

And in Canada, paralysis continues in the short term funding for Asset Back Commercial Papers market (ABCP)…

``The Canadian cash crunch that started with defaults on subprime mortgages in Southern California and Florida has hurt more than 25 companies that invested in commercial paper, including Sun-Times Media Group Inc. and Canada Post, the nation's mail service. Baffinland has 95 percent of its cash in Canadian commercial paper, debt that is due in 364 days or less.

``Investors fled Canada's asset-backed commercial paper, paralyzing the C$40 billion market for debt that carried the highest credit ratings, after losses from home loans to people with poor credit histories roiled global credit markets.” Bloomberg September 25^th

In the US, Commercial Paper Markets continue to shrivel…

``The U.S. commercial paper market shrank for the seventh straight week as the Federal Reserve's interest rate cut fails to improve conditions for short-term credit.

``Debt maturing in 270 days or less continued its biggest slump in seven years, falling $13.6 billion in the week ended yesterday to a seasonally adjusted $1.855 trillion, including a $17.3 billion decline in asset-backed commercial paper, according to the Federal Reserve in Washington. The week's decline is smaller than the previous week's drop of $48.1 billion, a sign that buyers are starting to return to the market after the Fed's half-point reduction Sept. 18 in its benchmark interest rate.” Bloomberg September 27^th

In contrast to the news presentation, a smaller degree of decline is no evidence that buyers have emerged.

Moreover, credit paralysis has been a worldwide phenomenon, now with its tentacles reaching Russia…

``Overnight lending rates in Russia climbed to 10 per cent, the highest since mid-2005, even after the central bank on Wednesday pumped an additional $2.56bn into the banking system via two one-day repo auctions. Traders and bankers said the spike came as companies and banks prepared to make a monthly round of tax payments and primed their accounts to meet central bank requirements in time for end of third quarter financial reports…

``The Central Bank was also forced to pump liquidity into the system via repo auctions at the end of August after foreign investors fled Russian money markets amid the flight to quality following the US subprime crisis and tax payments fell due. Russia racked up more than $5bn in net capital outflows in August.” September 26^th Financial Times

Notwithstanding, the bleak outlook from the IMF suggesting the credit driven volatility will most likely continue to affect the global financial systems….

``The global financial system has undergone an important test and the test is not over yet. Implications of this period of turbulence will be significant and far-reaching," Jaime Caruana, IMF director for monetary and capital markets departments, told a news conference…

``IMF Managing Director Rodrigo Rato said the impact on global growth from the credit crunch and re-pricing in credit markets will be felt in 2008 and that the United States will most likely be hardest hit.

``He said world economic growth should remain strong next year but looks set to be below the levels of 2006 and 2007 and downside risks increase the longer financial markets remain in crisis, Rato told a seminar in Madrid.” September 24^th Reuters.

Telegraph’s Ambrose Evans Pritchard says that US leading investment broker Goldman Sachs, previously a key proponent to the global decoupling theme, appears to have been proselytized to camp of the bears…

``Goldman Sachs has abandoned its ultra-bullish view of the world economy, warning of a likely recession in Japan and mounting risks that US property slump could spread to parts of Europe.

``In a new report, "The Global Economy Hits a Crunch", the US investment bank said it was no longer sure that Asia and Europe would be able to pick up the growth baton as America stumbled. It fears that turmoil is spreading beyond the debt markets to the factory floor.”

In short, Mr. Hyde still has a commanding presence that may shift the war of psychology in his favor with three apparent risks variables at play…the prospective escalation of the credit bottlenecks, a US led economic recession percolating to a global slowdown and a chaotic unraveling of the US dollar.

To say that Central bankers appear to have successfully cleared the hurdles as evidenced by the rising markets is analogous to playing the “Russian Roulette”…

Just because the first two shots were fired and you survived does not imply the revolver’s 4 remaining chambers are not loaded.