``Where in capitalism is the idea that you can spend more than you earn? Where in the vision of Adam Smith is the idea that foreigners will subsidize your standard of living – indefinitely? Where in laissez-faire is the notion that central bankers will prevent corrections by controlling the price of money? What had happened to the old sturm and drang? Where was Schumpeter’s ‘creative destructive?’ The new capitalists offered creation without destruction... resurrection without crucifixion! They offered not only to hold harmless investors in the face of their own bad judgment...but to revive booms before they ever expired and to cut short corrections before anything has been corrected.” –Bill Bonner
Global equity markets cheered anew the “socialization” of the financial markets, as shown in Figure 2, as major central banks such as the Bank of England and the Bank of Canada trimmed interest rates in response to the worsening global credit crisis and over concerns that such dislocations would spillover to the global economy.
Meanwhile the Reserve bank of Australia and the European Central Bank kept rates unchanged regardless of the signs of incremental increases of inflation (by their definition-higher consumer prices).
Figure 2: stockcharts.com: Equity Markets Applauds Central Bank Bailout Packages
This came about as dovish statements from key central bank officials as Chairman Bernanke and Vice Chairman Kohn indicated of concerns of heightened downside risks which possibly telegraphed messages of a forthcoming rate cut this December 11th.
As we have noted, the global equity markets since August have been living off from government crutches, i.e. buying the hope that the attendant remedial policy measures will be effective enough to thwart the ongoing rapid adjustments in the highly leveraged financial sector.
Despite several initial stopgap measures to contain the recent stress, equity markets continued to show signs of strain as selling pressures reappeared last November.
Recently even as equity markets appear to have been pacified the credit markets continue to manifest signs of significant dislocations as shown in Figure 3.
Figure 3: Financial Armaggedon.com: Biggest Spread since 1986 Mr. Panzer adds, ``More ominous, perhaps, is the fact that banks have much less in the way of cheap and relatively immobile customer deposits backing their outstanding loans than in the past. That means they are more dependant than ever on other banks and the financial markets to meet their funding needs”
This just shows how leveraged the global financial system is, deposit reserves which used to serve as sound collateral for lending has essentially dissipated. These have been replaced by collaterals of questionable value. In good times nobody challenged the viability of such premises. Now that the going gets though, the massive spike on yield spreads reflect on their reluctance to lend to each other which could signal a potential disorderly unwind.
Of course, again the equity market is hoping that the plans to mitigate losses from the mortgage market will gain traction as Treasury Secretary Mr. Henry Paulson alongside with industry lenders set up guidelines to freeze interest rates by affected parties.
But the problem is that these plans would only help a marginal number; from New York Times, ``The Greenlining Institute, a housing advocacy group in California that began raising alarms about subprime loans nearly four years ago, estimated that only 12 percent of all subprime borrowers and only 5 percent of minority homeowners would benefit from the rate freeze. The Center for Responsible Lending, a nonprofit group that supports homeownership, said the freeze would help only about 145,000 people.” (emphasis mine)
Second, is the concern over the breach of private contracts, from the Economist (emphasis mine), ``Whatever else it may be, the Bush administration’s agreement is an extraordinary intrusion by the government into private mortgage contracts…Whatever the economic arguments for the Bush administration’s plan, it amounts to poor public policy.
Third is the ambiguous procedural process, again from the Economist (highlight ours), ``But how the process will work is not clear. A national blueprint may make it easier to identify those who are eligible for relief, but the process of renegotiating the loan, or applying a rate freeze, must be done individually. Lenders will need to check borrowers’ incomes, debt levels and the current value of homes before they can agree to a change in the terms of the loan. Mr Paulson, in fact, acknowledges his plan’s limitations by saying that other relief measures are under discussion.”
Another is about the incentives and potential consequences, from Minyanville’s Mr. Practical, ``The biggest ramification is this. Those investors will have to decide whether or not to accept the new terms. If they accept lower interest payments because it is better than default, the value (price) of the CDO will go down to reflect the new present value of the payments. This is a big fact that I think everyone is missing: the price of CDOs will be marked down from current levels. Banks' desire to lend will go down as a result of this. As an illustration, the spread between libor and ECB funding rate (equivalent fed funds) rose again last night and is at a record 89 basis points.
``A nuance of the above is that senior trauches of CDO now have a higher certainty of pay-outs while the junior trauches now may be worthless. These junior trauches will sue like crazy as this thing unfolds.”
``What will happen is that banks/other investors who own these will then take another write-down but then declare this is the end. This will not be true. A huge percent of all re-negotiated mortgages eventually still default. It just buys a little time for a few more interest payments. The bottom line is these folks bought houses they couldn’t afford when paying market interest rates. This is really a plan to help banks take one more write-down and declare all is well and then hope for some magic turnaround. But there won’t be a turnaround.”
Finally on the proposed government bailout, again Mr. Practical, ``So far Mr. Paulson is trying to make this look like a “voluntary” plan by lenders. We all know there is lots and lots of pressure being exerted by government to get them to volunteer. But I have a feeling Mr. Paulson’s plan does not end here. There is also talk of getting Congress to pass legislation to let states and municipalities issue tax-exempt debt to refinance loans for those who cannot keep their homes. This would be nothing more than a government led bailout of banks and large investors at the expense of taxpayers. ”
As we have long argued, the
Second like any governments, they tend to be reactionary in their approach to problem solving--responding mostly to short-term popular demands but whose actions are likely to benefit vested interest groups.
Third, it is the nature of governments, given the backdrop of today’s paper money system, to utilize manipulative (inflationary) policies to steer an economy towards a short-term boom then blame the markets for the ensuing bust from which they would find the necessary excuse, backed by socialist experts and grandstanding politicians, to justify for the next policy (inflationary) maneuvers.
Lastly, such rescue plan has yet to be implemented and we are already seeing some signs of a backlash, which means like most interventionist policies they tend to end up with long term unintended consequences.
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