http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10715
I was always impressed that ECB President Jean-Claude Trichet would categorically – and repeatedly - state that “the ECB never pre-commits on interest rates.” The Fed has for years now operated otherwise, believing it advantageous to signal its intentions specifically to the marketplace. This has proved quite advantageous for some, but clearly much to the disadvantage of system stability. The ECB seemed to better appreciate that illuminating too much to the speculator community would simply ensure destabilizing speculation – and attendant Bubbles – based on the expected course of ECB policymaking.
Betting on the predictable path of Federal Reserve policy must by now be one of the more lucrative endeavors in history. In a CBB a decade ago, I made a flippant comment about the financial and economic landscape, writing “The titans of industry run money.” Never did I imagine back then that hedge fund assets were on their way to $2.2 TN, Pimco to $1.7 TN and Blackrock to $3.6 TN. Betting successfully on Fed policy has created billionaires . And, more importantly, those that have played this extraordinary policymaking backdrop most adroitly today control unimaginable sums of financial assets – in the hundreds of billions and even Trillions. There’s been nothing comparable in terms of the concentration of financial power and speculation since the late-twenties.
Ironically, this historic financial windfall even accelerated following 2008’s near financial collapse, as policy effects on financial markets reached only greater dimensions. Those that played it most successfully amassed only more incredible fortunes. And the stakes over just the past few months have been enormous. And those with the best sense – or, more likely, the best information – of how things were going to play out in Frankfurt and Washington added further to their kitties. And, predictably, additional assets to manage flow to the victors. ECB President Mario Draghi is clearly a very intelligent man. He is an MIT trained economist with the most impressive credentials. He has decades of experience as a professor, World Bank official and governor of the Bank of Italy. Mr. Draghi was also a vice chairman at Goldman Sachs for several years (2002-2005). Clearly, Draghi understands markets and the dynamics of speculative finance. When he warned against betting against the euro and European bonds the marketplace took notice. Amazingly, the ECB has gone from being adamantly opposed to pre-committing on rates to openly determined to pre-commit to huge open-ended market interventions and price support operations. After holding out, the ECB finally sold its soul – and the speculators have been giddy.
Bill Gross has been rather open about it: “We’re buying what the Fed and ECB are buying.” And Mr. Gross and others have been buying Spanish and Italian bonds, with a brilliant plan to sell them back to the ECB at higher prices. There’s a very large global contingent keen to place such bets, after similar trades in U.S. Treasuries and MBS have made gazillions.
In the face of alarming economic deterioration, European debt has become a hot commodity. The euro has become a hot currency. Reuters reported Thursday that the euro zone is considering a bond insurance plan. The idea is for the ESM to “guarantee the first 20 to 30% of each new bond issued by Spain.” Friday from Reuters (Andreas Framke): “The European Central Bank envisions buying large volumes of sovereign bonds for a period of one to two months once its ‘OMT’ programme is launched…”
From those among us questioning how the euro can trade so resiliently in the face of potential financial and economic calamity, I have this thought: The Draghi Plan has been in the process of transforming Spanish, Portuguese, Italian and other problematic debt into possibly the most appealing speculative asset in the world today. After all, all this paper provides a relatively decent yields (especially in comparison to bunds, Treasuries, or securities funding costs), and now at least the 1-3 year debt enjoys a commitment of open-ended liquidity/price support from the ECB. If the Draghi Plan does transform this debt from a fundamentally attractive short to a must have speculative long in the eyes of the powerful leveraged players, well, then the Draghi Plan truly has been a “game changer.”
There’s a lot that will likely go really wrong in Europe, perhaps even in the short-term. Greece is an unmitigated disaster, and Spain is running a close second. There was further dismal economic news this week, most notably from France. But that hasn’t in the least diminished recent keen speculative interest in European debt. Indeed, after the Fed sold its soul, I’ve often believed that the speculators became adept at recognizing periods of rising systemic stress and market vulnerability as opportunities to load up on Treasuries and MBS. And then it becomes a game: “OK Federal Reserve, make the value of these securities (or spread trades) go up or we’ll dump them.” They haven’t had to dump. The ECB has similarly opened itself up to blackmail. “Be ready with the OMT as promised - or we dump.” “Spanish and Italian politicians, play ball or we’ll dump.” “Mr. Weidmann and the Bundesbank, fall in line - or we dump!” “All policymakers everywhere, play or we dump.” At least in Europe, this is developing into one fascinating multifaceted game of chicken.Well, I’ve been ranting for awhile now about the “biggest Bubble in the history of mankind.” At this point, things increasingly remind me of 1999 and 2006. Bubble Dynamics eventually reach a degree of excess that is too conspicuous to deny. Yet the stakes are so much greater today. The amount of global debt is so huge and the quality so poor. It’s completely systemic and global. Dangerous excesses have gravitated to the core of Credit and monetary systems. Policymakers are now “all in” in a desperate gambit to hold financial and economic fragility at bay. And, dangerously, highly speculative markets seem determined to extend their divergent path from economic fundamentals. It’s frightening how enormous and enormously powerful dysfunctional global markets have become.
You Can Intimidate Everyone
- October 05, 2012
“I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.” James Carville, Clinton campaign strategist, 1993
Intimidating debt markets back in 1993? How about nowadays? When Mr. Carville paid reverence to the bond market, U.S. marketable debt totaled about $16 TN. Non-financial debt was at $13.1 TN, with Households on the hook for $4.2 TN, Corporations $3.8 TN, State & Local governments $1.1 TN and the federal government $3.3 TN. The Fed’s balance sheet ended 1993 at $424bn.
Intimidating debt markets back in 1993? How about nowadays? When Mr. Carville paid reverence to the bond market, U.S. marketable debt totaled about $16 TN. Non-financial debt was at $13.1 TN, with Households on the hook for $4.2 TN, Corporations $3.8 TN, State & Local governments $1.1 TN and the federal government $3.3 TN. The Fed’s balance sheet ended 1993 at $424bn.
Fast-forward to June 30, 2012. Total U.S. marketable debt ended Q2 at about $55 TN, an increase of 238% since 1993. Non-financial debt increased 212% to $38.9 TN. From 1993 levels, Household debt jumped 207% to $12.9 TN. Corporations have boosted borrowings to $12.0 TN, an increase of 215%. State & Local government debt of $3.0 TN was up “only” 159%. Federal marketable debt ended Q2 at $11.1 TN, up 231% since 1993.
Total Financial sector Credit market borrowings increased from 1993’s $3.3 TN to $13.8 TN, with ABS up 298% to $1.86 TN, Agency/GSE securities up 295% to $7.54 TN, Broker/Dealer borrowings up 437% to $2.05 TN, and Wall Street “funding corps” up 593% to $2.29 TN. Total outstanding Corporate and Foreign Bonds jumped from $2.05 TN to $11.96 TN (up 483%). The value of Corporate Equities rose 285% from $6.30 TN to $24.22 TN. The Fed’s balance sheet inflated 580% to $2.88 TN.
Since 1993, Private Pension Fund Assets have grown 180% to $6.39 TN. State & Local Pensions were up 187% to $1.04 TN. Nothing, however, compares to the growth experienced by the hedge fund community, which grew from about $50bn in 1993 to recent estimates approaching $2.2 TN (growth of 4,300%). And, importantly, the explosion in debt and financial assets management has been a global phenomenon.
I have argued that economic structure matters. I have further posited that a defining feature of contemporary economies (especially with respect to the consumption and services-based U.S. structure) is the capacity to absorb enormous amounts of Credit expansion/purchasing power with little impact on traditional measures of consumer price inflation. Moreover, I have attempted to explain how, when Credit expands, this finance flows into the economy before much of it finds its way out into the “global pool of speculative finance.” I have further argued that this ever-expanding pool of unwieldy finance is this Credit Bubble cycle’s most dangerous inflationary manifestation. The Greenspan Federal Reserve sold its soul back during the 1998 bailout of Long-Term Capital Management. Even prior to 1998, Fannie and Freddie had been playing the critical role as liquidity backstop to the hedge fund community in the event of market stress. I wrote some years ago that speculators could take highly-leveraged positions in MBS, confident that the GSEs were at anytime willing to pay top dollar for this paper – especially during bouts of market tumult. The Federal Reserve took a decidedly more “activist” approach to market interventions during the 2001/2002 corporate debt crisis and recession. After reading Dr. Bernanke’s and others’ “inflationists” writings, I recall a CBB about a decade back where I suggested that the Fed was determined to have hedge funds unwind their short positions in Ford and other corporate bonds - and furthermore entice them into going (leveraged) long. And, sure enough, the funds did adjust and made a ton of money. The Fed was subtler back then, but they were sowing the seeds for the recent backdrop where they’ve essentially guaranteed anyone that speculates in MBS or Treasury securities (corporate bonds, municipals debt, equities?) seemingly risk-free speculative returns.
I was always impressed that ECB President Jean-Claude Trichet would categorically – and repeatedly - state that “the ECB never pre-commits on interest rates.” The Fed has for years now operated otherwise, believing it advantageous to signal its intentions specifically to the marketplace. This has proved quite advantageous for some, but clearly much to the disadvantage of system stability. The ECB seemed to better appreciate that illuminating too much to the speculator community would simply ensure destabilizing speculation – and attendant Bubbles – based on the expected course of ECB policymaking.
Betting on the predictable path of Federal Reserve policy must by now be one of the more lucrative endeavors in history. In a CBB a decade ago, I made a flippant comment about the financial and economic landscape, writing “The titans of industry run money.” Never did I imagine back then that hedge fund assets were on their way to $2.2 TN, Pimco to $1.7 TN and Blackrock to $3.6 TN. Betting successfully on Fed policy has created billionaires . And, more importantly, those that have played this extraordinary policymaking backdrop most adroitly today control unimaginable sums of financial assets – in the hundreds of billions and even Trillions. There’s been nothing comparable in terms of the concentration of financial power and speculation since the late-twenties.
Ironically, this historic financial windfall even accelerated following 2008’s near financial collapse, as policy effects on financial markets reached only greater dimensions. Those that played it most successfully amassed only more incredible fortunes. And the stakes over just the past few months have been enormous. And those with the best sense – or, more likely, the best information – of how things were going to play out in Frankfurt and Washington added further to their kitties. And, predictably, additional assets to manage flow to the victors. ECB President Mario Draghi is clearly a very intelligent man. He is an MIT trained economist with the most impressive credentials. He has decades of experience as a professor, World Bank official and governor of the Bank of Italy. Mr. Draghi was also a vice chairman at Goldman Sachs for several years (2002-2005). Clearly, Draghi understands markets and the dynamics of speculative finance. When he warned against betting against the euro and European bonds the marketplace took notice. Amazingly, the ECB has gone from being adamantly opposed to pre-committing on rates to openly determined to pre-commit to huge open-ended market interventions and price support operations. After holding out, the ECB finally sold its soul – and the speculators have been giddy.
Bill Gross has been rather open about it: “We’re buying what the Fed and ECB are buying.” And Mr. Gross and others have been buying Spanish and Italian bonds, with a brilliant plan to sell them back to the ECB at higher prices. There’s a very large global contingent keen to place such bets, after similar trades in U.S. Treasuries and MBS have made gazillions.
In the face of alarming economic deterioration, European debt has become a hot commodity. The euro has become a hot currency. Reuters reported Thursday that the euro zone is considering a bond insurance plan. The idea is for the ESM to “guarantee the first 20 to 30% of each new bond issued by Spain.” Friday from Reuters (Andreas Framke): “The European Central Bank envisions buying large volumes of sovereign bonds for a period of one to two months once its ‘OMT’ programme is launched…”
From those among us questioning how the euro can trade so resiliently in the face of potential financial and economic calamity, I have this thought: The Draghi Plan has been in the process of transforming Spanish, Portuguese, Italian and other problematic debt into possibly the most appealing speculative asset in the world today. After all, all this paper provides a relatively decent yields (especially in comparison to bunds, Treasuries, or securities funding costs), and now at least the 1-3 year debt enjoys a commitment of open-ended liquidity/price support from the ECB. If the Draghi Plan does transform this debt from a fundamentally attractive short to a must have speculative long in the eyes of the powerful leveraged players, well, then the Draghi Plan truly has been a “game changer.”
There’s a lot that will likely go really wrong in Europe, perhaps even in the short-term. Greece is an unmitigated disaster, and Spain is running a close second. There was further dismal economic news this week, most notably from France. But that hasn’t in the least diminished recent keen speculative interest in European debt. Indeed, after the Fed sold its soul, I’ve often believed that the speculators became adept at recognizing periods of rising systemic stress and market vulnerability as opportunities to load up on Treasuries and MBS. And then it becomes a game: “OK Federal Reserve, make the value of these securities (or spread trades) go up or we’ll dump them.” They haven’t had to dump. The ECB has similarly opened itself up to blackmail. “Be ready with the OMT as promised - or we dump.” “Spanish and Italian politicians, play ball or we’ll dump.” “Mr. Weidmann and the Bundesbank, fall in line - or we dump!” “All policymakers everywhere, play or we dump.” At least in Europe, this is developing into one fascinating multifaceted game of chicken.Well, I’ve been ranting for awhile now about the “biggest Bubble in the history of mankind.” At this point, things increasingly remind me of 1999 and 2006. Bubble Dynamics eventually reach a degree of excess that is too conspicuous to deny. Yet the stakes are so much greater today. The amount of global debt is so huge and the quality so poor. It’s completely systemic and global. Dangerous excesses have gravitated to the core of Credit and monetary systems. Policymakers are now “all in” in a desperate gambit to hold financial and economic fragility at bay. And, dangerously, highly speculative markets seem determined to extend their divergent path from economic fundamentals. It’s frightening how enormous and enormously powerful dysfunctional global markets have become.
****
Global Credit Watch:
October 4 – Bloomberg (Ben Sills): “Liabilities that the Spanish government has held off its balance sheet are winding up on the taxpayers’ tab, threatening Prime Minister Mariano Rajoy’s efforts to haul the economy out of a five-year slump. Government debt will leap 17 percentage points to 85% of gross domestic product this year as the state absorbs the cost of bailing out banks, the power system and public contractors… The government, which offered guarantees and implicit backing to power users and local administrations through the economic boom that ended in 2008, has added to its liabilities during the crisis with the rescues of banks, regions and companies.”
October 2 – Bloomberg (Dakin Campbell): “Spain’s banks face a capital shortfall that could climb to 105 billion euros ($135bn), almost double the estimate the government provided last week, according to Moody’s… The nation’s lenders may need infusions of 70 billion euros to 105 billion euros to absorb losses and still keep capital ratios above thresholds outlined in legislation last year, Moody’s analysts wrote… ‘The recapitalization amounts published by Spain are below what we estimate are needed for Spanish banks to maintain stability in our adverse and highly adverse scenarios,’ the analysts, Maria Jose Mori and Alberto Postigo, said…”
October 5 – CNBC (Holly Ellyatt): “You know that something is seriously wrong with your economy when you tell an audience of learned academics and students at an elite university that your country doesn’t need a bailout, and the room rings with the sound of laughter. That’s what happened when Spanish finance minister Luis de Guindos took to the stage at the London School of Economics (LSE) and became an unexpected comic figure… ‘Spain doesn’t need a bailout at all,’ de Guindos said, straight faced and somber, as mirth spread throughout the audience…”
October 5 – Bloomberg (Angeline Benoit): “Spain said it’s studying European procedures to intervene on secondary debt markets as the euro area’s fourth-largest economy is ‘penalized’ by doubts about the region’s single currency. ‘In Europe, these interventions on secondary debt markets are more complex, they involve more complex procedures,’ Deputy Economy Minister Fernando Jimenez Latorre told lawmakers in Madrid today, contrasting them with the ‘fast’ and ‘significant’ responses to market tensions of central banks in the U.S., the U.K. and Japan.”
October 4 – Bloomberg (Gabi Thesing and Jeff Black): “Mario Draghi is waiting for Spain to get back to him on whether his plan to save the euro is needed. One month after the European Central Bank president unveiled an unprecedented bond purchase program to rescue Europe’s embattled southern fringe, Spanish Prime Minister Mariano Rajoy is showing reluctance to ask for the aid he pushed for with Italy on concern about the terms attached to it… ‘We’re back at this game of brinkmanship between the ECB and governments again, and it’s a case of who makes some concessions first,’ said Nick Matthews, senior European economist at Nomura… in London. ‘The markets will continue to play a significant role here and Draghi needs them to turn up the pressure.’”
October 3 – Bloomberg (Lisa Abramowicz): “Pacific Investment Management Co. and BlackRock Inc. are among U.S. investors buying up bank bonds in Europe’s most indebted nations as central-bank chief Mario Draghi wins back the confidence of the world’s biggest money managers.”
October 4 – Bloomberg (Ben Sills): “Spain was told by Europe’s economic overseers that its 2013 plan to cut the deficit to 4.5% of gross domestic product relies on excessively optimistic assumptions, two people familiar with the issue said… Spain’s 2013 budget assumes the economy will shrink 0.5%, less than the 1.3% contraction predicted by 21 analysts surveyed by Bloomberg…”
October 1 – Bloomberg (Patrick Donahue): “Europe faces a month that may decide the success of the European Central Bank’s bid to end the debt crisis as leaders navigate a tougher approach from creditor countries, unrest in Spain and a looming report on Greece. With the first of three summit meetings that European Union President Herman Van Rompuy has called ‘crucial’ taking place in Brussels on Oct. 18-19, investor sentiment toward the euro area that surged in September is on the wane.”
October 5 – Bloomberg (Gonzalo Vina and Emma Ross-Thomas): “Spain is already carrying out the policies that the European Central Bank would demand in return for buying its bonds, Economy Minister Luis de Guindos said as young Spaniards heckled him during a speech in London… He described the ECB’s plan to buy bonds of nations that agree to a rescue program as a ‘proposal’ tied to conditions that ‘aren’t very far from the situation we have now in Spain’ in terms of budgetary and economic policy.”
October 3 – Bloomberg (Charles Penty and Angeline Benoit): “Spain wants banks, insurers and other investors to control its so-called bad bank, a vehicle that will drive down house prices, Economy Minister Luis de Guindos said. ‘The bad bank is going to acquire assets at very conservative prices, and I believe it’s going to make the real estate market more dynamic in Spain and it is going to put homes on the market at lower prices,’ de Guindos told a parliamentary committee…”
October 5 – Bloomberg (Sandrine Rastello): “The International Monetary Fund won’t disburse its share of the Greek bailout if the country’s debt is not deemed sustainable or if other creditors don’t pledge to fill a financing gap in the aid package, a fund spokesman said. IMF Managing Director Christine Lagarde last week warned that the level of Greek debt would have ‘to be addressed,’ pushing European policy makers to consider writing off some of the aid to the country. While the fund is sticking to a target of 120% of gross domestic product by 2020, the Greek government forecast this week that… debt will climb to 179.3% of GDP in 2013.”
October 2 – Bloomberg (Scott Rose): “UBS AG Chairman and former European Central Bank Governing Council member Axel Weber said the euro region’s festering debt crisis will ‘continue to linger’ as the ECB fails to ease market disquiet and volatility. ‘While many expect that the ECB’s strong action would bring stability to financial markets, the risk is that the pattern of short-term rallies and long-term uncertainty will stay with us for some future,’ Weber said… Weber, who during his tenure at the ECB opposed the central bank’s previous bond-buying plan, predicted the monetary union will overcome the crisis even as there won’t be a “quick fix.” ‘The underlying fundamental perspective is not great at the moment… Austerity programs which are badly needed to restore market confidence and create fiscal room to maneuver will take a toll on the economy.”
October 5 – Bloomberg (Rodney Jefferson and Lukanyo Mnyanda): “Europe’s sovereign debt crisis is making the clocks tick faster for Scottish money managers. ‘This is not 18-month asset allocation territory, it’s 18 days perhaps,’ Andrew Milligan, head of strategy at Standard Life, said… ‘There’s money to be made at different times in the relative spreads of different bonds.’ As fissures widen in the euro region, investors who typically bet on long-term trends in the fixed-income market are becoming more nimble and switching more frequently…”
October 5 – Bloomberg (Rodney Jefferson and Lukanyo Mnyanda): “Europe’s sovereign debt crisis is making the clocks tick faster for Scottish money managers. ‘This is not 18-month asset allocation territory, it’s 18 days perhaps,’ Andrew Milligan, head of strategy at Standard Life, said… ‘There’s money to be made at different times in the relative spreads of different bonds.’ As fissures widen in the euro region, investors who typically bet on long-term trends in the fixed-income market are becoming more nimble and switching more frequently…”
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