HOW QUICKLY GREED TURNS TO FEAR
As the market complacently melted higher we continued to warn investors of the increasing three headed risks in the market. The combination of China tightening, financial regulation and Greek sovereign debt continued to weigh over foreign markets and U.S. investors just continued to live in their domestic bubble where nothing matters besides how many iPads Apple sells on any given day. Of course, that complacency is quickly catching up to investors. As a risk manager this is my primary goal here at the site – not always to highlight the next best opportunity, but to help you keep from getting your face ripped off. My first short positions in over two years were not implemented due to some crystal ball I have hidden away in my desk, but due to pure risk management. The environment of the last two months has been rife with complacency. Unfortunately, the situation is little improved across the globe as more government intervention proves to do little in helping matters.
The situation has deteriorated in Europe over the course of the last 24 hours as spreads in European sovereigns continued to blow out today. My guess is that Trichet is in Berlin today having his Hank Paulson moment – down on one knee in front of a powerful woman (Merkel) begging for her to accept his proposal of “going nuclear”, i.e., buying bonds. I can only imagine how the German heads of the Bundesbank must be feeling right now. Disgusted is the only way they can feel. Do they try to save the EMU or do they potentially inflate themselves into an even larger mess while imposing harsh fiscal austerity measures on member nations that almost guarantee depression? There truly are no good answers here.
The scariest part of this whole fiasco is that we might very well be seeing what I have predicted for years – the actual demise of the Euro. This is practically unprecedented. How would the nations even go about dissolving the EMU? Surely Germany must be considering the ways in which they could defect without causing collapse. For Greece, defection appears like a no-brainer though their no-brained leaders might not have realized this yet. From the German perspective, the rules have already been broken so all options must be laid on the table at this point. Saving the current currency format only destabilizes prices while saving a flawed system. There is no true “unity” here and I firmly believe each nation must do what is in its best interest. Natural selection is alive and well and must be respected.
The problems in Europe are potentially more frightening than the credit crisis and the failure of Lehman Brothers. This is a truly unprecedented set of events as we are now seeing the Euro for what it is – fatally flawed and unworkable going forward. The dissolution of the Euro has to be considered an option now and the complexity of such a move certainly has member nations shaking in their boots. Unfortunately, the alternatives do nothing to address the inherent flaws within the system. I think it’s time to impose some fiscal austerity on bondholders instead of forcing Main Street into depression. In other words, it’s best to take the medicine now as opposed to allowing this crisis to spread or pop up at a later date – which it will. It’s a true shame that we have become a world that values bankers more than Average Joes.
I still find it hard to believe that the member nations will find the wherewithal to shoot down the ECB’s pleas to buy bonds. This likely means we will drive Europe into recession, budget deficits will INCREASE and we will revisit these issues at some later date. This really is looking more and more like Bear Stearns all over again. Perhaps for once, those in power will do what is in the best long-term interest of all involved as opposed to ensuring that bankers meet their quarterly estimates. Thus far, the signs still point to a world by bankers for bankers. And that means painful fiscal austerity for all of Main Street Europe.
why do you think that the ECB has to print money? The saving rate in th EU is 15%, where should all the money go if not into government bonds? German consumers don’t lever up and the consumers in countries with a housing bubble pay down debt (I assume). If we will have 1-2% growth in europe for the next few years, there won’t be much credit demand from companies either, so where do all those savings go?
Is the demand actually there? Who is buying bonds from Greece right now? No one. I think TPC is saying that the lender of last resort is about to step in.
Who’s buying Greek bonds?
http://ftalphaville.ft.com/blog/2010/05/04/218026/whos-buying-greek-bonds/
But nobody else has to buy greek bonds because they already have the 110 bn package from the EU/IMF which finances their deficit for the next 2-3 years
btw. no, greece can’t default and introduce its own currency
http://www.voxeu.org/index.php?q=node/729
The problem is not Greece any longer.
And yes, Greece can do whatever they want just like the ECB decided to effectively break the Maastricht. The rules have bee thrown out the window and if they buy bonds the rules have been stomped and spat on.
Ironically, dissolution is the best long-term solution anyhow.
Obviously, there is very little demand for Greek bonds as the interest rates continue to skyrocket. That’s part of the problem here. Those 15 guys aren’t helping much.
Besides, as TPC already said the problem is now much bigger than just Greece and the original Greek bailout now looks like a waste.
tell me where the 15% annual savings of europe will go.
and no, I don’t think that the problem is much bigger than greece now. Who cares about Credit Default Swaps? Can the countries (except greece) borrow money on the market or can’t they borrow? Do they have to pay a premium to german bunds? Yes, but I would argue that german bunds are traded at ridiculous levels. If you count in inflation, germany is paying nothing for its debt.
Liquidity can only hide solvency issues for so long. At some point people remember to value their return OF their capital, not just the promised return on it!
It will sit in banks. Why does it need to go into Greek bonds?
Yep.
So the choice is EMU or IMF buy bonds = kick the can = save the banks. Or Greece defaults or leave EMU and devalues = banks and bond holders take the hit. Do I have that right? I’m guessing either way the Greek citizans are also going to take a hit. So is this why they formed the EMU and tied themselves to a single currency in the first place, to prevent the government from bailing out the big business? If that is the case and Greece does choose to default then maybe it’s not such a failed experiment after all. Unfortunately I’m guessing after the election Merkel will change her tune to kick the can.
You got it right.
I don’t see how Germany can watch all this go down and justify continuing this experiment. It’s not working for them. A Greek defection strikes me as an obvious, but again, I don’t think any of them are willing to take the risk of unwinding the EMU. That means we kick the can and it takes a much larger event to wake them up.
And let’s not forget it’s German elections next week. I’m still somewhat surprised that some opportunist politician hasn’t come out and suggested that Germany should leave the Euro…
Agreed. No matter how badly a system should fail, it will take more than one stroke to put it down.
Amen. Bondholders need to do principal write-downs.
Unfortunately government systems have become infected with special interests, transforming governments into vehicles whereby only they can drive.
We have witnessed a worldwide, colossal mis-allocation of investment resources, investment decisions made by men and women of influence of public funds trading off investments in education, research and public capital projects to sustain the countries prosperity for short term financial schemes that enrich only the schemers.
Those observers who have watched this unfold over the past 30 years should not be mystified in the reaction of citizens and the refusal to be subjected to austerity measures to pay off those who are privileged.
You don’t need a neo-classical economics education but only to experience live and people to understand the current events now unfolding.
ALAN GREENSPAN HAS REDEFINED EINSTEINS DEFINITION OF INSANITY.
“We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand,” Greenspan said, according to the transcripts of a March 2004 meeting.
Testimony to Congress in October 2008:
“I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms,” Greenspan said.
Waxman pushed the former Fed chief, who left office in 2006, to clarify his explanation.
“In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said.
“Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
Greece (as a sovereign debtor) will be solved like all insolvencies, blaming the Euro or talking about the demise of the Euro is a convenience but not a necessicty. Work-out will be: (a) writedown, (b) debt-for-equity swap (higher taxes), (c) devaluation (wage and price controls, capital controls etc.). (b) will result in massive civil unrest and inflation. Greece is toast. (c) will be the start of the great European bank run. Ironically, the Greek tradgedy like Weimar Germany will result in the rise of an ultra-right wing Greek idealogue who will invade Poland and then Germany in 2039. Germany will be powerless as their Turks will all leave to invade Macedonia and no one will around to build Panzers.
Great post TPC. No matter how you cut it, the EU looks like its going down that road. Germany leaving would signal a collapse I think.
During the early stages of the financial crisis where liquidity dried up, I recall seeing a trickly of redemptions in funds. Managers would react by selling their most liquid investments first to satisfy the redemption. Unforunately, what was remaining was the illiquid stuff that was the worst performers. So the investors who stuck by their manager were the ones who suffered the most. Whoever was last to the redemption door was the fool and had the worst of it.
This is what would happen with Germany, the strongest economy, leaving. Anyone holding Eurodollars would own the worst of whats left. At that point, people will be sprinting toward the exit signs and collapse would be imminent.
This is getting ugly.
So what’s the play here? We all know they won’t defect, because, as you say they will first try to bail everyone out.
So they will announce a huge QE program and markets will simmer down. Then analysts will run the numbers and realize that the debt problem still exists. Then default becomes the only option. So the question is, are we really seeing Bear Stearns v. 2.0? Does the Greek trageedy climax this Fall in a spectacular default?
TPC: loved the post, but thought your ending got a little “populist”. You said… “Thus far, the signs still point to a world by bankers for bankers. And that means painful fiscal austerity for all of Main Street Europe”
It seems to me the “Average Joes” of Greece have been putting one over on the world and the Eurozone for a while now. It seems they have a bloated municipal workforce, a severely overpaid municipal workforce, an early retiring municipal worforce, and a mostly tax evading population. It seems to me in Greece, the Average Joes have pulled a fast one on the bankers, and are now rioting so as to not even have to pay the bill for the party they’ve been having on everyone else in the Euro’s dime.
But, also, I do agree that money poorly lent should be allowed to blow up. So, I agree the bankers who lent money should be free to lose that money. Maybe in the future they won’t mindlessly let freeloading, poorly managed countries have access to the credit markets.
Europe is the bastion of big government spending. Many of these systems seem rotten. Imagine if they were also forced to have a budget that could field legitimate armies for self defense.