Another weekly letter by John Hussman that contains several nuggets of insight. Right off the bat, he makes it clear that conditions have turned decisively negative, in his view.
The current situation is "characterized by an extremely unfavorable ensemble of conditions across valuations, sentiment, economic factors, and other conditions. Current conditions cluster with periods such as May 1962, October 1973, July 2001, and December 2007, all of which produced 10-20% market losses in extremely short order."
Dr J notes the increasing disparity between the leading indicators that his firm and ECRI tracks, which now signal an extremely high probability of US recession, and the prognostications of mainstream forecasters and pundits.
He notes some exchange between a Bloomber interviewer and ECRI's, Lakshman Achuthan:
Bloomber interviewer: [ECRI recently made] a recession call. What happened?
Achuthan: It's happening.
Suggests significant cognitive dissonance out there regarding recession chances.
He also notes that the EU summit last week did (and can do) little to avert the central condition of credit crisis: solvency. Solvency is a shortfall between money owed and the resources needed to credibly repay it. Emphasis on 'credibly.' Printing money to pay back debts in devalued currency is not a credible strategy--at least in the eyes of creditors...
John suggests that perhaps one credible means for relieving stress in the EU is for countries to issue convertible sovereign bonds as they roll debt. The bonds would be convertible into the currency of the issuer at the option of the issuing government. Those countries with shaky fiscal houses would be required to pay a significant premium in order to compensate bond buyers for the commensurate risk.
Over time, John suggests, convertible debt might relieve the acute pressure that has built in the EU system. EU members would need to achieve sufficient financial credibility to remain in the EU system, lest they be subject to huge premiums on debt issued. The need for questionable bureaucratic enforcement mechanisms would be reduced. John suggests, "If the system can be saved, it will be saved" under such an arrangement.
One problem, of course, is that the significant discount that many EU countries currently enjoy by issuing debt under the implicit backing of the EU umbrella would vanish. Those countries would be forced to pay up and/or get their fiscal houses in order.
Market forces hate moral hazard...
position in SPX
Showing posts with label moral hazard. Show all posts
Showing posts with label moral hazard. Show all posts
Monday, December 12, 2011
Monday, December 5, 2011
Bail Out Mentality
Another sage letter by Dr J. In the front half he makes a compelling argument for a recession given the position of his forward looking indicators.
In the back half he discusses the EU situation given last week's 'coordinated' move by central banks. He reminds once again that the issue is one of solvency rather than of liquidity. Last week's coordinated dollar swap program is a short term measure aimed at boosting liquidity.
To remedy the solvency problem, it is likely that either banks fail or non-bank holders of EU debt must take haircuts. Thus far, no one wants to do that.
John ends with a section called "We represent the Lollipop Guild." His thoughts here are so wonderfully collected that I want to capture them here in their entirety:
"Frankly, I am concerned that Wall Street is becoming little more than a glorified crack house. Day after day, the sole focus of Wall Street is on more sugar, stronger sugar, Big Bazookas of sugar, unlimited sugar, and anything that will get somebody to deliver the sugar faster. This is like offering a lollipop to quiet down a 2-year old throwing a tantrum, and expecting that the result will be fewer tantrums.
"What we have increasingly observed over the past decade is nothing but the gradual destruction of the ability of the financial markets to allocate capital for the benefit of future growth. By preventing the natural discipline of the markets to impose losses on the poor stewards of capital, and to impose interest rates high enough to force debtors to allocate the capital usefully, the world's policy makers are increasingly wrecking the prospects for long-term economic growth. The world's standard of living (what we can consumer for the work we do) is intimately tied to its productivity (what we can produce for the work we do). That productivity requires scarce savings to be allocated to productive physical capital, and to productive human capital (primarily education).
"Nietzsche famously said, 'What does not kill me makes me stronger.' The corollary is 'What constantly rescues me makes me weaker.' The world will only stop looking for bailouts when policy makers stop handing them out."
Re-read until you understand.
In the back half he discusses the EU situation given last week's 'coordinated' move by central banks. He reminds once again that the issue is one of solvency rather than of liquidity. Last week's coordinated dollar swap program is a short term measure aimed at boosting liquidity.
To remedy the solvency problem, it is likely that either banks fail or non-bank holders of EU debt must take haircuts. Thus far, no one wants to do that.
John ends with a section called "We represent the Lollipop Guild." His thoughts here are so wonderfully collected that I want to capture them here in their entirety:
"Frankly, I am concerned that Wall Street is becoming little more than a glorified crack house. Day after day, the sole focus of Wall Street is on more sugar, stronger sugar, Big Bazookas of sugar, unlimited sugar, and anything that will get somebody to deliver the sugar faster. This is like offering a lollipop to quiet down a 2-year old throwing a tantrum, and expecting that the result will be fewer tantrums.
"What we have increasingly observed over the past decade is nothing but the gradual destruction of the ability of the financial markets to allocate capital for the benefit of future growth. By preventing the natural discipline of the markets to impose losses on the poor stewards of capital, and to impose interest rates high enough to force debtors to allocate the capital usefully, the world's policy makers are increasingly wrecking the prospects for long-term economic growth. The world's standard of living (what we can consumer for the work we do) is intimately tied to its productivity (what we can produce for the work we do). That productivity requires scarce savings to be allocated to productive physical capital, and to productive human capital (primarily education).
"Nietzsche famously said, 'What does not kill me makes me stronger.' The corollary is 'What constantly rescues me makes me weaker.' The world will only stop looking for bailouts when policy makers stop handing them out."
Re-read until you understand.
Thursday, September 15, 2011
EU Bank Bailout
This morning, a 'syndicate' of central banks stepped in to promise loans to European banks that are having trouble staying solvent. The announcement sent markets higher world wide. Euro bank stocks ripped 8-10% on the news.
The situation is similar to late 2008 when the Fed opened the uber cheap credit window to crippled US banks. Ironically, today is the third anniversary of the Lehman collapse.
Initiation of yet another bail out has stock buyers giddy today as morale hazard takes control. However, when market participants pause to consider just how dire the situation must be to motivate coordinated central bank intervention, perhaps their mood will change.
position in SPX
The situation is similar to late 2008 when the Fed opened the uber cheap credit window to crippled US banks. Ironically, today is the third anniversary of the Lehman collapse.
Initiation of yet another bail out has stock buyers giddy today as morale hazard takes control. However, when market participants pause to consider just how dire the situation must be to motivate coordinated central bank intervention, perhaps their mood will change.
position in SPX
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