Friday, September 19, 2008

A Message In Bold...And Another To M. Trichet

There's not much that Macro Man can write that you probably don't already know: markets are completely, utterly broken. Liquidity is nonexistent, in some cases literally, which naturally exacerbates the volatility which we are all observing.

While an RTC II is a welcome and obvious solution to many of the current problems, blaming short sellers and engaging in witch hunts are not. That policymakers seem to be opting for both reduces the integrity of the market.

Macro Man isn't able to write any more this morning, so below he leaves you with the post he wrote yesterday afternoon when it looked like the financial world was going to end (though in many ways, it looks even more so today.)

While it may not carry the immediacy that it had when he wrote it, its basic premise nevertheless applies. It's short and sweet. Enjoy....

"The ECB is a credible anchor of stability and confidence for 320 million citizens of the euro area."
Jean-Claude Trichet, 18 July 2008

"We have only one needle in our compass. That needle is price stability, our definition of price stability."
- Jean-Claude Trichet, 7 August 2008

Monsieur Trichet: 320 million Europeans say, "Look at the ****ing compass, you arrogant git!"


dblwyo said...

Well obviously y'all are up and running while some of us are still up and wheeping. For some erudite and witty commentary may I highly recommend:

And for some crude colonial humor courtesy of Jon Stewart may I lowly recommend:

Guilherme Diaz-Bérrio said...

First of all, let me say that you are on my list of "to read in the morning" blogs (in the company of Naked Capitalism, Alea, Big Picture and Brad Setser), and that I agree with most of your opinions...(and this witch hunt on short selling is really getting out of hand... why not ban sales alltogether?!)

Though in this case I must disagree with you on 2 topics:
The RTC II is as bad idea as was the "super SIV" one. If history serves me right - I am a young 24 year old trader, after all - the orginal RTC was very different. It had the assets of failed S&Ls in it's possetion.
Building a holding to sell them was the obvious and correct way to go. This is not the case here, from what I am reading.

This new idea seems to be "buy bad assets from banks" at a discount and sell them later. Correct me if I'm wrong but, isn't this another "warehouse" theory? (And we all know how the Feds balance sheet looks like from that theory, and how that gave no easing to the crisis). Quoting Ives Smith on Naked Capitalism, "it's like giving a blood transfusation to a dying man".

The japanese play book was the wrong one to pick (if one needed to pick one, at least the Fed could have picked the sweedish playbook for solving a financial meltdown). The results are here: the T-bill has traded since monday at near 0% yield... now, if my monetary policy doesn't fail me, that's text book liquidity trap, and Bernanke has now no intermidiate option between keeping rates at 2% or go all "quantitative easing, we have ZIRP", japanese style...

As for the ECB, I am an european. I come from Portugal, one of the PIGS that will suffer the most (in an ajustment that only came "too late"). Yet, I can't agree with you. Not entering into the fact that recessions should not be avoided - people only save and re-prioritize when they face one, and it is a necessary udjastment - cuting rates in Europe would little do to no good, like it did little to no good in the US.

The problem is, in my opinion, banks overlevered balance sheets facing an overlevered consumer basis. No ammount of rate cutting can save that one...

I may be wrong - I am only 24 :P - but that's how I see it from my trading desk here in Lisbon.

Keep up the good work/blog, and good trades in the middle of this chaos ;)

Anonymous said...

Good morning, MM

I hardly splept this night after RTC II theme got the whole scene and f***ed my bet on growing risk aversion. Well, shame on me! I should have factored in the "DEUS EX MACHINA" surprise...

Have a nice day, AT

CV said...

An apt message MM ...

The next big macro theme in Europe will be deflation in (Spain, italy, and parts of eastern europe). If Germany does not grow in q3, I would put that on my list too.


RebelEconomist said...


I agree with you. I have a feeling that the more conservative approach taken by the ECB is going to be more highly regarded in retrospect.

Team 1250 stikes back! said...

Just look at the SPX furures....

Manc Trader said...

I agree with Rebel Economist and diaz-berrio.
I am also curious about the short selling debate.
I short stocks myself and think its an important part of the market.
If there were no short sellers what's to prevent longs from manipulating prices of the financials to send false signals to the market causing more misallocations of capital.
That said at really big money levels there could be some nasty stuff going on.
Cramer claims that shorts like himself in the past can create self fulfilling death spirals in stocks.
If this is correct then the asians were probably right about their paranoia of hedge funds targeting their markets with predatory short selling tactics.
Neiderhoffer also believes in high level manipulations to take money from the weak to pay for the infrastructure ala horse track bettors paying for the upkeep of the race tracks, horses, stables etc.
Don't know for sure what to think but doesn't seem as obvious to me the role of short selling at the big manipulative levels.

Anonymous said...


could someone elaborate on this?

RebelEconomist said...


What is the source? It sounds like it is referring to the US reserves to me. Since the US does not hold much in currency reserves, it could mean gold. This might explain why gold is, according to Bloomberg, down today, which strikes me as a completely barking mad reaction to the RTC2.

Macro Trading Ideas said...

About ECB, their action until now have exacerbated the evolution of inflation, they act always too late.
They're action must be countercyclical otherwise it's like to buy highs and sell lows.
But about inflation, to their excuse, we're seeing a real inaction of govenment and a slowly, but we will see briefly how much, inelasticity of consumer demand curve.
Ecb must be worried also by high interest rate paid by govt debt in a recessionary environment: we're near fiscal breakout.

Anonymous said...

it is part of this money market plan, did get this first though

07:37 19Sep08 -TEXT-U.S. Treasury on money market guaranty program
WASHINGTON, Sept 19 (Reuters) - The U.S. Treasury Department issued the following statement on Thursday:
The U.S. Treasury Department today announced the establishment of a temporary guaranty program for the U.S. money market mutual fund industry. For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund both retail and institutional that pays a fee to participate in the program.
President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund for up to $50 billion to guarantee the payment in the circumstances described below.
Money market funds play an important role as a savings and investment vehicle for many Americans; they are also a fundamental source of financing for our capital markets and financial institutions. Maintaining confidence in the money market fund industry is critical to protecting the integrity and stability of the global financial system.
Concerns about the net asset value of money market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains in world markets. In turn, these pressures have caused a spike in some short term interest and funding rates, and significantly heightened volatility in exchange markets. Absent the provision of such financing, there is a substantial risk of further heightened global instability.
Maintenance of the standard $1 net asset value for money market mutual funds is important to investors. If the net asset value for a fund falls below $1, this undermines investor confidence. The program provides support to investors in funds that participate in the program and those funds will not "break the buck".
This action should enhance market confidence and alleviate investors' concerns about the ability for money market mutual funds to absorb a loss. Investors in money market mutual funds with a net asset value that falls below $1 would be notified that their fund triggered the insurance program.
The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934. This Act authorizes the Secretary of the Treasury, with the approval of the President, "to deal in gold, foreign exchange, and other instruments of credit and securities" consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at .

RebelEconomist said...

anonymous at 13.04,

Thanks for the source. I am afraid it does not shed much light on the background though. As would be expected, the US reserves are in foreign currency and gold, so they cannot be directly used for dollar lending. Perhaps the plan is to repo them (eg bunds) to raise dollars though.

Anonymous said...

I'm back in the USSA
You don't know how unlucky you are, boy

Anonymous said...



Anonymous said...

I love your blog but rightly or wrongly, I perceive your comments to be driven by p/l panic.
Trichet is very much culpable (as are all policymakers that have allowed the financial industry to run amok with ludicrous risk profiles). However, to link July's comments with today's volatility pushes the envelope too much. If you have no liquidity to trade then you should not have taken the position , inefficient pricing will never disappear completely. Kinda reminds me of the sub-prime club blaming the market for their losses?
Regulation is coming and I can't wait to hear the whinging.

mikarsky said...

I don’t know if those suggesting ECB rate cuts are actually living in some of the major Euro economies. Unemployment is at all-time lows, there wasn’t any serious asset deflation, credit conditions are relatively good through it’s harder for smaller firms to get credit. In other words, business as usual but depressed by development overseas – you can call it partial decoupling.

The ECB unlike the FED accepts a contraction, after all US consumption dropped out on the demand side and therefore contraction is inevitable. The contraction will do its part to reduce demand for credit, thus making a credit squeeze unlikely. At the same time, the USD system dives and oil and commodities may sooner than later rise. The ECB has absolutely ALL arguments behind it for now.

RE the exchange stabilization fund, it is used to intervene in currency markets. If they take money from the fund to back up dodgy holdings, it means they are confident they not needing the money to support the USD.

dsth_treharneassociates said...

Mikarsky and Guilherme (old head on young shoulders) are right about Trichet. If any central banker is going to come out of this sordid mess with a half-decent reputation in place (a big 'if'), it's likely to be JCT.

MM: although your attitude towards monetary rectitude (I think there's a cream available for that) is sometimes a bit too transatlantic for some of us stodgier Europeans, your blog is a must-read. Thanks for taking the time to share your thoughts.

D said...

Defaulting debt means stronger dollar strangely enough. Most of the dollars out there are of the commercial bank variety.


Anonymous said...

so where is the mega RTC?

and now... PANIC

Anonymous said...

I don't follow this crusade against short selling. Lehman did not fail because its stock was pushed down but because its balance sheet couldn't stand up.

Mencius Moldbug said...

Response: there's another compass...

Question: how does a short financial ETF (ie, SKF) even continue to operate in this environment? Its old positions remain, but it cannot open new ones? If so, will the price of the ETF diverge from the indicative value? I suppose it will, won't it?

Anonymous said...

re short selling, to me looks like mkt manipulation that goes against mkt functioning principles, but also unhelpful. Long only players mkt hasn't good prospects. Bear mkt happen because of longs capitulation.
this is a bear mkt rally in my view

re ECB these guys have been slow to anticipate inflation surge in first place, then the succumb of european cicle to multiple headwinds (and they are still looking for a q4 recovery), and now the slowing trend of inflation due to oil and recession.
To judge if fed cuts were useful or not you should be able to figure what would be the senario with FF stuck at 5.25%. Not pretty is my guess.

sick trader

Mencius Moldbug said...

BTW, the ESF features prominently in the still-mysterious Virgil Mattingly episode, beloved of gold conspiracy theorists. Could that $50 billion be in gold certificates - valued at $42 per ounce?

Mencius Moldbug said...

I just checked - ESF does not appear to hold any GCs at present. Of course, it has SDRs, SDRs are claims on IMF, and IMF has...

But the real concern that anyone who hopes to profit on Au/USD must have is that USG has a way to mobilize reserves covertly, whether its own or someone else's. Overt gold sales are not a realistic option and not an effective way to depress the market - it's putting out fires with gasoline.

Yesterday, of course, there was another way to bet against the US financial system. Today there isn't. Smart, guys. Very smart.

Also: note the difference between Fed and Treasury acting unilaterally under long-term Congressional authorization, and new legislation. Congress is not going to rubber-stamp this one. Their involvement in the process is not a way to increase its effectiveness. And the shock and awe might fade a little over the next week as that becomes clear.

Anonymous said...

Looks like team 1250 is gonna stick it again today...

Have never lost this much in two days ever... said...

Mr Macro. US2Y goes from 1.68 to 2,20 yield in two bout that???

And please, wake me up, is this for real???

Anonymous said...

I work for one of the large U.S. broker dealers in the U.S. that "failed." My job is not secure. I did not despair at all.

But the banning of short sales on the 800 or so financial companies on the SEC's list and requirement of hedge funds to disclose their shorts has made me more depressed than I've ever been in my life. The regulatory impact of the next 2 years is overwhelming to think about. We are all in the hands of politicians now...and this is emphatically NOT a good thing.


Anonymous said...

I agree with the previous posters in support of JCT. ~4% is historically low and definitely not restrictive. Surprise lowering of euro rates here would weaken the euro .5% that day, oil down 1% (in $), only to see both reverse 6 fold by the following week. Lowering now will exacerbate the cycle, precisely the opposite of what is intended.
Lowering rates here would also serve little purpose as the amount by which 99% of "homeowners" in trouble can't meet their mortgage payment vastly exceeds the small decrease from a lower euribor.
Having said that, unfortunately I think they will eventually lower and worldwide lower rates will get us double digit inflation by the end of 09. Very sad..

Anonymous said...

So if you don't like whats happening then what should we do ? I think they Governments had to get ahead of it. I never had a loan and I always save a good portion of my paycheck. But when I see money market accounts frozen and almost negative US Tbills then I ealize that this is better then a depression. And I am sure that if nothing was done it would of happened. Yes there will be massive inflation three years from now. So postion yourself for it and when 30 year bonds hit 14% buy them and retire to Barbados.

Anonymous said...

This week I'll give the PPT a 5.0 for execution but a 10.0 for degree of difficulty.

Anonymous said...

Roubini has a sensible proposal out. His basic point is that the roots of the problem are in the squeeze on the consumer. So, the proper solution begins with the mortgages, not at the derivatives.

I especially approve because 18 months ago, I was saying this was the right way out.

Odds of it being done sensibly? Zero would be optimistic.

But definitely read Roubini. History has some good lessons as to what works and what doesn't.

--Charles of MercuryRising

Macro Man said...

The message to JCT is sourced not from P/L considerations- I am doing reasonably well- but out of irritation at his smugness and his abject failure to acknowledge that circumstances may have changed.

European growth has slowed sharply, as has growth elsewhere in the world: fact.

Endogenous inflation in Europe has been very steady around the 2% target (at least as measured by the GDP deflator): fact.

Headline CPI has been driven largely by oil prices, and the ECB was quick to react to that in early summer: fact.

The growth outlook is fairly dim, and oil prices have fallen sharply: fact.

The facts have changed: fact.

"When the facts change, I change my mind. What do you do, sir?"

In the case of JCT, trot out the the same old bumph about second round effects and how 320 million Europens think he's the mutt's nuts.

Macro Man said...

As for short-selling restrictions, I was not aware that it was short-sellers who stuffed the financial system full of turds and called them filet-mignon.

This looks t. be something of a whistleblower syndrome, where the person who calls attention to malfeasance, rather than the perpetrator, gets blamed for the deed.

It was less than a decade ago that stock speculators were responsible for the last "once in a generation" event, when they bid dotcom stocks to farcical levels, which generated an eventul bust. How much higher would the bubble have inflated were short-selling not allowed? I don't know, but to say that you can only speculate from the long side will just open the door to further market abuse and return us to the internet bubble days of "pump and dump."

RTC2 in my view is a necessary evil because it will allow for accrfual accounting treatment of the turds, rather than a mark-to-market spiral of ever-shrinking values. Commercial banks don't mark to market their loan to Moe's Bar when Moe has a bad month, so it seems a trifle misguided to do so with some of the stuff that populates banking balance sheets these days, which carries a similar payoff profile to a loan to Moe.

Anonymous said...

Sure the facts have changed but they should have predicted that 6 months ago and at best could have lowered to 3% then. They can't chase current events with policy that has a 6-12month lag. When you get to the 1-3% area you are asking for trouble. In 6-12 months the economy bottoms around the time when his lowering now would start taking effect. I don't see how that would smoothen the cycle or keep inflation under 2-3%. The euro fell 15% as the US was lowering and he was raising so you really can't justify cuts on a currency basis either (directed at the "he's worried about oil but his raising spikes oil!" crowd). I think one has to consider exactly what effect rate changes have in the _current_ environment, rather than simply follow SOP. The costs and risks vastly outweigh the benefits at this point, imo.

Macro Trading Ideas said...

@mikarsky: do you really consider Switzerland the "average" european country??!! please go around europe and ask to the people "what's your feeling?" and you'll get the same answer: s**t!

Business as usual?? according to you if banks don't lend to themself, can they lend freely to corporation in a contractionary environment? At which costs? and if IG credit to the market pays huge spreads, HY since the beginning of the year is closed.
And, worst of all, firms have stopped all investment plans.

Retail sales in Europe are in free fall, the same industrial production: fact.
Living conditions in Europe are in free fall: fact.

A question: if a big bank in Europe fails or system destabilizes more, are we really sure that JCT could manage the situation?
What I've seen until now is that we remain in the FED's hands.........

Guilherme Diaz-Bérrio said...

Honestly, I prefer to be in the hands of the ECB than the Fed/tresury/SEC "wonder trio".

This RTC-II is just a incredably bad idea to begin with.

My point being:
We all remember the big plans for the MLEC, aka "Super SIV", and how that turned out. Potential sellers wanted "fair value" prices - fair to their balance sheets - while potencial buyers wanted "real" prices, not overvalue garbage.

This whole RTC-II, just seems to be a sequele on MLEC with two little "quirks":
1. The potential problem of "private buyers" is solved by placing taxes payers in the "dead seat";
2. It a whole lot bigger in size.

I'm memory serves me right, the Fed's Balance Sheet is 900 bln USD, give or take bln, so the RTC-II has to be of at least the same size.

A second note that worries me with this "big bailout" is the following:
This whole mess keept going precisly because banks didn't want to reveal the real price of their holdings, going as fair as not bidding or doing mark to model to level 3 holdings. Isn't this going to give an "open and public" price to those holdings? That will depress or reveal depressed prices, and last time I checked, if you have a "public price", you can't do level 3 accounting. Goldman Sachs as, for instance, enough level 3 assets to wipe out their entire equity!
We can go with the "fair value approach", but...
Who decides what the fair value is going to be? Consultants? What will be the credibility in that, as far as the US is concerned?

Even if the Fed/Tresury duo demand equity in return, you will have massive dillution on bank stocks, and we don't have the "profit taking" of the short-sellers to cushion the "fall".

And regarding the Tax Payer, again, this plan follows just like the Japan Playbook, with a significant difference: Japan had a 30% savings rate, the US is dependent on "external funding", and ultimatly on their AAA rating... how long will that hold?

Don't forget the Fed's Balance Sheet is full of dodgy assets, and they have the FNM/FRE/AIG debt to worry about (yes, it is not officially consolidated on the Federal Debt book, because they took stakes of 79,9%... but will that make a de facto difference on the risk premium investors will demand?

Can anyone see the dollar going up after this one? I may be young, but I really don't see that one coming.

And the only reason the T-bills came off from the ground, giving the FOMC some room on monetary policy, was the "insurance" of the Money Market Funds, which, for a lack of better expression "stinks of moral hazard".

And this whole short selling ban - something I have the feeling I will be telling my sons "Yes, your father was trading live on that historic momment of shier stupidity" - what will happen to the options markets?

Calls are hedged shorting the corresponding stock, by the market maker. Not being able to short financials, woun't premiums go up and liquidity dry? And puts are "extra pricy" today, because they are the only "option" to short finantials. Won't that reduce demand, and respective buying on the market to hedge the puts, by the market makers?

This adds to the dillution/price discovery that could drive bank prices under... right?

Asside from that, won't hedge funds blow up front, right and centre, forcing prime brokers (GS/MS?) even more under?

If this is sound policy... I really am thankful for the "unsound" policy of the ECB...

gramps said...

MacroMan -- I started reading your blog about this time last year, and I have to say it has become part of my required reading each morning (well, morning here in the States; noon over in London).

But I have to disagree with your assessment of the ECB. I will happily trade you Ben Bernanke for Trichet. Or I'll trade you Paulson for JCT. Christopher Cox for JCT. Heck, you can have all three.

The problem with the financial system has become all too clear: a bunch of irresponsibly over-levered beta players were fraudulently marketing themselves as alpha. Any monkey can borrow 30+ times his capital, go long MBS/ABS/whatever in a bull market and appear like a hero.

But 30x leverage means you can only tolerate about 3.4% loss (100/30) before you are bankrupt. Yes, I know I am oversimplifying things a bit -- but the general statement holds. Every market I have ever traded can move 3.5% for or against you in a few months. Even government bonds, never mind complex structured product.

Factoring in numerous off balance sheet liabilities, many "investment" houses were levered a lot more than 30x.

Home prices in the U.S. have fallen 10-15% nationwide, more in "bubble" areas. Given that many firms were levered 30x and could only tolerate 3.4% losses -- this means they are bankrupt three or four times over.

There is simply no Fed Funds rate that will change this. Not zero, not 5%, not 50%.

It has become patently obvious, even to the monkeys who masquerade as traders, that 30x leverage or more is unsustainable in anything other than a raging bull market. Hence, everyone is trying to delever at the same time

That is hardly a revelation -- but based on the comments of many market pundits, maybe it is.

Lowering the Fed Funds rate normally stimulates more economic activity by encouraging additional borrowing / lending at the margin.

That simply won't work here because (revelation time again) everyone is trying to delever at the same time.

If the Fed lowers FF rates to zero, it will not change the fact that almost every major player in the market needs to radically delever. At the margin, there must be less borrowing/lending. The Fed's usual weapon of choice is completely impotent in the current environment.

Bernanke doesn't seem to grasp this very simple fact.

The SEC has taken to citing "financial terrorists" to justify a witch hunt for short sellers. Whenever the Bush administration wants to take away civil liberties and do something they know will have zero support, they drag out the boogie man, monsters in your closet and terrorists. There are real terrorists in the world, but they aren't smart enough nor financially endowed enough to cause the current mess.

And then we have Hank Paulson, who seems to roll a dice or flip a coin to decide which firms will be bailed out at taxpayer expense and which will be allowed to fend for themselves. Regardless of whether taxpayer bailouts make sense, how is this arbitrariness supposed to sooth the markets?

Then we have his moronic super SIV idea, which mercifully failed to get any traction last summer. Unfortunately, he is now resurrecting this foolish idea, trying to fraudulently represent it as "RTC II". RTC bought assets of failed institutions, it didnt move bad assets off balance sheet like a super SIV.

Hopefully, this dumb idea will go the way of the other super SIV idea.

A big reason the markets appear illiquid is because banks don't want to sell their garbage assets at a "fair" or market price, they want to sell them at a pretend "model" price. No economically motivated player will pay a price set by an obviously bad model.

If the RTC II buys assets at a truly fair price (what an economically motivated player would pay), the all to obvious outcome is that most big banks and many big hedge funds are hopelessly insolvent.

The only way RTC II might "work" is if innocent taxpayers are hit for the difference between Wall Street's fantasy prices and reality.

All of us in the financial industries should really be careful what we wish for... If we are going to set a new precedent where taxpayers are hit with the bill for Wall Street's poor (non-existant?) risk management during bad times, we really won't have a leg to stand on when we try to collect million dollar paychecks once things return to good times. Taxpayers will be quite justified in saying they get first claim on earnings.

I have no interest in destroying the whole industry just to save poorly run banks/funds.

Anonymous said...

People are losing confidence in the U.S. financial system for the same reason they had no confidence in 3rd world / banana republic systems.

Central economic planners who arbitrarily change rules by the minute to suit the panic of the moment do not inspire confidence. Not even if you call it an "emergency measure". Consistency inspires confidence.

A system where the politically connected enjoy all the benefits in good times, but the general populace shares the pain in bad times is classic banana republic. The U.S. didn't used to be that way.

A political system where government officials knowingly break the law (sometimes under the guise of "emergency situations") does not inspire confidence. The Fed is prohibited from accepting equities as collateral, and they aren't supposed to have structured product on their books except in emergency (ie a very short time frame, not for months/years).

"Bending" the rules on a whim is what people expect from Hugo Chavez, not the U.S. Since the U.S. is behaving like Chavez, investors are quite justified in losing confidence.

The three biggest reasons not to have confidence in the U.S. financial system are Henry Paulson, Ben Bernanke and Christopher Cox.

Macro Trading Ideas said...

We all (i think) have the same opinion about the Wonderful Trio, we all now how much the system has gone crazy and leveraged, and all other consideration about short selling and manipulation of markets are correct BUT anyone has a different plan to fix the situation??? in every way you try to act you need to use a fiscal tool, so however the lender of last resort is the taxpayer.
US financial system is dreadful, but, sorry, are UBS or HBOS or IKB or other destroyed financial institution based in Europe or not?
Who will pay all RMBS, Cdo, etc kept in the balance sheet of European banks? always US taxpayer?
everyone is talking about US financial system, but UK financial system hasn't acted in the same way?
Euro policy can't be considered really unsound but JCT is taking a huge risk with growth and fiscal regime, i hope that he will be right, but for now I doubt.
He's using the rearview mirror...

However these days will have huge consequences for US election, London vs NY, our job and our future...

Guilherme Diaz-Bérrio said...

Lowering rates is not the solution for either side of the Altantic...

As for another solution:
How about getting the CDS and other derivatives out of OTC, once and for all?

And if you wanted to go all "bail out" on the financial sector (pulling a "south korea" stunt on markets may no be the most reliable way to go) at least do it like Sweden - Fast, with maximum ammount of pain for current stake holders and without the whole BS we've been seeing over the past year of "slow bleeding"/level 3 assets and other gimmicks...

Macro Man said...

A question for all the Trichet defenders out there: what forward looking indicator suggests that rates shoulds be higher now than they were at the beginning of the year?

While cutting rates to bail out banks is wrong (and I was on the record with this last year and earlier this year woith respect to both the Fed and the ECB), not cutting rates when macroeconomic circumstances have deteriorated is also wrong.

From my perch, JCT is sitting in a corner with his fingers in his ears and his eyes shut, chanting "I can't hear you."

When he grows up and is ready to sit at the big boys' table, he (and Merv) will take his fingers out and open his eyes.

One final thought: Trichet should be judged after all is said and done, not halfway through. The more time passes, and the more the situation deteriorates, the more his instransigence will stand out as bad policymaking.

The same holds doubly true for Merve the Swerve, who seems to be taking his cues from JCT these days.

Guilherme Diaz-Bérrio said...

Well I believe that a CB should not use interest rates as a way to avoid a recession, as I said in an ealier comment... though I may well be alone on that camp.

As for the evaluation of everyone, I must agree with you. Only when everything is settle in a (few) years can we gauge who is right or wrong...

RichL said...

Trichet may be operating on the likely mistaken assumption that the EU banks are more stable than the US institutions. The lowered short rates in the US have caused a positively sloped yield curve, providing an ongoing profit to US banks that can add to loss reserves.

However much you may abhor the US financial system, IMHO, it’s rather more transparent than the European and Japanese institutions. Losses aren’t disguised when there is mark to market accounting. Publicly traded stocks don’t have the luxury to time disclosure that the Landerbanks and such have.

How many unrealized losses in US mortgages are buried on Japanese and Euro balance sheets, marked at cost? Look at the list of Lehman creditors in the Ch.11 filing to see who the unsecured lenders to them were; a lot of Japanese institutions.

When the string of large losses start to show in European financial institutions, then the bankers will lean on Trichet to drop short rates to get their subsidy.

Guilherme Diaz-Bérrio said...

Forgive me but...

Aren't you forgetting about Level 3 Assets, aka mark to make-believe, sorry...mark to model?

Goldman, for instance, as much money on their "Level 3" account as in their equity account on their balance sheet...

RichL said...

I'm not forgetting. Neither are you, or the market. The problems are known. That's the point.

On the other hand, I doubt that the trash that was sold by Bear, et. al., to their foreign accounts is fully recognized.

mikarsky said...

Macro Trading Ideas 12:11 PM

RE Switzerland: I´m in Berlin at the moment, perhaps Europe´s trendiest capital but also one of the poorest cities in Germany. Again, unemployment at all-time lows, no house price deflation, though I have to admit there were fewer people in the bar I went to than usually. I asked an US friend about “his feeling” and he was quite outspoken while the Germans didn´t even know what we were talking about. At least here, the “crisis” didn´t arrive.

RE banks: There is no major Euro area bank that I can think of in danger. UBS in Switzerland is also unlikely to fail because in contrast to investment banks, it has huge private savings – indeed the world´s largest.

mikarsky said...

To all rate cut proponents:

At the moment, you can lower rates as much as you want but without the confidence, it will have have no effect. Indeed, this is what we have observed thanks to the US and this requires questioning old correlations observed in the past. At the moment, reducing rates does nothing to stimulate investment. With US consumption driven by asset inflation, the current asset deflation leads inevitably to contraction meaning less demand for goods. Firms know that and will reduce investments. That´s how functioning markets work.

In an environment of reduced investments, lowering rates CAN be an incentive for firms to invest. But it´s ONLY an incentive. If the outlook is still to the downside, firms would not invest even if they can borrow for free. They would only start investing if they think demand is increasing. So before lowering rates, you need to convince firms that the outlook is improving. Economic indicators are one thing, sentiment is the other. The ECB has done a great job so far.

gramps said...

MM: A question for all the Trichet defenders out there: what forward looking indicator suggests that rates shoulds be higher now than they were at the beginning of the year?

By any measure, inflation all over the globe has been quite high this year. Oil prices are down from their highs, but still far higher than they were last year.

The ECB's mandate is to protect the purchasing power of the Euro. There is NOTHING in their mandate about artificially stimulating economic activity, not even if we assume that Europe is in a recession.

Unlike the "regulators" in the U.S., Trichet is doing his job. He isn't making up new rules as he goes along, nor unilaterally changing rules that were created based on hundreds of years of market experience.

Bernanke and Paulson are behaving emotionally -- exactly what you might expect a newbie trader. They keep implementing "emergency stop gap" measures to buy time, but they have repeatedly failed to address the underlying problems.

Worst of all, they have repeatedly rewarded those who failed to exercise good risk management at the expense of innocent third parties.

Macroman: please name a halfway professional sports team that promotes its worst players while benching its better players... This goes way beyond economics -- this is just common sense.

Trichet should not lower rates for the same reason Bernanke was wrong to do so: the central bank cannot stimulate extra lending at the margin because there is already way too much lending already...

Almost everyone needs to radically delever themselves. The whole theory behind stimulating economic activity with lower rates simply doesn't apply in the current environment.

And a final thought that may not occur to those of you on the European side of the pond: The U.S. has an extreme shortage of savings. When central economic planners artificially lower rates -- they are creating a subsidy from savers (which the U.S. has a shortage of) to spendthrifts (which we have a surplus of).

The Fed has officially lowered rates 325bp, and unofficially a lot more because of the alphabet soup of legal (and illegal) "emergency" lending programs.

All that easing has not solved any problems at all. But the lack of savings vehicles that can keep up with the rising cost of healthcare, property taxes, food costs, etc is going to create MASSIVE problems going forward, especially for the elderly.

Therein lies the biggest problem with Wall Street's obsession with lower rates... as usual, Wall Street traders are only thinking of the next trading day -- completely oblivious to the longer term consequences of their actions.

That short term thinking is precisely how they got themselves and their banks into the mess they are in now