Markets are growing
increasingly illiquid. Asset prices are tumbling from equities, to
emerging market debt to mortgages to commodities to currencies. This is
not an orderly environment and one can almost hear a collective cry for help
echoing across capital markets.
One can also detect that
there is no responseâ€¦no one is home or no one caresâ€¦Katrina of capital
markets. Is it the desire not to push the GOP convention off the
news? Is it a desire to leave tough financial questions like
nationalizing the GSEs to the next president? Where is Paulson? Maybe
the RNC should mobilize a capital market intervention from the Minneapolis
Northstar hockey arena led by a cadre of
hockey moms. A few slap shots at the empty nets of the pencil heads
on Wall Street might work.
Even the Fed is onto the
problems facing not just the capital markets, but the real economy â€“ Governor
Rosengren on Wednesday and San Francisco Fed President Yellen today.
Dallas Fed President Fisher, on loan from the European Central Bank (foreign
exchange program), came out flailing against inflation today underscoring his
brethren in Frankfurt perilously pursuing price stability. But Fisher is
no Bernanke and the consensus is with the Chairman. The Fed has turned
pessimistic on the economy and the outlook is increasingly uncertain.
Perhaps they too see the data and can no longer pretend that a serious
recession is an ever growing risk. They also have the best idea of what
kind of shape banks are in and the latest take is lending standards are
So it was rather surprising
(not for all as ECB had signaled this policy move to the banks in private) that
Trichet took today to announce tougher lending standards for banks that park
ABS with the ECB in exchange for funds â€“ haircuts as of Feb09 from
12-17%. Ouch. Clearly the ECB wants to be compensated for the risk
it is assuming in taking questionable ABS for cash. Moreover, the ECB is
using the haircuts to address moral hazard. And this follows lots of
speculation in the press that banks are taking advantage of the central banksâ€™
generosity to make a buck. Arbbing cheap central bank sources of
John Kerry called the Iraq
War in 2004â€™s campaign the wrong war at the wrong time with the wrong
country. Well the ECB policy stance (leaning against inflation and moving
to tighten collateral standards) is arguably the wrong policy at the wrong time
and based on wrong fundamentals. ECB is in a stockade â€“ locked and loaded
for inflation which in normal times would be the right policy at the right
time. But the ECB continues to be in denial that the credit market crisis
will impact economic activity and weaker economic activity will impact the
credit market crisis. Not even a series of weak economic numbers is
enough to free the ECB from its policy stockade. Moral of this story is
that a rules based monetary policy makes lots of sense in normal times, normal
business cycle. But when things stop being normal pragmatism needs to
replace theoryâ€¦flexibility over rigidity. The ECB is now a contributing
source of financial system disorder.
Enter Bill Gross. He
said he ainâ€™t buying anymore and implied he canâ€™t sell what he owns (quality
mortgages and GSE debt). He also noted that Wells Fargo launched a
retail subordinated debt issue on Wednesday and is packaging it for retail
investors because institutional investors like PIMCO are full and canâ€™t absorb
In his own style Gross
issued a mayday to the US government to step in and support the debt markets.
I really think the Fed is
out of the picture beyond simply being lender of first and last resort to banks
and investment banks. Lower rates will not result in increased lending to
firms and households in a world where credit markets are saying no way because
the borrower may default. Pushing on a string â€“ a liquidity trap.
This is all
about W and Hâ€¦the White House and Treasury. Unfortunately the political
narrative is blocking any leadership much more intervention and hence it is
difficult to see how left to their own demise, capital markets will avoid a
solvency-led crash. We are passing from a bank-solvency-and-liquidity
phase to a household-and-firm-solvency-and liquidity-phase with an increasingly
broken transmission mechanism called the banking system.
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