Monday, October 31, 2011

No standing and keep your arms and legs inside the car

The stock markets took a big dive today, dragged down by bank stocks based on their exposure to Euro bonds. The panic started after the bankruptcy filing of MF Global, an investment bank run by former NJ Gov Jon Corzine. It appears the bank’s problems may have started when the former Goldman Sachs executive went short in a big way on US Treasuries (betting that the downgrade would drive up interest rates, it did the opposite) He also bet the wrong way on Euro bonds and lately they could meet margin requirements. Late today there are reports that 100s of millions in customer funds are missing.

MF Global was a small player compared to the big zombie banks. The biggest bank, JP Morgan has exposure to 85 trillion in derivatives and in order for holders of their bonds to insure them they are paying through the nose. Last week they sold one billion in bonds with the spread over Treasuries of 335 basis points or 3.35% over the rather low interest that Treasuries pay. This was a big improvement from a few weeks ago when the spread was 675 bp.

As it becomes more apparent that all these banks are really the walking dead, the spread is likely to increase again. At some point it becomes impossible for them to do business and it’s bail out time again.

Italy is being caught in a similar situation even though their economy is really quite strong. They are paying a six percent spread over German bonds and this is not sustainable. The Eurozone is caught in a self fulfilling death spiral, as more countries become unable reissue debt at a rate they can pay, the disease starts to spread. The problem is that the European Central Bank doesn’t seem to understand basic economics or know anything about the function of central banks.

The ECB is repeating the same mistakes the Federal Reserve made between 1926 and 1933, and you know where that led. It strains credulity however that in either case that they didn’t know what they were doing. These principles are hundreds of years old and to do the opposite suggests they want the outcome that will certainly follow their failure to act. Hang on tight, it will be a wild ride.


demand_sider said...

Bloomberg, 9/13/'11

"Mario Blejer, who managed Argentina’s central bank in the aftermath of the world’s biggest sovereign default, said Greece should halt payments on its debt to stop a deterioration of the economy that threatens the European Union."

“This debt is unpayable,” Blejer, who was also an adviser to Bank of England Governor Mervyn King from 2003 to 2008, said in an interview in Buenos Aires. “Greece should default, and default big. A small default is worse than a big default and also worse than no default.”

"Rescue programs backed by the IMF and European Central Bank are “recession-creating” efforts that will leave Greece saddled with more debt relative to the size of its economy in coming years and stifle growth, Blejer said. A Greek default would push Portugal to do the same and would put Ireland “under tremendous pressure to at least symbolically default” on some of its debt, he added."

This guy was interviewed on a BBC show I heard about 2 weeks ago. The guy managed the largest default in modern history. For the sake of the E.U., he is saying they should be allowed to default. But then, maybe Blejer just hates American banks.

You'd think they'd want to listen to this guy.