Weekend Round Up

It’s been a busy week. Particularly for sundry European leaders. Here’s a few suggestions for your consideration over the weekend.

Are stock markets really that stupid?

The extraordinary jump in the world’s various bourses at first sight of the Euro “solution” was out of proportion to the likely success of said solution. Actually it isn’t really a solution at all. It is a heavily disguised punt. None of its key features are what they seem. The haircut on the debt is voluntary. A hair cut is a great idea: let’s face it the Greek debt is nowhere near as valuable as the numbers the banks are carrying on their balance sheets. I would guess it’s worth about 20% of that carrying value. Nonetheless a 50% hair cut gets us closer to reality. The problem is that the hair cut is voluntary. There is no enforcement.

Why not?

Because to make the hair cut involuntary would open the door to the deal being called a default – as it it isn’t already. That is an odious word in the fantasy land of banking. A default would trigger all sort of doomsday activity, most of all in the credit default swaps market. The banks, you see are all terribly clever: they take on risk assets in order to make a profit from the risk, but then insure themselves against any losses from that risk by buying credit default swaps. Which they naturally buy from other banks. So the risk is shunted about within the banking system and ends up … who knows where? The world’s regulators have let this “pass the buck” activity grow so far out of control and undocumented properly to boot that everyone is terrified of what would happen were the banks to start making claims on this insurance. The losses implied by the hair cut could rumble about the system and destabilize banks in every corner of the globe. So no one wants to trigger a default, lest we unleash a second coming of the Lehmann debacle.

Here’s the silliness of this: the banks would thus have to book larger losses. Or at least those whose risks are properly offloaded. So, why in heaven’s name would they voluntarily take a hair cut? They would end up worse off.

But no one wants the hair cut to be involuntary.

Oh, what a tangled web the banks have us caught up in.

A second part of the Euro solution is it’s rescue fund. Hitherto that fund has been far too small to cope with the bail out of debtor like Italy – the world’s third largest issuer of sovereign debt. It can cope with small fry like Greece, but not the bigger nations now being sucked into the Euro collapse vortex. As the markets slowly realized this, the orthodox view became the rescue fund needed to top a trillion Euros. For some reason this magic number was seen as sufficiently large that it could act as a firewall: the crisis would crash against that bulwark and then ebb away as investors realized there was enough cash to keep the market alive.

So, hey presto, the negotiators conjure up a fund of over one trillion. The market heaves a gigantic sigh of relief and rages upwards. But. That magical figure is an illusion. It is the result of a proposal rather than a check arriving. The proposal is to – get this – leverage up the existing fund. Yes the bulwark against the debt crisis is the same leverage trick that sank Lehmann.

Whether the private sector can produce the debt implied in this plan I doubt. Especially when the furor dies down.

Meanwhile the most glaring deficiency in Europe – the lack of a clear lender of last resort – goes unaddressed. That means, in my view, the crisis will perk back to the boil as the next few months go by and everyone realizes that continent wide austerity is making debt problems worse

Governments cannot create jobs, but they can destroy them.

Poor Krugman. He’s beside himself this morning. I sympathize. The Republicans, whose mantra has been that the government cannot create jobs through spending – rubbish, but let’s ignore that for now – are apoplectic at the thought of all those job losses implied by cuts to defense spending.

Say what?

I admire the Republicans for having the nerve even to try this particular example of contorted mental gymnastics. It takes a very special mind to reason that defense spending is somehow not the same as any other kind of government spending. The thought is this: when the government hires a teacher, that is not job creation. When the government hires a soldier, that is most definitely job creation. More to the point: paying to build a school does not add to the economy and does not employ people. Building missiles does both. Ugh.

This twisted thinking sets a new low standard for even our political class. Yet here we are: the Republican leadership is all atwitter over the enormous damage to our unemployment problem were we to cut the offense defense budget. Just think of all those unemployed missile makers and generals. The horror. But slashing police, firefighters, and teachers from the payroll, which is what cutting domestic government spending amounts to, is somehow just fine.

There are words to describe this nonsense, but I defer using them for fear of hurting your ears.

Consumers to the rescue!

Well no, but if you are a breathless stuffed-shirt cable television expert it sounds nice to say so.

Today we learned why, or at least how, the third quarter GDP figures were as strong as they were. Don’t forget I don’t consider them strong at all. It turns out that in September, consumers spent way more than they earned. The savings rate dropped to 3.6%, it lowest since late 2007, while personal incomes rose a miserly 0.1%. Meanwhile consumer spending jumped 0.6%.

That doesn’t look like a sustainable trend to me. It looks very much like an end of summer blip.

It isn’t exactly rocket science to argue that spending cannot outstrip incomes for too long before we find ourselves back in a debt created mess again. Given that all signs indicate households are still trying to cut debt and not acquire it, the September reversal in the savings rate should be an aberration.

The implication is that the uptick in the GDP consumption category, which as you may recall was the biggest single reason for what growth we saw in the third quarter may ebb away as winter arrives. This means the other categories within GDP will have to take up the slack. Since none appear likely to do so, I think it fair to predict that the third quarter is not the start of a steady increase in activity, but is, more likely, simply another bump in a long list of such bumps along a stagnant road.

Which is what I have been trying to argue all along.

One last thing:

Back to Europe …

Fitch, one of the top rating agencies, says the Euro deal is good for Europe.

This means the deal is almost certainly not good for Europe.

Recall that Fitch, like the other ratings agencies, told us that those Mortgage Backed Securities were just amazing. Their brilliant analysis led them to go along with the magic wand trick that turned sub-prime into, not just prime, but AAA prime assets.

These people cannot be trusted to turn a calculator on correctly, let alone actually use one properly.

This is one group of folks whose recent body of work indicts their professional standing. It calls into question their ethical standing too, but that I will leave alone for now. Suffice to say Wall Street is hardly center of virtue.

But you know that already.

Enjoy the weekend.