Daily Market Reports | Sep 16 2011
By Greg Peel
The Dow rose 186 points or 1.7% while the S&P gained 1.7% to 1209, recapturing that important 1200 level, and the Nasdaq added 1.3%.
We're getting closer.
There is a certain irony in the fact that last night marked a rather significant third anniversary on Wall Street. As world authorities scrambled to address what is seen as a potential plunge into a credit freeze and liquidity crisis in the global banking system, it was remembered that it was September 15, 2008, when Lehman Bros went under. It serves as a stark reminder of what did happen, why it happened, and why it could happen again.
For three years Europe has failed to adequately address the issue of excessive sovereign debt in the eurozone. You can say all you like about Club Med profligacy and corruption (anyone who read Paul Sheehan's article in the Fairfax press yesterday will know he won't be offered any complimentary moussaka anytime soon) but at the end of the day someone made a decision to lend those sovereigns the money. They took a calculated risk in a free market and they lost.
The problem, however, is that they haven't actually lost. The reason the EU-IMF-ECB has been desperately trying to prop up Greece for two years is not because they fear what the standard of living would become in Greece were that nation to default on its debt. It is because they fear what impact a default would have on the balance sheets of those European banks which hold most of that debt, that is, the losers. Hand-outs to Greece (and friends) have come with conditions of strict budget cuts and austerity measures – measures which prevent those economies from ever generating enough income to get on top of their debt commitments. Two years of “no change” simply proves that such an approach has been flawed from the beginning.
In 2008 there was a raging debate about the “moral hazard” of using US taxpayer funds to recapitalise US banks and prevent their collapse. While those banks were clearly the culprits in their lending on mortgages, to allow them all to fail would have been to plunge the world into a Depression which would have made the Great one seem like a garden party. But moral hazard or not, it was done, it was done (relatively) swiftly, and today the US taxpayer has had the bulk of that investment returned with a profit. The US economy is not exactly strong today as a result, but nor is it depressed.
The US Troubled Asset Relief Program (TARP) allowed US banks to write down toxic debt on their balance sheets to zero and to then get on with banking life in the new, post subprime environment until such time as they were able to raise their own capital from the private sector and pay back their obligations to the government. What many possibly don't appreciate is that while those toxic debt instruments were valued as zero by the market at the time, a large chunk have since matured without default. In other words, they returned in market value from zero back to 100 cents in the dollar, or equivalent. All that was needed was time, and a removal of irrational panic from financial markets.
Now simply substitute the sovereign debt of Greece, or Portugal, or Italy in 2011, for subprime CDOs in 2008. What if those bonds were written down on bank balance sheets to zero and government funds were injected into those banks such that they could return to simple banking again in a new, post sovereign debt crisis environment? If irrational panic can be removed from financial markets, there's a good chance that over time those banks can repay those government funds and raise capital once more from the private sector.
For Greece and friends, the impact of default would be harsh, and deserved, but at least it would be over with. Budgets would still need to be strictly contained but they would not have to be so prohibitive as to prevent any chance of economic growth. Look at Russia in 1998 and look at Russia now. The moral hazard argument may still be relevant, but so too is the argument that if nothing decisive is done in Europe, and soon, we'll be back in 2008 again. One only has to look at the recent sharp rise in the global interbank lending rate to know that a credit freeze is just around the corner.
So can Europe finally get its act together in time?
Last night it was announced that the European Central Bank in coordination with the Bank of England, the Bank of Japan and the Swiss National Bank, and with the cooperation of the US Federal Reserve, would provide emergency US dollar liquidity facilities to those European banks edging dangerously close to a liquidity crisis which would ultimately freeze global credit markets once more. In the past few months European banks have been finding it increasingly difficult to attract the dollar funds they need to service their operations. It's hardly surprising, given institutions across the globe have become more fearful that they would never see that money again and as such have tightened their lending.
The announcement represents the first real step towards alleviating the European debt crisis in two years. It has taken the critical decision process away from the politicians of seventeen parliaments. Those parliaments can now feel a lot less nervous about voting in the E500bn European Financial Stability Facility (EFSF). Votes should be completed in the next month or two, and in the meantime Greece will get the next tranche of the bail-out funds it needs to pay the bills for the time being.
It is quite possible that by even as early as this weekend, it will be proposed the EFSF take on a new look with a slightly different agenda, or at least that the EFSF will be complimented with another facility – a TARP. US Treasury Secretary Timothy Geithner will meeting his EU counterparts in Warsaw tonight and it is assumed by Wall Street that he's carrying his handbook on “How to create and implement a troubled asset relief program”. It is the first time the US “finance minister” has ever been invited to join the finance ministers of Europe in one of their meetings. Why might that be?
Geithner's visit, and last night's announced central bank intervention, point to a global and more decisive solution being sought for Europe. Wall Street clearly likes the idea.
And as such it was a “risk on” session last night. The euro rallied, sending the US dollar index down 0.8% to 76.26. The US ten-year bond yield jumped 10 basis points to 2.08%. Gold fell US$31.30 to US$1789.80/oz. The Aussie is up 0.7% to US$1.0338.
Base metals rallied 1-2% in London. The world's benchmark oil price jumped US$2.94 to US$115.34/bbl. West Texas crude rose US74c to US$89.75/bbl.
The SPI Overnight gained 46 points or 1.1%.
We're getting closer. It's not over yet by any stretch of the imagination, and yawning downside risk still exists, but we may now be moving in the right direction. A Euro-TARP would not, of course, “solve” the problem. But like its predecessor, it will alleviate panic and buy time. That's the most that can be hoped for at this point. Let us not forget, amidst all of this European calamity, that sitting in the background are emerging economies, led by China, which are growing at a rapid pace.
Let us also not forget there is a potential safety net sitting under the world's biggest economy. Remember QE3? That talk seems like an eternity ago.
Last night it was revealed the US CPI jumped 0.4% in August on the headline, and 0.2% on the core. Annualised core inflation has now hit 2.0% growth for the first time since November 2008. This result would tend to suggest QE3 will not be called upon, at least not in any sense of an emergency expansion of the Fed's balance sheet.
US industrial production rose 0.2% in August when 0.0% was expected. The Philadelphia Fed manufacturing index has risen this month to minus 17.5 from minus 30.7 in August – still in contraction, but at a slower rate. The Empire State equivalent has fallen this month to minus 8.8 from minus 7.7 in August.
America is by no means out of the woods of a possible return to recession. One does wonder, nevertheless, what psychological impact a definitive policy in Europe might have on US, and global, business and consumer confidence.
If you happen to be around in the Sydney CBD today you can catch a special celebrity appearance by Rudi in the foyer of the ASX in Bridge St for a live recording of BRR's Round Table at 3pm. Or catch it at brr.com.au.
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