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Generational Dynamics Web Log for 11-May-2010
11-May-10 News -- Europe's super-nuclear bailout

Web Log - May, 2010

11-May-10 News -- Europe's super-nuclear bailout

Incumbent Republican senator Robert Bennett defeated by Tea Party activists

Europe announces a super-nuclear bailout plus

The word "gobsmacking" was heard several times on the BBC on Monday, describing the spectacular bailout package. Markets in Asia, Europe and North America surged 3-4%.

The package seems to promise an almost unlimited amount of money for ailing eurozone economies, coming from all directions. Eurozone countries will bail each other out. The International Monetary Fund (IMF) will provide hundreds of billions of euros. The Fed will swap dollars for euros with European banks, to provide plenty of liquidity.

The "nuclear option" has been adopted by the European Central Bank in full force. The ECB will buy up toxic debt issued by trouble eurozone economies, much as the Fed bought up toxic assets from US banks. There seems to be no end to it.

MarshAviator in the Generational Dynamics Forum said that it reminded him of the article, "One, Two, Three ... Infinity," from 2008, in which I compared to the ever-increasing government spending plans to a book by George Gamow that I read in school in the 1950s. My use of that particular phrase was to convey the idea that debt was on an exponential growth path that would not be stopped except by a major financial collapse and crisis.

And indeed the Zero Hedge blog stated it pretty well:

"Morgan Stanley's Stephen Roach spoke with Bloomberg's Tom Keene earlier, pointing out the most troubling statistic about recent market activity, which has to do with both the frequency and amplitude of catastrophes: "The crises are coming with greater frequency. Over the last 25 years we have had an average of one crisis every 3 years. The gap this time is 18 months. The scale is bigger. This is a much more serious problem in the eurozone than the Asian financial crisis." So intercrisis half-life continues to decline as the severity jumps exponentially. In other words, in nine months we will need a combined Fed-ECB-BOE-PBoC-BOJ effort for about $10 trillion just to calm the markets. 4.5 months after that, $100 trillion more..."

In fact, there was a great deal of skepticism on Monday. This is a big change in public mood from 2008, when the large bailouts and stimulus programs were generally greeted with optimism -- and indeed, then resulted in last year's renewed stock market bubble.

As usual, from the point of view of Generational Dynamics, we're most interested in changes in behaviors and attitudes of large masses of people, and so we look at what various people are saying as a reflection of those attitudes and behaviors.

Outright hostility - in Europe and America

What investors are looking for is a repeat of last year's bubble. If a huge US bailout program can drive the Dow up a few thousand points, then maybe a eurozone bailout program will drive it up another few thousand points. Nobody I heard today was that explicit, but that seemed to be the prayerful hope.

On the other hand, there was plenty of outright hostility. The Germans, who will have to bear the brunt of the bailout, are very unhappy at this turn of events, after reluctantly agreeing to pay 25 billion euros as their share of the bailout of Greece. Chancellor Angela Merkel, whose governing coalition suffered major losses in Sunday's regional elections, is doing a hard sell on the new bailout. According to AP, Germany's share will be 123 billion euros or more. Merkel plans to push it through Germany's parliament as quickly as possible.

As EuroIntelligence put it, "Here was Merkel sacrificing the future of Europe for the price of winning a state election, and now she loses it."

There's also some hostility in America's contributions to the bailout. These objections are very small right now, but they seem to be growing, and could either fizzle or become a major political issue.

Here's how well-known financial writer John Mauldin expresses his anger:

"Was it only last week I was expressing outrage that US taxpayers would have to pick up the check for Greek profligacy in the form of IMF guarantees? This morning we wake to up the sound of $250 BILLION in IMF guarantees for a European rescue fund, most of which will go to countries that are eventually (in my opinion) going to default. That is $50 billion in US taxpayer guarantees. Not sure what that translates into for Britain or Canada or Australia.

I can swallow the Fed dollar swaps to the ECB. Don't really like it, but I can deal with it, as I don't think it will ultimately put US tax-payers at risk, as long as the swaps are in dollar terms. But the IMF bailout is just wrong.

Interestingly, the euro shot up on the announcement in what was now clearly short covering. As I write this, it is almost back down to where it started. That seems to me to be a vote of "I don't believe you." We will see. But if the ECB actually goes ahead and floods the market with liquidity, that will be very good for all types of risk assets.

Note that in last Friday's letter I quoted Trichet where he said we would not do what he agreed to do over the weekend. What a turn-about. So much for ECB independence. The European leadership must have realized the wheels were coming off and brought out the nuclear option in order to stave off a very serious crisis. In my opinion, this buys time but does not solve the problem.

The eurozone leaders assume that this is a liquidity problem. It is not. It is a solvency and balance sheet problem. You do not solve a debt problem with more debt. This only shoves the football a few yards (or maybe I should say meters) down the field. And it is going to cause a MASSIVE misallocation of capital once again which will create more imbalances that will have to be dealt with. Ugh."

Mauldin makes interesting points that are worth dwelling on because they may become important political issues.

He points out that Jean-Claude Trichet, president of the European Central Bank (ECB), did a complete flip-flop. This really is incredible. At a press conference in the middle of last week, Trichet said that the ECB governors weren't even DISCUSSING the nuclear option, and certainly had no plans to adopt it. Unless he did a complete about-face in four days, he must have been lying at the time.

Mauldin says that "eurozone leaders assume that this is a liquidity problem. It is not. It is a solvency and balance sheet problem." Now, I agree that Mauldin is right about it being a balance sheet problem, but I believe Mauldin is wrong about what the eurozone leaders believe.

Like many people, Mauldin is giving the eurozone people too much credit for honesty and credibility. He's saying that the leaders are providing liquidity, so therefore they believe that it's a liquidity problem. I'm afraid that's not true. They know very well that it's a solvency problem. They know very well that Mauldin's points about massive misallocation of capital are correct. But these politicians don't give a shit, any more than the investment bankers gave a shit when they were creating toxic assets and defrauding investors with them. They just want power, money, votes, like everyone else, and they'll be looking all around them for every possible opportunity to blame someone else when the time comes.

We've quoted well-respected Financial Times columnist Wolfgang Münchau several times in the last few weeks, because he seems to be one of the few expressing realistic, knowledgeable opinions, and he doesn't seem to think any more highly of the eurozone's political leaders than I do:

"The eurozone must take responsibility or it will split

"Whatever it takes" is not a bad motto for the fight to save the eurozone. And the same goes for the new European stability fund, which fills a yawning gap in the institutional fabric of the eurozone. But for this to work, we need clarity about which fights to fight and which instability to stabilise. And this is where the proposed reforms are likely to fail.

When I heard Jean-Claude Juncker, the president of the eurogroup of finance ministers, talk about a globally organised attack on the euro, I realised that the game was probably up. The reforms, desirable as they may be, are probably too late. Europe’s leaders are not solving the problem, they are fighting a public relations war. Their target is not economic imbalances, but speculators: hedge funds, investment banks, bond market vigilantes and, in particular, those ominous Anglo-Saxon rating agencies. “Whatever it takes” means that the European Union will set up a European rating agency, funded by public money and subject to European regulation.

Their populism has spun out of control. Angela Merkel, the German chancellor, still has difficulty in reining in the anti-Greek bigotry she unleashed in Germany during the early stages of the crisis. It seemed the politically expedient thing to do at the time.

We know from the history of European financial crises that politicians are ill-equipped to communicate with the financial markets. They are happy to take the bondholders’ money to finance their excessive deficits, and then act outraged when those bondholders retreat and push up interest rates. But look at this from the perspective of bond investors. Over the past nine months, they had to put up with the news that Greece had cheated for years, that a German chancellor was making political commitments without the readiness to back them up, and a Spanish prime minister in denial over his country’s deep structural problems. The bondholders know that the southern Europeans cannot get out of the mess through higher nominal growth. The rise in southern European interest rates is not the consequence of a speculative attack or a sinister plot. It is a belated realisation of an underlying misalignment. ...

Ms Merkel’s other proposal to deprive deficit countries of their voting rights is even less realistic. The logic behind it is that an organisation that relies on unanimous votes for important decisions can never impose a penalty on a member. ...

I have heard the suggestion that this may be part of a German game plan to forge a small “core Europe” with Germany at the centre. I am not so sure but whether by design or accident, it would do lasting damage.

I still hope that EU leaders choose integration over division, but what they are saying is not consistent with what I am hoping for. “Whatever it takes” sounds good. But I fear it is a lie."

The people I'm quoting are not marginal "nothing" people like myself. These are major mainstream media figures, expressing the same kind of anger and cynicism that I've been expressing for years, long before it was fashionable.

I listened to a lot of pundits and analysts on Monday. I heard some of them say that the market was going to go up and up and up -- but that's what they're required to say on CNBC or Bloomberg TV. But I don't believe that I heard a single one of them say that the bailout was going to solve Europe's problems, or that Europe's problems weren't going to get worse. This is a big change in mood during the last year -- or even the last few weeks.

High anxiety

Volatility and anxiety are very high these days. Several people wrote to me over the weekend using the word "scared," after what happened last Thursday. In each case I wrote back to point out that they have a big advantage over other people because they read this web site and they know what's coming, and therefore they can use the time to prepare.

A lot of people breathed a sigh of relief on Monday, as the Dow Industrials index gained over 400 points. The problem is that the giant gains are a mixed blessing. Yes, it's good that the market is going up, but an outsized gain is as much a measure of panic and anxiety as an outsized loss.

In September and October of 1929, the market had been falling steadily. People must have been very frightened about losing their life savings. (See my Dow Jones historical page. )

Then, on Monday, October 7, the market shot up by 6.32%. Can you imagine how people must have felt that day? They thought that they were out of the woods, and everything would be ok. What they didn't know was that this was just three weeks before the stock market crashed, and they would lose everything.

So take care, Dear Reader. The best that you can hope for is that things will settle down for a while. The worst is a major financial crisis -- and as regular readers know, Generational Dynamics predicts that this must happen at some point.

BBC interview with Michael Lewis

Financial author Michael Lewis was interviewed on the BBC program The Interview over the weekend.

His book is about people who analyzed the subprime mortgage-backed securities that were being sold by the trillions in 2005-2006, and were able to invest in credit default swaps on these securities, and ended up making billions of dollars.

What I found personally interesting is that all the people who made money from the crisis ended up being hated, according to Lewis. "All the main characters in the story all suffer health problems in the course of their journey."

However, the part I want to comment on is when he was talking about whether the people involved in the deals were fools or crooks - because they had to be one or the other. Here's my transcription of what he said:

"What's interesting about their experiences - they almost always take the view that, for the most part, the system fooled itself. Yes, people were deceptive, people were telling lies. To a large extent, even the very powerful people in the system tended to believe those lies, and the proof of it is that the Wall Street firms at the center of it -- Merrill Lynch, CitiGroup, and Morgan Stanley -- Goldman Sachs is an exception -- these firms ended up with billions, tens of billions of dollars of losses because they end up eating their own cooking. They ended up owning this stuff.

So the punch line is, they disguise the risk from the system so that they can peddle this junk, but they also ended up disguising the risk from themselves.

And so it's a hard question to answer. I think there were some crooks, but generally I think it's more a story of mass delusion than criminality."

It infuriates me the way that Lewis and other financial journalists pay obeisance to the bankers that defrauded millions of people. And Lewis is completely wrong in this analysis.

Banks like CitiGroup had absolutely no intention of assuming any risk whatsoever. They sold the toxic assets through a separate investment bank called a "structured investment vehicle," or SIV. (See my 2007 article, "Questions and answers about the 'credit crunch.'")

The same Citi employees worked in the SIV, and they collected all the fat fees and commissions when they defrauded investors by selling them the toxic mortgage-backed securities. But since the sales went through the SIV, Citi and its employees were protected from any future losses. So Lewis is completely wrong when he said that they were disguising the risk from themselves. They were very well aware of the risks, and the fact that they even used this SIV mechanism is evidence of guilt.

The reason that Citi ended up having the toxic assets on their own books is because, once the public became aware of the scheme, regulators demanded that Citi close out the SIVs and bring all their assets and liabilities back onto Citi's own balance sheet. But Citi never intended for that to happen. They thought that they could just sit back and collect money from fraudulent deals, and never worry about losing anything.

Even then, Citibank tried everything it could to rid of the toxic assets without having to pay any price. One of the most amazing (and most cynical) proposals was the "Master-Liquidity Enhancement Conduit." (See "Big banks discuss mind-boggling 'M-LEC' superfund to bail themselves out.")

The proposal was to put all the toxic assets into the M-LEC, so that, once again, Citi could protect its own profits, and employees can keep collecting their million dollar bonuses. In the end, regulators didn't allow the M-LEC to be used. (However, Citi still got bailed out by the government, and the employees still got their million dollar bonuses.)

The thing is that Lewis knows all this. He's been buried in all these details for several years writing his book. He knows very well how Citi used SIVs to protect themselves from risk, and yet he sucks up to them so that they'll talk to him when he writes his next book.

One story that will never be told -- because the journalists won't tell it -- is how the mainstream bloggers and journalists were just as much a part of the fraud as the bankers. I wrote many articles criticizing the absolutely ridiculous things that were being said on CNBC or in the Wall Street Journal, or on some of the blog sites, and I could barely touch the tip of the iceberg. But these mainstream journalists and bloggers are totally in the tank for the bankers who committed fraud because they want to protect their sources, protect their ad revenues, and continue to be invited to parties and conferences.

Additional links

Democrats have been apoplectic about the defeat of Utah's three-term incumbent Republican senator Robert Bennett in the Republican primary by 'Tea Party' activists. But I keep telling you, ladies and gentlemen, that the 'Tea Party' is part of a major political realignment underway, and it will target Republicans as much as Democrats. CS Monitor

Nearly 40 million Americans are receiving food stamps -- the highest number in history, and an amount that has been increasing every month since December, 2008. Reuters

Freddie Mac and Fannie Mae has already been bailed out with tens of billions of dollars of taxpayer money, but they're going to need tens of billions more in bailout money. NY Times

Morgan Stanley strategist Teun Draaisma has "thrown in the towel," and turned from a bear into a bull on European equities, after the weekend's massive bailout. FT Alphaville. The reason I mention this is because the article ends with, "Time to put the tin hat back in the cupboard for a couple of years," implying that anyone's who's a bear is a crazy loon. I wonder what FT Alphaville thinks of Financial Times columnist Wolfgang Münchau, whom I quoted earlier? I guess they think that he wears a tin hat as well.

Danger: Robots with knives could attack humans accidentally. Telegraph

Under direction of Saudi king Abdullah, Saudi Arabia's clerics have issued a fatwa against funding terror. The thrust of the fatwa is that funding terrorist organizations like al-Qaeda is just as criminal as actual engaging in terrorist activity. Memri

We've reported that the Palestinian Liberation Organization (PLO) has agreed to engage in "proximity peace talks" with the Israelis. That was based on the hope/assumption that the Israelis were quietly cutting back on building Jewish settlements in east Jerusalem. However, Israel said on Monday that it has on intention of halting construction of settlements. AP

Crisis-stricken Russians are nostalgic for bloody dictator Josef Stalin. Spiegel and NY Times

Putin, not Medvedev, remains master of Russian foreign policy. EurasiaNet

(Comments: For reader comments, questions and discussion, see the 11-May-10 News -- Europe's super-nuclear bailout thread of the Generational Dynamics forum. Comments may be posted anonymously.) (11-May-2010) Permanent Link
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