Monday, August 13, 2007

Injections of Futility or, Bail and Fail

The big central banks are injecting temporary liquidity into the system, at around $150 billion a pop, most of it as O/N loans to banks (i.e. here today, gone tomorrow). This amount is large when compared to normal CB money market operations, but it is less than a drop in the bucket when compared to the size of the credit market, currently in turmoil. For the US alone, total credit market debt outstanding is $46 trillion, an amount so unfathomable that it defies comprehension (it translates into $400,000 of debt for every single US household).

The global liquidity injections thus amount to 0.32% of this debt alone and given the size of the still developing credit crunch, they are but mere exercises in futility. Of course, they must be undertaken if only because that's what central banks are obliged to do under their role as lenders of last resort (Prof. Bernanke has written two books on the subject), but I do not for an instant believe they are going to make any real difference. In the end, they act mostly to underscore the extent of the problem and the Fed's predicament.

This is not a repeat of the 1998 LTCM situation, where a single large player made a wrong bet and was quickly bailed out to avoid more serious consequences to an otherwise sound financial system. Rather, today it is the whole system that is in deep trouble: it relies on too much debt piled on top of overinflated assets, further complicated by monstrous amounts of derivatives. The most apt analogy I can think of is a runaway nuclear reaction, with central banks in the role of small lead rods - too small to contain it once it gets going.

There is nothing within the sole purview of the Fed, or any other central bank, that it can do to transform and rectify the system; its relative size is too small in comparison to the modern financial behemoths. Goldman Sachs alone has balance sheet assets of $943 billion, an amount larger that the GDP of every country in the world except for the top 10. But, tellingly, their equity is a mere $38 billion, so their leverage is a troubling 25x and this is before the off-balance sheet items, like various swaps. Nevertheless, the days when a large private financial house could act as de facto central bank (e.g. Morgan in the 1890's) are gone forever, even if some fervid neo-conservatives would like to see the government drowned in a bathtub.

There is a glaring paradox here: those same free market enthusiasts that ardently proclaim the supreme efficiency of modern finance in allocating capital where it's best utilized, go begging to the government to save them when their capital evaporates due to their own folly. It is actually not a paradox at all, of course - since time immemorial such behavior has been known simply as childish, or wanting to have your pie and eat it, too. Actually, since central banks are owned and financed by governments (i.e. taxes), they want to have their pie and eat everyone else's, too. Laissez faire when it suits, sauve mon derriere when it doesn't. That's called virulent capitalism, not free market economics.

There is certainly a strong ethical dimension in the divisive question that has come up in recent days: should the CB's bail out the big financiers and their rich customers with public money, or should they let them learn a sharp lesson about risk vs. reward? There are firm proponents of both opinions, but there is also a third one: Even if they bail, they are still going to fail. The reason was made clear above, i.e. it is the whole asset-credit system that is in trouble, not just a few players within it.

We need a Plan B to deal with this situation and we need it ASAP, but...

(a) I am certain there is currently no Plan B. Ideologues with blinders are running the show right now and they can't even fathom that Plan A could be wrong. Witness the extremes to which Plan A could theoretically be taken, if all else fails (helicopter cash). This is not novel thinking, just much more of the old.

(b) Any Plan B would by necessity seriously damage the vested interests that reign within Plan A and would immediately be painted as dangerous, radical and unpatriotic.

(c) Individual human thought may leap, but society's habits change only gradually and then only after the proof hits them hard over the head. Witness global climate change, for example.

Attempting to close on a more humorous note, maybe the central banks could start by changing how they name their money market operations. For example, the ECB calls the injection of an unprecedented 95 billion euro "a fine tuning operation". The whole orchestra sounds like a dozen buzz saws ripping through rusted sheet metal and they worry about A sounding flat?

So, in this hot summer season, here's my own suggestion, inspired by a film by Lina Wertmuller:

Travolti da un insolito destino nell'azzurro mare d'Agosto

or, in English,

Swept away by an unusual destiny in the blue sea of August.

P.S. For the reader comment section: If you have seen the film, who do you think should play the market-equivalent parts of Gennarino the sailor and signiora Raffaella?


  1. Sorry have not seen the film. I do see on Bloomberg that stocks are rising this mourning due to

    "Stocks rallied worldwide and U.S. index futures advanced after analysts recommended buying equities and central banks moved to ease a credit crunch following losses in higher risk mortgages."

    Seems if you drink the Koolaid it can change your perspective.

    Out here in rural land a guy I know is pulling the plug. He has put his place and equipment up for sale even though he acknowledges sales have been dropping and foreclosures rising on property along with equipment piling up in dealers yards. His accountant told him if he invested the money from his sale, I believe it was in ten years it would grow to 5 million!

    The theme here in the dirt is that denial is everywhere and your

    "(c) Individual human thought may leap, but society's habits change only gradually and then only after the proof hits them hard over the head. Witness global climate change, for example."

    rings true. He may admit that his "assets" may be priced a little high but he believes that he will sell for a profit and be able to invest and have it grow into an ever bigger sum and not have to work.
    I did try to tell him if he does sell all his "means of production" which is paid for that in the 70's the banks would gladly lend you a thousand at double digits if you had 10,000 in CD's on deposit. The point of tight credit and future deflation was lost on him.


  2. Dear Hellasious,
    I repeat, it is not because our scenario seems to develop as assumed that we have now to reinforce it (bullish become more bullish in uptrend and bearish do the same in the downtrend..)Being contrarian with yourself sometimes brings serenity...may be. On the bail out : no bail out at all. The Fed and the ECB lend money at repo rate because banks could not refinance at these rates. But banks which have borrowed must give back the loans in a few days. the fed and the ECB have not bought the collateral brought by the banks; these asset will not go in the FEd ECB balance sheet. For the it is not a bail out, it is a responsible answer to a abnormalr credti crunch.

  3. I agree with Miju, However I too belive it is futile.... Something's gotta give....

    I anticipated this, and anticipate more futile efforts once this fails.... I remain faithfully short the dollar.

    You see, FAITH, will carry me through this crisis.

    Alleluja! Is that how it's spelled...?

    Good luck to all,


  4. Ahhh, a bailout is the exactly correct term. Notice I did not say the CB's solved the problem. They just paid the bail (injected "futility") and got the crooks out of jail for the time being.

    But bail must be repaid and the crooks must appear before a judge, to be tried and - if sentenced - serve time in jail. And then there is no bail...heh.

  5. Should or shouldn't? Wow, never thought to ask myself that question. It's almost like.... like.... we're living in a democracy or something. Wow.

    Long term growth in SOMA at no more than the growth in productivity! Quit stealing middle class savings!

  6. This guy has another solution which I found interesting:

  7. Re: investing believing "in ten years it would grow to 5 million!"

    Rule of 72 implies his CPA thinks he can get at least 7% compounded on 2 1/2 Million. However, taking taxes into consideration, he probably needs something north of 12% compounded. If he starting with 1 1/4 million, we are talking 24%! Please...what is the CPA recommending to get this high return? I may want some, too.

  8. You are wrong. CBs, especially the FED,
    are not part of the government. This is the mistake you make. They are owned largely by the banks that own the funds that need to be bailed out. Thus, the vicious circle jerk of inflation, with joe sixpack taking it in the rear.

  9. The responsible answer to funding speculative behaviour involving huge maturity mismatches and large illiquidity risk is to allow the price of the risk in that funding to be dsicovered. If that involves a spike in overnight rates and others so be it. Those that need such funding to cover their funding of speculative positions should pay the price for their behaviour and,or deal with the positions that are causing it. Those that do not can hold off or raise funds temporarily elsewhere.

    It appears that the intervention has introduced a backstop for the backers of risky behaviour to avoid and or delay the direct consequences of that behaviour. This is the Trichet, Bernanke et Alia. We will see how long it lasts but since markets are future discounting mechanisms clearly they believe the fix is in.

  10. "It is the cause, it is the cause, my soul..."

  11. "Swept away by an unusual destiny in the blue sea of August." Oh what a delicious quote you found. Just perfect. Great film too ;)

  12. Well written article. There certainly is a major crisis, and the stats that you included regarding the amount of debt that major investment banks are carrying is very telling.


  13. Penultimate anon,


    Perhaps technically not a 'bailout' but can you tell me a bit about those MBS, e.g. Agency or 'synthetic Agency' created via use of
    Agency CDS to provide the required guarantee..

    But then that has little to do with a global financial system that's become too complex, too big to bail but, as it persists in running into its own internal contradictions and real economy limits, must deflate.

  14. Travolti da un insolito destino nell'azzurro mare d'agosto
    well... I remember another rather old film, from the seventies maybe, that may better suit the case, but I do remember neither the title nor the director...
    rich people on a sailboat in the mediterranean sea: they all jump off for a bath but nobody remembers to drop the stair to come back on board.
    The last sequence shows the boat alone in the open sea, and nothing afloat.
    La morte รจ 'na livella... ;)