Fallacious Post Hoc, Ergo Propter Hoc Reasoning
As sometimes happens following a weak showing from Thursday through Monday, the stock market turned around from another deep selling squall on Tuesday, ending the day well in positive territory. Note please that the various 'reasons' cited in the press for the sudden change of direction once again do not hold water.
For instance, some people at first insisted that the emerging details of the Dexia rescue gave the market a boost. This can not really be the case, as the fact that Belgium and France are guaranteeing Dexia's debts was known well before the market opened and was initially greeted with a wave of selling. Others mentioned a vague commitment by euro-group finance ministers to 'recapitalize euro area banks', a topic that allegedly is now viewed with the required urgency after many months of denial. Naturally, there are no details yet, and nothing concrete was decided.
As the rally occurred shortly after the FT reported that 'EU examines bank rescue plan' ('examines'?), the financial media engaged in a bout of 'post hoc, ergo propter hoc' fantasizing.
This is especially so as the bearer of the good tides was Olli Rehn, the incarnated, walking talking contrary indicator.
“There is an increasingly shared view that we need a concerted, co-ordinated approach in Europe while many of the elements are done in the member states,” Olli Rehn, European commissioner for economic affairs, told the Financial Times. “There is a sense of urgency among ministers and we need to move on.”
“Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty,” Mr Rehn said. “This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis.”
Mr Rehn cautioned that while there was “no formal decision” to begin a Europe-wide effort, co-ordination among EU’s institutions – including the European Central Bank, European Banking Authority and the European Commission – on necessary measures had intensified. Finance ministers left open the exact means of how the recapitalisation could be co-ordinated.
In other words, there is no plan, and the only thing that is progressing so far is the usual squabbling. However, we concede that it may be seen by some as 'better than nothing'.
What we found far more interesting than this was the tacit admission by Dexia, SocGen and BNP that they have 'not valued their Greek assets correctly on their books'. The fact as such is not news to us (we have been tirelessly pointing out over the past year that bank accounting is a complete sham and bears no relationship to what one would consider conservative accounting practices). What is new is only that there is now a public admission of this fact – in the context of the banks concerned resisting the necessary write-downs! According to Bloomberg:
"Dexia SA (DEXB), BNP Paribas SA and Societe Generale SA are resisting pressure from regulators to accept more losses on their holdings of Greek government debt amid criticism they haven’t written down the bonds sufficiently.
While most banks have marked their Hellenic debt to market prices [really? We don't think so, not the bonds they hold in their 'banking books', ed.], a decline of as much as 51 percent, France’s two biggest lenders and Belgium’s largest cut the value of some holdings by 21 percent. The practice, which doesn’t violate accounting rules, may leave them vulnerable to bigger impairments in the event of a default, or if European governments force banks to accept bigger losses than signaled in July. The three would have about 3 billion euros ($4 billion) of extra losses if they took writedowns of 50 percent, data compiled by Bloomberg show.
The three are some of the top foreign holders of Greek government bonds. They were also among the worst performers in the 46-member Bloomberg Europe Banks and Financial Services Index yesterday. Europe’s markets regulator last week likened the inconsistency and lack of transparency about the banks’ holdings to subprime mortgages that triggered the credit crisis.
“It’s no coincidence that the banks with some of the biggest holdings of Greek debt took the smallest writedowns,” said Peter Hahn, a professor of finance at London’s Cass Business School and a former managing director of New York-based Citigroup Inc. “You’ve got banks, which are supposedly comparable, putting different values on their assets. That destroys the credibility of the banking system, and is one of the reasons why the shares are being hit so badly.”
We would note here that this accounting problem is far more pervasive than indicated in this article and not only concerns exposure to Greece. We will soon bring an update on the economic wasteland known as Spain and its widespread use of creative accounting, which extends from the banks to the government and should serve as a good example of what is actually going on.
In any case, if one wonders why the stock market rallied late on Tuesday, we would point mainly to technical reasons. It was clear that the market was severely oversold and the recent break of support by the S&P 500 index and the DJIA (confirming the earlier support breaks by a great number of other indexes) may have brought about the kind of spike in negative sentiment that requires at the very least a strong short term rally to relieve the oversold conditions. That said, these short term sentiment driven moves are very difficult to forecast, especially in the middle of a financial crisis. A few days can make a very big difference in terms of the price levels that are attained before the market changes direction and there is no possibility to be certain of how meaningful a short term directional turn is (it may be a one day wonder, but it may also be the beginning of a multi-week rebound – this can only be played 'by ear' as the situation evolves).
As an aside, after the market close, Moody's once again downgraded Italy's government credit rating, this time by two notches to 'A2' with the outlook remaining negative. The details of this latest downgrade can be seen here. We would note to this that we believe that the current focus on Italy should not detract from what are actually the more likely sources of the next phase of sovereign debt crisis upheaval in euro-land. The weakest link in the chain after Greece is in fact Portugal, the government bond yields and CDS spreads of which have quietly deteriorated further in recent weeks. Portugal's predicament is in many ways similar to that of Greece – and once the markets focus on Portugal again, the next country in line is actually Spain, not Italy. Spain is in a 1930's style economic depression and as noted above, is home to 'creative accounting' on a grand scale (details to follow soon in an upcoming post). Spain is like a country that has been struck by an earthquake, only all its buildings are still standing. In fact, too many of them are, a legacy of the bursting of the real estate bubble – which was one of the biggest ever witnessed anywhere.
Regarding Greece, we would point out that the German press reported that many analysts were apparently 'bewildered' by the fact that it was possible for Greek finance minister Evangelos Venizelos to find enough money lying around somewhere to enable Greece to pay its bills for a month longer than was originally reported. There must be a secret stash somewhere. Meanwhile, Greece is facing , which is sure to help its economy get back on its feet. Actually, it may not matter all that much, since the strikers are all 'public servants', i.e. they are not contributing to economic growth and wealth creation anyway. Alas, their strike creates obstacles for those that do. PASOK has stuffed state-owned companies and the bureaucracy for decades with its radical leftist supporters and this is the result. They are now fighting for the 'free lunch' they have always considered a birthright. Insofar as this hastens the inevitable default it is probably a good thing, but we commiserate with all those in Greece who are trying to make an honest living under the current difficult circumstances.
A 15 minute chart of the SPX, showing the action over the past two trading days. As can be seen, the entire turnaround took place in just the final 45 minutes of trading on Tuesday – click for higher resolution.
The CBOE put-call ratio (total). This shows that there have now been four significant 'fear spikes' since August, with the most recent one slightly diverging from prices (i.e., a slightly lower high in the ratio occurred concurrently with a lower low in the indexes) – click for higher resolution.
This chart of the implied percentage of Rydex assets in money market funds shows that Rydex traders have turned very bearish/cautious (similar signals are given by the more traditional bull/bear asset and cash flow ratios) – click for higher resolution.
Ben Bernanke Testifies
The helicopter pilot gave one of his regular testimonies on the Hill on Tuesday. The prepared statement can be viewed here – in essence it is a slightly more elaborate version of the FOMC statement issued in September. In other words, he didn't tell us anything we don't already know.
Noteworthy were only the following points: first of all, Bernanke noted that while the 'Fed stands ready to employ its tools' to help what's left of the 'recovery' along, 'monetary policy is no panacea' (this change in tune regarding the previously assumed omnipotence of the central planners has been frequently coming through in his utterances since April).
We want to caution readers that this is by no means an admission that the Fed's policies have failed, even though this is obvious even to aunt Frieda and her chihuahua. It is therefore also not an indication that Bernanke's monetary policy experimentation is about to undergo a significant change. What it represents is really an 'advance excuse', in case the next trick they deploy fails as well.
The other noteworthy remark was that Bernanke insisted that 'Operation Twist' is the equivalent of a '50 basis points cut in the federal funds rate'. We don't know how the planners come up with such numbers – presumably it involves mathematical modeling of the extraordinary policies designed to overcome the so-called 'zero bound' of the interest rate. In other words, they design models that purport to calculate how the Taylor rule can be implemented in spite of the fact that negative interest rates can not be imposed by the Fed. This pseudo-scientific approach is unfortunately a hallmark of economic science today.
Lastly, Bernanke told lawmakers that they should set about squaring the circle, by calling in Augustine of Hippo fashion for 'fiscal chastity and continence, but not yet'. This is to be accomplished by letting a 'credible fiscal consolidation' plan set sail, while not actually decreasing spending right now, since dont'cha know, 'that would harm the economy in the short term'.
The contradiction inherent in this exhortation was not reflected upon as far as we could tell. Either a lot of government spending is a good thing, or it isn't. How exactly can it be good in the short term and concurrently be bad in the long term? This reminds us a bit of the many people who like to call for a 'little bit of socialism' while concurrently pretending that they are against a whole lot of it.
In any case, Bernanke reiterated that the Fed stands ready to intervene further, in other words, our contention that the central bank will not allow private sector deleveraging to result in money supply deflation continues to stand. It is important to realize here that the facts as they have evolved since 2008 prove beyond a shadow of doubt that the Fed is both able and willing to keep inflation going in the face of private sector credit retrenchment. As a reminder: from early 2008 to April 2011 (the latest available data point), total credit market debt owed rose from about $50 trillion to $52.5 trillion – an increase of 5% – while the US true money supply TMS-2 increased by a stunning 51% from $5.3 trillion to just over $8 trillion.
However, a fourth 'dissenter' – Richmond Fed president Jeffrey Lacker – also added his two cents in a speech yesterday and indicated that he does not believe that the current easy money policy is going to do anything for economic growth. He specifically criticized the 'Evans-Rosenberg' line that the Fed should aim for higher inflation until the jobs market recovers. As Lacker noted, this has already been tried before and back then resulted in economic chaos and the Fed losing its vaunted 'credibility'. He is of course correct, but we believe the Bernanke line continues to prevail at the Fed for now. As we have mentioned previously, the importance of the dissenting regional Fed presidents lies mainly in the fact that they are keeping the debate alive.
Euro Area and US Credit Market Charts
Below is our usual collection of charts of CDS spreads, bond yields, euro basis swaps and a number of other charts, including CDS on a few major US banks and brokers. Prices in basis points, with both prices and price scales color-coded where applicable. Prices are as of Tuesday's close, which is to say in the case of euro area charts they precede the turnaround in the US stock market. As can be seen, as of Tuesday's close in Europe, the situation continued to worsen, in some cases considerably. Many sovereign CDS landed at new all time highs.
5 year CDS on Portugal, Italy, Greece and Spain – all jumping higher on Tuesday – Greece saw its CDS increase by a big 500 basis points following the EU's decision to delay the payout of the next bailout tranche – click for higher resolution.
5 year CDS on Ireland, France, Belgium and Japan – all were rising on Tuesday, in the case of France and Belgium sharply, as these governments are becoming less creditworthy in light of the Dexia bailout. Note that CDS on Japan also keep making new highs – click for higher resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria – new highs everywhere – click for higher resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – more new highs – click for higher resolution.
5 year CDS on Romania, Poland, Slovakia and Estonia – with the exception of Estonia, new highs all around – click for higher resolution.
5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – also a number of new highs here – click for higher resolution.
10 year government bond yields of Ireland, Greece, Portugal and Spain – mixed. There hasn't been a lot of movement in those lately – click for higher resolution.
10 year government bond yields of Italy and Austria, UK Gilts and the Greek 2 year note. More 'safe haven' buying – click for higher resolution.
Three month, one year and five year euro basis swaps – the 'euro-doom' indicators kept worsening on Tuesday as well – click for higher resolution.
5 year CDS on Germany (new all time high!) and the US , the Markit SovX index of CDS on 19 Western European sovereigns (just below its high, but still trending up). CDS on US sovereign debt have come in again – these are wont to rise whenever the 'debt ceiling' debate is reignited – click for higher resolution.
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paaschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) - a big 20 basis points jump higher on Tuesday – click for higher resolution.
5 year CDS on 'derivative king' JP Morgan – moving to yet another new high, in spite of the stock market rebound – click for higher resolution.
5 year CDS on Morgan Stanley (MS) – these finally dipped a little on Tuesday after the recent rocket-ride higher. Note that Egan-Jones has downgraded the credit rating of MS, citing its exposure to Europe, especially France, and to derivatives. Egan-Jones specifically noted that these exposures are very large relative to the firm's capital – click for higher resolution.
5 year CDS on Australia's 'Big Four' banks – these have continued to move sharply higher on Tuesday – click for higher resolution.
Charts by: Bloomberg, StockCharts.com, BigCharts.com
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