Saturday, May 8, 2010

Latest Laissez Faire Market Collapse Belies Far Right Rhetoric re Fannie, Etc.

The graphs at left are the picture of a debt crisis in the so-called PIIGS (Portugal, Italy, Ireland, Greece, Spain) countries. As you can see the PIIGS are facing a huge increase in their funding costs and their budget deficits mean that they will either have to impose severe austerity or face default. This is the root of a brewing global financial crisis.

As I posted earlier this week we seem to be spinning into another risk aversion credit market collapse that is wrecking havoc on global financial markets. Essentially we seem headed for a Lehman moment but instead of subprime mortgages it involves European debt. I feel like I have seen this movie before and it does not end well.

The main plot is this: banks gorged on risky credits in search of yields above no-risk U.S. Treasury obligations; easy credit meant borrowers overextended themselves; the unregulated derivatives markets spread the risky credit throughout the entire global financial system; now creditors do not trust even creditworthy borrowers; the system is now poised for a deflationary shock; and credit spreads are exploding globally. Here is how legendary bond guru Mohamed El-Erian sees it playing out: "The Greek crisis has already morphed into a regional Eurozone shock. It now stands on the verge of morphing into a more global phenomenon." According to high-profile European bankers the European Central Bank needs to bailout the banking system over there or we face a freeze up that could be "worse" then Lehman. Noble laureate Joseph Stiglitz sees "the very survival of the Euro at stake." I personally do not how this ends or how long we get to the endgame. Events this weekend will play a huge role in market action next week. I fear Americans are largely oblivious to events over there, but that may change next week, if markets give the thumbs down to the latest ECB and Eurozone actions.

I do know this however: these transnational banks gorged on excessive sovereign debt all on their own. Like commercial real estate, there simply was zero argument that some vague government policy or law caused the banks to gorge on risk that led to millions in payout for CEOs and a crash of global capitalism. Fannie and Freddie bought no Greek debt. Yet, the unregulated global financial system and the very lightly regulated global banks took these risks on board anyhow. In the US our top ten banks threw $176 billion at PIIGS debt.

So let's stop with the delusional laissez faire rhetoric. These transnational banks took these risks because they wanted these risks. These ultra-sophisticated banks with armies of quants armed with PhD.s took these risks because they wanted fatter profits than prudent banking would yield. The CEOs of these massive banks took these risks because they got huge bonuses on the front end and golden parachute payouts on the back end when their firms failed. Fannie and Freddie played a bit role at best in this still unfurling mega-drama.

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