Friday, December 14, 2007
The First Horseman of the Macropocalypse
What - really - is the first horseman? After all, I've been talking about it for a few days now.
It's simple: the sheer inertia that prevents the machine from being dismantled slowly and piecemeal, meaning that it will have to fall totally into decay, before the incentives are great enough for a better financial system to be built are great enough.
Look. I know this stuff sounds a bit ott. But I'm not kidding around.
Consider (in the comments):
"...Full credit here goes to Brad Hintz. This is just a few paragraphs from a piece he put out the day before the TAF was announced.
The reason that funding tightens at calendar year-end is that as December 31 approaches, commercial banks begin to reduce their discretionary lending activities in order to "window dress" their balance sheets for year end. And as this large funding source disappears, the cost of funding over that short period near December 31 rises rapidly. For the fixed income divisions of the institutional brokerage firms, because their year end is November 301, this presents an earnings opportunity. The US brokerage firms increase their balance sheets and purchase assets that have been shed as part of this year-end window dressing by the commercial banks and provide funding at highly attractive rates2 through financing trades.
This bit of Wall Street trivia is important because the 2007 year end is going be much, MUCH more 'exciting' than normal because major commercial banks around the world, which have suffered losses in Q3 2007, are now in challenging capital positions. To shore up their Tier 1 capital ratios and to appear both liquid and financially strong when they print their 2007 year-end balance sheets, the only available solution is to reduce discretionary loans and shed assets prior to year end."
Bolding's mine. In other words, the Fed's plan is timed perfectly to let banks shore up balance sheets when exactly they need it most - and so the dance of simulation can go on for another few quarters.
But it's a short term plan - it doesn't fix any of the problems in the DNA of the system.
In fact, it amplifies then: by granting the banks access to cheap liquidity at exactly the critical juncture when they need it most, the Fed is actively, deeply, and durably destroying the incentives for reform.
Look: I used to call this the Wall Street Virus - the near-total moral hazard rife on the Street for the last...well...forever.
Now, the Fed is - astonishingly - letting the virus multiply.
That's inertia. The machine is malfunctioning, but it's being kept running: the costs, the Fed reckons, to the larger economy, are just too great.
So the old, creaking, decaying system is held together with a bit of glue and a prayer.
Of course, that just means - when the reckoning comes, it will be that much worse. The costs aren't going down - they are buried inside the system, eating it from the inside.
And the failure of regulators to address the real problem is going to let the viral load of moral hazard explode - until it totally rots and consumes the body of the financial system from within.
Look: that may sound extreme. But it's actually tame, compared to the massive implosion in future value that's taking place globally.