Credit Bubble Bulletin

October 12 – ANSA: “European Central Bank or investment company President Mario Draghi defended quantitative easing at a meeting with former Fed main Ben Bernanke, saying the policy had helped create seven million careers in four years. Once you give an advantage it’s just very hard to take it way. This sure appears to have turned into a bigger and more technical issue than it turned out before. Taking away benefits is obviously and center in contentious Washington with taxes and healthcare reform entrance.

It is fundamental to the problem confronting central bankers nowadays. During the mortgage fund Bubble period, I often described “The Moneyness of Credit” and “Wall Street Alchemy.” Various risk intermediation procedures were basically changing endless (more and more) risky loans into recognized safe and liquid money-like devices. Throughout history, the insatiable demand for the money created great peril and power.

I can’t conceptualize a more far-reaching market distortion than conferring money qualities to risky financial equipment. Pandora’s Box. For a while now, I’ve been astounded that the Government Reserve has no pressing concern with epic market distortions. Fannie and Freddie were on the hook for insuring Trillions of mortgage securities. These GSEs essentially had no equity or reserves in case of a significant downturn, a fact that had no bearing whatsoever on the safe haven pricing of their perceived money-like securities.

Insurers of Credit were on the hook for Trillions, with reduced reserves. So, investors held (and leveraged) Trillions of “AAA” with little concern for deficits or illiquid trading. Meanwhile, there was the gargantuan derivatives marketplace thriving on the assumption of continuous and liquid marketplaces, despite hundreds of years of market history replete with continuing bouts of dislocation and illiquidity. There have been as well myriad variations of cheap market “insurance” easily available, bolstering risk-taking with the misperception that risks (equities, Credit, interest-rates, etc.) could be easily hedged always.

And as long as Credit expanded rapidly (risky loans into “money”), the economy boomed, and marketplaces inflated, the prices for market insurance remained low (or went lower). As Einhorn stated, “the risk was transferred, however, not really being moved, and not properly valued.” It amounted to a historic market Bubble distortion. Underlying risks were being distorted and mispriced available on the market grossly.

Distortions fostered an enormous expansion of dangerous Credit and untenable financial intermediation – a powerful boom and bust powerful that culminated in a collision. Amazingly, catastrophic market distortions evolved gradually enough over years so to barely garnered attention. Can’t worry about risk when there’s easy “money” to amass. Central bankers discovered the incorrect lessons from that modern-day market crisis.

The post-crisis focus was on traditional financing and bank or investment company capital. As the thinking goes, so as banks avoid reckless lending and stay well-capitalized long, the risk of the repeat crisis remains negligible. Central banking institutions did come to understand the risk of institutional Too Big to Fail, but again the perfect solution is being additional bank or investment company capital.

Market distortions behind the Bubble and the crash didn’t even enter the debate. Indeed, the Fed shifted to reflate market prices aggressively, using various measures that specifically manipulated market perceptions, prices, and dynamics. There is no recognition that course would elevate the whole structure of global market Bubbles to TOO LARGE to Fail. “Moneyness of Credit” evolved into the “Moneyness of Risk Assets.” It transferred so far beyond Fannie, Freddie, and Wall Street structured fund distorting perceptions of risk in mortgage securities. The Federal Reserve and global central bankers turned to brazenly distorting risk perceptions throughout equities, corporate, and business Credit, sovereign debts, EM, and the others. Slash rates and pressure savers into the risk-asset market.

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Inject new “money” into the securities markets and guarantee water, continuous and levitated markets. Who wouldn’t write flood insurance during a predetermined drought? And then, why not reach for risk, speculate and leverage with prices rising and market insurance remaining so cheap? History’s Greatest Market Distortions. The VIX finished Friday’s program at 11.43, only above recent historical lows relatively.

The Fed is a few weeks from what will likely be its fifth “tightening” move of this routine. And with rather conspicuous market excesses facing a tightening-up cycle, why does market insurance remain so cheap? For just one, marketplaces presume that central bankers will not actually impose a tightening up of market or financial conditions.