Greek Metaphors Converge on Creditanstalt

Greece finally begged for a bailout today. "Greece Declares Unilateral Withdrawal from Reality" was the faux headline of ZH, worthy of the best of The Onion. 

The metaphors have moved from Bear Stearns to Lehman to now the grandaddy of all defaults, Creditanstalt, the Austrian default in May 1931 that led to a series of other defaults in Europe and the second wave down after the 1929 crash.

What is perhaps overlooked by many is that Creditanstalt was rescued by capital from the Austrian government, the National Bank and the Rothschild's, but the announcement of the rescue caused a run which took the bank down. This run drained the government, and by mid-June its credit had run out and it fell. 

The rescue caused the ruin. 

Why the run? The creditors to the bank seized a chance to get out and dump their bad debt on the government. Could that happen this time? Mish provides this chart of the exposure of various banks by country. What if the French and Swiss banks, who are particularly over-exposed, decide to get out and dump their debt onto the IMF? 

Curiously, then, the lesson is that the very rescue of Greece may cause its demise. Or, that the private banks will stick the hot potato into the taxpayer's lap. 

Comments

[Chabazite]

'French banks account for a quarter of all foreign-bank loans to Greece.' Speaking as an Englishman, I think Greece has an obligation to default at the earliest opportunity!

[Charles DG]

We Surrender!

[Chabazite]

You normally do!

[GlennLoserNeely]

Not our infamous Charles "DG".
He argues about EVERYTHING!!!
:)

[Chabazite]

Hmm - I thought it might have been Charles de Gaulle, and he certainly DID argue against everything British. Never really forgave us for sinking the French fleet on July 3rd 1940. Well, seemed a perfectly reasonable sort of thing to do. The French need their fleet sunk every hundred years or so. More tea anyone?

[Hockthefarm]

"Peesse off Chabazite" is how I believe you say it. We are still smarting about da boats.

Andre Maginot

[yelnick]

Chab, there has been a rebirth of interest in WWII over in the US, so it has come to our attention that when the US first came to North Africa to push Rommel out, the Vichy French fleet opposed us. I am sure there was mixed feelings amongst the crews, many of whom would still remember the US expedition to France in 1917.

[Hockthefarm]

Wow! Forget about the Boston Tea Party. I suspect folks will be moving to Vermont:

http://realestate.yahoo.com/promo/what-300000-buys-you-now

What a tidal wave.
Hock

[Hockthefarm]

A good one from Doug Noland:

In a word: are we really going rein in the trash that made the last 15 years possible?

"For the private-sector Credit mechanism to supplant government Credit will require an enormous expansion of risky loans. These risky Credits must then either be held directly by the financial sector or intermediated and sold into the marketplace."

Hock

Deficits and Private-Sector Credit:
The small cap Russell 2000 index has gained 18.6% so far this year, slightly ahead of the S&P400 Mid-Cap’s rise of 16.9%. The S&P 500 Homebuilding index has surged 38.6%, and the Morgan Stanley Cyclical Index has advanced 16.5%. The Morgan Stanley Retail Index has jumped 28.0%, trading today to a new record high.

The bullish contingent is these days increasingly confident that there is much more to the recovery than a mere stimulus-induced “sugar high.” The marketplace now comfortably disregards bearish developments - and becomes further emboldened by “market resiliency”. The market this week brushed aside issues with Greece, China, Goldman and financial reform.

Complacency abounds, in true Bubble fashion. The U.S. stock market dismisses that there could be meaningful ramifications from the unfolding Greek debt crisis. Chinese authorities’ recent determination to restrict mortgage Credit barely garners a headline. And while the Goldman allegations generate great interest and discussion, few believe they will have much general market impact. Financial reform, well, it’s an afterthought when the market is open. Market participants are enamored with the notion that the securities markets and real economy are now conjoined in the initial phase of a big bull cycle.

Count me a subscriber of the “sugar high” thesis. The combination of double-digit (to GDP) deficits, protracted near-zero rates, and the Fed’s unprecedented Trillion-plus monetization has worked wonders. Government stimulus stabilized the Credit system, asset prices, system incomes and economic output. The bulls today believe that a new expansionary cycle has commenced, and fundamentals and prospects couldn’t be much more encouraging from their point of view. Surging stock prices have the optimists disregarding the possibility of a systemic addiction to massive government spending, ultra-low rates, and overabundant marketplace liquidity. Potential issues in the area of risk intermediation are not on the radar screen.

Yet, the sustainability of this recovery will be determined by private sector Credit - eventually. The markets assume private Credit growth will snap back after its long recuperation – as it always has in the past. But, mostly, analysts expend little energy pondering this issue. Deficits of about 10% of GDP, rapid expansion of government-backed Credit (MBS, “build America bonds,” student loans, bank deposits, etc.), and near-zero rates have created a recovery backdrop where minimal private-sector growth has sufficed. This won’t always be the case.

Greek Credit default protection began December at 176 bps. Not many months ago there was little fear of a debt Crisis and no worry of default. Yet here we are today with Greece 2-year debt yielding 11% and annual default protection priced at about 600 bps. Markets fear insolvency and debt restructuring.

The U.S. Treasury borrows these days for three months at 15 bps and for two years at 1.02%. No one dares contemplate how dramatically the world would change if fear injected itself into the equation. While there is certainly more recognition of the structural debt issues confronting our government borrowers (local, state and federal), there is no concern for short-term funding issues. There was an important aspect of the Wall Street/mortgage finance Bubble that receives little attention: The explosion of Credit provided an enormous boost to governmental receipts. Especially in the case of federal debt ratios, boom-related revenues reduced borrowing requirements and distorted debt-to-GDP ratios.

At about 70% of GDP, outstanding Treasury debt is not on the surface overly alarming. Obviously, if one throws in GSE liabilities and the massive future spending obligations related to social security, healthcare, pensions, etc., things are much worse. Yet it is conventional wisdom that the U.S. has the luxury of several years to get its fiscal house in order. And there is today great faith that economic recovery will, as it always does, lead a revival of government receipts and ensure rapidly declining deficits. Count me skeptical. The previous Bubble helped disguise underlying structural debt issues at the state, local and federal levels. Going forward it’s payback time.

First of all, economic recovery on its own won’t rectify the federal deficit problem. Instead, the expansion of private-sector Credit will prove the key. Economic recovery is thus far having little impact on deficits specifically because the current expansion is financed chiefly through government borrowing and spending. It is the expansion of private-sector debt that creates government receipts that are not offset by rising expenditures – thus reducing fiscal deficits. The optimists take it for granted that this recovery will work as they always do – that fretting over U.S. structural debt problems is premature by a number years.

There are important factors unique to this cycle that I believe make it improbable that private-sector Credit will expand sufficiently to promote federal government debt relief. First, in the post-housing mania environment, it will take years for a substantial rebound in private mortgage Credit growth – and perhaps decades to return to 2005’s and 2006’s $1.4 Trillion annual expansions. The demand for borrowings is much reduced, while Credit standards have tightened meaningfully from the manic years.

Moreover, it was the historic expansion of mortgage Credit over the past decade that so inflated system Credit and, in the process, altered the underlying structure of the U.S. “Bubble economy.” The inflation of asset prices, incomes, corporate cash flows, and government receipts fashioned a system acutely dependent on robust Credit creation. The entire system became dependent on enormous, uninterrupted and risky Credit expansion. Today, the private-sector Credit mechanism suffers from severe post-Bubble impairment. At the same time, massive Federal government intervention has sustained the Bubble economic structure with its outsized Credit appetite.

In the current stock market frenzy, the economy’s structure and the prospects for private-sector Credit hardly seem relevant. The underlying fragility of private-sector Credit is masked. The markets are buoyant, while economic recovery gains momentum. Apparently, there’s no reason to focus on Greek debt woes, China’s vulnerable Bubble, Goldman’s and Wall Street’s trust issues, or the uncertainties associated with financial reform – not with corporate earnings surging and many stocks in virtual melt-up. Expectations have adjusted sharply higher, with most now believing the markets are discounting quite favorable economic prospects. I would instead hold the view that reflated securities markets are again nurturing financial and economic vulnerability.

Recent issues in Greece, China, Wall Street and Washington should not be dismissed. Importantly, this confluence of developments holds the potential to further restrict the capacity and stability of private-sector Credit. The Greek debt crisis appears to have created dislocation in the Credit default swaps marketplace. This will likely increase market volatility, along with heightened susceptibility for market yields to lurch higher, while perhaps hurting liquidity in government debt markets generally. This may not be an issue for Treasuries today, but it could foster debt market vulnerability going forward and make the inevitable bear market even more challenging.

The SEC’s allegations against Goldman increase the odds of meaningful financial reform. Risk-taking by the major financial institutions will be further reigned in; trust in contemporary Wall Street finance will be further shaken. There will be more intense efforts to crack down on over-the-counter derivatives and push derivative trading to the exchanges. None of this would seem to have a major impact today – but I view these developments supporting my expectation for restrained private-sector Credit growth going forward.

Over the years, I’ve emphasized the prominent role “Wall Street alchemy” played in fueling Credit Bubble excess. The Street’s astounding capacity to transform risky loans into perceived safe and liquid securities was absolutely fundamental to the Credit Bubble. The OTC derivatives markets – including collateralized debt obligations, asset-backed securities, Credit default swaps, auction-rate securities, etc. – were critical for the intermediation of risky, high-yielding loans into “money”-like securities. This brand of risk intermediation and distortion was instrumental to the historic boom and bust – and this week it returned to the regulation spotlight.

As I’ve attempted to explain over the years, risk intermediation invariably becomes a central issue inherent to protracted Credit Bubbles and their resulting Bubble Economies. The amount of Credit necessary to sustain the Bubbles rises each year. And each passing year requires an increasing (exponentially-rising) amount of riskier Credit. Our government’s massive injection of Credit/purchasing power coupled with interest rate and market liquidity intervention sustained the existing economic structure. As they say, “that’s the good news.”

For the private-sector Credit mechanism to supplant government Credit will require an enormous expansion of risky loans. These risky Credits must then either be held directly by the financial sector or intermediated and sold into the marketplace. Admittedly, this may not be much of an issue today – with government Credit expansion and monetary stimulus abounding. But there is no escaping the harsh reality that acute Credit vulnerability is only held at bay by Trillion dollar deficits and ultra-loose financial conditions. I am skeptical of notions of shrinking deficits and a graceful Fed exit.

The unfolding Greek debt crisis, China Bubble vulnerability, and more intense scrutiny of Wall Street risk intermediation now work in confluence to increase the probability for a negative surprise in our risk markets. Sure, the equities bulls have become intoxicated by some incredible stock and sector performance. But equity market reflation must be approaching the point of unnerving the bond market. And it can’t help sentiment that, as reported today by CNBC’s Steve Liesman, a rising number of FOMC members support a timely sale of assets and a removal of the Fed’s extraordinary liquidity measures. More bearish fundamentals for the private-sector Credit mechanism gladly ignored by a stock market Bubble.

[Account Deleted]

Respected DG !!

JUdging from your few chart pictures in a previous post u now seem to be in agreement with NEELYs view of a Multiyear Triangle and we could be in the B leg of this multiyear Triangular formation.Also we are in the last combination of a Triple combination in the B leg.Is this true ?. Also if its a Triple combination in the B leg then it goes without saying tht it will end with a Triangle itself.
Your views are highly appreciated.

Thanx in Advance
VB

[DG]

VB,

I agree on the wave-(B) part, but I am not convinced of the Triangle part at this point. In fact, the duration of wave-(B) has me thinking Flat more than Triangle. Now, the wave-(C) of this Flat wouldn't necessarily equal wave-(A) and, in doing so, make a new low. So long as wave-(C) was Impulsive in structure and met the minimum relationship to wave-(A), that would complete the decline from the 2007 high.

One thing that has me wary of my Triple Combination structure is that the 2nd :3 in my structure took longer than the first :3 plus the first x-wave combined. That is a bit of a stretch in terms of the time relationships.

I was originally looking for a Triangle to end the Triple Combination, but, this leg from the February lows is taking so long that I am not sure a Triangle will work. If you look at the initial rallies from the March 2009 low and the July 2009 low, the first leg up took much less time than the current one. This leads me to wonder if this isn't a self-contained structure. I am looking at it as a "Neutral Diametric", i.e. a Diametric whose first five segments follow the rules of a Neutral Triangle. If that is the case, I will know by April 29th because that is when time will run out for that structure.

If that's the right structure, that would make this rally from March 2009 a Triple Three, not a Triple Combination. Either way, if it is a Triple, that also argues against new lows.

[Account Deleted]

Respected DG !!

Your counts more than sum it up that u arent looking for a NEW LOW in DOW from now on.Thats actually good news Isnt it.
If its a FLAT then what we could ideally have is a DOUBLE FAILURE Pattern which is a neutral to bullish pattern.Implying good times ahead.Ideally what could the time of the C wave of a presumed FLAT.Would it be approx 14 months(A+B/2) or would it be slightly longer.Could u please throw some light on this.
IF this is a TRIANGLE then what could be the time implication of C D and E legs based on maximum and minimum allowable Time these can take.

Thanx in advance
VB

[DG]

VB,

Sure, no new lows is good news.

It gets a bit tricky to say what type of Flat it will be because if you measure wave-(A) from ~1300 SPX, wave-(B) has already retraced over 80% of wave-(A), so it hasn't "failed". Yes, you could still get a C-Failure Flat and that would be my forecast, given that almost regardless of what the exact wave structure from March 2009 is, it is a structure which should not be retraced 100%, i.e. it has at least one x-wave in it.

However, simply because something is a Complex Correction, especially if it is a Double Complex Correction, but not a Triple, doesn't mean it's impossible that it get retraced 100%, just pretty unlikely.

For timing, yes, that is my best guess if we are in a Flat and for the Triangle option, I see no reason to disagree with Neely's forecast in his Monthly plot from January 2010, which I believe runs out to the 2012-2014 time range.

[Account Deleted]

Respected DG !!

Did u mean tht if its a DOUBLE COMPLEX correction there is still a remote chance of the entire wave being retraced.But if its a TRIPLE COMPLEX correction or a TRIPLE THREE it just cannot be completely retraced.If true then since u have been suggesting a TRIPLE THREE or a TRIPLE COMPLEX CORRECTION since MAr09 low then its ofcourse we wouldnt hit new lows.Are my assumptions true.

Regards
V B

[DG]

VB,

Yes, that is correct. For an example of a Double Complex Correction that gets completely retraced at this degree on the SPX, the bull run from 2003-2007 is one, as is the bear market from 2000-2003, both of which count best as Double Threes.