Archive for the ‘Moral Hazard’ Category
If feedback from the real world is suppressed, then decisions will necessarily be bad.
You’ve probably heard this stock market truism: what everyone knows has no value. This has several components:
1. If you’re basing your trading decisions on the same contexts and conclusions as everyone else, it’s difficult to develop much of an edge.
2. Unless it’s completely manipulated, the market generally doesn’t reward “what everyone knows,” i.e. the consensus, for long.
3. “What everyone knows” often includes trends and targets. For example, everyone now knows gold is in a bear market and the next technical target is $1,250 – $1,300. As a result, everyone’s on one side of the boat: those recommending buying gold at $1,480 are few and far between.
Legendary traders like Jesse Livermore viewed the market as a mechanism for taking as much money from the consensus as possible: taking as few traders as possible along on bullish runs higher and punishing as many traders as possible on bearish declines.
This raises two questions:
1. What does everyone not know that might have value?
2. Is there some contrarian value in what everyone knows?
We all know the Federal Reserve is manipulating the stock market. It does so in two ways:
1. Financial repression: lowering the yield on “safe” assets such as Treasury bonds to negative rates (adjusted for inflation, you’re paying the government to park your capital in its bonds), which drives capital into so-called risk assets that offer a yield, for example dividend-paying stocks and rental housing.
2. POMO and bulk purchases of futures contracts on the S&P 500 before the market opens. Studies have found that the majority of gains in the stock market occur on POMO (one of the Fed’s quantitative easing programs) days and on days when large lots of E-Mini futures contracts are purchased, pushing the markets higher at the open.
Everyone knows markets in the U.S. and Japan are levitating higher as money is created and pushed (via currency devaluation and financial repression) into stocks.
What nobody knows is the eventual consequence of all this manipulation. Right now the consensus is “don’t fight the Fed,” meaning stay invested in stocks because they’re going higher.
In less-manipulated markets, we would expect the consensus to eventually be punished, simply because the market rarely rewards the majority for long. But in central-planning manipulated markets, the feedback that is the foundation of open markets has been suppressed.
Feedback is another way of saying information from the real world is allowed to enter a transparent exchange. We know the exchange is no longer transparent, what with dark pools and high-frequency trading machines. We also know signals from the real economy are not the dominant market-moving forces.
What we know, but cannot say out loud lest the charade lose power, is that the Fed is manipulating the stock market higher because it has lost the ability to manipulate the real economy. Our political and financial Elites would prefer to extend their neofeudal dominance by expanding the traditional foundations of debt-based “prosperity”: increasing household income so households can spend more and service more debt.
With household incomes for the bottom 90% in structural decline, they’ve failed, for reasons they either can’t understand or dare not discuss.
Their only control is the lever pushing stocks higher. Publicly, Fed chairman Bernanke has justified goosing the stock market and housing higher as the only available way to trigger the wealth effect, an inner state of consumerist bliss in which the owner of assets sees his assets gain in value. Feeling wealthier, he goes out and buys a bunch of junk he doesn’t need with debt, boosting demand and bank profits.
As for the fact his real income is declining–sorry, Bucko, we can only boost your assets and herd you into risky bets and more debt. The 90% of you with no meaningful exposure to the stock market–well, don’t you feel things are picking up when you see those “Dow hits new high” headlines? Of course you do; that’s the propaganda value of goosing markets higher.
When the causal connection between risk and consequence has been severed, we call it moral hazard. When banks get to keep their gambling profits and taxpayers cover the banks’ losses, this is moral hazard writ large.
In effect, the Fed is extending moral hazard to the entire stock and housing markets. What the Fed is implicitly promising is this: “Go ahead and sink your wealth and income into risky stocks and housing, because we have your back–we’ll never let stocks or housing go down again.”
Do we know if this campaign of extending moral hazard into every market is sustainable over the long term? No. It is an unprecedented experiment, just like the Krugman Cargo Cult Fantasy being played out by the authorities in Japan.
One thing to keep in mind is the size of the markets the Fed is manipulating. The Fed is injecting $85 billion a month into the stock market ($15 trillion) and the housing market ($17.6 trillion). It also manages the purchases of S&P 500 futures contracts via proxies, but these are in the billions of dollars, not hundreds of billions.
So the Fed is leveraging a relatively modest amount of money to manipulate and control very large markets. This is possible because the percentage of total assets that trade daily is small.
Should the herd that actually owns most of the stocks (mutual funds, pension funds, insurance companies, 401K management firms, etc.) get spooked and decide to book their profits, the Fed’s $85 billion bazooka will be revealed as too small to stem the tide.
The keys to the Fed’s success are trust and belief. These don’t lend themselves to data and charting, though we can measure some aspects of trust/belief via sentiment indicators.
But the whole game really rests on participants’ trust/belief that the Fed can continue pushing markets higher and that it will continue to do so.
The problem with cutting the links between risk and consequence and the real economy and the stock market is that a market deprived of feedback from reality is prone to disorderly disruption. Why is this so? Participants make decisions based on the information made available to them. If the information from the real world is suppressed or limited, then the decisions made by participants will necessarily be misinformed, i.e. wrong.
Moral hazard does not lead to positive outcomes. As I explained in my book Why Things Are Falling Apart and What We Can Do About It, this leads to making bigger and riskier bets at the casino, until a loss occurs that bankrupts the house.
What happens when a bet that can’t lose does in fact lose? Trust is lost.
I see a lot of long-term charts where technical analysts extend past trends and cycles out 10 and 20 years. Many predict a new Bull Market in stocks starting in 2015 or maybe 2016 and running for 13 to 18 years.
It’s easy to project the past onto the future, but what few observers seem to ask is: what happens to the belief system that supports the stock market when trust and credibility are undermined by central-planning manipulation that failed?
If feedback from the real world is suppressed, then decisions will necessarily be bad.
The only choice for participants who have lost faith in central planning’s promise of permanently higher markets will be to abandon the manipulated markets entirely.
Charles Hugh Smith – Of Two Minds
It’s important to draw a line between two very different flavors of banker: “restrained” (Dr. Jekyll) and “unrestrained” (Mr. Hyde).
Those who read The Proper Use of Credit (April 4, 2013) know that I see a vital role for credit and yes, banks, in a sustainable economy. But as many observers have pointed out, banks must be controlled lest the predatory, parasitic Mr. Hyde replaces the proper Dr. Jekyll role of providing capital to worthy enterprises and households.
In response to Debt = Serfdom (April 2, 2013), longtime correspondent Jeff W. delineated the difference between Good Banker (restrained) and Bad Banker (unrestrained). Unfortunately, as Jeff explains, it is Mr. Hyde (unrestrained banker) who has captured the political and regulatory machinery of governance.
Here is Jeff’s commentary:
“I distinguish in my mind two different kinds of bankers: I’ll call them “restrained” and “unrestrained.”
The restrained banker loads up the debt serfs with debt up to their Plimsoll Lines or credit limits. Then he stops. He knows that if he keeps loading more debt onto them, they may go bankrupt, and he wants to avoid the mess and losses that come with that.
The unrestrained banker has a completely different skill set. He will make high-interest loans (Payday Loans) to insolvent borrowers. He is not afraid of bankruptcies; bankruptcies are part of his business model. He knows how to take advantage of borrowers who are desperate, ignorant, or impulsive (or all three). He knows all about asset stripping. He knows how to unload bad loan paper on suckers. He thrives in an environment of chaos and desperation, where his customers are often at the end of their ropes.
In the old days, the restrained bankers and community-minded Americans used to put controls on the unrestrained bankers. There were usury laws that made it illegal to charge interest above a certain rate, such as 15%. Unrestrained bankers were not welcomed into polite society, and people were warned against doing business with them.
Which of the two kinds of bankers operate the Federal Reserve and have seized control of the Federal government? I say it is the unrestrained variety. I say that the securitization of mortgages was, all along, a scheme to unload bad mortgage paper on suckers, such as pension funds and the U.S. taxpayer.
Obama’s stimulus was the work of unrestrained bankers. The Obama deficits have been the work of unrestrained bankers. The Simpson-Bowles Commission was an effort by the restrained bankers to keep the U.S. debt below its Plimsoll Line, which Reinhart and Rogoff have put at 80% of GDP. But the unrestrained bankers have not hesitated to blow right past that.
If my observation is correct that the U.S. government has now been subverted by unrestrained bankers, it means that:
- Our nation’s fiscal policy is being dictated by people who are not afraid of the chaos of bankruptcy, but who thrive in that environment.
- Federal policies are being dictated by people who like to deal with debtors who are desperate and at the end of their ropes.
- Federal policies are being dictated with a view of future asset stripping.
- With this group in power it means that In a future bankruptcy scenario, everyone is going to come out a loser except the unrestrained bankers.
Where restrained bankers might be compared with bloodsucking fleas or lice, who are parasites on healthy bodies, the unrestrained bankers can be more aptly compared with maggots, who feast on the bodies of the dead.
So I say it is important to know what kind of bankers you are dealing with. If you are dealing with unrestrained bankers, it can bring nothing but bad luck.”
Thank you, Jeff. As correspondent Lew G. noted, the key feature of a sustainable, non-parasitic banking sector is that banks and bankers have “skin in the game,” i.e. they personally suffer losses when their loans and bets go bad.
This is the essence of moral hazard: the separation of risk from consequence. Put another way, those who are insulated from risk will have an insatiable appetite for risky bets because any gains will be theirs to keep but any losses will be covered by the central bank or government: this is known as “privatizing profits and socializing losses.”
As Lew G. also observed, if players (in this case, bankers, legislators and regulators) “have a choice of games, they will play the one with the best payoff,” i.e. the one in which they have no skin in the game and the Central State/bank will backstop/ socialize their losses to the Tax Donkeys (taxpayers) while they keep the ill-gotten gains.
The Federal Reserve, the Obama Administration, the housing agencies and the U.S. Treasury are all offering bankers and financiers high-payoff tables that require no skin in the game. No wonder our system is dominated by the unrestrained bankers, sociopathological Mr. Hydes who offer a few coins in compensation for running down the nation.
Charles Hugh Smith – Of Two Minds
The United States of Debt Addiction: Our reliance on debt has created an entire economy fortified in the fires of moral hazard and fiscally dangerous leverage.
16 point 7 trillion dollars. That is our current national debt. 12 point 8 trillion dollars. That is the amount households carry in mortgage and consumer debt. We are now addicted to debt to lubricate the wheels of our financial system. There is nothing wrong with debt per se, but it is safe to say that too much debt relative to how much revenue is being produced is a sign of economic problems. At the core of our current financial mess is how we use debt as a parachute for any problem. We’ve been masking the shrinking of the middle class by allowing households to take on too much debt for a couple of decades. The results were not positive. Too this degree, we have now created a massive moral hazard economy where savings are punished into oblivion. There is very little incentive to put your money in a bank account yielding zero percent interest when real inflation is eating away at your money like a hungry wolf. So what do people do? Well many simply cannot save and therefore choose to go into debt to finance cars, housing, and education with very little down. Where does this debt addiction lead us?
A little bit of deleveraging
US households have deleveraged from the peak in the crisis. However, much of this deleveraging has been forced via the 5 million foreclosures that have occurred:
I’m not sure if we can interpret that as some sign of a healthy and growing economy. Households have had their access to debt limited in many sectors. Yet one sector that never retreated was that in higher education. There is little doubt that there is a major bubble in higher education. Instead of addressing the problems head on we now have more access to debt as the solution. In order to compete in our service driven economy, having a skill is very important. Most will make the investment to pursue a college degree but the issue is that with easy access to debt, prices have soared. It is no surprise that college prices are following the trajectory of what happened in housing.
If you look at the above chart, a big part of the contraction has come from deleveraging from mortgages and credit card debt. Yet we are now once again loading up on auto debt and college debt. The system is now setup to punish any type of savings. Good luck trying to stash your money in a bank account and outrun even the steady pace of inflation.
Take a look at the current savings rate for Bank of America:
Of course the Fed has a hand in all of this. The Fed realizing that our system for over a decade has been juiced by debt spending, had to step in and make it unattractive to save to the point that people are willing to dive into risky investments yet again. Because of this however, you create moral hazard.
Read the rest at My Budget 360
At about 13:00 minutes in, a familiar face makes an appearance.
In this episode, Max Keiser and co-host, Stacy Herbert discuss the alleged meritocracy of old Etonians running the world (into the ground) while the rest of us remain wards of the state – from the President of France to PhDs on foodstamps. In the second half of the show Max talks to John Titus, producer of the new documentary, Bailout.
The film premiers in Chicago on May 16th. A must-see when it comes to your area.
Brought to us courtesy of senators Kay Hagan of North Carolina and one of the banking lobby’s most obedient lap dogs, Bob Corker of Tennessee.
The United States Covered Bond Act of 2011 is designed to allow bundling of any kind of debt including derivatives, into marketable securities guaranteed at full face value by the FDIC.
Asset classes eligible to be rolled into Covered Bonds are shown below including “H” which leaves the door open for anything left over, What would qualify would be the decision of one unelected official, the treasury secretary/Goldman Sachs representative.
(A) a residential mortgage asset class;
(B) a commercial mortgage asset class;
(C) a public sector asset class;
(D) an auto asset class;
(E) a student loan asset class;
(F) a credit or charge card asset class;
(G) a small business asset class; and
(H) any other eligible asset class designated by the Secretary, by rule
and in consultation with the covered bond regulators
The full text of the bill is here.
Thanks Bob Corker for working to build this new FDIC insured landfill where our TBTF banks can dump all of their unwanted financial refuse and collect 100 cents on the dollar on their way out.
Please write your congressman to stop this before it is too late.
Insulate participants from risk with policies like the Bernanke Put and you guarantee destruction of both the market and institutional legitimacy.
Identify the common characteristic of these three statements:
1. The Federal Reserve will never let the stock market decline, i.e. the “Bernanke put”
2. The Chinese government will never let property prices decline
3. The European Central Bank will never let Greece default
The answer of course is moral hazard: a person who is insulated from risk will have an insatiable appetite for risky bets because any gains will be theirs to keep but any losses will be covered by the central bank or government. The global financial authorities’ success in propping up assets (stocks in the U.S., real estate in China, banks in Europe, etc.) over the past three years has strengthened this asymmetric disregard for systemic risk into a dangerously quasi-religious faith that central banks and governments have essentially unlimited power to keep asset prices aloft via printing money, manipulation of markets and financialization of their economies.
What happens if markets crumble despite massive, sustained central bank and government intervention? The institutions that created moral hazard will be revealed as false gods, and that faith will be destroyed.
This loss of faith in the transparent functioning of markets will trigger what I call the delegitimization of both the markets and the institutions which have essentially promised a permanent upward bias in assets.
We can see the global scale of this central bank-cnetral State induced moral hazard in the tight correlation of all markets: the stock exchanges rise and fall in near-perfect unison, oil and gold rise and fall in parallel with equities, and so on.
As I have noted before, beneath the surface there is really only one trade in the entire global marketplace: all assets on one side and the U.S. dollar on the other. Correlation is not causation, of course, but it is more than peculiar that every decline in global equities is matched by a concurrent rise in the dollar.
Transparent, independent markets do not move in lockstep. The campaign to prop up all asset classes with implicit guarantees of intervention has completely insulated institutions and punters who believe that the Bernanke Put and the Chinese government’s equivalent prop under real estate is not just policy but a guarantee of god-like power.
Thus the gains from gargantuan speculative bets are yours to keep, and any losses will be made good by the central bank or government. This is the ideal recipe for misallocation of capital and speculative derangement on an unprecedented scale.
Moral hazard is the ultimate perverse incentive: it rewards all that is unproductive and risky and punishes long-term investment and prudent risk assessment.
A second feature of the global central bank’s moral hazard is the necessity to punish any punters who dare to bet against the banks’ manipulations. Thus Fed Chairman Bernanke could opine that oil would decline and presto-magico, a “surprise” release of oil by central authorities occurs the next day.
This second feature of central bank manipulation leaves a market devoid of short sellers and thus of any buyers as markets crumble.
Once trust is lost, it cannot be won back. Once participants’ faith in the markets and in the god-like power of central bank intervention is crushed, the markets will lose participation on a grand scale. The authorities’ favorite game, goosing asset prices to create an illusion of recovery and rising wealth, will be revealed as a global fraud.
Announcements of future interventions will be scornfully dismissed and thus they will have lost their power to prop up the markets.
All of this flows from the very nature of moral hazard: insulate participants from risk and give them unlimited leverage and “free money” to play with, and what you eventually end up with is catastrophe. There is no other possible end state.