Wednesday, November 30, 2011

Does the Federal Reserve Have a Secret Bailout Plan For Europe?

Today's announcement of a coordinated monetary easing program led by the U.S. Federal Reserve, providing currency swap lines to the central banks of other major nations, was the news the stock market wanted to here: a walloping big dose of moral hazard that infused dollar-denominated liquidity into an increasingly stressed European banking system. The Dow Jones Industrial Average blasted upward 490 points, the largest move in two and a half years. Markets always love it when a governmental body reduces their risks. Recall, however, that there is no such thing as the elimination of financial risk. It can only be transferred. If risk is transferred away from market participants by a government program, you know who just got the short end of the stick. (Hint: look in the mirror.)

The Fed's move came when the EU was wobbling precariously at the edge of the precipice. The recent spasms and convulsions of EU member governments has accomplished nothing except prove that the EU's governance process couldn't hold together a neighborhood book club. The absence of action by elected officials has led many to urge that the European Central Bank monetize the EU's sovereign debt by buying it up. But the ECB, hewing to its charter purpose of maintaining price stability, has only dipped a toe or two in the shark infested waters of the EU sovereign debt markets. Even as it buys a distressed nation's debt, it sells debt of stronger nations in order to keep the supply of Euros stable. This, however, doesn't monetize debt.

The Fed, by contrast, has promised with its currency swap program, to print dollars early, often and in bulk. The swap lines are priced to provide Black Friday discounts, except for the next 14 months. The Fed provides to other central banks dollars in exchange for Euros (or Canadian, British, Japanese or Swiss currency), with the other central bank obligated to return the dollars at the same exchange rate as existed when the swap was entered into. Thus, the Fed nominally has no risk.

Consider, however, what might happen when the Fed is dealing with the ECB. The latter won't print money; and consequently has available only so many Euros to swap with the Fed. If the ECB needs more dollars than it has Euros to offer in swap, it's out of luck under the currency swap program. But the Bernanke Fed is clearly hellbent on delivering liquidity, and the delivery process used would only be a technicality. If one process isn't enough, they'd use another. This is the approach the Fed took in the 2008-09 financial crisis, when it expanded the scope of its quantitative easing to buy mortgage-backed securities, commercial paper, business loans, car loans, and other consumer loans. Had the crisis worsened, the Fed probably would have bought the kitchen sink and Uncle Arnie's old lawnmower.

The Fed has its thumb in the European dike. Its currency swap program has bought a little time for Europe's politicians to get their act together. But let's be real. Even though the politicians fervently claim that they will now give the crisis their full attention, experience teaches that they will fail. The EU has a herd of cats dynamics, and true European fiscal discipline and reform is less likely than Bernie Madoff being paroled.

What if the ECB needs more dollars than the currency swap program could provide? This may be a possibility. European banks may experience yet more difficulty getting dollars to fund their dollar-denominated loans as the EU crisis metastasizes. To prevent a credit crunch, the Fed may decide that it would buy EU sovereign debt. The Fed has wide latitude to decide how to implement monetary policy. While buying sovereign debt denominated in a foreign currency would be a first, one suspects that the Fed would, as it has in the past, liberally interpret its mandate in order to do what it considers necessary.

Buying EU sovereign debt would set the Fed on the slippery slope. If there were losses, where would the losses land? (Hint: look in the mirror.) And what if the Fed's money printing were inflationary? Where would the burden of inflation land? (Hint: don't shift your gaze.)

Of course, high ranking government officials in the U.S. and Europe would decry such a scenario as preposterous. But consider that Europe is deadlocked in a death spiral. The politicians can't function and the ECB firmly believes it is legally precluded from monetizing the EU's sovereign debt. The one governmental body in the world that has the resources and willingness to step in is the Fed. Today's action takes the heat off Europe's politicians, if only momentarily. They will probably take it as an excuse to stall and delay instead of impose harsh conditions on all of their electorates (which would be austerity for the spendthrift nations and payment of the bailout costs by the wealthier nations). They'd probably figure they could get away with inaction because the Fed would surely step in with more moral hazard.

If the Fed monetized EU sovereign debt using dollars, that would likely signal the demise of the Euro, with the dollar substituting as Europe's common currency while European nations again issued local currencies. This was the way Europe worked in the 1940s, 50s and 60s. In such scenario now, the Euro bloc might be able to disentangle itself from the crisis, albeit painfully, without triggering a worldwide credit crunch. Maybe that's the Fed's secret plan.

The Fed's not above acting dramatically if quietly. We've recently discovered that it loaned over a trillion dollars to distressed banks during the 2008-09 financial crisis, far more than it had previously acknowledged. Ben Bernanke demonstrated that he would act when it looked like no one else could or would. The eyes of the world may again turn to him, and we shouldn't expect inaction.

Sunday, November 27, 2011

Hidden Bargains

If you want a Black Friday bargain, you have to be ready to be pepper sprayed, horse collar tackled, and perhaps trampled a few times. There are easier ways to get bargains.

Business Laptops. If you're in the market for a laptop, look at less expensive business models. Unlike laptops specifically aimed at consumers, business laptops are designed for heavy duty use, careless handling (it's the company's property, after all), and enough longevity that sales reps can convince corporate buyers the equipment is cost effective. Many business laptops are shock and spill resistant. They are often preloaded with good quality software. This, all for a price in the $500 to $700 range. Business laptops don't come in pastel colors, and are heavier than personal laptops (the additional ruggedness adds weight). But a well-made one delivers good value for the dollar.

Prepaid Cell Phone Plans. Prepaid plans give you direct feedback about your usage, by forcing you to buy more time when you're running low. These periodic demands for money teach you how much your yacking actually costs. You learn to reduce this negative feedback by controlling phone usage. You save by not paying for time you don't use.

Balanced Investing. A portfolio that's about 50% stocks and 50% bonds offers comparative stability in returns (see Investors who enjoy stable returns are less tempted to trade, incur lower transactions costs, and face less of the volatility that tempts one to buy high and sell low. By reducing these negative factors, balanced portfolios can deliver good long term returns.

Renovated Homes. It's axiomatic among real estate professionals that home renovations, with rare exceptions, boost the value of a house less than 100 cents on the dollar cost of the renovations. This necessarily means a recently renovated home is a comparative bargain for the buyer who carefully researches prices and figures out where the actual market price is. A home that was renovated in the past year or two has a good chance of being a bargain. One that was renovated five or ten years ago may have appreciated enough that buyers don't really get a discount from the renovations (depending on the market). A beat up, water damaged foreclosure sale may a good deal. But so may be a sparkling recently renovated home. Do your research.

Year Old New Cars. Cars on a dealer's lot that are brand new, but one model year old can be an excellent bargain. The dealer will seriously discount them (sometimes with a quiet subsidy from the manufacturer) in order to make room for current year models. Year old new cars can be a better bargain than year old used cars, because they have no mileage but sometimes sell for not much more than a used car with 10,000 miles. Buying what the seller doesn't want is a good way to get a bargain.

Wednesday, November 23, 2011

The EU Sovereign Debt Crisis: Skipping a Few Dominos

A hooded figure of Death appeared at the Euro's door today, scythe in hand, beckoning insistently. Germany held an auction of 6 billion Euros worth of 10-year bonds (called "bunds") and sold only 60% of it. The German central bank, the Bundesbank, bought the rest. But that's like your right hand buying from your left hand. The German auction was catastrophically bad. And, who knows, the Federal Reserve may have contributed to the shortfall, by subtly putting pressure on U.S. banks to trim their Euro-denominated exposure (see

By contrast, the U.S. Treasury Department today sold $29 billion of 7-year Treasury notes, receiving three times as much in bids as it was offering (or close to $100 billion in bids). Even though the U.S. may be approaching another credit rating downgrade, the greenback remains a sturdy oak in a forest of blighted trees.

That the German bund auction went so badly means the European sovereign debt crisis is fastfowarding more rapidly than anyone anticipated. Next to topple were supposed to be Italy, Spain, France, Belgium, and Austria. Then, the Netherlands, Finland and Luxembourg would be at risk. But Germany was seen as the last bastion of stability, the wealthy uncle who could save the family if disaster struck. Indeed, the latest concept being proposed for salvation, the Eurobond that was to be backed on the entire EU, would be feasible only if Germany's creditworthiness was beyond question. That's no longer true. If Germany can sell only 60% of a bund auction, how could the EU as a whole sell a Eurobond auction?

The sovereign debt crisis has skipped the intermediate dominos and smashed directly into Germany. The German government continues its opposition to Eurobonds. At this point, that may be irrelevant because the viability of the Eurobond has been called into question. One naturally asks what else might be on the table. That's the really scary part. There is no Plan B. Germany has always been the fallback, the backup, and the backup to the backup. After Germany there's no one, not the IMF, not America, not China, not Russia and not Brazil.

The EU sovereign debt crisis is now proceeding at warp speed. That doesn't mean collapse is imminent. Experience teaches that the financial markets hear what they want to hear and need only one or two rosy press releases from prominent government officials to stage a relief rally. Time and time again, that's the way the EU has kicked the can down the road and avoided the moment of truth. But the EU's principal tactic has been to substitute new debt for old debt, offering promises to replace the promises that this member nation or that couldn't keep. Actual transfers of wealth to reduce debt doesn't seem to be on the agenda. But this paper-for-paper game keeps expanding the amounts of debt outstanding, and investors will eventually tire of playing (as they did with the German bund auction today). When that happens, the Grim Reaper will be waiting to collect his due.

Tuesday, November 22, 2011

The EU Sovereign Debt Crisis: A Farewell to Globalization?

Today, the Federal Reserve announced a new round of stress tests for the six largest American banks to find out how well they would withstand a market discombobulation emanating from the EU sovereign debt crisis. Translated from regulatory speak to plain English, this is a strong hint to the big banks that they straightaway ditch as much of their EU exposure as they possibly can, devil take the hindmost. Those banks that don't move with alacrity will be required to boost capital levels, an exercise detested by bonus loving bank executives (which would be about all of them).

It is ironic that the Fed would try to quietly build a firewall around the U.S. banking system. It has preached internationalism throughout the past four years as the financial markets belly flopped, and maintains generous dollar-denominated lines of credit to foreign central banks. The latter measure helps the dollar fulfill its role as the world's reserve currency, ensuring that there are enough dollars for the wheels of commerce. But encouraging major U.S. banks to offload Euro-denominated obligations de-globalizes. In effect, the Fed is saying, "Lafayette, nous allons partir."

Euro-denominated investments will face downward price pressure if U.S. banks begin casting them away. The Fed surely knows this would be bad for the EU's banking system, which is desperately reaching for any lifeline in turbulent seas. One can't help but wonder whether the Fed has concluded that the EU may not be able to pull itself out of its nosedive.

Sunday, November 20, 2011

Why the Congressional Supercommittee Can't Reach a Budget Deal

Today, news services report that the Congressional supercommittee tasked with the responsibility for reaching a $1.2 trillion budget deficit reduction deal has a snowball's chance in a convection oven of success. That's really not surprising. Even though last summer's debt ceiling debacle taught every member of Congress that fooling around with the federal government's financial standing is reckless, the problem is that the American electorate doesn't want a deal. We have a Democratic President and Senate, and a Republican House. We want fiscal stimulus to combat with the nation's economic woes, but we also want fiscal conservatism to constrain long term debt growth. In other words, we want to have it both ways. That's not how to reach the compromises needed for a deficit deal. That's a formula for failure.

Look at California. The Golden State is the home of the no new taxes movement. In 1978, an amendment to the California Constitution severely limiting real estate taxes was approved by the state's voters in a referendum called Proposition 13. The antitax sentiment that propelled Proposition 13 to success set down deep roots in the state, and today California is a fiscal mess. Voters want good public services and schools. But they don't want to pay for them. To accommodate voters that want to have it both ways, California's state and local governments made fools of themselves with budgetary and borrowing shenanigans that accomplished little except kick the can down the road while schools and other public services deteriorated. Everyone--voters, politicians, public sector unions, and government employees--are to blame. There's no meaningful solution in sight. California has governmental gridlock that makes the federal government look somewhat functional even on bad days.

California, first in so many trends, will be America's fiscal future, unless we make up our minds to grow up. We have to pay for what we want, which could mean raising taxes. We also have to live within our means, which could mean cutting back on federal expenditures. We have to elect a government that can and will make decisions. But today, in Washington and across the nation, we are a house divided. That does not portend well for the future.

Of course, if there is no debt deal and the financial markets panic, all eyes will turn toward the Federal Reserve. This moment, if it occurs, will reveal the fallacy in the Federal Reserve's policy of endless accommodation. Because the Fed has been there when everything else failed, everyone now assumes that the Fed will always be there for us. Neither Congress nor the President have the incentive to actually do anything. Doing things in Washington necessarily means you will make enemies. And elected politicians always prefer to avoid making enemies. So it's better to do nothing and wait for the appointed officials and career civil servants at the Fed bail us out, because we know they will try. Of course, a few disheveled Cassandras foam at the mouth about moral hazard and the limitations of monetary policy. But ebullient pronouncements by inflation doves on the Federal Reserve Board allow the rest of the government to hear what it wants to hear and rationalize inaction. So Washington bubbles along, believing six impossible things before breakfast, and peering through the looking glass for the imminent arrival of prosperity that won't cost us anything.

Wednesday, November 16, 2011

The EU Sovereign Debt Crisis: There Are No Safe Havens

The EU sovereign debt crisis has metastasized in two weeks from being a problem with Greece, to being a problem with Italy, Spain and France. Bond yield spreads for the debt of these much larger countries are widening away from German bunds. The dollar is once again dearly loved in the capital markets in spite of the Federal Reserve's persecution of positive returns on dollar denominated loans. The EU's much touted expansion of its bailout fund to over one trillion Euros is d.o.a. With the large Romance language speaking nations on the cart approaching the guillotine, a trillion or two just doesn't amount to jack, especially since this proposal was simply another paper shuffling shell game to flim flam creditors into believing that swapping new EU debt for old debt was somehow in their interest. The EU's overall ability to repay has been deteriorating. Why would new debt be attractive?

With all the turmoil, one would think that gold would be skyrocketing in value. But it hasn't. Since reaching its peak of $1923 per ounce this past summer, gold dropped below $1600 and has recently meandered around in the $1700s. As we discussed in September (see, gold is intimately linked to financial assets, and derives its value from financial market interactions. It's no safe haven.

Nor is anything else. Countries that are viewed as having sound currencies, like Switzerland, have been intervening in the currency markets to keep their exchange ratios down. Otherwise, capital will flood in, drive up the value of their currencies, and wreck their export businesses.

Weirdly, the U.S. dollar has by default remained the world's safe haven. If nothing else, investors know that, in the worst case, the U.S. Treasury will conspire with the Fed to print however much money it takes to pay America's debts. The Congressional Supercommittee tasked with reducing the federal deficit is on the verge of belly flopping. But the financial markets remain sanguine, evidently believing that capital has nowhere else to go.

Sunday, November 13, 2011

Old-Timers and Their Rolls of Cash

Back in the 1950s, 60s and 70s, it was commonplace for men who had lived through the Great Depression to keep rolls of cash in their pockets. Many carried $200 or $300, equivalent to $1,000 to $2,000 today. Usually, these weren't wealthy men. They were ordinary men who had learned from experience that life is unpredictable, usually in a bad way. In their time, banks had failed, the stock and real estate markets had collapsed, unemployment had risen to 25%, families had fallen apart, young people felt lucky to have a job--any job--and prosperity returned only after the world survived the crucible of a horrendous world war. Cash was their insurance policy against all kinds of hazards, including the uninsurable. Cash felt good.

We're now in another era of uncertainty. While government safety nets, stimuli and other measures have kept us out of a Depression, the unresolved debt crises in America and Europe, as well as depressed real estate and volatile stock markets, continue to inhibit recovery. Another downturn may be in the offing. Federal deposit insurance relieves us of the need to keep large amounts of paper currency on hand. But the value of cash is strongly correlated with increases in market volatility, and cash is getting to be extremely valuable now.

Safety nets are wearing thin. Government benefits for many have run out and there's no room in the budget for more. Many are one paycheck away from homelessness. Illness, layoffs, disability, a new roof, a major auto repair, and other unpredictable expenses wait in ambush. Credit is tight. The only people who can get loans are the ones that don't need them. Keep 6 to 12 months living expenses in an emergency fund that's FDIC insured. Then set aside some more money to cover hell and high water expenses. The chances of another worldwide financial crisis swirl like a morning fog that may not lift. All the newfangled financial engineering hasn't made the world a safer place. The old-timers knew one thing: cash is the best port in a financial storm.

Thursday, November 10, 2011

The Cost of Poor Governance

The world is mostly run by organizations. Some are large. Many are small. But almost everything of consequence is done by organizations. How well an organization functions is crucial to its success. Today offers vivid examples of why an organization's governance processes matter.

The European Union. The first and best example is the structurally flawed EU. Its charter calls for a constrained and disciplined central bank, mandated to prevent price inflation. The 17 EU members that adopt the Euro are required to control their fiscal expenditures and hold deficits to 3% of GDP or less. But there are no effective controls over fiscal spending. Thus, when Greece, Ireland, Portugal, Italy and just about all other 17 members violated the deficit limits, the EU had no effective way to police their conduct. These tight monetary controls and basically non-existent political controls combined to produce a toxic excess of debt that can't be addressed in time-honored fashion by depreciating the Euro. And the EU's clumsy governance process, which generally requires unanimity of its members, prevents a swift response to a rapidly deteriorating crisis.

The EU's governance flaws have already proven costly. The EU has already committed hundreds of billions of Euros to a bailout fund. Then, there are the losses that creditors have taken or will take in the Greece bailout. In addition, we have the expense of the Benelux bailout/nationalization of Dexia, SA, and the failure of MF Global. Ongoing market consternation over Greece's and Italy's failed governments is imposing more costs as stocks gyrate. And then there are the future costs, which are now inevitable even if we don't yet know what they are.

The EU is a political entity without effective political governance. That's a formula for disaster, and the disaster is upon us. The European Union remains a wealthy part of the world, and has the economic resources to solve its problems. But it doesn't have the governance process to determine the baseline question: how among creditors, debtors, insurers and taxpayers will the cost of the sovereign debt crisis be allocated? So the EU--and the rest of the world--may suffer severe consequences.

Pennsylvania State University. The Penn State child abuse scandal has blown up the pristine reputation of a storied football program and ended the career of the greatest college football coach of all time. This, because people holding crucial positions in the university's internal governance process allegedly couldn't figure out that the welfare of minor children is more important than the reputation of their football program. This isn't altogether surprising. The day-to-day pressures on employees of maintaining and enhancing organizational performance can exaggerate their perception of the importance of the organization's priorities, and diminish their perception of external considerations. Personnel may forget that the organization exists within a larger community, and ultimately is subordinate to that community. This is true of universities, and also of major Wall Street banks. Failure to maintain perspective and humility can be very costly, both to the organization and those that are victimized.

The United States of America. There's a lesson for America from the two preceding examples. But we see little sign that the processes of the federal government have improved since the debt ceiling debacle a few months ago. The budget deficit supercommittee is wallowing in dysfunction. The President hasn't exactly been front and center to provide leadership. One gets the sneaking suspicion that all elected officials in Washington are laying the groundwork to play the blame game in next year's election, rather than trying to actually do something. But fingerpointing falls into the category of poor governance. Unless America figures out some way to make things work, we can look forward to sharing the fate of the EU and the Nittany Lions.

Wednesday, November 9, 2011

Italy: A Financial Run in the Making

If you ever wanted to see what a bank run looks like, you can watch the 1946 film, It's a Wonderful Life, starring Jimmy Stewart, or you can watch Italy. Greece's deterioration in the past few weeks laid the foundation for Italy's distress. As Greece was sucked down the drain, Italy began wavering, and then wobbling. Now, yields on Italy's bonds are skyrocketing, exceeding 7%. That's the range bond yields for Greece, Ireland and Portugal reached before those nations went down the tubes. Italy isn't literally a bank, and holders of Italian bonds can't go to the counter and make a withdrawal. All they can do is sell in the secondary market for whatever price is available, and lots of them are.

Rumor has it that the ECB is buying Italian bonds in an effort to stabilize the situation. But that would be a temporary measure. The ECB by itself is a wee bazooka, unless it starts printing money and that's not allowed by its charter. The EU has already announced that it has no plans to bail out Italy. Indeed, its bailout fund, the EFSF, doesn't have enough money to bail out Italy. Nor does the IMF. Nor do the Chinese or the Brazilians. Eyes will inevitably turn toward America. But the political situation here precludes a fiscally funded bailout for Italy. And the Fed, which has no compunctions about printing money, can't print Euros. Its bazooka uses different ammo.

Italy is on its own, and Jimmy Stewart is no longer around to step in and calm things down. It's up to Italy to persuade the fixed income vigilantes that it can pay its debts as they fall due. That's a tall order in this time of Euro-skepticism.

Compared to Italy, Greece has a small amount of sovereign debt outstanding. Yet Greece's problems were enough to knock down a major European bank, Dexia, and a significant American brokerage firm, MF Global. If Italy's bonds maintain their downward trajectory, it's entirely possible that more financial firms will fail. Sadly, we don't have enough readily available information about the bond holdings, derivatives exposures and counterparty risks of financial institutions to easily predict which ones might be in trouble. That lack of information exacerbates the potential for systemic risk. Volatility reigns supreme in the financial markets.

Sunday, November 6, 2011

The European Union's Only Option

The downfall of George Papandreou, prime minister of Greece, illustrates the European Union's only option for survival. Germany and France dictated the terms of the latest iteration of the bailout for Greece, which included tough austerity requirements and a 50% haircut for creditors. Both Greeks and creditors squawked, but ultimately knuckled under. Then, Papandreou threw a wrench in the works by calling for an ad hoc national referendum on the deal. Why he latched onto this misguided notion remains unclear. Whatever the reason, it threw the financial markets into a tizzy.

The prime ministers of Germany and France summoned Papandreou to be chewed out in Cannes. Most likely, George didn't get much time to work on his tan. Back in Athens, he called off the referendum. His next move was to maneuver for a coalition government, while his opposition called for snap elections. Germany and France stepped in again and made it clear that they wanted Greece to have a unity government that would implement the terms of the revised bailout.

Next thing you know, Greece is announcing that it has reached a tentative deal for a unity government. Tomorrow, Greek politicians will spar over who their next national leader will be. It won't be Papandreou.

What's happened in Greece was dictated by Germany and France. The Greeks weren't given a choice. They were told what bailout they would get and what governmental process they would use to implement it. In essence, Germany and France have assumed supervisory political control over Greece. This--the political unification of the EU--is the union's only chance for survival. Economically speaking, the EU's continuation depends on a transfer of wealth from the well-off nations of northern Europe to creditors of the more profligate EU members. The price of this transfer is political domination by the north.

Germany's been through this once before. When the Berlin Wall fell, prosperous West Germany unified with moribund East Germany. West Germany paid a very high price in bringing its formerly Communist sibling into the world of free enterprise. But the West Germans wanted unity and they were willing to pay for it. Now, Germans depend on the Euro Zone to sustain their prosperity, and they are gradually coming to realize their reluctant willingness to pay for the survival of the EU. The continued fecklessness of Greece and its government in dealing with the crisis has forced Germany and France to take charge. By the most contorted of processes, the EU is evolving toward political unity.

It's not inevitable the process will continue. Other nations are in trouble. Italy is the next target of the sovereign bond vigilantes. Interest rates on its bonds are rising sharply vis-a-vis German bonds, and it has recently agreed to be monitored by the IMF. Many Italians are irked by this infringement on their sovereignty. If Greeks and Italians feel put upon enough, they can simply leave the EU. That might seem highly irrational, since it could lead to the collapse of their financial systems and steep recessions. But let's not forget that twice in the last century Europe descended into horrific world wars that killed tens of millions of people. Europeans are eminently capable of highly irrational and self-destructive behavior.

No one knows all this better than the Germans, who were the most irrational and paid an enormous price for their self-destructiveness. That's why they're willing to pick up the tab now for the profligacy of their neighbors, but only if they can exercise political control over the spendthrifts. The question is whether Europeans, with their vast cultural differences--far greater than those between folks north of the Mason-Dixon Line and those to the south--can achieve the compromises and concessions needed for lasting political unity. The post-Communism breakups of Yugoslavia and Czechoslovakia tell us that Europeans don't always have a preference for political unification. Expect a bumpy ride in the financial markets while the EU works things out.

Wednesday, November 2, 2011

The Greek Referendum: What European Union?

Is there even such a thing as the European Union? The Greek prime minister, George Papandreou, has just announced an impromptu referendum to be held toward the end of this year, in which the Greek people will decide if they will accept the austerity and other measures required by the EU's bailout of Greece. The referendum was not previously mentioned by Greek leaders to the EU, and the EU is displeased, to put it mildly. It's holding back a bailout payment of 8 billion Euros that was to have been given to Greece in mid-November. Greece hasn't back down, and EU leaders are suggesting that Greek voters be asked to decide whether or not Greece should remain in the EU. Who knows? The Greek electorate may respond with a digital salute.

The Greek prime minister also faces a no confidence vote this Friday, Nov. 4, 2011. His legislative majority has been shrinking, and he officially has just barely enough votes to survive. If the no confidence vote fails, Greece will hold early elections. Those could further delay implementation of the EU's bailout plan.

The referendum and no confidence vote throw a massive wrench into the EU's governance "process." As it is, the EU has no established way to deal with a problem like the ongoing sovereign debt crisis, in which its very existence could be threatened. Europe's leaders have been winging it, meeting every week, and issuing innumerable upbeat press releases to manipulate the financial markets upward. Somehow, this ad hoc process produced a back of the envelope bailout that might at least delay the day of reckoning. But all the EU's efforts have now been suspended by the unexpected announcement of the Greek referendum and no confidence vote.

The referendum and no confidence vote demonstrate that there simply is no European Union. At its moment of greatest crisis, the fate of the EU rests on a snap decision by a Greek politician to hold a plebiscite and a no confidence vote. No one else in the EU signed off on this sui generis procedure. Yet, the EU, its currency, its financial system and its economic fortunes rest on the political vagaries of a country whose GDP is maybe 2% of the EU's GDP. There isn't a European Union. The EU has no rules, no governance process, no decision makers and no efficacy. It's like a group of people who have jammed themselves onto a very small life raft and are working against each others' efforts to keep the thing from tipping over.

If the EU blows up, the rest of the world will be dragged down as well. All this because of the political dysfunction of a nation with 0.5% of the world's GDP. That the fate of the European Union, and the world's financial system and economy, should rest on the electoral process of a small nation like Greece suggests that the interconnectedness of the world's financial system and economy has gone too far. Technology, derivatives and other linkages allow capital--and more importantly, financial risk--to flash around the globe almost instantaneously. While that's good when life is copacetic, reality is that some days are rainy. Today's hyperquick, hyperactive, and opaque financial system guarantees not only that capital flows immediately to the most attractive profit opportunity, but also that risk and financial contagion move equally fast in unpredictable, and therefore unhedged, ways. It may be time to establish significant limits on the extent to which financial risk can be palmed off. When faced with risk, people have a tendency to become responsible. But when you can pass the hot tamale to someone else, expediency trumps maturity. What we desperately need today is responsible behavior.

The only firewall left for the financial system is the taxpayer. Because taxpayers are becoming increasingly stressed, central banks have printed or will resort to printing money. This isn't a solution, just a kick of the can down the road. The Greek prime minister's decision to hold a referendum and no confidence vote serves as a reminder of a truth that is rarely acknowledged: there is no way of the current financial crisis without serious pain for everyone. The Greek prime minister is asking Greeks to grow up, face the fact that they will have to endure tough times, and agree to take their castor oil. Sooner or later, the rest of the world will have to do the same. But their politicians and other leaders continue to spin tales of Lake Wobegon, where everyone is in the top 1% and occupies only executive suites.

Tuesday, November 1, 2011

The Really Bad Thing MF Global Did

Perhaps the worst thing MF Global did wasn't lose a pile of money speculating in hinky European sovereign debt, although that was a pretty astounding belly flop for a firm run by a former Chairman of Goldman Sachs. It was that the firm evidently tapped hundreds of millions of dollars of client funds for its own use as its fortunes tumbled. See and

The financial markets have, since the Middle Ages, been built on trust. Without trust--especially by customers of financial institutions--the financial system couldn't exist. Brokerage firms such as MF Global are required by law to segregate customer assets and keep detailed records of customer accounts, so that the other people's money with which the firm is entrusted remains intact. When a firm uses customer funds for its own purposes, it violates the most fundamental principle of the customer-broker relationship: that the firm will be a faithful custodian of the customer's assets.

MF Global's customers appear to have primarily been big, fast money players, hedge funds and the like that can move their accounts at a moment's notice. MF Global also appears to have financed its activities with short term credit--financing that can evaporate faster than frontrunner status among GOP contenders for the Presidency. Running a firm with short term financing and professional money managers for customers is like drinking with a bunch of Good Time Charlies. If the bar stops running a tab for you, your drinking buddies will duck out the door muy pronto.

With the news about MF Global indulging in some helpings of customer money, a lot of hedge funds and other customers will be giving their brokers sidelong glances, looking for any flinching, eye shifting, throat clearing, hand rubbing, feet shuffling, or other signs of uncertainty. Lawyers up and down the length and breadth of Wall Street are preparing customer requests for withdrawal of accounts in draft form, ready to be delivered by e-mail, courier, snail mail, Pony Express, and even carrier pigeon at the first hint that a broker is in even a scintilla of trouble.

By casting a dark shadow over the trust between customer and broker, MF Global may have done far more damage to the financial system than its proprietary trading losses and whatever ripple effect that may have with the firm's counterparties. Now, every broker on the Street is suspect. Prudent money managers may presume that their brokers are guilty until proven innocent. The chances of further instability in the financial system has increased. Tighten your seat belt, because the ride could get rockier.