Capital Markets Update

By Louis S. Barnes      Friday, May 18th, 2012

　　　　 The few spatters of economic data this week did not change the plod-along US outlook. Meanwhile the priority story (Europe) was obscured by the media's demented focus on the Facebook IPO and the blown trade at Chase.
　　　　 Today markets are on exhausted hold, hoping for some miracle at this weekend's G-8 meeting. German 10-year bunds hit all-time-low yields on successive days this week, the bottom at 1.41% while Spanish and Italian equivalents reached 6.38% and 5.91%,respectively. Inflation and deflation camps have been in balanced argument ever since Lehman, as have dollar-fearful and dollar-safe-haveners, but Europe has now tilted the show to deflation: gold has dropped from 1790 to 1590. Those still fearing inflation ran to dollar-denominated inflation-protected Treasurys (TIPS), driving the newest auction to a negative 0.391% yield. Yup, below zero: lose money to be ready for a 1970s replay. It's been forty years, but you never can be too prepared.
　　　　 The G-8 gathering will be only seven (Czar Vladimir is busy): unstable Italy; stable for the moment Japan, UK, and France, none in a position to help anybody else; Germany ("Vee vil hit yu mit zis ztick until yu agree to hit yorzelf"); and the US and Canada ("Europe is a rich continent able to solve its own problems"). A new flurry of can-kicking may follow, but European markets are poised to implode before the next Greek election on June 17. Reversing the euro to local currencies would be briefly chaotic, and slow the global economy, but it is the one way to rationalize the economies involved. If Europe had done so two years ago the losses would have been far less than today, or will be tomorrow. The US 10-year fell to its all-time low, 1.70%.
　　　　 There are some things to be learned from the Chase pratfall. The Left-side media are ascendant: "EEK! Bankers Found Gambling!" The Right-side doesn't get it (ever): "Private Sector Hurt By Government." Both wrong, of course.
　　　　 The great post-Bubble fable holds that we can easily return to the safe banking of yore by removing profiteering bankers and their profits. Wrong three times. The fable rests on memory of US banking from 1933 to roughly 1973, but this period was extremely atypical. The sound regulation and deposit insurance of '33 was followed by a time of such overwhelming US/dollar dominance that banks struggled to lose money. Banks ever since have been in and out of systemic trouble just as ever before.
　　　　 Modern economies (since, um…Rome) cannot grow without credit and banks. That means somebody has to bear the risk of monetary alchemy: depositors of all kinds require instantly available cash and a return on that cash, but to earn the return banks must run the risk of credit and illiquid investment. It is possible to run a (nearly) risk-free bank, and we have: the hyper-capitalized silk-stocking affairs who catered to the rich, who wanted only safety and did not care about return, and which provided little credit to the economy. Leaving the 99% out in the cold, as did the great, private, merchant banks, from Rothchilds to the old Wall Street partnerships. Real, beneficial banks must take risks that will go unpredictably bad. Always.
　　　　 Chase's blown trade was not a hedge. It was crafted to look like one, in defiance of the spirit behind the misbegotten rigidity of the proposed "Volcker Rule." De-risking spirit is important today, while we are in post-Bubble hysterics, over-tightening credit, and every dumb-assed trick re-ignites the hysterics. However, this trade did not threaten Chase, even at an ultimate $4 or $5 billion loss, nor did it bring systemic risk, nor was it done in the dark. Chase's directors knew, and the on-site Fed team knew (all big banks since 2008 have had on-site Fed teams).
　　　　 Perfect punishment is underway. Arrogant Jamie Dimon has a lot less to be arrogant about, and of course should resign. Even if he is not forced out (he has not the grace to do so un-prodded), his day is done, and a warning to the others. There will never be a way to de-risk banks in accordance with the post-Bubble fable; we will have to live with the risk, cycle in, cycle out, one bank after another. The worst error is to build an ever-thicker rulebook, instead of looking for ever-better people.