Monday, February 8, 2010

The Total Miss Pricing of Risk

I had to take the day off as I was up too late celebrating the big win. I think I did more work today around the house than I would have done in an entire weekend.

New Orleans Saints 31, Indianapolis Colts 17
What can I say? After a shaky first half the Saints came out and played their game. The onside kick was a huge game changer. By the end of the third quarter the Colts defense was visibly breathing heavy and in the fourth they were spent. The Porter interception for a touchdown was shocking in how fast the game came to an end.

Congratulations New Orleans Saints, I have waited for this for a long time.

The Total Miss Pricing of Risk
I had mentioned last week that I was expecting some kind of announcement by the Euro Zone players concerning the Greece situation. As of right now, nothing has been brought out. What was interesting was a "secret" meeting of Central Bankers in Sydney Australia over the weekend:
Central bankers to meet in Australia to discuss looming new crisis
To be a fly on the wall!

February 11, 2010 may have some significance in the geo-political realm:
Iran anniversary 'punch' will stun West: Khamenei
"The Iranian nation, with its unity and God's grace, will punch the arrogance (Western powers) on the 22nd of Bahman (February 11) in a way that will leave them stunned," Khamenei, who is also Iran's commander-in-chief, told a gathering of air force personnel.

That does not sound good.

The mortgage mess keeps gaining steam:
Fitch: New Year, No Improvement as U.S. Prime Jumbo RMBS Delinquencies Approach 10%
Housing bottom indeed.

Unemployment is stated at 9.7% but this graph is far more informative (via The Big Picture and original work by Bianco Research):

No job growth for a DECADE. This is troubling.

So what am I trying to say?

I came to the following idea as I watched the reaction to the possible Greece bailout over the weekend:

Instead of being scared or fearing the need for another large scale bailout of an entire bankrupt country the reaction was one of joy over another financial rescue.

This is important because I think that financial risk is severely miss priced right now. Market (stocks, bonds, currencies, etc) operators are basing their decisions on a perceived backstop of all things at all times.

Here again is Moral Hazard:
Moral hazard occurs when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk

And yes "Too Big to Fail" has it's very own Wiki entry!

What a miss pricing of risk allows is distortions. Just like a bubble causes capital to be invested in non productive ways, the bailout bonanza has made all assets be treated as of the same risk regardless of underlying fundamentals. There is no price discovery in this way and thus right now may be a time where true "value" of many instruments are unknown.

Money is being created. The open ended commitments on the table are staggering. Whether it is Fannie Mae loans, Greece, Spain, or AIG the magnitude of intervention is astounding. While various observers feel that inflation is nonexistent, what do you call the artificial propping up of the housing market? Is that not inflation? What about Euro money created to save Greece (should it come), does that not constitute inflating?

The situation is not "more stable" after two full years of intervention. Instead assets across the spectrum are miss priced and risk is the most miss priced of all. Anything of significance right now is seen as fully insured by governments and taxpayers (truly "Turtles all the Way Down!"). With such a one way bet going on we can expect a serious market dislocation should that prove not to be the case.

For Consideration
I was thinking about the European drama and I was reminded of Dollar Swaps and how they may play into the mess.

Economic Reality Blog had a good write up on this:
Another Dollar Shortage?
Short excerpt:
As is evident, the dollar swaps did everything they were supposed to do. But now that they’re gone, there is a possibility that the dollar shortage will return. The dollar has been gathering momentum for quite some time. Those that look at charts had to have seen the massive divergence between the price action and most of the indicators (MACD is a good example) that first appeared in the spring. Now that the dollar is back in an uptrend with negative news from the Eurozone supporting it, we are looking at what could possibly be the second phase of the dollar shortage. It’s on the brink already and it only needs one little push.
If you want to "frontrun" the Euro zone bailout look for a headline renewing dollar swaps as a necessary precursor.

Co-Author Stoneleigh of The Automatic Earth has a thoughtful essay up tonight that is worth a look:
Corruption, Culpability and Short-Termism
Great stuff.

Have a good night.


getyourselfconnected said...

from the department of "I am right" I offer a story that makes the guess that Goldman is behind sqeezing Greek CDS just like the AIG hijack:

This has got to stop.

Lisa said...

But, wait! Didn't Bernanke just end the currency swaps with everyone? Oh, my, what are we to do? (total sarcasm)

Dave Narby said...

Makes you wonder what the Iranians have planned for Thursday (rumor on ZH(?) they will only take gold or RMB for oil).

sedentary state said...

What a day. Markets love bailouts. Crack addicts love free crack.

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