This morning feels like a bad Facebook scam. Mr. Geithner continues to remain convinced that nothing bad would have happened had Lehman not gone bankrupt – in spite of a dearth of evidence supporting that view – and has decided that giving more of my money to the IMF will help “solve” things.
Solve had been re-defined to mean temporarily, possibly, delay facing consequences only to face bigger problems at some point in the not too distant future. The IMF, EFSF, EU, G-20 are all busy figuring out how to take more taxpayer money to “solve” the problem. The problem is debt that cannot be paid back. Nothing is being done to ensure that the original lenders can pay back the debt. Not a single word of what is being discussed does anything about that. All this done is shift who will ultimately lose when that debt is not repaid. That is it. Instead of banks bearing the risk for bad credit decisions, they will roll out of their positions and shift it into all the supra-sovereign creations they have devised.
Contagion has spread to Spain and Italy not because Greece and Portugal are having problems, but because Spain and Italy have too much debt and their banks have too many bad loans on their books. 21% unemployment in Spain. Pictures of big buildings that are completely empty are easy to find. What cannot be found in Spain is real write-downs of the debt that financed that property boom. Spanish banks aren’t in trouble only because of their exposure to sovereign debt, they never took the pain for their bad commercial and residential real estate lending. The problem is similar in Italy. We are just pumping money to delay a day of reckoning, but the cycle of each “solution” providing less relief for less time, more institutions and countries lining up at the trough, and fewer (if any) strong institutions there to provide those handouts.
Something will happen because we have brought up the “Lehman Moment” this morning. How so much can be blamed on Lehman is beyond me. It seems like a convenient myth because it leads to the simple conclusion that no big bank can fail. Yet Lehman just wasn’t that big to cause all the damage that is attributed to. But since we have a convenient scapegoat, we will implement policies to save Lehman in the belief that fixes everything. It didn’t fix things here, it didn’t even provide a near term floor, and it is possible that the policies are why the economy has failed to stage a solid rebound and is continually in need of more government funds.
As equities rebound from some slight overnight weakness when briefly the attention was focused on the fact that financial conditions in Spain are deteriorating rather than the imminent solutions, we see credit remain weak. Italian and Spanish yields are increasing both on an outright basis and relative to Germany. I’m not sure that Spain and Italy can afford too many more “risk on” days or else their yields will get back to “dangerous” levels. Though 5.8% on Italian 10 year bonds doesn’t seem that “safe”. This is back from low yields of 4.9% when the ECB was buying bonds daily. I guess you can trick the market for a few weeks with ploys to re-allocate money, but the reality of a weak economy, no credible plan to fix it, and way too much debt eventually overwhelms the fiction that the politicians and central bankers try to create.
I am sure we are due to get a good IMF rumor, a good EFSF multi trillion rumor, or even plan, so am prepared for one more good run in stocks, though I think a lot of this is built-in, and shortly after any new grand plan is announced, the attention will shift to France and its problems. French and Belgium bonds are the worst performing bonds in Europe today. I would expect that trend to continue.
On a side note, JPM has 234 billion of debt outstanding and generated 1.9 billion of profit from spread widening. I don’t know how much of the debt is categorized in such a way that JPM has to run the spread widening and spread tightening through income, but I do know JPM credit spreads were relatively stable. JPM CDS went from 77 bps to 162 bps in the quarter. Not even 100 bps of widening in CDS. MS CDS went from 161 bps to 488 in the quarter. Again, I don’t know what % of MS debt is subject to that form of accounting, or exactly where it was on June 30th, but with only 1.9 billion shares outstanding, MS could have a monster headline EPS number. From what I can tell, the consensus is 30 cents. The high estimate is 56 cents. If they only take the same 1.9 billion DVA that JPM took, those estimates will be blown away. How the market will respond is another question, but it should be an interesting announcement.