Streetwise Professor

Like Freddie Krueger, I’m baaaaaack again, folks.  This time, more regularly, I trust.

Catching up on a few things that have caught my eye since last time-and like Freddie, I brought my knives.

1. The LIEBOR mess continues to metastasize.  It is now sucking in regulators.  Including Timmy! It appears that the dissembling about LIBOR, TIBOR, EURIBOR, etc., was the worst kept secret in the world’s financial centers.  And let’s pray that’s true.  If the Fed, the Bank of England, etc. DIDN’T know that there was a complete disconnect between the rates that banks reported to the BBA and the rates at which they were actually borrowing (or not)-now THAT would be a reason for panic.  In fact, they were all-bankers and regulators alike-operating pursuant to the Juncker Maxim: “When it becomes serious, you have to lie.”
2. I detest manipulation of markets, and have made a life’s work of studying it, calling out manipulators, and now and again testifying against them.  But I find it disgusting to hear high government officials in high dudgeon on the subject, when they are in fact often the most outrageous and shameless manipulators.  The most flagrant example: the Lilliputians who are the collective “leadership” of the EU and the Eurozone.  For what else can you call their repeated fudges, misstatements, lies, etc. related to the latest “solution” to Greece’s problems, or Spain’s, or Italy’s, than “manipulation”?  How many billions have changed hands on the EUphoric rallies that occur after the announcement of such solutions, and on the, umm, “retracements” that occur when the truth comes out.  The agreement on a Spanish bailout, and banking regulation changes, that came out of the most recent Summit of the Lilliputians is only the latest example.  Look.  Europe is screwed.  Metaphysically.  The math does not work.  Cannot work. Even mores, the politics cannot work.  The core is empty.  No real deal is possible.  Accept it.  And once you accept it, mock any pronouncement of the next “solution”.  And for God’s sake don’t buy except on the theory that other suckers buy and you will sell out before they do.
3. FCM Peregrine Financial Group apparently absconded with $220 million of “segregated” customer money.  This is both shocking and depressing 10 months after MF Global.  The scheme has apparently been going on for at least two years.  But the CFTC allegedly gave all FCMs the full anal probe post-MF, and saw-like Sergeant Schultz-NOTHINK! So since they can’t find a rather banal fraud at a middling futures brokerage, it’s truly obvious that they have game to regulate the entire world, and every complex financial institution and complex derivative trade in it.  What could go wrong? No doubt that the Peregrine debacle will lead to calls for more regulation.  Regulation, the only human activity where failure is the primary justification for more of it.
4. The CEO of inter dealer broker GFI, Mike Gooch, has said that hedge funds need to become liquidity suppliers/market makers in order to fill the gap left by banks, post-Volcker Rule.  I predicted this would be the outcome in a couple of posts written soon after the rule was mooted.  There is a serious question here: will this really lead to greater stability during times of financial turbulence?  Given that credit to hedge funds-which comes largely from banks, by the way (funny thing, that!)-typically contracts severely during periods of such turbulence, their market making activities are likely to contract as well during such times.  Meaning that market liquidity supplied by hedge funds will be highly pro-cyclical.  Bank supplied market liquidity is too, but the ones subject to the Volcker Rule-you know, the ones who have sticky insured deposits-are likely to be able to resist these cyclical pressures better than hedge funds because their funding is not as fragile.  So yes, Mike, hedge funds will be needed to fill the gap left by the exit of prop trading banks, but they won’t be there precisely when needed.  Things will work just swell.
5. Gazprom was named the most opaque corporation in the world.  I am shocked and stunned.  It is allegedly the most profitable.  Again, no surprise: government enforced monopoly is a nice gig.  But the company has been forced to make price concessions on contracts to big customers.  It is fighting a rearguard action against the flood of gas being discovered around the world.  It won’t happen overnight, but government mandated monopoly or no, the company’s future is not bright.
6. The to-ing and fro-ing over privatization in Russia continues.  Putin allegedly threw a spanner into Sechin’s ambitions to acquire “privatized” assets, including electricity generators.  But his words are pretty weak: “That does not mean we should limit ourselves to participation by Rosneftegaz.”  So you could envision some competitors in the bidding process, and them prevailing enough times to give the impression that a real privatization is going on.  But this is likely to be a Potemkin privatization, and Sechin et al are likely to prevail.  Sechin certainly thinks so: “Russia’s most influential energy official, Igor Sechin, said on Tuesday the state-owned energy holding Rosneftegaz was given permission to invest cash on its balance sheet in comments which seem to contradict assertions by a top government official [Akardy Dvorkovich].” I would bet on Sechin.  Hands down.
7. There is a spate of bad news about the weakness in China’s economy.  I have been a China bear for going on three years, or more actually.  The first reason for my pessimism has always been China’s ramshackle and rigged financial and banking systems: this predates the crisis.  This post provides an excellent overview of the reasons to find that system “scary.” Yes, the Chinese government has papered over past problems, but there are limits to this, as there are to all things.  Indeed, as the economy has gotten larger, and in the aftermath of the crisis and the massive monetary and fiscal response thereto, the state’s capacity to continue to do this is very questionable.  The second reason is that, contra Tom Friedman or Ray LaHood, I adamantly do not believe that the allocation of capital by the state, directly, and indirectly through financial repression and a hugely distorted banking system, will end well.  In fact, I believe the exact opposite is true.  Suppressing price signals and allocating capital to cronies and state owned enterprises is a recipe for grotesque misallocations of capital.  In the short to medium term, it can lead to impressive GDP numbers.  But spending insane amounts on investment eventually leads to catastrophe if that investment doesn’t produce returns.  That, in a nutshell, is what China looks like to me.  And these two sources of pessimism feed off one another: when the investments don’t generate returns, and in fact generate losses, the banks and trust companies and insurance companies and whatever that provided the finance are toast.  When you force feed a goose, you can at least get good liver pate (but not in California!).  When you force feed investment, eventually you get a bust.

That’s all for now folks.  Catch you again soon. Promise.