No Predictions, Just Observations

• Lots of debt, public and private, has been created and "must be" repaid or refinanced (or not).
• When you "invest" in bonds you're lending money.
• Leveraged share repurchases have substituted productive investment (capex).
• Risk premiums (term, credit, inflation, liquidity) are thin or non existent: we're not being compensated adequately for the risks we're assuming, there's no real margin of safety.
• Today's US equity valuations are extreme and unsustainable unless one believes that the conditions "created" in the last 5 years will be continued indefinitely.
• Today's valuations ALWAYS have an impact on tomorrow's returns.
• There IS a difference between value and price.
• Momentum can be negative too...things that can't continue indefinitely eventually end.
• Complacency and overconfidence are the fruits of incomplete analysis and lack of critical thinking.
• Greece has been a problem for 4 or 5 years.
• Initial conditions matter more than predicting the future.
• Herding behavior exists...crowded trades sew the seeds of there own destruction.
• Liquidity and volume are not the same.
• Liquidability matters.
• There may be a buyer for every seller but perhaps not at every price point or risk level.
• Cash seems like a bargain with respect to the value (and opportunity cost) of other risk free and risky assets.
• Things, as always, are unpredictable and complicated.

Insolvency Isn't Readily Observable...Until It Is

Overnight deposits at the BCE are at all time highs and the collateral posted at the BCE is of dubious quality at best. European banks are still under capitalized and are hoarding liquidity when what they need is more capital / less leverage. The CEE is further from, not closer to an agreement on a Fiscal Union, Greece is a walking corpse. Economic growth in the Eurozone is screeching to a halt, etc., etc.


Taken in isolation, these are interesting, if not worrisome data points. Combined in a complex evolving system these anecdotes could provide the catalyst and / or accerlant for a potentially very negative outcome (or not).  But maybe we should take Pascal's advice and stop worrying about the probabilities of the various outcomes and start focusing on the consequences of an improbable but very negative outcome.  Maybe it's time to weigh and not to count. It's a bit like the difference between capital (solvency) and liquidity.

Postponement and Inevitability

The bondholders of Dexia have been saved (Dexia has failed). Greece has defaulted without triggering a credit event (Greece has failed). The European banks will be recapitalized with the assistance of more borrowed money from the same States that find themselves in financial difficulty (the european banking system is failing).

We're approaching grave problems with frivolity of a child's game, making up rules, imagining or creating a new reality when the scenario doesn't please us, threatening to take our marbles home if the others won't play by our rules. WTF.  

The financial environment is a part of the economic ecosystem.  We know that pollution and toxins in one corner of the environment can have an impact on an entire ecosystem. Once the dioxins are in the ground water or the oil spills out of a ruptured tanker we can no longer prevent or contain the problem, we must clean it up. 

The economic ecosystem and all its micro environments; labor markets, capital investments, innovation, social programs etc. have been compromised by ignoring reality and by attempting to prevent a catastrophe that has already occurred. Like a war that has already been waged, it's time for the reconstruction to begin, which means bulldozing the irreparably damaged structures (inefficient financial infrastructure) and starting over, building on the foundations and the pillars of what has remained, what has always remained (values and culture).

The difficulty in all of this lies in the ability to recognize or admit that we don't know and we can't know everything. Intellectual humility over ideological hubris, reconciling reality to truth.

Heroin and Meth.

Planning to plan, preparing to announce, close to an agreement, a susbstantial (levered) arsenal (of more debt). My friends, Europe is on the road to recovery!  Like the heroin addict who can "kick his habit" by getting some publicly provided meth, the underlying illness goes on but we can temporarily all feel a little better. 

Anything that can't continue indefinitely must end and debt that cannot be repaid must be defaulted on or restructured, with the irresponsible parties bearing the consequences for their mismanagement and malinvestment (indebtedness). Until now, "we the public" have born the burden of malfeasance,  fiscal mismanagement, mischief and moral hazard in the form of economic stagnation from the misallocation of capital.  

We don't know if a sovereign (or bank) default will bring Mr. Geithner's “cascading default, bank runs and catastrophic risks”, certainly those are possible outcomes but almost as certainly they are not the only outcomes, and possibly they are not even the most probable outcomes, we just don't know.  Myopia has petrified us and has caused the authorities to not consider alternative solutions in which the risk takers bear their losses but depositors and taxpayers interests are rightfully safeguarded.

The choice is clear: continue to lever up, incessantly accumulating more debt, substituting / alternating meth for heroin,  or treat and conquer the illness inflicting the inevitable pain and discomfort on the addict (debtor) and his pusher (creditor).  In the first case the addict continues to live (until he doesn't) imprisoned and immobile in his addiction and in the second he recovers, probably damaged and scared, but he moves forward responsibly, unchained and knowledgeable of his errors and his opportunities.