Don't Be So Sure This Will Work

Last night Trichet and other policymakers in Europe basically forced Bernanke's hand, initiating 100% guarantees of interbank lending.

This forced Bernanke to follow suit early this morning, lest the US markets and US credit system implode into a smoking hole instantly.

This was not a position Bernanke was willing to take on his own, or he would have.  But when the rest of the world has done it, you literally have no choice, unless you intend to be turned into an instantaneous credit island - an event that the United States would literally not survive.

So the die was cast and Paulson and Bernanke's refusal to endorse this step in the G7 meeting Friday was literally rammed down their throat.

Now, however, we have a new problem.

You see, if there are defaults, they now flow straight through to sovereign balance sheets.  The IMF is now stating that there are three nations that are insolvent now, and there will be more.  You can bet on it.

Amazingly, The United States is not anywhere in the worst shape here.  While we certainly have our problems those over in Europe are much greater, but they're also distributed - not every nation over there is in an equal amount of trouble.

With no common taxing authority the EU has a horrifying problem if the defaults start to cascade, as allocating the losses will be nearly impossible to do with any sort of fairness.  The political and monetary unrest that is likely to come from this will be considerable, and at this point I suspect that the "common currency" may fail outright - a disastrous outcome and one that could threaten geopolitical stability in the region.

Something interesting happened on the 10th, which I missed - Luigi Zingales, an apparently-well-published economist at the University of Chicago, came up with his "Plan B", which is a rather-expanded version of The Genesis Plan to thaw the credit markets.  Luigi's ideas include forced re-contracting for mortgages, which is an interesting and novel way of forcing home prices to contract back to reasonable levels in an expeditious fashion, especially if we can get appraisals to be forced to a metric where median home prices are 3-3.5x average incomes.  Without that his plan will fail, as in those areas where the rot is worst we're not close enough to a bottom yet (we'd have to go do it again, and again, which is really bad) but in those places where the rot is mostly worked out in the market it would work.  His bank recap plan is almost identical to my equity cramdown proposal, to the point that it is essentially identical.

I like it, and have emailed him.  We'll see if we can get something joint there, and then add more people to it.  The louder the voice.....

The reaction in the credit markets was less than inspiring.  The TED Spread and LIBOR came in, but not what should have happened.  Both should have been flattened - they weren't.

This leaves us with an obvious - and uncomfortable question - what if this doesn't unlock the short-term credit markets?  What if lending still doesn't happen, because banks still don't believe their counterparty is good - sovereign backing or not?

Well then we really do have a problem eh?

The resistance to forced truth-telling is maddening folks.  It has been going on now for over a year, and until it stops, I just don't see the market normalizing.  I know the counter-argument - "everyone is broke" - but if that's the truth, then let's get on with it, because we're only delaying the inevitable.  You can't make the broke un-broke, you see.  If we need to set up some state-sponsored banks (to do it FAST) and then spin them off in IPOs, letting the existing system die, then so be it. 

Perhaps such a time would be a good opportunity to include The Fed in this sort of forced replacement, since they are and were complicit in the original destruction and have been part of the liars charade!  After all, what Congress giveth via legislation, it can taketh away, no?

In any event don't get complacent; I see nothing here right now that suggests the "crisis is over", but the mouth-breathers in the media are of course cheering the market's rally. 

Good for them. 

We'll see how long it lasts.

Check Libor, the TED spread and the IRX tomorrow when our bond market is open for trading.  You should get a decent idea of what's what at that point.