Oct 08 2011

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Wall Street in Denial

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Soothing But Not Effective

“Confidence” has become the elusive greased pig of the international economy, with governments, central bankers and international financial institutions  straining to design policies that will allow them to gain hold.

Investors, meanwhile, are digesting these antics and appear to have entered the five-step grieving process, internalizing the news they like and blocking out the rest.

Consider Europe.

This week, investors were cheered when the governments of France and Belgium forcefully came to the aid of Dexia SA, a Belgian bank that is drowning in bad sovereign debt, stating that their governments would take “all necessary mean” to protect creditors and depositors.

Indeed, the life-line to Dexia was complemented by a fresh announcement from the European Central Bank (ECB) that it would provide longer-term loans to support banks and cushion them against a severe credit crunch.

That, in turn, was complemented by news that the International Monetary Fund (IMF) is crafting a proposal for the upcoming G-20 meeting that would provide short term credit lines to governments that are at risk due to the sovereign debt crisis.

In total, these measures appeared to be a soothing balm for investors, now comforted that authorities were dealing with the EU sovereign debt crisis.

Stock indices were up this week on these developments.

But consider this news, also out this week.

Moody’s placed Belgium under review for a possible credit downgrade.

That’s right.

The country that came riding to Dexia’s rescue with France, is a heightened credit risk by virtue of the very action it took to support Dexia.

Belgium, with a debt to GDP ratio that is already 100 percent, will be significantly strained as it tries to sort out Dexia’s break-up  (liabilities over 500 billion euros) with the risk that other Belgian banks will require the same type of guarantee.

 Fitch Ratings actually downgraded the government of Spain two notches to double A minus, citing the debt crisis and an expectation that growth in Spain will will be less than two percent through 2015. In addition, Italy also suffered a downgrade, to A plus, due to weak economic growth prospects and uncertainty over the efficacy of Italian deficit reduction plans.

And as a sign of continued commercial banking unrest among the PIIGS countries, Moody’s also downgraded the ratings of nine Portuguese banks, citing their holdings of Portuguese government debt.

Seen through the prism of these events, how can the public policy measures proposed this week be seen as anything but inadequate?

Yet investors are cheered?

At home, the September jobs report showed 103,000 jobs created. If you take out the 45,000 jobs representing striking Verizon workers from the previous month, that puts job creation at 58,000.

The markets responded with relief.

Yet it takes 125,000 new jobs per month to simply keep up with population. It takes 200,000 or more jobs per month to put a dent in unemployment.

So this report is considered good news? Because it isn’t worse?

The same September report showed that the long-term unemployed – those seeking work for more than six months – increased.  Nearly 45 percent of all workers  (6.2 million) have now been out of work more than six months.

If you calculate unemployment based on the larger pool of people who are working part time out of necessity, and those who have given up looking for work altogether for lack of jobs, the unemployment rate jumps to a staggering 16.5%

And the markets are up?

What is going on here?

Properly functioning markets are brutally efficient in pricing risk. That is unless the risk is so large as to undermine the very markets assessing the risk.

2008 was an example of that type of hubris.

What comes next in Europe and its cascade impact across the globe is likely to be orders of magnitude worse.


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