2010′s Sovereign Debt Crisis vs. 2008′s I-Banks: It’s Deja Vu All Over Again

admin — Mon, 01 Mar 2010 23:07:08 +0000

One of the next targets for speculators is highlighted on the front page of Bloomberg right now, in an article titled, “Greece Now, U.K. Next as Scots Ready for Pound Plunge.” Speculators are trying to make sovereign debt the falling domino this time around as part of the ultimate game of financial chicken.

As Yogi Berra once said: “It’s deja vu all over again.” This reminds me of the speculators who went after the i-banks in 2008, from weakest to strongest, like wolves, starting with Bear, then Lehman, then Merrill, with Morgan (JPM) and Goldman (GS) spared by the AIG (AIG) bailout, TARP, them becoming commercial banks under the Fed, FDIC debt guarantees, FNM/FRE takeovers, Citi (C) bailout, etc., etc.

What also feels deja vu-like is that the U.S. equity markets seem like they want to keep rallying, despite the underlying increase in risk in the credit markets, just as they did right up until August 2007 when you didn’t have to be smarter than a fifth-grader to finally see what was going on. Yet SPX still did not top until October 2007, even though it was already game, set, match at that time, in terms of the potential for the eventual collapse of the highly overleveraged credit system.

Here’s a comment by the equity strategist at JP Morgan Chase on February 26, that gives an excellent summary of Wall Street’s currently bullish views:

“Equities have been range-bound, reflecting the mixed economic news in the US (most recent are elevated weekly claims and disappointing consumer confidence against better home price data and credit trends), coupled with lingering concerns about sovereign debt as well as potential policy actions in Emerging Markets (EM). The market simply has not yet received “tie-breaking” data that firmly establishes the trajectory of the US economic recovery. Hence, while derisking has likely exhausted itself, we do not sense investors are yet adding risk to their portfolios. However, our thesis remains that as global investors add risk, they are likely to favor US equity markets given lower inflationary pressures (vs. EM) and relative visibility (over Europe).”

I have been strongly emphasizing the last point in my recent articles, i.e. that money is very clearly flowing out of Euro assets and into dollar assets, even in the face of some recent weaker U.S. economic data (see my articles on Feb 26, Feb 18, and Feb 24). I think favoring U.S. assets over emerging markets at some point runs the risk of calling into question the latter as the clear source of global growth while U.S. growth shifts down from the unsustainable 5.9% 4Q GDP growth.

The JPM strategist then goes on to slightly bump up his estimate for SPX 2010 EPS, from $80 to $81, driven by technology, discretionary and financials, saying that “we believe the Street is still chasing EPS estimates higher,” i.e. Wall Street’s standard “better than expected” earnings game, which should have been ended no later then after the 1990s tech bubble, otherwise what was the point of the so-called “reforms” following that collapse.

Adding to my feelings of deja vu, from recent books about and by two Paulsons — “The Greatest Trade Ever,” about hedge fund manager John Paulson’s multi-billion dollar payday from being early and right on the collapse of the credit markets tied to the real estate bubble, and “On the Brink,” by Hank Paulson — and others like Sorkin’s “Too Big to Fail,” it is so clear how far behind the financial curve Washington policy makers were, and still are.

Particularly with respect to credit default swaps. The New York Times’ Gretchen Morgenson had a February 28 article titled, “It’s Time for Swaps to Lose Their Swagger.” Buried in it is an astounding quote by Martin Mayer:

“Credit default swaps are ‘a way to increase the leverage in the system, and the people who were doing it knew that they were doing something on the edge of fraudulent,’ said Martin Mayer, a guest scholar at the Brookings Institution and author of 37 books, many of them on banking. ‘They were not well-motivated.’”

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2010′s Sovereign Debt Crisis vs. 2008′s I-Banks: It’s Deja Vu All Over Again