The last week has been filled with historic developments in the world economy, but it's easy to lose their significance when one is bombarded by the 100 ring circus of 21st Century capitalism. When you're dealing with the world stock and bond markets, or the political machinations of Washington,DC or Europe it's easy to get lost in the billions of details. Nevertheless, a few of the political and economic developments of late appear to me to be particularly significant in Wall Street, Washington, and Europe.
The unprecedented 1000 point intraday drop in the Dow Jones Industrial Average has certainly been in the news. And it's fairly interesting that to date, no one has found any easy explanation for the mysterious swan dive and instant recovery that manifested itself.
I may be wrong, but I remember a statistic to the effect that 70% of all the volume of trading on the various big boards in NYC is done by institutions on a regular basis lately. And much of that volume is done with limited human intervention in the form of program trading. Big firms from Goldman Sachs to Wells Fargo have computer operations established capable of making trades based on .oo1 of a cent. These microscopic trades mean back and forth operations that can take place hundreds of times a second. Since there are no commissions for market makers, these trades are free, and 99.9% of the time they make money. Just look at the fact that all of the big banks have had positive, money making days trading for 61 working days in a row.
This infallability has been cobbled together by PhDs in mathematics and geniuses in computer programming, who are behind what people traditionally think as the boys in the pinstripe suits. The problem is that the stock market, being what it is, has had two events in the last two years that should statistically happen only once every 100,000 years. The first statistical anomaly was triggered by the collapse of Lehman Brothers in September, 2008. The second was last week's flash crash. All the math in the world cannot account for this kind of behavior. As such, the stock markets can be seen as being similar to nuclear power plants or modern offshore drilling platforms. They're incredibly reliable, until something really rare and bad happens.
WALL ST. IMPLICATIONS
This so far unexplained behavior of the market last week should put more political power into the Angelides Commission, which is responsible for examining the 2008 crash. As such it should pave the way for more substantial reforms of the world of Wall St. in the future. In the immediate future, this will put more wind in the sails of the Dodd legislation and the proposals put forward by President Obama on financial re-regulation.
More interestingly, this meltdown that wasn't is leaving even hardened apologists for Wall Street privately admitting that perhaps program trading is a bull in the china shop of finance. This may strengthen the legislation put forward by Sen. Charles Schuemer of New York to ban program trading. And it may put wind in the sales of the few like Rep. Peter De Fazio who are calling for a 0.1% tax on all stock all stock and bond transactions. Any eventual limitation or banning of program trading on Wall Street would mean profound changes from the way business is currently being done.
WASHINGTON, DC: SANDERS -PAUL
But beyond this is yesterday's passage out of the US Senate of the Sanders Amendment. Similar to legislation successfully passed out of the House under the leadership of Rep. Ron Paul, both pieces of legislation require a historic, first-time ever audit of Federal Reserve Board functions. I anticipate that a conference committee will hash out any differences between the House and Senate versions with veto-proof majorities eventually, giving President Obama no choice but to go along with the program or else.
IMPLICATIONS OF SANDERS-PAUL
While there will be many people spotlighted in a GAO audit once it comes out (Hank Paulson, Alan Greenspan, and Ben Bernacke in particular), the real person who should be sweating is none other than US Secretary of the Treasury, Timothy Geithner. Geithner, who was Fed Reserve Governor of New York at the time of the economic meltdown was the man most responsible for monitoring all of the shenanigans on Wall Street from the continued blessing of financial sausage made from liars' loans to the pawning off of toxic CDOs on unsuspecting pension funds and other investors.
Geithner is also the man who admittedly made a series of inconsistent calls on financial triage. He was the midwife that got Bear Stearns to liquidate a $70 per share stock for $2 a share, and he was the man who told Hank Paulson that nothing could legally be done to save Lehman Brothers, and yet the US Government almost immediately turned around and said that institutions like AIG, Merrill Lynch, and others could be saved through government intervention.
A dispassionate audit report from the Governmental Accountability Office may eventually supply plenty of kindling wood for the eventual burning of the current US Secretary of the Treasury.
THE EUROPEAN UNION
A similar about face in policy direction took place last week with Claude Trichet, head of the European Central Bank. Up until last week Monsieur Trichet adamantly refused to offer the ECB's services to the Greek government, saying firmly that it was the responsibility of individual governments in the EU to keep their fiscal houses in order. The fevered and secret meeting of EU finance ministers and other major Western world finance powers on May 8th through 10th produced a massive 750B Euro relief package that has been incorrectly dubbed Le Tarp.
Like the TARP and the Federal Reserve/Treasury, this package represents a radical departure from historic policy by providing a safety net for the immediate budgetary shortfalls of Greece, Spain, Portugal, Italy, and Ireland (also known as the PIIGS) should the need arise. And the ECB has opened up a window to buy the PIIGS securities on the open market to support their fiscal stability should the need arise. This complicated plan also calls for the 19 members of the European Union to pony up any additional monies to cover the PIIGS defecits through their own budgets. In other words, a run on the PIIGS means greater budget defecits for everyone in the European Union, as well as the United Kingdom, Canada, and Japan.
With even less coverage, the US Federal Reserve has put forward a minimum of $50B in its own funny money as loan guarantees through the backdoor of the International Monetary Fund. Should it be activated, the bill in a bank run could impose as large a cost as $125B to the US Treasury. This is because the United States government represents roughly 40% of financial participation of the IMF, and the IMF has committed 250B Euros to be set in play should the EU countries be threatened with default.
While Teabaggers may rage at the hanky panky of the Federal Reserve in this, actually for the time being there appears to be very little to fear about such a committment being activated. The financial markets were overjoyed, as seen by the 400 point rise in the Dow on May 10th. There is general consensus in the financial community that the European financial crisis has been put to rest for the time being. Any money that the IMF (and therefore the Fed commits) is like having a piece of heavy artillery. It doesn't mean that this money will be spent. That would happen only in the event that financial anarchy was let loose, requiring the firing of the big guns.
However, there are more disturbing long term trends in Europe that still hang over us like a thundercloud, and that is the populist reaction to the financial pain that will surely be inflicted on the PIIGS. The European Central Bank and the IMF have both ladled out the same bitter prescription for the PIIGS, and their citizens may choke when they try to down the medicine. With the IMF's heavy hand of destroying countries ( historically including Somalia and Yugoslavia) based on a program of cutting pensions, social services, denationalizing industries, lowering tarriffs that protect fragile local industries, cutting government employees, raising taxes and interest rates while a mini-depression is going on -- all of this reeks very strongly of the same kind of medicine that Herbert Hoover prescribed in 1930 and 1931. And it may very well induce the same result in the PIIGS.
On top of this, wealthy European countries like Germany, Finland, and the Netherlands have elements that are chafing at the thought of having to go into defecit conditions to bail out their profligate Mediterranean brothers and Ireland. The protesters in Athens may very well provide the talking points for the wealthier classes of Berlin and Amsterdam as they seek payback against German and Dutch government leaders who signed off on the EU emergency package. At the very least, the structure of the European Union may be challenged in the next 18 months, and along with it the concept of the Euro.
The world markets have yet to see what this continentwide discontent will produce in this area.
For regular readers of my column, you'll see that my first prediction about the events of 2010 was 100% wrong. My idea of a gradual slippage of Spain and Portugal into trouble was a pipe dream. The very few people in power who actually knew what was going on were not forthcoming in their private statements to the press and punditocracy. I think there was this concept about not wanting to scare the horses.
Unfortunately the horses, in the form of Greek, Spanish, and Portugese bond yields were already whinnying in outright fear when the EU had its series of round the clock meetings, finally coming up with its complicated plan only hours before the markets in Asia were set to open. Had the EU not taken action the way it did, it is most likely that there would have been yet another meltdown rivalling the meltdown on Wall St. in 2008. Yes, we came that close to another financial nuclear disaster.
This demonstrates not only the difficulty of trying to predict the future, but the conspiratorial power of those few people who know all of the facts. Thank you, Monsieur Trichet.