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Tuesday, June 17, 2008

 

road to revulsion


how would a deflationary asset-price collapse play out? with the unfettered optimism of banking authorities all the way down -- via john mauldin, societe generale's james montier.

We have seen the heads of virtually all financial institutions stand up over the last few months and claim the worst is behind us. Why would anyone listen to these people? They didn't see the disaster coming, and yet somehow they are qualified to tell us it is all alright! Perhaps I am just unduly sceptical, but this reeks of a conspiracy of optimism. The recession has barely started, let alone reached its nadir. The market moves of late have all the hallmarks of a classic sucker's rally. This isn't discounting the recovery, this is denial! Far from being behind us, the worst may well still be ahead!


unfortunately, i suspect montier is dead right -- we have sailed past the breaking point of the financial institutions that support the market. their engines of profitability such as dominated the last several years (particularly securitization) have largely been dismantled. they ae left in the aftermath heavily overleveraged into securities which are defaulting at unexpected, record and increasing rates. thusfar, they have managed to delay the inevitable by expanding balance sheet with the help of central banks to prevent cascading liquidations and insistently refusing to mark portfolios down to what could really be got for them.

that period of evasion will, however, pass in due time. and what will be left is the continuation, indeed the brunt of a systemic deleveraging which has only just begun in the last year and will take several more quarters to play out. per montier:

... [S]anguinity is likely to be misplaced. The slowdown in the US is barely starting. The charts below show that both the demand and supply for .credit. are evaporating. This effective shutdown of both sides of the market should be a serious concern for monetary policy makers, as it is one of the hallmarks of a liquidity trap situation.

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