Asia Getting Hammered, Discouraging Report on ECB Commitment

Wellie, nothing like a lack of leadership to turn an ugly market day into an utter rout. But in another sense, the fake leadership in lieu of real leadership (as in taking a tough stand now and again and bringing the public around) is what set up conditions for a spectacular market unwind in the first place.

It’s one thing to do the equivalent of put the financial system on life support to deal with a crisis, quite another to leave the patient on life support and pretend you’ve returned to status quo ante.

The downdraft continues. The Nikkei is down 4.4%, the Hang Seng is off 5.9% and the Korean stock indexes are all off more than 7%. S&P future are down 25.80. Gold is at $1756 and Brent is just below $100 a barrel . The yield on ten year Treasuries continues to fall and is now at 2.30%. The euro had fallen into 1.41 territory but is now at 1.4219. The Aussie dollar had fallen below parity but is back slightly above it.

The plunge in big bank shares in the US has apparently focused the minds of the officialdom. Bank of America closed down 20.3%, Citigroup was off 16.4%, and JP Morgan, 9.4%. The Financial Stability Oversight Council is meeting tonight. Per the Financial Times:

Regulators convened an emergency conference call of the Financial Stability Oversight Council, which brings together the Federal Reserve, the US Treasury and other agencies. But government officials said there was no evidence of broader systemic instability or institutions’ funding coming under pressure. Banks have been moving to secure longer-term funding in advance of the market turmoil…..

Mike Mayo, analyst at CLSA, told clients that BofA might have to consider selling Merrill Lynch, the broker it acquired during the crisis, and “can no longer rule out a capital raise” because of exposure to mortgage-related losses and litigation.

I think there is a wee bit of denial as to the fix BofA is in. First, I’d like to know who exactly can and would buy Merrill right now, given the upheaval in the markets. Plus there is the not trivial possibility that the bank wrong footed its position going into this meltdown and is sitting on losses (I don’t mean life threatening, I mean enough to impair the price). Second, managements tend not want raise equity when a stock is distressed and often wind up pulling the trigger when it is even more distressed.

Two factors that gave the markets a push to the downside was the halting response of the ECB to the widening Eurocrisis and the astonishing lame Obama speech this afternoon. Europe opened weaker and the ECB was notably absent from the market. When it entered and bought bonds, stock markets recovered to flattish (the Italian index was actually up 4% at one point) but as the ECB went back to the sidelines, the market went down (US stock index futures moved in sympathy). That is not to say the intervention didn’t have an impact: Spanish 10-year yields declined by 105 basis points and Italy’s by 81.

Some commentators have hoped that the ECB would step to the fore and finally act aggressively. A fair point is even if they were to stabilize the markets yet again, the European officialdom seems no closer to a real end game, even in terms of having a viable plan for patient zero, Greece, or the disease carriers, the Eurobanks. So buying more time is a necessary but far from sufficient condition.

A report from a colleague, who knows staffers at the ECB, was very discouraging. The bank has $5 billion in equity. Although a central bank is not constrained by its equity, it is constrained by inflation (as in if it were to incur losses in excess of its equity it can still keep printing. As former central banker Willem Buiter has discussed, the constraint on a central bank is inflation. It won’t need to go hat in hand to a national treasury for more dough to be recapitalized until inflation is imminent.

But the ECB is dominated by Bundesbankian fear of inflation. And the bank is engaging in extend and pretend. My source said the reason the ECB is so opposed to a serious restructuring of Greek debt is that its exposures, including repo, in the €130 to €140 billion range. So Trichet does not want to restructure since it would reveal the size of the losses.

But that’s barmy. The losses exist. Not reporting them is an accounting fiction. But Trichet’s objectives are merely to keep things together until his term is over (which I believe is in November of this year). If he is afraid of exposing losses, that also almost certainly means he will be loath to balloon the bank’s balance sheet unless he is highly confident he is buying assets in distressed markets and is at no risk of loss.

I was also told the meeting of the ECB board have become heated, with members resorting to nationalistic sniping (“What do Italians know about austerity?”). Needless to say this does not sound promising either.

I’ve long been using the metaphor that the markets for the last year or so reminded me of a man trying to keep spinning plates balanced on poles. If you’ve seen that trick, the performer has to keep manipulating the poles to keep the plates aloft. I’ve felt so many of the plates looked wobbly that if one fell, others would come down in quick succession. But even a gloomster like me never thought more than one would come down separately but on the same timetable.

This post originally appeared at naked capitalism and is reproduced here with permission.