When the going gets weird, the weird turn pro. - Hunter S. Thompson

17 September 2008

Six impossible things before breakfast

Lewis Carroll’s White Queen “believed as many as six impossible things before breakfast”. Traders could use that skill. Here are six things we have been asked to believe since markets closed on Tuesday.

First, the US Federal Reserve is lending $85bn to American International Group to stop it from going bust. AIG is an insurer, not covered by the Fed. The action is without precedent. Does it damage the decisive move against moral hazard when Lehman was allowed to fail? Arguably not. AIG was of greater systemic importance. And Wednesday’s market response suggests that it in no way dampened aversion to risk.

Second, a US money market fund has “broken the buck”, or dropped below a nominal value of $1. For decades US savers had thought this impossible.

Third, the yield on the world’s safest investment, three-month Treasury bills, dropped to 0.15 per cent, its lowest since Pearl Harbor. Safety has not been so expensive since the war.

Fourth, the US Treasury had to bolster the balance sheet of the Federal Reserve, the anchor of the world financial system.

Fifth, Wall Street’s last two independent investment banks, Morgan Stanley and Goldman Sachs, will stay independent for days at most, judging by the price of their equity and credit.

And sixth, the risk that the US itself defaults, according to credit markets, has quadrupled in the past six months. Its triple-A rating, according to one rating agency, is “not God-given”.

All six things appear to be true. A seventh, pushed by contrarians, is that it is time to buy. The last rally, in July, started when restrictions on short-sellers were announced; draconian measures against shorts were unveiled on Wednesday. And extreme panics generally precede rallies. But this panic must be resolved first, and it looks different from the panics that have preceded it this year.

The Short View: The cost of safety (John Authers, Financial Times, 17 September 2008)

I virtually never reproduce an entire article when I blog... but, like the Federal Reserve said when they bought AIG without, you know, strictly speaking having legal authority to do so, I claim exigent circumstances in this case.

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