Yes, I’d say it is. As FOMC member, Thomas Koenig put it recently in a CNBC video interview with Steve Liesman:
…a capitalistic economy – if you really believe in its long-term benefits – has cycles. People do make mistakes. See, the market is valuable not because it’s the smartest in the world, but because it’s the harshest. It captures mistakes and punishes and forces a correction. It’s when you then interfere with that that you allow the path to go off longer and the correction to be more severe and harder on people. And that’s what you can’t lose sight of when you say you’re for Capitalism, but not really.
Mr. Liesman: I thought the market was better than government.
Dr. Hoenig: Well, but that doesn’t make it smart.
Mr. Liesman: Right.
Dr. Hoenig: It just makes it better than government.
What a refreshingly clear and honest view this is. Take just a moment to compare it to yesteryear’s fashionable idea, the efficient market hypothesis, that markets are always perfectly priced. Which one makes more sense to you?
Interestingly, CNBC very quickly edited this bit out of the video, perhaps a bit too strong a tonic for its viewers. But the point stands and has never been clearer to my mind. Markets are often stupid and today’s equity market is a prime example.
Why so? Well…the writing is on the wall in credit markets isn’t it? Greece is now trading at a virtually 100% likelihood of default. Greece carries some $470 billion in public debt. When Lehman Brothers filed for bankruptcy it faced a black hole somewhere in the vicinity of $130 billion. If Greece defaults, do we really think the bill is likely to be less?
The European situation has some startling parallels with the pre-Lehman period. There’s a bunch of dodgy assets underpinning a bunch of highly interconnected too-big-to-fail-banks. There’s a malformed regulatory structure that has completely failed to prevent the imbalances. The regulators themselves are constantly behind the curve, using outdated methods and ideologies to address a runaway problem that is far bigger than they are.
When/if the default comes the consequences are pretty straight forward. There will be some kind of seizure in European bank funding. As Zero Hedge illustrates nicely today, that’s already well underway. There will then be some kind of counterparty knock-on effect throughout global banking. In that eventuality, global trade will collapse again and global recession ensue.
And none of that factors in ANY further consequences for other European countries, even though a Greek default seems also to be a declaration that the EFSF is dead, leaving Europe with no sovereign debt mitigation plan beyond a hobbled ECB.
Maybe it wouldn’t be as bad as 2008. Then again, maybe it would be worse.
Of course, there’s always the chance that Greece won’t default and it’s credit markets that are the dills. But what then?
No, it’s the equity market that is looking a bit slow, at least for now.
