Bailouts Can’t Save This Fragile System

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It’s obvious the global economy is painfully fragile. What is less obvious is the bailouts intended to “save” the fragile economy actually increase its fragility, setting up an inevitable collapse of the entire precarious system.

Systems that are highly centralized, i.e., dependent on a handful of nodes that are each points of failure — are intrinsically fragile and prone to collapse.

Put another way, systems in which all the critical nodes are tightly bound are prone to domino-like cascades of failure as any one point of failure quickly disrupts every other critical node that is bound to it.

Ours is an economy in which capital, wealth, power and control are concentrated in a few nodes of the network we call “the economy.”

A handful of corporations own the vast majority of the media; a handful of banks control most of the lending and capital; a handful of hospital chains, pharmaceutical companies and insurers control health care; and so on.

Control of digital technologies is even more concentrated, in virtual monopolies: Google for search and YouTube for video. Facebook/Instagram and Twitter for social media. Microsoft and Apple for operating systems and services.

The vast majority of participants in the economy are tightly bound to these concentrated nodes of capital and power, and these top-down, hierarchical dependencies generate fragility.

When unexpectedly severe volatility occurs, the disruption of a few nodes brings down the entire system. Thus the disruption of the subprime mortgage subsystem — a relatively small part of the total mortgage market and a tiny slice of the global financial system — nearly brought down the entire global financial system in 2008 because it is a tightly bound system of centralized concentrations of capital, power and control.

Currently, we’re seeing the fragility of a meat production system that has concentrated ownership and production of meatpacking into a relatively few nodes on which the entire food supply chain is totally dependent.

And so what’s the status quo “fix” when this intrinsically fragile system comes apart?

Increase its fragility by bailing out the most tightly bound, dominant nodes. This is what the monopoly on creating currency, the Federal Reserve, is doing on a vast scale.

Rather than reducing the fragility of the system, the Federal Reserve is increasing the fragility, guaranteeing a collapse of not just the financial system but the currency as well.

To better understand systemic fragility, we turn to Nassim Taleb’s description of antifragile systems:

Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder and stressors and love adventure, risk and uncertainty. Yet in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better. This property is behind everything that has changed with time: evolution, culture, ideas, revolutions, political systems, technological innovation, cultural and economic success, corporate survival, good recipes, the rise of cities, cultures, legal systems, equatorial forests, bacterial resistance… even our own existence as a species on this planet.

And we can almost always detect antifragility (and fragility) using a simple test of asymmetry: Anything that has more upside than downside from random events (or certain shocks) is antifragile; the reverse is fragile.

We have been fragilizing the economy, our health, political life, education, almost everything… by suppressing randomness and volatility. Much of our modern, structured, world has been harming us with top-down policies and contraptions… which do precisely this: an insult to the antifragility of systems. This is the tragedy of modernity: As with neurotically overprotective parents, those trying to help are often hurting us the most.

Given the unattainability of perfect robustness, we need a mechanism by which the system regenerates itself continuously by using, rather than suffering from, random events, unpredictable shocks, stressors and volatility.

Does our financial system advance via unexpected shocks, extreme volatility, unknown unknowns and ceaseless variability? You’re joking, right?

The smallest perturbation in any node brings the system to the edge of collapse. Exhibit No. 1 is last fall’s crisis in the obscure financial node known as the repo market.

This relatively modest part of the financial system almost triggered a stock market crash, so the Fed immediately printed hundreds of billions of dollars to bail out every single player in the repo market — all behind the scenes, of course, lest the extreme fragility of the entire overleveraged, speculative contraption become visible.

Making an incredibly fragile system more fragile via bailing out every node of concentrated capital, power and control guarantees the entire rotten structure will collapse.

Risk cannot be made to disappear; it can only be shifted. By bailing out the sources of systemic fragility with trillions of dollars, the Fed has shifted the risk to the entire financial system and the nation’s currency.

Simply put: The only possible output of Fed bailouts is the complete collapse of the entire financial system, including the currency the Fed is creating with such abandon.

Below, I show you why the current collapse can’t be compared to any other, and why the collapse has only begun. Read on.


for The Daily Reckoning

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Did the Fed Bail out the Market Today?

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The good news first:

We learn by the United States Labor Department this morning that the economy took on 273,000 jobs last month.

Consensus estimates came it at 175,000.

Unemployment slipped from 3.6% to 3.5%… equaling a 50-year low.

Meantime, December and January estimates were upgraded by no less than 85,000 jobs.

Thus there is more joy in heaven.

Now the bad news:

The stock market picked up the news… and heaved it into the paper basket.

“Black Swan-dive”

The Dow Jones hemorrhaged another 800 points by 10 a.m. The other major indexes also gave generously — again.

VIX — Wall Street’s “fear gauge,” exceeded 48 this morning. It had guttered along under 15 until late February.

In all, global equities have surrendered $9 trillion in nine days — $1 trillion each day.

Never before have global equities retreated so swiftly and violently.

Meantime, the 10-year Treasury note achieved something of the miraculous this morning…

Yields collapsed to an eye-popping 0.664%.

Many were flabbergasted when yields sank to a record 1.27% low in July 2016. Yet this morning, they were nearly half.

Well and truly… these are interesting times.

Michael Every of Rabobank shrieks we are witnessing a “Black Swan-dive, as yields and stocks tumble in unison…”

A New Contrarian Indicator

But at least the crackerjacks at Goldman Sachs gave us advance notice of this thundering stampede into Treasuries…

A Bloomberg headline, dated Feb. 10:

“JPMorgan Says Bonds to Slump, Fueling a Return to Cyclicals.”

And this, bearing date of Feb. 23:

“JPMorgan Says Rally in Treasuries May Be Nearing Turning Point.”

May we suggest a new contrarian indicator?

The “JPMorgan Indicator.”

The reference is to the famed 1979 BusinessWeek cover declaring “The Death of Equities.”

Of course equities embarked upon the grandest bull market in history shortly thereafter.

Perhaps JPMorgan can provide a similar service.

As Zero Hedge reminds us, most hedge funds are clients of JPMorgan. Those who took aboard its advice are presently paying. And royally.

They “shorted” longer-term bonds — betting they would fall.

If You Don’t at First Succeed…

We imagine Mr. Jerome Powell is scratching his overlabored head today. His “emergency” rate cut Tuesday failed to fluster the fish.

But that does not mean more bait is not going on his hook…

Markets presently give 50% odds the Federal Reserve will lower rates to between 0.25% and 0.50% by April.

The central bank is already woefully unprepared to tackle the next recession. Yet it appears ready to squander what little ammunition that remains.

And Bank of America is already assuming a global recession is underway:

“[Our] working assumption is that as of March 2020 we are in a global recession.”

A global recession can wash upon these American shores.

What is the Federal Reserve to do in event it does?

Dwindling Options

It has little space to cut interest rates, as established. And purchasing Treasuries has lost its punch. Recall longer-term Treasury yields presently dip below 1%.

Additional purchases could drag yields to zero… and below.

Eric Rosengren presides over the Federal Reserve Bank of Boston.

He moans these conditions “would raise challenges policy makers did not face even during the Great Recession.”

Again, what could they do?

In a situation where both short-term interest rates and 10-year Treasury rates approach the zero lower bound, allowing the Federal Reserve to purchase a broader range of assets could be important.

… We should allow the central bank to purchase a broader range of securities or assets.

Full English translation:

The Federal Reserve should be authorized to purchase stocks.

But Is It Already?

This Tuesday we vented the theory that the Federal Reserve has been sneakily — and illegally — purchasing stocks.

Citing Graham Summers, senior market strategist at Phoenix Capital Research:

For years now, I’ve noted that anytime stocks began to break down, “someone” has suddenly intervened to stop the market from cratering…

[And] a year ago, I noticed that the market was behaving in very strange ways.

The markets would open sharply DOWN. Seeing this, I would begin buying puts (options trades that profit when something falls) on various securities, particularly those that had been experiencing pronounced weakness the day before.

Then, suddenly and without any warning, ALL of those securities would suddenly ERUPT higher.

Mr. Summers theorized that the Federal Reserve was purchasing Microsoft, Apple, Alphabet (Google) and Amazon stock.

Because these behemoths wield such vast heft, they can haul the overall market higher.

Did the Federal Reserve possibly resort to the same skullduggery today?

The Smoking Gun?

At 3:08 we noticed the Dow Jones flashing 25,268 — another whaling to conclude the week.

We next looked in shortly after 4 to tally the final damage.

Yet we were astonished to discover the index had surged to 25,938 in that hour.

For emphasis: That is a 670-point spree in the span of one hour.

It settled down to 25, 864 by closing whistle. But the index closed the day only 256 points in red — a victory of sorts.

What happened?

A quick look at Apple revealed it began rising around 3 o’clock… as if by an invisible hand.

Microsoft displayed a nearly identical pattern. And Amazon. And Google.

All mysteriously jumped at 3 p.m.

We leave you to your own conclusions.

A Record of Mischief

It’s long been argued that the Fed shouldn’t and doesn’t buy stocks.

However, the fact is that the Fed does a lot of things it’s not supposed to do. According to the Fed’s own mandates, it should never monetize the debt by printing money to buy debt securities.

The Fed’s already done that to the tune of over $3.5 TRILLION.

Moreover, we know from Fed minutes that as far back as 2012, the Fed was shorting the Volatility Index (VIX) via futures, or options. Here again, this runs completely contrary to the Fed’s official mandate. And if you think this is conspiracy theory, consider that it was current Fed Chair Jerome Powell who admitted the Fed was doing this!

Simply put, the Fed has been skirting its mandate for years in the name of “maintaining financial stability.” In fact, what usually happens is the Fed does things it shouldn’t, denies it for years and then finally admits the truth years later, by which point no one is outraged.

I believe the Fed is currently engaging in precisely such a practice when it comes to the outright rigging of the stock market today.

The Laws Fall Silent

The Federal Reserve Act does not authorize the central bank to purchase equities.

But financial emergency is akin to wartime emergency.

And as noted, the Federal Reserve took… extreme liberties with the law during the last crisis.

It may be taking additional liberties at present. And it will again if necessary.

“Inter arma enim silent lēgēs,” said Cicero — “In times of war, the law falls silent.”


Brian Maher
Managing editor, The Daily Reckoning

The post Did the Fed Bail out the Market Today? appeared first on Daily Reckoning.

Daily Reckoning 2020-01-09 17:55:42

This post appeared first on Daily Reckoning.

Dear Reader,

“Journalism is about covering important stories,” said one scalawag. “With a pillow.”

A staggering bailout of the banking system presently proceeds apace.

The mainstream financial press has seized a bed pillow, placed it over this important story… and pressed down murderously.

Today we pry away the pillow… and vent in desperately needed oxygen.

Here we refer to the Federal Reserve’s ongoing support of the “repo” market.

Precisely how large is this bailout? Might it exceed the entire Wall Street bailout of 2007–10?

Answers, elusive answers, anon.

What Is the Repo Market Again?

Here again is a brief sketch of the repo market:

Financial institutions borrow or lend money in the overnight money markets as need dictates.

This short-term borrowing and lending activity takes the form of “repos”… or repurchase agreements.

If a firm wishes to borrow monies, it goes before the “repo” market with an open hat.

It holds up high-grade securities such as Treasury bonds as collateral.

Another financial institution accepts the collateral. It then agrees to loan the overnight money.

The next day the borrower “repurchases” the collateral it originally put up… and returns the borrowed money (with some slight interest into the bargain).

Hence the term “repo.”

The repo market oils the gears of the financial system. Should the lubricant run dry, this system would suddenly and violently seize.

Yet the repo market goes nearly entirely unnoticed. It quietly and routinely hums beneath the thundering din of the stock market.

Explains one Alexander Saeedy in Fortune:

One of the most vital pieces of plumbing that powers the global financial system usually runs so smoothly that it gets overlooked by market watchers. It’s the “repo market”…

“The repo market is at the center of the U.S. financial system but it is little understood even by most people working in finance,” adds another observer, John Carney by name.

How Can It Be Coincidence?

The stock market has gone on a gorgeous spree since the second week of October.

The primary media lavishes credit upon a trade war truce. Some lovely economic data, recently rolled in, have livened the pace.

Yet we are deeply suspicious of the account. Come pull up to the facts…

In September repo market liquidity began to evaporate. The Federal Reserve’s New York branch rushed in with emergency hoses

Come next to this capital fact:

On Oct. 11 the Federal Reserve announced plans to purchase $60 billion of Treasury bills monthly.

And mirabile dictu… the stock market was immediately up and away.

In brief, the stock market rampaged only after the Federal Reserve commenced “QE lite.” Or as some wags have labeled it, QE4.

In all… the Federal Reserve has expanded its balance sheet $400 billion these past four months — a $1.2 trillion annualized rate.

The Federal Reserve shrieks in protest, denying it is QE of any sort, shape, form.

But the balance sheet argues it is.

An Ocean of Liquidity

The grand scale of the operation flabbergasts, staggers, astounds.

Put it against recent history, for example. Look first to 1999…

The Fed laid in $120 billion to support the repo market before “Y2K” — to prepare for the worst.

It likewise backstopped this market after Sept. 11, 2001… and during the Great Financial Crisis.

But these operations are minnows besides today’s whale.

The Federal Reserve is currently carrying on at such a gait… it shames all previous examples. Behold:

An Ocean of Liquidity

Now this question:

Will today’s repo bailout exceed even the supercolossal Wall Street bailout of the Great Financial Crisis?

A $29 Trillion Bailout

Wall Street on Parade sets the backdrop:

During the 20072010 financial collapse on Wall Street the worst financial crisis since the Great Depression the Fed funneled a total of $29 trillion in cumulative loans to Wall Street banks, their trading houses and their foreign derivative counterparties between December 2007 and July 21, 2010.

Last Friday — while the media were fabulously distracted — the Federal Reserve quietly released the minutes to its December meeting…

What did these minutes reveal? Wall Street on Parade:

The Fed’s minutes… acknowledge that its most recent actions have tallied up to “roughly $215 billion per day” flowing to trading houses on Wall Street. There were 29 business days between the last Federal Open Market Committee (FOMC) meeting and the latest Fed minutes, meaning that approximately $6.23 trillion in cumulative loans to Wall Street’s trading houses had been made in that short span of time.

For emphasis: The Federal Reserve has extended $6.23 trillion of loans in 29 days. That is equal to $215 billion per day.

If the business goes on at the present rate… the repo bailout will exceed $29 trillion by June.

That is, it will exceed the scale of the 2007–10 Wall Street bailout by June — if you can believe it.

Can you?

The Deafening Silence

Will it go along at existing rates? Perhaps not. But the Federal Reserve will hold up the repo market through April — by its own admission.

We bet high it will extend beyond April. Beyond June. Beyond August. Beyond October.

Come the end, whenever it is…

We conclude the present operation will ultimately outsize even the great bailouts of the financial crisis.

Yet in the primary press… all is silence.

One question nonetheless hovers in the air: What happens when the Federal Reserve eventually yanks the crutches — and the market is left to stand alone?

We have located a clue. Glance backward to 1999–2000, to “Y2K”…

A Parallel Example

As noted, the Federal Reserve was bracing the repo market in event the world’s computers lost track of time.

From October 1999–April 2000, it emptied in some $120 billion to prepare.

How did the stock market initially take it?

Analyst Jim Bianco of the eponymous Bianco Research:

The Nasdaq went on a tear rarely seen in American finance, starting literally the day the Fed opened its Y2K lending facility.

In reminder, the major averages began going amok in October — precisely when the Federal Reserve announced it would begin monthly Treasury bill purchases:

The Fed announced it would start buying T-bills on Oct. 11, 2019. Stocks have gone [on] a tear since… 9% of the stock market’s gains [this year] came after Oct. 11, when the Fed announced its T-bill purchase problem. So a big part of this year’s nearly 30% stock market gain has come on the heels of Fed moves, much like last year’s 20% decline was coincident with the Fed’s hawkish rhetoric.

Return now to 2000. That April the Federal Reserve announced a halt to the business… and walked away.

Did the Nasdaq stand up, Mr. Bianco?

It crashed 25% the week the facility closed (April 7–14, 2000).

That is our example, nearly a perfect parallel to today. We expect a similar trouncing when the Federal Reserve withdraws present support.

And recall — today’s operation vastly outdoes 1999’s. It may therefore come down with a correspondingly greater thud.

A Tiger by the Tail

And so Jerome Powell has a tiger by the tail…

He can let it go now, and allow the thing to maul the repo market. It would likely proceed against the stock market next.

Or Mr. Powell can hold on until the repo market can stand up alone.

But the stock market bubble may inflate to dimensions truly obscene if he does hold on.

And how could he let go then?


Brian Maher
Managing editor, The Daily Reckoning

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