When the stock market plunged 1,000 point in half of an hour on Thursday, the immediate rumors were of a "fat finger" trader who punched in $16 billion instead of $16 million. It's a disturbing idea, that a single trader could cause such financial destruction, but its better than the alternative - that the stock market plunge happened while the markets were functioning the way they were supposed to.
Since the original rumor, the facts have been revealed - there was no "fat finger". The stock market crashed on Thursday because that is the way the system is set up to function. Thus was should expect this event to happen again in the not so distant future.
Credit markets don't work unless there is an amount of trust that debts will be honored. Ponzi schemes stop working when the supply of new suckers dry up.
The current markets have a shortage of both trust and new suckers. The stock market rally since the March 2009 bottom has been done largely without the retail investor, who never fully regained his/her trust in the markets after the 2008 crash. The market rally was based on extremely thin trading. A stunning 73% of Wall Street trades are high-frequency trading, where powerful computers shave pennies off of trades from non-insiders.
A stock market without "dumb money" is a volatile market, and crashes like these will do nothing to regain the trust of retail investors.
The current crisis of trust involves Europe, and Greece in particular.
Since I began writing about Greece back in December, its economic situation has deteriorated into a full-blown crisis that threatens to bring down the government. Even animals are in revolt.
There is a concept in economics known as the "snow-ball effect" on debt. It involves the self-reinforcing effect of debt accumulation arising when the growth of the national economy is less than the interest paid on public debt.
In math it looks like this:
The concern is that Greece's economy is fundamentally uncompetitive in the world market, that it must borrow just to maintain its basic needs, and that interest payments on the debt accumulation is now reaching levels that has forced Greece to drastic action. Raising taxes and cutting social services to pay the interest will smother the economy further, making more borrowing necessary.
If you think this has a very familiar feel, you aren't alone.
"This does feel like '08 and '07 all over again whereby we had these sort of little fires pop up and they are supposedly contained but in reality they are not quite contained,'' said H3 Global Advisors chief executive Andrew Kaleel.
"Dubai should have been an isolated incident and now we are seeing issues with Greece, Portugal and Spain.''
The scale of this building sovereign debt crisis cannot be understated. Unless it gets contained quickly we could be looking at the next leg down in a global margin call.
One month ago, the IMF suspiciously expanded their funding reserves by 10-fold. They did this just a few weeks after the monetary fund’s chief, Dominique Strauss-Kahn, said that Europe needed a "Fire Brigade" to deal with any potential banking crisis.
On Sunday, the IMF began allocating the money to the Fire Brigade.
A number of investors and analysts have argued that even if Greece follows through on the tough cutbacks in pensions and wages, as called for by the IMF and euro-zone countries, Greece still won't grow enough over the coming few years to avoid a debt default down the road...
"What's not credible [to markets] is that despite draconian measures, the result will be a debt-to-GDP ratio of 150%," said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., or Pimco, and former senior IMF official. He says he doubts Greece will comply with all the austerity measures and advocates either a debt restructuring or a reduction of the interest rates European governments charge Greece to zero.
The problem that keeps forex traders and global bankers awake at night is that Greece's problems are merely a microcosm of the entire western world. A report from the BIS last month had this to say:
"The aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to the boiling point", said the Swiss-based bank for central bankers -- the oldest and most venerable of the world's financial watchdogs. Drastic austerity measures will be needed to head off a compound interest spiral, if it is not already too late for some.
"Current fiscal policy is unsustainable in every country (in its study). Drastic improvements in the structural primary balance will be necessary to prevent debt ratios from exploding."
...Historical data shows that once public debts near 100pc of GDP they act as a ball and chain on wealth creation.
If countries do not retrench quickly, they will create a market fear of "monetization" that becomes self-fulfilling. "Monetary policy may ultimately become impotent to control inflation, regardless of the fighting credentials of the central bank" it said.
The Greek debt crisis is starting to show up in the form of dollar hoarding in foreign countries. This is creating a global liquidity crunch for the world's banks similar to the 2008 crisis. Like two years ago, the Federal Reserve is ready to reopen its currency swaps with foreign central banks.
“At the moment, it feels worse than 2008,” said Geraud Charpin, a fund manager at BlueBay Asset Management in London. “There is no buyer of risk in the market.”
“There is a concern the market may be ceasing to function, with government bond liquidity drying up completely as everyone looks to sell,” said Mark Austen, managing director at the Association for Financial Markets in Europe.
The markets are already pricing in European bank failures at rates higher than during the Lehman Brothers failure. Some are even warning that we are looking at the greatest economic crisis in 100 years, and the chances of it happening are sooner than you think.
"The flames have rushed through the firewall of the IMF/EU programme for Greece and now threaten other peripheral countries. While the sell-off on sovereign bond markets so far remains discriminating, the risk that it might suddenly mutate into irrational panic can no longer be ignored. Eurozone policymakers need to take further steps quickly," he said.
So what if the current plan to rescue Greece fails? It's a situation that no one wants to consider.
Then all the things that the rescue measures were intended to prevent could in fact transpire: Lenders would have to write off their claims, banks would have to be rescued once again, speculators would force the rest of the weak PIIGS nations (Portugal, Ireland, Italy, Greece and Spain) to their knees -- and the euro would fall apart.
If that happened, the rescuers themselves would be at risk. Even Germany, in international terms a country with relatively sound finances, has amassed enormous debts. If it became caught up in the maelstrom of a euro crisis, the consequences would be unforeseeable.
It wasn't supposed to be like this.
A year ago the leaders of the world gathered at the G20 meeting in London. They were supposed to decide on new global financial rules to prevent a repeat of the 2008 economic crisis. Instead, nothing significant was accomplished.
President Obama was elected in the midst of a global financial meltdown. Instead of looking to fix it, he decided that health care reform would come first. At the current time, financial reforms have still not passed Congress, and the proposed regulation would fail to address the most important problems.
The reason for this inaction is both obvious and distressing - the influence the bankers hold over the politicians of the world.
The financial sector invested more than $5 billion in political influence purchasing in Washington over the past decade, with as many as 3,000 lobbyists winning deregulation and other policy decisions that led directly to the current financial collapse, according to a 231-page report issued today by Essential Information and the Consumer Education Foundation.
The entire conflict over the financial regulation bill appears to be just kabuki theater.