Jeremy Grantham on....
Business Insider reports that Kyle Bass told a University of Chicago audience that one of the world largest banks has asked him to close his Japan CDS trade. I said this would be the new financial debacle one year ago.
Here is a Kyle's world
"The AIG of the world is back. Here's what I mean by that.
I have 27-year-old kids selling me one-year jump risk in Japan for less than one basis point. $5 billion worth at a time.
You know why? Because it's outside of a 95 percent VaR. It's less than one year to maturity. So guess what the regulatory capital hit is for the bank? It rhymes with "hero." Right?
And, if the bell tolls at the end of the year, the 27-year-old kid gets a bonus. And if he blows the bank to smithereens, ah. He got a paycheck all year.
We're right back there. I mean, the brevity of financial memory is only about two years. I wouldn't sell nuclear holocaust risk in Dallas for less than a basis point. You should be fired for thinking about selling something for less than 50 basis points, you know? And yet, this is happening again.
And it's happening in huge size. You know, huge. We bought $0.5 trillion worth of these options.
Interestingly enough, recently, one of the biggest banks in the world called me and asked me if I would close my position. That was an interesting day for us. That happened to me in 2007, right before the mortgages cracked.
They said, "You know, we ran some new risk tests."
And I said, "Really?"
And they said, "Yeah, you know, our new stress scenario is a little bit more punitive than the last one."
And I said, "Well, what is it?"
And he says, "We don't want to share our proprietary secrets of our bank with you."
And I said, "OK, then I'm not closing it."
And they said, "Whoa, whoa, whoa, whoa. Well, how about: in our old one, we had rates being stressed 50 basis points, and the new one has rates being stressed 400."
And I said, "Ooh, yeah, 400. That would really hurt you on this trade, wouldn't it?"
And they said, "Yeah, we'd like to close that one."
And I said, "Well, I'd like to, but I'm not going to do that for you, so I'm sorry."
But anyway, they are starting to realize. Why would they run a stress test like that? Who would have them run that stress test? This is happening."
"Sure they’ve probably been right about the macro gloom, but it’s fair to state the perma-bear view on market valuations has misfired in many cases.
Why is it that those who once got things so right are now failing to predict things accurately?
I would argue it’s because, just like me, they have been slow to recognise the awesome power of government intervention.
Once we appreciate this, and the fact that markets have de facto been nationalised, it’s easy to understand why we’re sitting on such a major inflection point when it comes to equity valuation.
Government support for debt markets has gone about as far as it can. From here on the scramble for a finite number of “safe” debt assets becomes self defeating on account of negative rates and the zero bound. What you acquire in safety you must pay for in negative yield. There are consequently no real safe debt assets anymore.
Equity on the other hand has no such cap. It has, as many people now recognise, infinite potential."
I think this is going to work until it doesn't and then its going to end horribly bad. The government intervention she speaks of of is central bank intervention. They have distorted the price of risk -pushed most (except for high credit rated home buyers) out onto the short end - floating, provided a disincentive for congress to compromise and pushed everyone into risk asssets with low return expectations over the next decade.
At some point some central bank will go too far -my vote is for JCB or the ECB to reach this point first -and then expecations will become unanchored and rates will back up.
The idea that the CB just prints "equity" until it doesn't need to as a panacea for all world problems seems to be the mainstream view. I am still admittedly in the "there's no free lunch" camp. Every month permabears, like myself, lose more credibility. This is how I felt in 2007. The fact that more and more opinion in moving to one side of the boat ("the FED can do anything" view) I find, as a natural contrarian, comforting to my perspective. One - sided trades based on "overwhelming convential wisdom" unwind very disrutpively. Meanwhile the real economies all over the world are sputtering and debt is increasing. Nothing has been done to deal with the structural unbalances in the global economy - the eruozone is nowwhere near on a sustainable footing and even the US government can not afford rates to go back to "normal".
It is however, ironinc that as one who has argued (for the past 15 years) the Fed should be able to spot bubbles and target them, the FED and other central banks are doing exactly that now - targeting asset prices. Be careful what you wish for.
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