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Thursday, December 13, 2007 9:42 AM

Question of Trust Between Banks

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In one of the biggest gap and crap plays I have seen for quite some time the market gapped up 2% on Wednesday, went into the red then closed slightly higher.

Already there is speculation that the Fed Cash Proposal May Not Be Enough.

The plan may not matter much, said Richard Yamarone, chief economist at Argus Research in New York. "It doesn't address the underlying problem here, which is trust," Yamarone said. "Banks don't want to lend to each other because they don't know what the counterparties own and, in all actuality, they don't even know what they own and they don't even know how to price it."
What's The Right Question?

Is the question about trust or is the question about insolvency or is that really the same question?

Sometimes it's hard to know what the proper question even is, but this Question from Todd pretty much sums it up for me:
"Between the coordinated agendas, discount window collateral changes, invisible hands, superfund conduits, sub-prime bailout plans and now, the biggest act of international economic cooperation since the 9/11 terrorist attacks, you can't help but wonder what the heck the Fed sees that the markets, 5% off their highs, have yet to price in?"
I think that's a rhetorical question as I discussed in Global Coordinated Panic, but perhaps others disagree.

Who was surprised and why?

Given that economists were almost unanimous in predicting a 25 basis point cut, why should there have been such a huge selloff? And then why the gap and crap with the latest Bernanke surprise party? Was no one really surprised? Was this a pretend surprise? Did everyone want a bigger surprise? Was everyone surprised at 8:30 but unsurprised an hour later?

The questions keep mounting up here. For an entertaining perspective on all these questions I recommend reading Fed's Expected Cut Spurs Shoulda-Woulda-Couldas by Caroline Baum.
So much disappointment in so many quarters over something so expected. Go figure.
  • The stock market was disappointed.
  • The TV commentators were disappointed.
  • Economists were disappointed.
  • Money managers were disappointed.
  • Even money markets were disappointed with the cut.
  • And yours truly was disappointed at the wave of disappointment.
The only people who weren't disappointed but were surprised nonetheless were bond investors, who sent Treasuries soaring.

Maybe all the disappointment was just a dose of reality creeping in. Investors are looking for the magic bullet that would make everything OK, encourage banks to lend (a lower rate would help), heal the wounds in the home-loan market, wipe away the accumulated debt of consumers and put the economy back on track. Alas, there is no such tool in the Fed's arsenal.
That there is no magic wand Fed's arsenal should not be such a great revelation but perhaps it is. The number of people that have emailed me recently describing the Fed's ability and willingness to inflate forever and for the market to respond favorably to that stimulus is staggering.

Maybe that realization that the Fed has no magic wand is what has everyone surprised here. And if you can't trust the grand wizard who can you trust?

Mike "Mish" Shedlock
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