Will The EU Emergency Fund Work?
Readying for reality after a historic week
Faith in the system and the credibility of our leaders has long been fingered as the issue at hand for markets at large. (See: The Credit Card.)
Decisions made in a state of panic often have serious repercussions. We witnessed this dynamic evolve during the last eighteen months as the unintended consequences of the government intervention manifested. From moral hazard to record profits -- and bonuses -- at financial institutions to the attendant class war and shifting social mood, risk wasn't destroyed -- it simply changed shape.
What if high-frequency trading actually provides liquidity in the marketplace? It's conceivable that Thursday's 1000-point swoon was triggered by computerized models "pulling bids" at precisely the same time. If that's the case -- I'm not saying it was, I'm simply posing the possibility -- banning the robots would lead to more, not less, market volatility.
What if "naked CDS" are banned, as we've long suspected might happen? The knee-jerk reaction would likely be a melt-up in the equity space, but we could then see "counter-party contagion" given the $500 trillion dollars of notional derivatives tying the world together. If you think there was confusion Friday when mom & pop couldn't get a handle on their exposure, imagine the domino effect if JP Morgan (JPM), Goldman Sachs (GS), Bank of America (BAC), Citigroup (C), and Morgan Stanley (MS) suddenly have billions of dollars of unidentified risk. (See: Regulatory Risk Abounds!)
And what if the reaction to last week's crash causes investors -- many of whom have been burned multiple times during the last decade -- to lose faith in the system, if only for a spell? While psychology can be manipulated for extended periods of time, free will, as discussed Friday, can never be caged. In that regard, the reaction to the EU Emergency Fund, not only today but in the weeks ahead, is entirely more important than the Fund itself.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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