What Caused the August 2011 Panic? The Damn Europeans

by royalarse13

So much ink has been spilled explaining the causes of crises over time that another iron in the fire is welcomed (if to only displace one of the others amongst the crowded indiscernible pile).

This time is different, so we’re led to believe, because debt levels are excessive on both public and private balance sheet.  So overtaxed by these burdens is the developed Western world that governments have opted for an eyes-wide-shut solution: make up new rules.

The rule in question was proposed was by newly appointed Chairman of the “International Accounting Standards Board”  Hans Hoogervorst.  Mr. Hoogervorst suggested a solution to the European debt problem that closely resembles the solution to the panic of 2008: suspend Mark-to-Market accounting (of sovereign debt on Euro bank balance sheets and companies listed in the EU).

Discussing the parallels to the USA’08-09 and EU’11  Jason Schwartz writes (emphasis added):

“Mark-to-market was repealed at 8:45 a.m on April 2, 2009, which finally put a stop to the short term liquidity crisis … Banks no longer had to raise capital as long term stability was brought back to the system.  The exact same scenario would have happened in 2011 Europe under Hoogervorst’s plan. Without the threat of failure by those banks who hold high amounts of euro sovereign debt, investors would be free to move on from the European crisis and the stock market could resume its fundamental course.”

During a panic, Mark-to-Market forces liquidation of holdings in order to satisfy the collateral requirements of counterparties.  When everyone has this issue, margin-call-like forced liquidations are like the tide going out: it lowers all ships in the Harbour as cash is raised as quickly as possible, often without tactical discretion.   Mr. Hoogervorst describes the importance of this rule (IFRS 9) and its impacts on markets as follows: 

“Under IFRS 9, impairments will still be painful but I am convinced it would be more timely done because the cliff effect is much less severe,”

The premise is one the financial community is very familiar with: lets make life a little easier for the banks and relieve some potential stress from our already taxed system (in the absence of the appetite or wherewithal to write-down the bad debts).  Moral hazard aside this seems reasonable given current economic conditions and the lustful bedfellows banks and big government.  

However, a voracious opponent to this approach has emerged and on August 4th 2011 announced that Jan 2015 would be the earliest implementation date.

We have been in a panic ever since.  http://chart.ly/pyd78w6 HT @traderstewie . How does this end?  Who knows.  Markets will bounce around and if they aren’t closing higher by the weeks end, well then they’ll be closing lower.

What I do know is that tinkering with the rules of engagement by big brother always has unintended consequences.  This time around it caused trillions in paper losses within a week and forced Gold up to $1800 per oz.  These risk-off assets are soaring against their own fundamentals (UST’s rally) due to fear.  Greed will step in eventually.  For more perspective see this video from @chessNwine from iBC .