By Todd Harrison
NEW YORK (MarketWatch) — The stock market is never wrong and prices are the ultimate arbiter of variant financial views.
As that dynamic is an ever-changing verdict, the bulls will argue that European policymakers have successfully navigated the sovereign sequel to the first phase of our financial crisis. See Minyanville’s “Five-Step Guide to Contagion.”
They are also quick to note the difference between “drugs that mask the symptoms,” as administered by the U.S government in 2008, and “medicine that cures the disease,” in the form of debt destruction and/or reorganization. See Minyanville’s “Shock & Awe.”
While global markets collectively exhaled when they heard the news of the latest Greek rescue, a looming question remains — and it’s a biggie: Will the European Central Bank debt swap spark unintended consequences that reverberate up and down the financial food chain? See Minyanville’s “Will A European Solution Trigger a Selective Default?”
I spend a lot of time thinking about the current European tact, in large part because the above-mentioned distinction — the quick-fix of drugs vs. the legitimate cure of medicine — has been my argument in front of, during and on the heels of the perfect financial storm.
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Take me at my word, I very much want to put this crisis behind us — legitimately put it behind us — as I, like you, stand to prosper in a free-market where meritocracy, rather than political posturing, dictates our financial fate; one where we can measure growth without the asterisk of an out-sized government crutch.
There is the potential in our forward probability spectrum that dictates we will emerge from this stretch a stronger, more unified global economy; one where responsibility will be shouldered by those who are culpable and reward is received by those who assume intelligent risk.
Conversely, there is a scenario that is entirely more disturbing; one where 75% forced haircuts are not deemed “voluntary,” where profound societal and geopolitical responses await subjective policy, and where a court of law is needed to decipher a rule of thumb — which may or may not trusted when push comes to shove.
Investors presumably choose fixed-income strategies in an effort to guarantee safety in exchange for upside gains. If that safety is deemed arbitrary — if a central bank is able to subordinate other investors of that very same security — then that, my friends, is a default regardless of snazzy semantics or promises that it’s an isolated situation. You don’t need a law degree to understand this; you only need to have an unbiased lens.
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Where does Greece go from here?
The future of Greece and the euro zone after a bailout package was approved for the troubled country on Tuesday.
The concern in the marketplace has never been Greece; it has been the ramifications of a Greek default on an interconnected maze of global derivatives tying together financial institutions that, until a few years ago, viewed sovereign debt as one of the safest investments in the world.
The underlying issue — and the fate of the free market world — boil down to one very simple, yet complicated question: Who wrote the Credit Default Swap contracts, and what collateral/counter-party risk sits on the other side of that bet?
The answer, as it stands, is “I don’t know.” Nobody does, and that’s the problem.
There are no central clearing houses for these instruments and precious little educated assimilation of the outstanding risk, or the domino effect that could transpire if this “solution” is deemed, as it should be, a default.
While the European approach to their sovereign situation is, in many ways, the polar opposite of how the United States dealt with our crisis — we bought the cancer and sold the car crash — there is one extremely critical commonality: the specter of containment vs. contagion will dictate our forward fortunes.
I don’t profess to have a simple solution, and I’m not sure there is one. What I can share, as I do every session on the Minyanville Buzz & Banter, is that I added a layer of short-side risk in the S&P 500 /quotes/zigman/3870025 SPX +0.07% and Nasdaq 100 /quotes/zigman/123472 NDX +0.23% following the sharp rally last week, and nibbled anew on a bit more exposure yesterday morning. Click here for a free Buzz & Banter trial.
I may be mistaken — it wouldn’t be the first time — but my current exposure, while subject to change, is directionally consistent with what I’m feeling, which is that a gut-check for the bulls is waiting in the wings.
Harrison has positions in SPX and NDX.