Stocks Rally on Bad News?
Board: Macro Economics
The 4% spike in stock markets worldwide in response to news of a coordinated central bank liquidity plan being implemented seems to demonstrate a frightening absence of short term memory on the part of markets. To understand why, step back and review exactly what happens between banks every day and the role of a central bank.
* a central bank exists to act as a lender of last result
* banks are normally expected to balance their books nightly by LOANING TO EACH OTHER to even out deposits and loans
* any time a bank reaches the point where it either cannot AFFORD the interest rate charged by its peers to help it balance its books that night or NONE OF ITS PEERS WILL LOAN IT ANY MONEY AT ANY PRICE, it has to borrow from the central bank
* by definition, when a bank has to go to the central bank's Lender of Last Resort (LOLR) window, its peer banks are saying they either have ZERO trust in the bank caught short or they have ZERO slack in their own books to lend out
* BY DEFINITION, any time a single bank has to borrow from the central bank acting in its lender of last result capacity, that is NOT A GOOD THING
Now carefully review all of those bullets above a couple of times. Who should know better the health of a giant bank than its peer giant banks? If THEY don't trust the bank to extend loans for a SINGLE NIGHT, how near death must that bank be?
* any time a central bank has to act as LOLR for MORE THAN ONE BANK AT A TIME for large amounts of money, that by definition is a WORSE SITUATION than just a single bank coming in the middle of the night needing LOLR money
Now review that for a moment and let it sink in.
* under normal conditions, the odds of any collection of human beings agreeing on anything involving large sums of money are very low
* under normal conditions, the odds of any collection of human beings not only agreeing on something involving large of sums money AND agreeing to ACT in lock step are even smaller -- near zero
* we just saw central banks across three continents ACT IN UNISON and commit a MASSIVE AMOUNT of lender of last resort funny money not just for a short 1-week or 1-month interval but for over ONE YEAR -- the terms extend into 2013.
Now sit back and think about that long and hard.
The news that hundreds of billions in LOLR resources have been publicly promised to banks for OVER A YEAR INTO THE FUTURE isn't a sign of springtime in a gloomy financial winter. A concerted LOLR expansion on the part of multiple central banks is a sign of incredible danger in the financial system. If the credit lockup on August 10, 2007 (see #1) was the starting pistol for the eventual meltdowns in March and September of 2008, this action is a cannon shot for what's to come.