Market MAYHEM

Finance Minister Jim FLAHERTY sang yet another "lullaby" to the roiling banking sector this morning offering to "insure" Canadian Bank's debts for a fee. The apparent market effect saw perceived "higher quality/retail" franchises fall (TD, RY) while "poor perceived quality" rose (NA, BMO). The announcements coming from LatAm region recently - the Mexican Banker's Acceptance (BA's) Market has seized up and Argentina's has nationalized the US$30bn private Pension Industry likely had something to do with Scotia Bank (BNS) tanking! (Although it may have just been reaction or hedging related trade to the recent purchase offer for CI Financial).

The "Canadian TED" spread narrowed on the news. The real benefit will be to insulate Canadian banks from the still rampant global banking contagion, despite the relative good health of Canadian Bank sector. Together with the recent temporary loosening of "mark to market" accounting rules may make the Oct 31 FYE for many of the Canadian banks bearable.

We are still in a Global Banking crisis - triggered by meltdown of insolvent U.S Investment Banks, that infected Commercial Banks globally. The crisis has now caused a full blown meltdown of our entire financial system. Bin Laden could not have done better. Contributing mightily to the panic has been the "hair on fire" approach of politicians in the U.K and U.S that dramatically escalated the severity surrounding the initial events - in the UK the nationalization of mortgage lender, Northern Rock PLC in Feb 2008 and in the U.S., the liquidation of investment bank Bears Stearns in March 2008. Both responses ignited a collapse of trust that spread like wild-fire given the widespread speculations and financial alchemy undertaken with full connivance of the federal government through institutions like Freddie Mac and Fannie Mae.

The financial repercussions of the collapse of the banking sector is now spreading to the "real economy" and lending is seizing up or grinding completely to a halt. The stock markets have been showing this turmoil for weeks and - I believe - many other speculative enterprises such as hedge funds attempt to unwind positions due to necessity by bankers or because their "investment thesis" no longer holds water. IMHO, this all of these events will definitely cause a severe Global recession - and indeed all current indications point in this direction. It is not so much a problem of judging an entry point that is near the bottom - as there will continue to be other follow-on earthquakes. It is now a question of all economies regaining the ability to function at all. At that point markets will stabilize and we can begin the recovery process.

What bothers me now is that I can not understand how that recovery can take place without massive deflation (similar to the Japanese experience during their 1990's post-bank collapse) which would render a return to a "normal" yield curve impossible.

I will continue to follow this crisis as event unfold.

[Addendum: Mon Oct 27 - Financial Post: The Next Worry: a deflationary slump, like Japan. Right on cue! Jacquie THORPE refers to Roger BOOTLE's 1996 book "The Death of Inflation" in which he correctly described the phenomena that had gripped Japan following it's banking sector collapse in 1991. He predicts U.S deflation of -2% next year. One aspect that is troubling is that digging out requires vast amounts of public sector spending. In Japan the government pumped billions into the banking sector - M1 (aka M1 or currency in circulation + cash in chequing accounts) grew at 20% while M3 (the broadest measure of Money Supply) barely grew at all. His prescription: get ready for more bailout measures!]