From my friend David Kotok
Jamie Dimon & Greece: Imperfect Together
May 13, 2012
“In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored.” Jamie Dimon
Janet Tavakoli speaks plainly. See her column in the Huffington Post (May 12). Here is a sample: “Jamie Dimon’s problem as Chairman and CEO – his dual role raises further questions about JPMorgan’s corporate governance – -is that just two years ago derivatives trades were out of control in his commodities division. JPMorgan’s short coal position was over sized relative to the global coal market. JPMorgan put this position on while the U.S. is at war. It was not a customer trade; the purpose was to make money for JPMorgan. Although coal isn’t a strategic commodity, one should question why the bank was so reckless.”
Markets will now see a series of political and regulatory initiatives. Hearings and probes will abound. JPM is about to spend a protracted period defending itself. Whether stock weakness is a buying opportunity now remains to be seen. As we quickly wrote on Friday, situations like this explain the value of diversifying within sectors by using ETFs. All ten sectors are discussed in our book From Bear to Bull with ETFs. In the book, we list the heavy weights within each of them and talk about managing the weights. At Cumberland, we have used this technique to insure that JPM is a small weight in our US financial-sector portfolio positions.
And to think that part of the JPM rationale was to hedge against European developments. We will leave that logic to be examined by shrinks.
Segue to Europe and to Greece
To understand the current state of the Greek tragedy, one must stand back and examine the big picture. The private investor in Greek debt has been crushed. His contract with the Greek government has been rewritten. He has lost any semblance of legal recourse. His recovery of loss cannot happen for years. Maybe decades. Maybe never. Greek equity investors have also been crushed. The loss in the Greek stock market now exceeds the percentage loss that US stocks experienced in the 1929-1933, Great Depression bear market. (hat tip Jim Bianco)
Greece is and has been bleeding. Its banking system would completely collapse were it not for the Emergency Liquidity Assistance (ELA). The Greek National Bank publishes these numbers with a considerable lag and with obscuring text. It is a lot of work to ferret them out and estimate them. We are doing it daily for all countries in the Eurozone. ELA is an indirect form of assistance from the European Central Bank (ECB). The mechanism is complex. The ECB now lists the aggregate ELA for the Eurozone. However, the ECB will not disclose it by country, because they fear triggering additional bank runs. It took repeated requests to get this far. The ECB has, at least, acknowledged that ELA is an indirect form of monetary assistance and stimulus.
Caveat, caveat, and caveat: when a government agency of any type invokes confidentiality, it immediately invites scrutiny and analysis by those who wish to investigate. The ECB has done that. At Cumberland, we will be publishing details and methods of investigation once we finish our ongoing research. Meanwhile, investors must understand that the banking system in the troubled periphery of the Eurozone is deteriorating on a continuing basis.
Therefore, Greece is now a ward of the ECB and the IMF and other European and global organizations. They are all organized by governments. In other words, now both the investors in and lenders to Greece are governmental institutions. Private-sector involvement in Greece has been rendered irrelevant.
Therefore, if a government is owed by the Greek government and if the governmental body that provides the funds ceases to continue to provide them, then the Greek government cannot pay and it will default on the payments it owes to the other governments. This has become perfectly circular.
Circularity is a financial condition we rarely see. It means the government that supplies the funds must keep supplying new funds in order to avoid having the recipient government default on the payments it owes to the supplying government. Since monetary policy-created funds currently have no cost (zero interest rates) and since they have no credit multiplier, this process can go on indefinitely or until monetary policy restores a cost to what is now free money.
Those who may disagree need only look at the United States for an example. Fannie and Freddie are examples of circularity. For years, they said they were independent firms. Then they failed. Then government came in so that a gigantic meltdown could be avoided. Since then they have not been fixed and they have been sustained by the actions of the US Treasury. Private mortgaging in the US has not returned, except for the high-end balances that were never covered by Fannie in the first place.
The lesson of circularity is that it does not easily end. Politicians find it is easier to insert more incremental money and preserve a losing arrangement for an additional temporary period than it is to stop and experience the actual default. This is the condition in Greece. This is the condition in the US with GSEs.
In the Eurozone, the present concern is Portugal, Spain, and Italy. All three economies are in recession. Their banking systems have to deal with developing negative issues. Their debt reflects higher risk, as measured by widening credit spreads. We track these spreads weekly at www.cumber.com. The three countries are in downward spirals. They have not retrenched their economies in order to obtain growth.
Italy is the key one to watch. It is the third largest debtor nation in the world. It is raising taxation and stifling growth in order to impose austerity. It is a wealthy country, but its demographics and social promises render its budgetary situation politically impossible and fundamentally unbalanced. We expect things to worsen in Italy.
We watch the two Iberian countries struggle. They, too, are in downward spirals. In sum, this Eurozone crisis is not over.
The only player that can assist is the ECB. It cannot fix an issue of solvency. However, it can offset the pressures of illiquidity. It has done so and will do so again. We expect the ECB balance sheet to expand again by a large amount as it attempts to use additional liquidity to stave off collapsing markets.
Cumberland has a low investment weight in Europe. We do not own the periphery. Our ETF strategies focus elsewhere. My colleague Bill Witherell is heading to the GIC conference in Poland within a few days. He will be writing about his observations when he returns. Major European central bankers and analysts are attending. See the GIC website for the lineup, www.interdependence.org.
David R. Kotok, Chairman and Chief Investment Officer
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