STOCK MARKET WATCH -- Wednesday, 26 August 2015

[Demeter]

3. So much for that amazing rebound---DJIA down 200+, S&P down 25+

And you can see by the shape of the curves it was all PPT, all the way, and losing the battle...which brings me to this post:

Perry Mehrling: No One Has a Good Idea of How to Keep the Fed From Having to Rescue Mr. Market Again as Yves Smith called it, or

Toward a robust dealer system of first resort

http://www.perrymehrling.com/2015/08/toward-a-robust-dealer-system-of-first-resort/

Goldman Sachs takes “A Look at Liquidity”, and tells us what they see. Suffice it to say that different people see different things, depending on their vantage point, like the proverbial blind men touching the elephant. Let’s see if we can construct a picture of the animal as a whole from the snapshots provided.

What seems clear is that the bank dealer system of the past is now gone (notwithstanding last-ditch pleading to bring it back). Banks are largely out of that business, guided by new regulations (specifically the “non-risk-based leverage and liquidity rules”), but also motivated by their own experience with the crisis. Banks do not want to be in the position of requiring emergency support from the Fed any more than the Fed wants to be in the position of providing that emergency support.

Ever since the crisis, central banks have been standing in for the pre-crisis bank dealer system, flooding the system with funding liquidity. World-wide QE has essentially bought time for a new more robust dealer system to begin rising from the ashes of the old. However, at the moment that new system is far from complete, even as central banks (led by the Fed) are signalling that they will not be around forever. In normal times the central banks supports the market; only in crisis times does it become the market. What will the new normal times look like?

Steve Strongin talks about how the Fed might respond to the next crisis: “the Fed might have to buy the distressed assets directly and/or other parts of the government might have to step in” (p. 5). That is of course how the Fed responded to the last crisis, as I have myself recounted in my book New Lombard Street. But the necessity for that response shows exactly the inadequacy of the old dealer system–it was not a robust first resort system. That’s why we have junked the old system. The question is whether we can rely on the emerging new system to be more robust.

There is a lot of hype about electronic exchanges, and also Exchange Traded Funds, and some of the hype is warranted. Yes, to the extent that we can make it easier for buyers and sellers to find each other and do business directly, we can do without the now-missing dealer intermediary. In effect, all such measures work by making the broker function more efficient, which is fine if markets are balanced. “But the largest problems are likely to arise when markets are not balanced and under significant net selling pressure…” (p. 5)



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