$50bn hole appears in New York financial markets – Fed is “looking into it”

Most people would quickly notice if $50 went missing from their purse or wallet. They would certainly notice if $50k suddenly disappeared from their bank account. But a fortnight ago, it took the New York Federal Reserve more than a day to notice that $50bn was missing from the money markets it was supposed to regulate.

Worse was to come. By the end of last week, the NY Fed was being forced to offer up to $100bn/day of overnight money.  And it was also clear that the authorities still have no idea of what is going wrong.

This is perhaps not surprising when one remembers, as I charted here between 2007-8, that the Fed failed to notice the subprime crisis until Lehman went bankrupt in September 2008.

For the past 2 weeks, extraordinary things have been happening in a critical part of the world’s financial markets. And unfortunately, the NY Fed didn’t notice until after it had begun, as the Financial Times later reported:

  • First, on Monday 16th, the repo market suddenly began to trade higher – reaching a high of 7%
  • Then as the market opened at 7am on Tuesday, “Rates rocketed upward again, to 6% within a few minutes and then to a high of 10%. That was four times the rate the repo market was trading the week before. Typically, repo prices move around by a few basis points each day — a few hundredths of a percentage point.

Finally, someone at the Fed woke up – or perhaps, somebody woke them up – and they announced $75bn of support to try and stop rates moving even higher. Even that had its problems, as “technical difficulties” meant the lending was delayed.

As Reuters then reported next day, this cash wasn’t enough. The shortage “forced the Fed to make an emergency injection of more than $125bn …. its first major market intervention since the financial crisis more than a decade ago.”

Of course, as with the early signs of the subprime crisis, the Fed then went into “don’t frighten the children mode“.  We were told it was all due to corporations needing cash to pay their quarterly tax bills, and banks needing to pay for the Treasury bonds they had bought recently.

Really! Don’t companies pay their tax bills every quarter? And don’t banks normally pay for their bonds?  Was this why some large banks found themselves forced to pay 10% for overnight money, when they would normally have paid around 2%?  And in any case, isn’t repo a $2.2tn market – and so should be easily able to cope with both events?

Equally, if it was just a one-off problem, why did the NY Fed President next have to announce daily support of “at least $75bn through 10 October” as well as other measures? And why did the Fed have to scale this up to $100bn/day last Wednesday, after banks needed $92bn of overnight money?

Was it that corporations were suddenly paying much more tax than expected, or banks buying up the entire Treasury market? The explanation is laughable, and shows the degree of panic in regulatory circles, that their explanation isn’t even remotely plausible.

We can expect many such stories to be put around over the next few days and weeks. As readers will remember, we were told in March 2008 that Bear Stearns’ collapse was only a minor issue. As I noted here at the time, S&P even told us that it meant “the end of the subprime write downs was now in sight“.

I didn’t believe these supposedly calming voices then, and I don’t believe them now. Common sense tells us that something is seriously wrong with the financial system, if large borrowers have to pay 10% for overnight money in a $2.2tn market.

And what is even more worrying is that, just as with subprime, the regulators clearly don’t have a clue about the nature of the problem(s).

My own view, as I warned in the Financial Times last month, is that “China’s (August 5) devaluation could prove to be the trigger for an international debt crisis”.  Current developments in the repo market may be a sign that this is more likely than many people realise.  I hope I am wrong.


The €2bn WiFi company that wasn’t

Gowex Jul14Blog readers often travel a lot.  And they certainly use WiFi.  So here’s a question:

Q.  Do you ever remember using a WiFi service called Gowex?

A.  Lots of puzzled looks in response

Q.   Not sure?  You think it might be vaguely familiar, but maybe not.  Well this is what the company’s website says:

“Your city is a WiFi city  With loads of projects, GOWEX leads the development, creation & exploitation of WiFi Cities in the World. Learn how GOWEX takes WiFi to every corner of your city and how you can be part of the greater network of WiFi cities in the world.”

A.  Now you’re looking puzzled.  You’re sure you should have heard of something this big, but it really doesn’t ring any bells for you.

Gowex had a €2bn ($2.75bn) market capitalisation as recently as April.  Last November, it was named one of Europe’s “Best New Listed Companies” by the Federation of European Stock Exchanges and the European Commission.

Its founder, Jenaro Garcia, won Spain’s top marketing prize in May, and a Spanish government prize for export achievement in March.  He was the 39th-richest person in Spain last year as his personal wealth soared to a peak of €177m, due to investors bidding the stock up from €2 in late 2012 to a peak of €26.

But on 1 July, US investment firm Gotham City Research LLC published a report suggesting that up to 90% of its reported revenues did not exist.  This week, Garcia admitted the results had been fabricated for 4 years.  Gowex has since filed for bankruptcy.

So there is just one final question.  Why did this happen?  Why did a G20 government, a reputable financial firm such as Ernst & Young and large numbers of professional investors fail to ask the obvious questions about Gowex’s business?

And there is only one answer.  Investors wanted desperately to believe that it was a solid business, that could make them money.  The policies of the central banks had very deliberately forced them to take on more and more risk, for less and less reward.  So anything that looked as though it might have a pulse was a possible investment, as long as it had momentum.

Everyone else was buying Gowex, just as everyone else was buying WorldCom in the dot-com bubble.  Investors didn’t want to ask too many questions, for fear of finding out the truth.  Nor did the Spanish government, desperate to show as its current advertising campaign states, “Its the moment of Spain”.

RingOfFire Jun14

The Gowex bankruptcy connects, of course, to current events in Qingdao, on the opposite side of the world.  That started in April with a possible $160m scandal.  By last week, an alleged $15bn scandal related to gold was uncovered.  Last year there was the fall of OGX in Brazil, where the one-time 8th-richest person in the world saw his company file for bankruptcy protection.

The connection as the chart shows, is the debt-fuelled fault-lines created by stimulus and quantitative easing.

The blog thus continues to fear that Gowex and Qingdao and OGX are, like Bear Stearns in 2007,  just the early warning tremors of the potential earthquakes that are developing.

Gowex founder Garcia confessed to a judge yesterday that the accounts had been fraudulent since 2005.  Bloomberg clearly have the same view as the blog of the whole affair:

In the end, the most shocking part of Let’s Gowex SA (GOW)’s implosion this month wasn’t that the Wi-Fi company, worth €1.9bn ($2.6bn just 3 months ago, was a fraud. Its that it wasn’t spotted sooner.  Gowex founder Jenaro Garcia fabricated clients and contracts, listed a defunct company as a holding company for his stake in Gowex, and put numbers in reports that didn’t make any sense, even as matters of basic arithmetic.”

Clearly, the only possible answer is that ‘nobody wanted to know’.