It seems that the regime in Syria is going through its last phase. The emerging civil war may wrap up the first phase of the face-lift in the Middle East. Almost 2000 years ago, on the road to Damascus someone else set the foundations that changed the face of history. The symbolism of Damascus cannot be overlooked, and thus I recall the lyrics of Rich Mullins, a songwriter whom I admired, whose memory we recall these days, after his premature death fifteen years ago. They go like this:

On the road to Damascus
I was hung in the ropes of success
When you stripped away the mask of life
They had placed upon the face of death

We are still in the early stages of the risk normalization process. To some extent the deleveraging process is still in the infant phase, given the continuous rises in the total credit market debt. So it may be time to review the masks of “market life” that institutionalized vested interests are placing upon a dying marketplace. Why a dying marketplace? Here are some basic facts:

• Banks (especially in the EU) are overleveraged. A not that big of a shock could wipe out their capital

• The counterparty risks in the banking sector are such that through derivatives (valued at over $700 trillion) a relatively minor tremor could create tidal waves that would devastate the global economy

• The socialization of banking failures’ costs through higher public deficits has made national debt in several countries unaffordable, unsustainable, and unrealistic in terms of ability to pay it back

• The peripheral EU economies are on the verge of catastrophic chaos with public finances (or the lack of it), unemployment, and social instability feeding a monster that cannot be satisfied unless it is either extinguished (debt elimination) or satisfied (swallowing economies)

• The rising costs of financing debt will soon start cutting off pertinent economies from financing options

• The deleveraging process infuses deflationary pressures on all assets, which in turn devalue growth prospects and reduce start up potential, while eliminating risk appetite without which fear reigns supreme

• Chaotic disintegrating forces in the EU are already reducing growth prospects around the world. In the latest IMF Spillover Report, it is estimated that the GDP of the EU could go down by 5%, while US could also fall into a recession (and these are conservative estimates)

• The discussion about a US “fiscal cliff” could become a self-fulfilling prophecy that could start the bursting of the greatest bubble of all a.k.a. bonds

But which are the masks of “market life”? Here is again a basic list:

• QE measures initiated by central banks for the purpose of injecting liquidity a.k.a. kicking the can down the road in the hope of a deus ex machina

• Degradation of collateral standards, again for the purpose of extending liquidity to dying banks (especially in the EU)

• Currency manipulation for the sake of demonstrating a “healthy and reviving” Euro ( a currency which was ill-conceived and ill-executed)

• ELA (emergency liquidity assistance) and similar programs that resemble an oxygen machine to keep the patient alive

• Discussions regarding debt mutualization in the EU

• Plans for a banking union (again in the EU)

• Bond purchases by the ECB of Spanish and Italian bonds

• Explosion in the central banks’ balance sheets

• Pronouncements like “whatever it takes,…and believe me it will work” by central bankers breath positive suasion in a market desperate for some ray of hope

• The funding of the permanent EU bailout mechanism known as ESM (the successor to the EFSF, assuming that the German Constitutional Court does not shut it down at least as far as Germany is concerned) while is assumed to be a good mask, it runs the danger of becoming obsolete if Spain ends up needing a full bailout, since it will start running out of ammunition pretty soon thereafter

• Of course that problem might be overcome if the ECB extends a banking license to the ESM. That could turn out to be the ultimate mask over the face of death. However, such action endangers Germany’s reaction given that such license will proliferate QE measures, the degradation of standards for credit, and will unleash the forces of inflation

We consider that August 2007 marks the turning point in the markets. By mid August 2007 it was obvious that credit markets had reversed trend and started their freezing process. ABS (asset backed securities) programs and the commercial paper market were clearly exhibiting significant strains. Thus, as we remember this 5th anniversary when the collapse started, it might be useful to review some facts. The following two links might be useful for such review.

Financial Crisis: Timeline

Financial Crisis: 25 People at the Heart of the Meltdown

In the hope that the ECB might start acting using the Powell doctrine of overwhelming force, then we would not be surprised if markets wear for a few weeks the mask of celebration, hanging in the ropes of “success”, until reality unmasks the face of death.

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