Manic Markets

The day after the worst day for the markets of 2012, the markets staged their best day of the year on....

* news of further ECB easing?  No, while this was rumored it never came to pass.

* news of Eurobond issuance? Nope, again just a rumor. *** UPDATE: this morning Merkel of Germany said that Germany could support Euro-area instruments.  Wow.  I think she may want to check with the people of Germany but this is the sort of news the market wanted to hear.

* Rumor of a rumor that more free money will be available?  That sounds about right.

Last night after the markets closed in the US, a Federal Reserve Board member hinted at possible further actions by the Fed (which begs the question: who knew what she was going to say and when?).  This was the first public admission that I've seen that the banks are going to get their wish and the Fed is going to bend over backwards to save the stock market (again!). 

Today China joined the easing train, cutting their benchmark bank lending rate.  All of these stories have turned the tide in the markets from "Europe is falling apart" to (in my best Oprah voice) "and you get free money, and you get free money and you get free money!".

Business Insider pulled together a ton of charts today from various websites and most of them are old news but if you want to understand why the banks want this current model to continue consider the following:

When we bailed out the banks in 2008 it was with the understanding that without a bailout, the banks would stop lending and that would lead the economy to seize up.  Well, the inconvenient truth is that banks took the bailout and reduced lending anyways (some of the decline was due to lower loan demand).  So what did the banks do with the money?  Well, according to Chart 1 it appears that they bought about $700 billion worth of government debt. 

So take a moment to wrap your head around that circular logic - The government borrowed money from China, pensions, and US citizens to save the banks.  The banks then took that money and lent it back to the government by purchasing government debt.  I'll pause to allow your head to explode.

Also during the 2008 recession the Fed announced a plan to help the banks by paying them interest on "excess reserves".  Well, if you are a bank and you can borrow from the government for basically 0% and you can earn 3% from the government (see above) and 0.25% on excess reserves guess what happens... well, Chart 2 shows that pretty clearly.

As the stock market held its own earlier this year and the economy appeared to be picking up a little steam, the banks could see the writing on the wall.  Their free money gravy train was coming to an end.  If we've learned anything over the past 5 years it is that the banks will not be denied and thus, we had a May sell-off which has prompted a tremendous amount of chatter of FURTHER easing (read QE3, TWIST2 or whatever).  That is what has goosed the markets sharply in the past 24 hours.

Cheers!