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Capital Markets Clogged - Call a Plumber

This being the first official week of Fall, I would have hoped for temps to cool off a little.  Instead, it appears things are heating up again, not unlike what is happening politically in Washington D.C.  This week we saw the House of Representatives launch an impeachment inquiry, the United Nations facing the heat on climate change, and a liquidity anomaly that doesn’t seem to be going away.  In all, it was a busy and contentious week for the markets.

Let’s start with the liquidity anomaly which started last week. I didn’t report on it because, frankly, no one seemed to know precisely what was causing it. To be honest, there still isn’t a clear answer. For decades, banks with excess cash would lend that money to those banks who need to borrow to meet reserve requirements. This is a very low-risk proposition since the borrowing typically is only overnight. The banks with extra cash make a little money in interest and provide liquidity to the financial system, while those who need to borrow have a well-oiled structure to do so.

However, starting last week banks who needed to borrow discovered there wasn’t enough money in the system and overnight rates shot up to 10%. Ultimately, the Federal Reserve had to step in with $75 billion per day in liquidity injections to keep the system solvent. This emergency liquidity, which was supposed to last just a few days, continued into this week and was expanded to $100 billion per day. Why are banks no longer lending to each other? Is it a question of confidence? Or instead, why do banks have less excess cash? Is it a question of these banks finding investments with better returns elsewhere? Likely, the Federal Reserve understands why this is happening, but has yet to share that explanation with the market. Essentially, this is a $400 billion bailout that is going largely unreported. I hope a more forthcoming explanation will be out soon.

Out of Europe, we learned this week that individuals do not have the right to be forgotten worldwide. Europe’s top court ruled that Alphabet’s Google does not have to remove links to sensitive personal data worldwide, five years after this case was originally heard. However, people do have the right to be forgotten in Europe. Chalk one up to Google. Also, out of Europe, the high court ruled that Starbucks does not have to pay almost $33 million in back taxes to the Netherlands. This is important because the same judges will decide a similar, albeit significantly larger, $14 billion case against Apple. And lastly, the British Supreme Court ruled that the suspension of Parliament by Boris Johnson was unconstitutional. This throws the whole Brexit fiasco into another dimension. Will the parliament reconvene? Will Boris Johnson be forced to resign? Will a new Brexit deal be agreed upon in the next month? It is impossible to know.

In closing, you might be wondering how have markets responded to previous impeachment proceedings?  The S&P 500 fell as much as 4.9% on October 8, 1998, the day the House voted to begin impeachment proceedings against President Clinton, before trimming losses to end the day down 1.2%.  By the time Clinton was acquitted by the Senate in February 1999, the index was up 28%.  Markets shrugged off an impeachment inquiry against President Nixon on February 6, 1974, but the S&P 500 fell around 30% by the time he resigned due to Watergate.  To be fair, with Nixon there were other forces at play including the suspension of the gold standard and a recession following the oil shock of late 1973.  Based on these two limited cases, the market will either go up or down.  Now you know.

Bruce J. Mason, MBA