Felix Salmon

Volatility, luck and a margin of safety: An excellent round-up — Abnormal Returns

Would love to see a debate between Julia Whitty and Matt Ridley. Sparks would fly — Mother Jones

Fund was complaining to the SEC about Goldman’s CDOs in early 2008 — Reuters

The Definitive Incomplete Analysis Of Today’s German Shock And Awe — Zero Hedge

How serious is Conde Nast about moving downtown? Very serious! Could be there by 2013 — NYO

BaFin statement on Germany’s naked short selling ban — Alphaville

Pork goes punk — Wilamette Week

“The odds are overwhelming that investors who buy stocks today will reap puny returns” — Fortune

The most harmful drinks in America — Women’s Health

The FT refuses to run Amnesty ad — Amnesty

Doing Sicily the Right Way — Palate Press

On this day in 2009, Goldman Sachs closed at $141.85 per share, adjusted for dividends; since then, it’s announced $24 per share in earnings. It’s now trading at $137. Somehow, the bank has managed to lose value over the past 12 months, even as the S&P 500 has risen by 25%. Here’s a chart showing the relative one-year performance of Goldman (blue) and Bank of America (green) against the S&P 500 (red), up to yesterday’s close: it doesn’t even include today’s 4% drop in Goldman’s share price.

Goldman is now trading at less than a 7% premium to its book value last quarter of $128.33 per share — and remember that given how profitable it is, that book value is surely rising by the day. Its p/e ratio is floating around 6, which is hilariously low for a company making this much money. And looking at the chart, the fate of Goldman’s stock has nothing to do with being too big to fail — anybody who would stop Goldman from growing would do the same to BofA.

It seems to me that even if a pretty tough version of the Volcker Rule is implemented, there’s a good chance that Goldman will be able to either get around it by cutting off its access to the Fed discount window, or else will be able to make a windfall profit if forced to sell of its swap desk. So the risk here is reputational: Goldman really has lost its golden aura, and with it the prospect of garnering a lot of fee income going forwards. And if Goldman ends up getting convicted of criminal charges — which is still a possibility — then it could just disappear entirely, just like Arthur Andersen.

Suzanne McGee has a book out next month entitled “Chasing Goldman Sachs”, whose thesis is that the financial crisis was caused in large part by banks trying to emulate Goldman and failing. Right now, no one is chasing Goldman Sachs at all, and if the current slump in its share price continues, Goldman will no longer be enviable in any way, and instead will act as a cautionary tale.

Incidentally, that share price is the main thing to look at if you’re handicapping the future of Lloyd Blankfein. He can weather bad headlines, but if he presides over the permanent loss of tens of billions of dollars in shareholder value, then he’s toast. His shareholders will forgive anything but that.

Spencer Bailey has a piece on old-school wine journalists vs new-school bloggers, in which he essentially says that the former are qualified to do their jobs, while the latter have freshness and an appealing voice. The oddest part of the column, for me, was the emphasis on the qualifications of the old guard:

A number of amateur bloggers, for instance, now call themselves critics. This is, some argue, a worrisome trend for the winemaking industry itself, if not also for professional wine writing…

“Maybe what blogging will do is undermine the whole idea that this is a subject that is rich and deep and requires some substantive thought and substantive knowledge,” says Karen MacNeil, author of The Wine Bible and one in a small stable of writers that wine critic Robert Parker has recruited to contribute to his Web site, erobertparker.com. “If everybody’s an expert,” she says, “nobody’s an expert.”

MacNeil, for the most part, is right. Magazine writers, newspaper columnists, and heavyweight critics like Parker—the industry’s leading critic, who launched The Wine Advocate in 1982 and created the 100-point rating system widely in use today—have become respected for a reason. These writers and critics really know their stuff, and the brands they write for are trusted as a result…

Wine is, after all, a complex drink, and it needs to be analyzed in a complex way, usually by someone with a deep understanding of wine or by someone with credentials, such as a WSET advanced degree.

As a recently-minted wine columnist for Reuters and someone with nothing approaching a WSET advanced degree, this was all very interesting to me, and in general I couldn’t agree less.

For one thing, it’s great for the winemaking industry that the universe of wine criticism is expanding from a few all-powerful critics to something much broader and more heterogeneous. No longer does everybody need to make the same style of Parker-friendly wines: winemakers now are increasingly able to follow their own tastes and instincts, and to find critics out there who understand and get excited about what they’re doing.

As for the importance of substantive knowledge and expertise, I’m increasingly coming to the conclusion that such things are a double-edged sword. Yes, it helps to know what you’re talking about. But all too often expertise manifests itself in impenetrable winespeak (“cardamom and leather on the nose, with lingering top-notes of freshly-mown grass and wet greyhound”) and an ever-shrinking audience of older, richer wine snobs. Wine is wonderfully social and democratic drink — you can find some great stuff for $15 a bottle, or $3 per generous glass, which is a great price-to-pleasure ratio. But all too often people get scared off by the snobs, decide that they “don’t know anything about wine”, and never discover this wonderful world.

Learning about wine, I think, is something best done over time and out of love, by drinking it and by occasionally visiting wine-growing regions of the world, which are invariably beautiful places to go on holiday, even if you’re not a wine geek. And it’s perfectly fine for wine writers to take their readers on that journey with them, rather than waiting until they’ve achieved some level of snobbishness before feeling qualified to write anything. All too often, natural enthusiasms are educated out of wine drinkers, who are constantly and unhelpfully told that the most expensive wines are the best wines. This syndrome is particularly pronounced in California, where heavy and tannic cabs, which pair well with nothing except for maybe a bloody steak and a cigar, are elevated to cult status and aped by winemakers across the state.

I, for one, would fully embrace a world where everybody’s an expert and nobody’s an expert, where people can find critics and bloggers whose tastes overlap with their own rather than feeling intimidated into thinking that if they don’t like what Wine Spectator likes then there’s something wrong with them. As for the idea that magazines get respected because of the degree of knowledge that their writers show, I think it’s much more the other way round. And the 100-point system is an absolute abomination, which in and of itself is reason to hate old-school wine journalism.

The best wine writers, I think, are those who wear their erudition lightly, and who don’t tell their readers what to like. John Brecher and Dot Gaiter used to do that in the WSJ, and it’s a crying shame that they’ve been replaced by critics who habitually zoom to the most expensive part of any wine list. After writing my first official wine column, I noticed something quite human about myself: I wanted to show off, and talk about obscure and expensive wines. But that doesn’t serve a broad audience: it just exacerbates the syndrome of people buying wine for all the wrong reasons.

So let’s celebrate the diversity of the wine-blogging world, and let’s stop being intimidated by experts. If you’ve found a wonderful $6 bottle of rosé, then that’s fantastic: you get loads of pleasure without having to spend lots of money. There’s no shame in that, and if you want to share your discovery with the rest of the world, then please do. No need for expertise.

Eric Falkenstein has a great blog entry on the relationship between risk and return, riffing off my post on what stock-market volatility should do to investors’ asset allocation. Essentially, he says, the idea that returns increase with risk is simply wrong:

Steve Sharpe and Gene Amromin found that in questionnaires investors tended to have higher return expectations when they forecast volatility as being relatively low, and lower return expectations when they forecast lower volatility. Exactly the opposite of what they should be thinking. This isn’t a missing a constant in the second decimal, rather, screwing up the sign.

As this is consistent with the theme of my book Finding Alpha, I thought this paper was awesome, and asked Steve Sharpe why it wasn’t in a journal. He noted that referees just kept sending it back for various reasons. This is unsurprising, because all the referees presume there must be some sort of mistake, that this can’t be true; it’s counter to all their theoretical training. …

Sharpe’s result really puts the standard model in a box. Unlike the CAPM betas, for which we can say we ‘just don’t know the true market portfolio’, this result takes fewer assumptions, so its empirical failure is all the more fatal to the core financial theory. People should be increasing their expected returns in volatile markets, and on average that should manifest itself in actual returns. We don’t see that in actual returns, or in surveys of expected returns.

A powerfully bad theory is like a lie–it has many inconsistencies because it isn’t true (a worse bad theory is wrong and consistent with the data, but merely because it doesn’t predict anything). One of the many bad implications of having the delusion that risk begets a higher expected return is that people invest in the stock market thinking they then deserve a higher return, a strategy that worked pretty well in the U.S. in the 20th century.

This is the heart of my case against investing in stocks. For one thing, you have no good reason to expect an equity premium going forwards, and if there isn’t an equity premium, then your allocation to stocks should be tiny: you’re not being compensated for the extra risk you’re taking. On top of that is the question of volatility, which is not exactly the same as risk, but which again should be compensated for with higher returns, and isn’t.

My feeling is that people like to invest in stocks because they like knowing that there’s a chance that the stock market will solve all their financial problems when it rises. Think of it as a three-pronged strategy: buy a house, invest in stocks, and work hard. Any one of these three things can pay off with lots of money at retirement, in the way that investing in TIPS won’t.

What’s more, an entire generation of Americans started working and saving and buying a house in the early 1970s — and millions of them hit the trifecta, becoming successful in their careers even as their stocks rose and the value of their real-estate soared. I doubt that particular combination is going to happen again in the U.S., but the experience of that generation is so powerful as to give a lot of people a lot of hope. Even if that hope isn’t particularly rational.

Tim Duy has a provocative thesis: the Europe crisis is good for the US economy, at least for the next few quarters.

Bottom Line: The European crisis, by keeping US interest rates in check and oil prices low, may do more to help the US recovery than hurt it. In the process, however, we would expect the flip side of the resulting capital inflows into the US to emerge – namely, a rising external imbalance. Arguably, this simply shifts the ultimate adjustment to sometime in the future. Again.

Is this really true? Interest rates can hardly be any lower than they are, so for the time being they’re exactly where they would be even if there wasn’t a European crisis. The situation in Europe might at the margin make the Fed slightly more reluctant to start tightening, but it’s not going to make any real-world difference for a while yet, if ever.

As for the price of oil, again I think the influence of European news is marginal, and only secondarily due to fundamentally lower demand from Europe. Mostly, I think that the option value embedded in the oil price — the idea that you might be able to buy now and then sell in the future at a profit — has fallen, as the prospects for serious oil-price appreciation have eroded. In other words, the fall in oil is financial, rather than fundamental. Which still helps US growth: the price of oil is the price of oil either way. But I think the connection with Europe is a second-order effect.

More to the point, if the European crisis really does end up delaying and therefore exacerbating the way that the US is going to have to deal with its twin deficits, that bodes ill for future interest rates, and is likely to keep the yield curve steep for the foreseeable future. If global liquidity embarks on another flight-to-quality trip to the US, that’s a nice short term boost on this side of the pond. But it’s not at all sustainable, and I’m not even sure it can reasonably be considered a “net positive” if it only increases the likelihood of a W-shaped recovery.

Barbara Kiviat is right that (a) it makes perfect sense to abolish the mortgage-interest tax deduction, and that (b) it’s not going to happen any time soon. But rather than get defeatist about this, I think the answer is to take Paul Volcker’s advice and embark on an ambitious root-and-branch overhaul of the way that debt is treated everywhere in the tax code. Remember that the overall tax rate on equity finance is 36.1%, while the tax rate on debt finance is negative 6.4%. No wonder American businesses, just like American homeowners, are overleveraged! (Frankly, it’s a wonder to me that American companies aren’t more leveraged than they are, given how attractive the tax treatment of debt is: maybe this is just a function of how easy it is to avoid taxes in less dangerous ways.)

Maybe the thing to do is to phase this in gently: start by allowing the tax-deductibility of only say 90% of interest payments, and then bring that number slowly down to zero over time. And of course include mortgage-interest payments in the overall bill. Fiscal conservatives would love it, since it would raise billions of new dollars, while at the same time reducing overall systemic risk — which is always highly correlated with overall systemic leverage. Let’s give it a go!

As for the mortgage-interest deduction specifically, the best way I’ve found to explain that it makes sense to abolish it is to point out that only 20% of American households itemize their deductions on their tax returns, while about 65% of American households own their own homes. This clearly isn’t something which helps most homeowners: it basically just helps homeowners in very expensive houses in New York and California.

HAMP Update: Twice As Many Homeowners Kicked Out Of Obama Foreclosure Program As Given Permanent Relief — HuffPo

QE at the ECB: It’s on, and it’s done disingenuously to boot — Alphaville

Ambulances are not regulated by NHTSA for the crash protection of the occupants in the back — How We Drive

Equity analysts have, on average, overestimated S&P 500 earnings by 2x for a generation — Kedrosky

Merkley-Levin Is a Joke — Economics of Contempt

Is chartjunk really “more useful” than plain graphs? — Gelman

Tett says the WSJ was hobbled during the crisis by newsroom balkanization. She’s right — Daily Beast

Waldmann vs Tabarrok — Angry Bear

Last week, I published an op-ed in favor of movie box-office derivatives, which was followed up by an argument against them from Joshua Brown. Brown gives six reasons why box-office futures are a bad idea, in order:

1. Creativity, which Brown seems to think will suffer if the derivatives exchange takes off: “the influence of creative ‘believers’ will wane even further as the siren call of ‘hitting the number’ becomes even more crucial in the movie biz mindset,” he says. But the fact is that “hitting the number” is important precisely to the degree that your movie isn’t hedged. If you can hedge your investment and thereby trade lower upside for lower downside, then it becomes easier, not harder, to invest in more creative movies.
2. Sequels and remakes: this is the flipside of the creativity coin, although Brown forgets that some of these things (The Godfather Part II, The Empire Strikes Back, Aliens, Toy Story 2, The Dark Knight) are actually rather good. Besides, insofar as sequels and remakes are profitable and have profits which can be locked in on derivatives exchanges, those profits can then be funneled back to the true-believer creatives, in a virtuous circle. After all, the studios won’t find the likes of Christopher Nolan if they don’t fund smaller creative films.
3. Betting: I argued that people care more about movies they bet on, which is surely true. Brown reckons that people only bet on sporting events which they’re going to watch anyway, but it’s surely true that once they start betting, they watch more sporting events and care more about them. I’m not saying that people will watch films they’ve bet on just because they’ve bet on them. But I am saying that betting on a movie helps to heighten the sense of anticipation before the movie comes out.
4. Manipulation: Hedge funds could buy up empty theaters on the opening weekend, in order to make profits on the futures! This is ridiculous, of course, but also weirdly wonderful, in a way: it’s free money flowing from speculators to Hollywood. What’s not to love?
5. Regulation: “the jurisdictional wars over who should be supervising Hollywood futures will be hilarious to watch,” says Brown. Only they won’t: it’s already crystal clear that if the Senate allows these contracts to exist, they will be regulated by the CFTC. End of story. The MPAA might like to get involved, but it won’t.
6. Insider trading. Bring it on! Derivatives markets are largely exempt from insider-trading rules to begin with, since derivatives aren’t securities. When people find out information about what’s going on with a movie, they might well trade on that information. Which means, in turn, that the box-office futures will be that much more accurate as a prediction of how well the movie is going to do. That’s information that senior production executives should love, seeing as how they’re often the last to know when it comes to this kind of information.

In any case, this is all pretty moot, since the CFTC’s main overseer, Blanche Lincoln (whose sister is a Hollywood film director) is sure to push through the ban on box-office futures. More’s the shame.

Structured credit ratings history repeats itself, the first time as tragedy, the second time as farce:

Standard & Poor’s cut to junk the ratings on certain securities, backed by U.S. mortgage bonds, that it granted AAA grades when they were created last year…

The reductions were among downgrades to 308 classes of so- called re-remics… About $150 million of the debt issued last year, as recently as July, with top rankings were lowered below investment grades.

I consider myself pretty cynical when it comes to structured finance, but this comes as a shock even to me. S&P knew, when it was rating these re-remics, exactly where it had gone wrong in the first round of structured-credit ratings, yet somehow was unable or unwilling to fix the problems in that group.

Tracy Alloway quotes S&P citing significant deterioration” in the performance of the underlying mortgages as the reason for the downgrade — but the whole point of a triple-A-rated mortgage-backed security is that it’s robust to such deterioration. If it isn’t, then it should never have been rated triple-A in the first place.

If we needed one more reason to strip all official recognition from credit ratings, this is it. S&P and Moody’s are clearly completely incompetent, and no one should base any investment decisions on the random series of letters they apply to bonds. If the CDO fiasco wasn’t enough to make them change their ways, then nothing will be.

Jim Surowiecki today looks at the flipside of the moral hazard trade: if you can’t count on governments to bail you out in extremis, then you’re likely to have volatile and unpredictable markets.

Political risk is hard to manage because so much comes down to the personal choices of policymakers, whether prime ministers or heads of central banks. And those choices aren’t always going to be economically rational—witness Merkel’s recent tergiversations. Similarly, the U.S. government’s failure to bail out Lehman Brothers in 2008 seems to have been in part the result of Treasury Secretary Henry Paulson’s desire not to be seen as Mr. Bailout. Investors, then, are being forced to read the minds of policymakers—not something they’re good at. Markets work best when there’s lots of information available and a historical track record to go on; they excel at predicting things like horse races, election outcomes, and box-office results. But they’re bad at predicting things like who will be the next Supreme Court nominee, as that depends on the whim of the President.

Surowiecki is saying not only that Merkel should have bailed out Greece with alacrity and that Paulson should have bailed out Lehman: he goes on to praise successful interventions in the markets such as the Clinton/Rubin bailout of Mexico, Hong Kong’s successful 1998 intervention in its own stock market, and the Obama Administration’s decision to preserve as much equity and debt value of the banking system as it could.

In all these cases, government intervention was used to prop up market prices — of Mexico’s bonds, of Hong Kong equities, and of US bank stocks and preferred debt. And yes, when there’s a government put, volatility goes down. But that doesn’t mean that government puts are a good idea: after all, it’s not the job of government to reduce market volatility.

What’s clear is that governments — and I’m including central banks here — have much less ammunition now than they did pre-crisis, even if they still have the willpower to intervene to save markets from themselves. And the willpower is evaporating rapidly, to boot. The result is that the moral-hazard play is becoming increasingly dangerous, and that volatility is sure to stay high.

The only thing keeping markets from plunging on worries surrounding European finances is faith in the political credibility of the European Union and the ECB. And on that front, there’s a lot more downside than there is upside, since we’re leaving a world of very high European cohesiveness and entering a world of much greater uncertainty. It’s already clear that the UK is going to be absent from the European project for the foreseeable future; the big risk is that the Germans will follow suit.

A lot of investors have made a lot of money from the moral-hazard trade over the past 15 years or so. When that trade comes to an end, expect the losses to be just as big, if not bigger.

Meredith Whitney is trying to make an updated case that we can’t pass financial reform because it would cost jobs. I don’t buy it, partly because I simply don’t believe her numbers, which kick off with two interlinked claims:

States will approach their June fiscal year-ends and, as a result of staggering budget gaps, soon announce austerity measures that by my estimates will cost between one million to two million jobs for state and local government workers over the next 12 months.

Typically, government hiring provides a nice tailwind at this point in an economic recovery. Governments have employed this tool through most downturns since 1955, so much so that state and local government jobs have ballooned to 15% of total U.S. employment.

First, there hasn’t been much ballooning going on. Let’s look at the numbers here: there were 17.3 million state and local government workers counted in the latest jobs report. That’s down from 17.6 million a year ago. In terms of percentages, state and local government now accounts for 13.3% of total nonfarm employment, unchanged from a year ago.

Does Whitney really believe that these very stable numbers are suddenly going to be upended over the next 12 months? Yes, many states have announced job cuts — but announcing job cuts is vastly easier than actually implementing them. To get a good idea of how difficult it is to shrink a mammoth bureaucracy, look at Citigroup, which has a storied history of announcing enormous job cuts only to see its total headcount rise: it took a good five or six attempts before it actually managed to shrink its total payroll. It’s simply not credible that state and local governments are going to reduce their total job count by between 6% and 11% over the next year.

Whitney then goes on to say, quite rightly, that small businesses are the best engine of job creation. But then her logic goes a bit skewy again:

Small businesses fund themselves exactly the way consumers do, with credit cards and home equity lines. Over the past two years, more than $1.5 trillion in credit-card lines have been cut, and those cuts are increasing by the day. Due to dramatic declines in home values, home-equity lines as a funding option are effectively off the table. Proposed regulatory reform—specifically interest-rate caps and interchange fees—will merely exacerbate the cycle of credit contraction plaguing small businesses.

If banks are not allowed to effectively price for risk, they will not take the risk. Right now we need banks, and particularly community banks, more than ever to step in and provide liquidity to small businesses. Interest-rate caps and interchange fees will more likely drive consumer credit out of the market and many community banks out of business.

Essentially, Whitney is saying that small businesses fund themselves with credit cards; that financial regulation will reduce the amount of credit-card credit; and that therefore financial regulation is bad for small businesses. What’s more, she applies this argument specifically to community banks.

It’s true that small businesses fund themselves with credit cards. But it’s not true that exorbitant interest rates of 30% or more are a result of “effectively pricing for risk” — instead, they’re a way of trying to extract as much profit as possible out of every cardholder. And it’s trivially true that a small business funding itself at an interest rate of something over 30%, where the proposed caps are going to kick in, is not going to be doing a lot of new hiring.

And while it’s also true that we need community banks to provide funding to small businesses, the fact is that the overwhelming majority of credit cards come from the giant too-big-to-fail banks. If a small business wants to get a loan from a community bank, it can and should do so the old-fashioned way, by getting a loan from its local community bank. Local banks have very little dependence on small-business credit-card revenue, and in fact if the big banks cut their credit card lines further, that might serve only to drive ever more small businesses to get loans from their local institutions. Community banks, in other words, have nothing to fear from financial reform: in fact, they have quite a lot to gain. And small businesses, too, should welcome anything which keeps their funding costs down and stops them being ripped off by their banks.

Overnight markets: Sliding — Alphaville

Bill Clinton is actually, legally, running Haiti — Truthout

The WSJ’s ad campaign hits the L train in Williamsburg, misfires catastrophically — Twitpic

El-Erian on courage, vision and the dangers of short-term expediency — Alphaville

Waldmann vs Tabarrok — Angry Bear

Robert Mugabe sends ‘ark’ of animals to North Korea — Guardian

Chicago’s mayor “gleefully” declares that he’s going to start posting all FOIA requests online — Sun-Times

I win the American Statistical Association’s Excellence in Statistical Reporting Award — Columbia

Europe = Marge Simpson — Ritholtz

“A carbon market isn’t innovation; it’s just a regular old commodity market” — Economist

Is everybody overstating the consequences of a Greek default and/or devaluation? The Economist points out that Europe has seen quite a few defaults in recent decades (Russia, Poland) and also break-ups of currency unions (Czechoslovakia, Yugoslavia) — and that none of these events caused a lot of lasting damage.

I’m not convinced, if only because the Russia default caused the collapse of LTCM and a serious crisis; if it weren’t for tough arm-twisting by the Fed and billions of private-sector dollars from America’s biggest banks, it could have been much worse. And the end of the koruna and the dinar also meant the end of the Czechoslovakia and Yugoslavia, and the worry is very much that if Greece or anybody else were to exit the euro, then the whole currency union could fall apart, endangering the EU itself.

More generally, financial markets are good at taking the collapse of risky assets in their stride: what they’re bad at is dealing with the collapse of assets they thought were safe. And until very recently, Greek bonds were considered to be an interest-rate play, not a credit play. As a result, the institutions owning them can ill afford to see big losses on them.

The euro was designed to be a super-safe currency; as such, the repercussions of it falling apart would surely be many orders of magnitude greater than anything we saw in the wake of the collapse of the unlamented Yugoslav dinar.

Mike Kinsley also notes, in the North American context, that if you don’t have an economic union, then other issues tend to get worse — like illegal immigration.

All of which is to say that the great euro experiment seems to be unwinding, the Estonia news notwithstanding, and no one knows where it’s headed over the medium term. If economics and politics become fractious and nationalized across Europe, then within the region only Germany will any longer provide the kind of safety that investors are currently looking for; everybody else is going to start returning to their pre-convergence trade levels, which were a long way away from where we are now.

So anything which threatens the unity of the eurozone or the EU is surely going to have market consequences much worse than a single day drop of a few percentage points on European stock exchanges. And right now it’s far from clear that the political will to keep the union together is going to be sufficient.

It’s going to be another panicky weekend in Europe after today’s torrid market action: the positive effects of last weekend’s emergency meetings clearly didn’t last even until Friday, and the ever-weakening euro is now dragging down the continent’s bourses. This isn’t (just) a sovereign-credit issue any more: the financial markets have worked out that there’s a pretty simple trade-off between fiscal austerity and economic growth.

At the same time, markets clearly don’t believe that fiscal austerity is going to be a reality either: Greece’s CDS spreads are now back out over 600bp, and the rest of sovereign Europe seems to be gapping out too.

Most worryingly of all, the biggest losers today on European stock exchanges have been the banks — which means that we could be heading for a reprise of the 2007 credit crunch.

The big picture here is that risk, in Europe, is being replaced by uncertainty. The difference is that risk can be priced, while uncertainty can’t, and a market dominated by uncertainty is always going to be jittery and dangerous. No one knows whether the trillion-dollar bailout package announced last weekend will ever actually exist in practice; no one knows whether there’s a Trichet Put or not; no one knows whether the historic alliance between France and Germany, in which both of them do whatever it takes for the sake of European unity, still really exists; and everybody knows that the UK now has the most eurosceptic government since Margaret Thatcher resigned 20 years ago.

Meanwhile, on this side of the pond, we’re seeing large stock swings yet again, with the Dow down over 200 points and the VIX at 33: the uncertainty in Europe is clearly spilling over to the U.S., and this time a phone call from Barack Obama to Angela Merkel is unlikely to do much visible good.

This isn’t a second financial crisis yet. But the fact is that the world’s governments and central banks have much less ammunition than they did last time around if such a thing were to emerge. So the possible downside is enormous, especially given how much markets have rallied in the past year. If you can’t stand a lot of heat, then this particular kitchen is one to avoid for the time being.