Archive - Oct 19, 2011

The European headlines continue to roll in. As far as I can tell, they either hired someone to play devil's advocate, or for the first time since at least July they actually tried to translate some of their words into action. They are running into legal roadblocks, death spiral scenarios, the reality that once they give the money to the PIIGS that the power reverts to the PIIGS, that everything is circular and self-referencing, that debt markets in the end can decouple from CDS markets, that Germany and France are going to see borrowing costs spike (even after the ECB rate cut), and that there are so many holes to plug - bank capital, bank bonds, PIIGS debt, Belgium debt, something about Dexia that no one even remembers, voters are against it, Greece isn't going to fool anyone, etc.

We may have posted this already minutes ago, but at this point it is all one big blur, so we will go ahead and regurgitate. The latest counter-disinformation from Europe comes from Reuters: "Plans to tackle the euro zone debt crisis have stalled with Paris and Berlin at odds over how to increase the firepower of the region's bailout fund, French President Nicolas Sarkozy said on Wednesday. Sarkozy told French parliamentarians the dispute was holding up negotiations. He then flew to Frankfurt to talk with German Chancellor Angela Merkel in an attempt to break the deadlock ahead of a make-or-break European leaders' summit on Sunday. A French presidency source said the French and German leaders were meeting other euro zone policy chiefs and International Monetary Fund head Christine Lagarde on the sidelines of an event mark the end of Jean-Claude Trichet's presidency of the European Central Bank. France has argued the most effective way of leveraging the European Financial Stability Facility is to turn it into a bank which could then access funding from the ECB, but both the central bank and the German government have opposed this. "In Germany, the coalition is divided on this issue. It is not just Angela Merkel who we need to convince," Sarkozy told the parliamentarians at a lunch meeting, according to Charles de Courson, one of the legislators present. His comments fuelled doubts about whether euro zone leaders will be able to agree a clear and convincing plan when they meet on Sunday. " Judging by the reaction of the EURUSD, this IS news because it only made Bloomberg minute ago, even though it hit Reuters about 45 minutes earlier.

Even as the realization that the "EFSF as an insurance policy" is dead on arrival, just as Zero Hedge predicted following some simplistic math exercises yesterday, is spreading following a report just out by the WSJ that "EU lawyers have rejected direct EFSF guarantees", the multi-trillion CDO-insurance hybrid has received an endorsement from a most surprising source: Moody's which "called for increasing by as much as fivefold the firepower of the euro area’s temporary rescue fund, the European Financial Stability Facility. A 2 trillion-euro ($2.8 trillion) EFSF “is not an unfair figure. What is needed is that there are resources to cover the entire area including Spain and Italy." Well, when one considers that there are about $30 billion in structuring fees on the table, a lot of it payable to the rating agencies, and quite a bit due to the EU's financial advisor (which has remained very stealthy through this point: we wonder just who is advising the EU and Eurozone on the daily changes to the bailout proposals - is it Goldman Sachs? BNP? SocGen? Inquiring minds deserve to know), it is probably not that strange that Moody's will pull a 180 and now demand a far larger "rescue facility." After all, without one, not only will the rating agency make billions less in the current fiscal year, but it will have no excuses to not downgrade the countries in Europe's core whose fiscal situation is deteriorating with each passing day.

We though we were the only ones brought to the verge with the relentless lies out of a completely clueless Europe, which as we learned at last weekend's G20 meeting, has 3 more days to get is act together. Oh wait, they were lying too? Got it. Well, no, David Rosenberg has also had it pretty much up to here. More importantly, Rosenberg also, like us, but also like Citi's and RBS, to throw some more "credible" names, is convinced that this latest deux ex machina is D.O.A. To wit: "How cool is it that we live in a world where complicated financial engineering in a radically overleveraged system forms the cornerstone of the solution to these debt problems...Why are we so skeptical? Well, when you go back to the opening months of 2010, it was all about Greece and the prime goal was to prevent contagion to Portugal and Ireland. We know how that went. Then that fall, the risk was Greece, Ireland and Portugal and this was when the term PIG was coined. At that time, the goal was to protect Spain and Italy. And we know how that went. Then just this past July, the crisis moved beyond just Greece, Ireland and Portugal to include Italy and Spain (and this is where PUGS was coined). At this point it was about preventing contagion to the banks, but nothing has worked. The contagion has merely spread, and this is not the first time a late-day press release or policy announcement was leaked to juice the market. So, we are still living in a world were levering up is somehow deemed to be a solution to a world of excessive credit and all this will do, again, is just kick the can down the road." As we made it all too clear, far less diplomatically yesterday, "Are we the only ones dazed, confused, and tired beyond comprehension with this endless, ridiculous, pathetic, grovelling Groundhog Day bullshit? Stop risking civil and international war just to satisfy your bureaucratic vanity. THERE IS NO MONEY! YOU KNOW IT, WE KNOW IT, THE PEOPLE KNOW IT. ENOUGH!!!" So much for enough: 6 hours later we had the latest European rumormongering fiasco courtesy of The Guardian which has now devolved to the status of England's latest "paid for publication" tabloid.

We're getting the biggest derivative security in history in the next few days. Some thoughts on how it will be priced.

In his seminal work The Rise and Fall of the Third Reich, William Shirer recounts how the struggling Weimar Republic printed its way out of reparation debt from World War I. Out-of-control printing caused the German mark to fall from 75 per dollar in 1921, to more than 4 billion just 3-years later. Talk about chaos. After a brief period of credit-fueled economic respite, the onset of the global depression in 1929 had people in the streets clamoring for change. Hitler's National Socialism promised the world... and under such economic distress, people believed him. There are two important lessons here. First is that hyperinflation comes very quickly. Confidence languishes for months, even years... until one day the currency begins to slide, slowly at first, then exponentially. The second is what followed. Economic disaster begets social unrest, the two are inextricably linked. Populist rebellions and roving gangs became a constant presence in the republic.

Time for European headlines. Because we haven't had any in about 3 minutes or so. Courtesy of Bloomberg, here is Angela Merkel doing her best channeling of Hank Paulson.

• MERKEL SPEAKS AT TRICHET FAREWELL IN FRANKFURT
  
• MERKEL SAYS EURO IS STABLE, HAS PROVED ITSELF IN TURBULENT TIME
• MERKEL SAYS IF THE EURO FAILS, EUROPE FAILS
• MERKEL SAYS 'WE SHALL NOT ALLOW' EURO TO FAIL
• MERKEL SAYS NEXT EU SUMMIT IS `NOT THE END POINT' FOR CRISIS

And most importantly...

• MERKEL SAYS NO 'MAGIC WAND' TO SOLVE EURO DEBT CRISIS
• MERKEL SAYS PAST ERRORS WILL NOT BE SOLVED IN ONE STROKE

True, many, many strokes will be needed. But what about the market which has already priced in not only the Magic Wand but the Quidditch match victory over Slitherin. What now?

And so Citi becomes the third firm after Goldman and JPM to put all their gross CDO criminal (wait, allegedly, they neither admitted nor denied) activity behind them with a $285 million wristslap.

• Citigroup will pay USD 285mln to settle SEC charges for misleading investors about selling CDOs related to housing market, according to SEC
• Citigroup's main US broker-dealer unit misled investors about USD 1bln CDO tied to US housing market, in which Citigroup bet against investors.

It is unclear if the money used will be courtesy of FDIC-backed TLGP notes still on Citi's books. Either way, justice is now "served."

The best thing about veteran traders, such as Art Cashin, is that they have truly seen it all, not just one or two gyrations of the business cycle, or in most cases, half. Which is why we are delighted to share this anecdote from the grizzled UBS trader and Fermentation committee chairman, of his personal remembrances on this anniversary of the day in which the Dow Jones plunged than 22%, and has since entered popular folklore as Black Monday.

All you need to read.

Several (all) European nations spent too much, borrowed too much and promised too much to their people. That led the market to question whether these countries could pay back their debt. That led to spread widening. As spreads widened and deficits increased, investors became concerned about the ability to roll over their debt. This caused spreads to widen further, CDS activity to pick up as investors want to hedge their positions and speculators want to profit from further weakness. Economic conditions decline. Debt grows more rapidly than forecast and current budget deficits increase. Rolling over debt in the public market becomes very difficult if not impossible. CDS trades in points up front and the yield curve inverts as the bonds trade on price rather than yield, with investors focusing on potential recovery. The solution that they are closest to "achieving" is the destruction of the sovereign CDS market. Naked short bans are on the way. Forced Restructuring that doesn't trigger a Credit Event is the current plan, and one of the EFSF or ECB is likely to sell protection. Sov CDS only has any bid because people don't believe they can force 100 per cent of bonds to restructure so their will be residual value as countries choose to pay off or default on the stub pieces.

Like yesterday when just before 10 am we had a big gap down in PIIGS bonds, represented in this case by Italy's BTPs, only to be followed by ECB buying of peripherals, so today, same time, same place, the ECB gets involved to prevent yet another market rout, this time amplified by the fact that one can not longer short PIIGS using CDS and shorting cash bonds is the only option. Alas, as the chart below demonstrates, as yesterday the ECB intervention merely delayed the downward price trajectory of Italian bonds, so today we expect the same result. In the meantime, ECB buying has driven the EURUSD, and thus the ES higher, however briefly.

There are many charts out there all of which are to some extent worth of the adjective "scary" although today's Bloomberg chart of the day may just take the prize, if only for a few days until the European hopium daze passes and reality manifests itself in the form of line and bar charts. The chart below is perfectly simple and perfectly self-explanatory...

In May, shortly before receiving a EUR 78bn bailout, the Portuguese government trumpeted encouraging snippets regarding the state of the economy. “Fiscal revenues up 16.8% y/y in April” (May 20th). “January-through-April central government deficit EUR 1.55bn, 2.28bn less than a year ago” (5/20). The new government announced “to set an example of cutting spending in administration” and intended “to surprise, go beyond bailout terms” (Coelho 6/6). The good news continued: “Central government deficit for the first five months of 2011 cut to 1.03bn”; “State spending fell 7.2%, revenues rose 6.9% in the period January through May” (June 20th). With all those feel-good reports it was only fair for the EU’s Troika report on Portugal to be “very positive” (Baroso, June 23rd). The EFSF disbursed its funds to Portugal on June 29th.  However, as anybody who has ever visited a Hungarian coffee house can confirm, as soon as you pay the fiddler, the music stops. After six months, “there was a shortfall of 1.1% of GDP in budget” (Finance Minister, August 12th). Wait a minute. According to the INE (Instituto Nacional de Estatistica) the budget deficit for H1 2011 amounted to 8.4% of GDP or roughly EUR 6.7bn. So we went from 1bn at the end of May to 6.7bn mere four weeks later?