Archive - Oct 28, 2011

A short, sweet and spot on summary of what is most likely going to happen to MF Global courtesy of the only rating agency worth listening to, Egan-Jones. "A race - the Company is in a race to re-establish its business while clients, employees, and its business position slides. The major issues are the real losses from poor investments in the EU, whether MF can attract interest in salable assets, and if interested buyers are willing to step up currently or wait until a transaction is potentially blessed by a trustee in a reorganization (in the case of the Lehman Brothers reorg, Barclays was confronted with a fraudulent conveyance issue). The most likely outcome is that the majors will pick off MF key employees and clients will flee. No news is bad news."

I can’t begin to describe how excited I am to be visiting Tokyo while the Japanese yen is at its all-time, historic high. My timing couldn’t possibly be worse. For reasons that are completely incomprehensible, the yen is still viewed as a stable ‘safe haven’ currency despite four completely hopeless black marks:

1) Japan’s public debt puts other bankrupt nations to shame. As a percentage of GDP (225%), Japan’s debt is more than twice as bad as the United States.

2) The political situation in Japan is anything BUT stable. Japan has blown through 6 prime ministers and 9 finance ministers since 2006. And every one of them was a failure.

3) Social demographics are a ticking time bomb. Both life expectancy AND average age in Japan are higher than just about anywhere else on the planet… and the country has neither the work force nor the financial resources to support the massive waves of retirees that are coming.

4) Oh yeah, Japan’s economy hasn’t actually grown in two decades. No biggie.

Despite these obvious headwinds, though, the market is telling us that Japan is the safe place to be right now. And as a result, prices here are just plain stupid.

The first kicker in the just released S&P statement on the revised and AAA-rated EFSF is the following: "In our opinion, there is an "almost certain" likelihood that the EFSF's 'AAA' rated member governments would provide timely and sufficient extraordinary support to the EFSF if needed." So, uh, S&P is determining the fate of trillions worth of securities on the basis of a hunch, a whim, if you will. A strong one, but a hunch nonetheless. Swell. And the second kicker:  "If we lowered the ratings on one or more of the 'AAA' rated member guarantors, we would also likely lower the ratings on funding instruments that the EFSF had issued before the date of the downgrade, if the lower ratings on the member guarantor were to lead to less than 100% 'AAA' rated coverage for the relevant EFSF funding instrument." This, in the parlance of our times, is known as a springing downgrade, which sets off the kind of cataclysm that only AIG could achieve once the investing community realized it had a rating-based collateral schedule. So once again the fate of the free world depends on FrAAAnce. Swell².

We now know that private holders of Greek bonds will be “invited” (seriously–this was the word used in the EU summit statement) to take a write-down of 50%–halving the face value of the estimated $224 billion in bonds that they hold. This will help bring the Greek debt-to-GDP ratio down from 186% in 2013 to 120% by 2020. The big question–apart from how many investors they will get to go along with this, given that they couldn’t reach their target of 90% investor participation when the write-down was only going to be 21%–is whether this will trigger a CDS pay-out. That this is even up for discussion is mind-boggling. These credit default swaps are meant to be an insurance policy in case Greece doesn’t pay the agreed upon interest and return the full principal within the agreed timeframe. If they don’t pay out when bondholders are taking a 50% hit then what’s the point? I call shenanigans. ISDA, the International Swaps and Derivatives Association that wrote the agreement governing most derivatives trades, states clearly that a Credit Event would be triggered under the type of haircut proposed…but only if this haircut is forced on all bondholders. And here’s where it gets interesting.

For the last couple of decades, ECRI's leading indicators have provided a reasonable early warning for rising and falling forward EPS estimates. With the ECRI growth rate hovering near the July 2010 lows, having fallen considerably recently, it seems that either intervention (the new normal) will come in the form of QE3 (as it did the last time we were here in Q3 2010) or EPS estimates will start to collapse notably (in line with yesterday's perspective on the rolling-over of forward EPS expectations).

Everyone exposed to losses in the corrupt, speculative apex of malinvestment known as the U.S. housing market doesn't want a truly healthy housing market, they just want a return to the bubble era. Sorry, folks, ain't gonna happen. (And yes, I own property, too, but it is what it is.) Bubbles do not reinflate, even with the Fed chanting its Keynesian Cargo Cult mantras ("zero interest rates forever!") and waving dead chickens over the embers. The conditions which inflated the bubble cannot be called up by incantations; faith in the system has been destroyed, and only the complete socialization of the mortgage market by the forces of Central Planning--the Fed and the Federal government's Socialized Mortgage Makers, Fannie and Freddie-- have staved off the complete collapse of prices which would have wiped out the banks and cleared the market via actual capitalism in practice, i.e. a transparent marketplace which is allowed to discover price. Despite the fact that a truly healthy housing market is anathema to the Status Quo and current property owners sitting on huge mortgages, let's lay out the necessary characteristics of such a housing market. A lot of this will strike many of you as counter-intuitive, but that only highlights the pervasiveness of the speculative propaganda that slowly hollowed out our culture's previous understanding of housing and replaced it with a devilishly magnetic financialization model.

No one questions that “something” is brewing, or rather simmering beneath the surface in America. The discontent, having finally reached the heretofore silently and sublimely disaffected youth who are occupying Wall Street and any other street in any other town you might mention, is a phenomenon that has every journalist and blogger on the planet analyzing their heads off.  Is the OWS movement the left’s Tea Party? Will progressive politicians regret throwing in with the legions of urban campers? Do these people have a platform? Who is supporting  them?

Here is the basic problem and why Italian and Spanish bonds are getting crushed again today (ignoring horrific unemployment data out of Spain). If Italy defaults with a 40% recovery, there is 1.613 trillion euro of debt affected (that is up about 10 billion in about a month). That means creditors would lose 970 trillion. Spain with 663 billion would cost almost 400 billion (its debt has shot up about 15 billion in a month). The problem is that EFSF doesn't take default off the table. It may delay the time to default (by helping roll debts as they mature), but all it mainly does is shift who would take the loss. The guarantors can't handle losses that big. There is no "ideal" solution because the problem is just an order of magnitude too large to provide any real help. Either the economies are going to get to balanced budgets (some combination of growth and cuts) or it will fail. Will EFSF do enough to see if the economies can get there?

Wondering why the future for housing as an asset is so bleak, why median housing prices continue to tumble and recently saw their biggest three month drop ever, and why there is no bottom in sight? Simple: the American public appears to have woken up to the reality that homes are no longer a flippable asset, and in fact continue to drop in price, an observation that is obvious to virtually all now. So what happens next? Why renting of course. Here is Morgan Stanley explaining (granted in a pitchbook for REITs but the underlying data is quite useful) why the Housing 2.0 paradigm is all about renting.

Do you really think Europe, which is even MORE insolvent that the US, is somehow going to experience a different ending from the Bazooka move? They’re in far, FAR worse fiscal shape that the US was in 2008 (including unfunded liabilities, REAL Debt to GDP levels for most EU members is north of 400%... heck even Germany’s is over 200%).

Lauren Lyster, the enticing Russian TV/Capital Accounts host gave me the rare opportunity yesterday to sit down & run my mouth for 15 minutes straight. This format's most conducive to true conveyance of knowledge and information, at least in my not very humble opinion. I'm just not the 8 second soundbite type. Plus, I'm sure I pissed many long-only guys off...

The common assumption amongst Americans is that nothing can be done without mass action resulting in “compromise” from leadership. That the healing of our cultural dynamic is a “top down” process. That one person alone has little at his disposal for bettering the world. In fact, it is always self aware and self sustaining individuals who build better societies, not angry mobs without understanding or direction. Individuals blaze the path that the rest of the world eventually follows, and they do this through one very simple and effective act; walking away. By walking away from the corrupt system, and building our own, we make the establishment obsolete. This philosophy could be summed up as follows: "Provide for yourself and others those necessities which the corrupt system cannot or will not, and the masses (even if they are unaware) will naturally gravitate towards this new and better way. Offer freedom where there was once restriction, and you put the controlling establishment on guard. Eventually, they will either have to conform to you, attack you, or fade away completely. In each case, you win. Even in the event of attack, the system is forced to expose its tyranny and its true colors openly, making your cause stronger."

Presented with little comment as we note BTPs have broken the week's low prices and are significantly off their knee-jerk response highs.  It is clear that investors don't want to be too long BTPs into a weekend which will be full of research and thinking about reality as we broke the dismal Maginot line of 6% yield. Chatter of ECB buying came and went as it is very clear that managers and traders want out. The unintended consequence of banning CDS combined with an EFSF that is both self-referencing and paradoxically weakened as majors deteriorate is certainly not helping here.

Now that the kneejerk euphoria, in which nobody had done any work, confirming that the only thing worse than a clueless Europe is an even more clueless market, over the non-bailout has ended, here is the hangover, courtesy of Tullett Prebon.