Archive - Nov 2011

They say a week is a long time in politics. Last week, quite frankly, a day seemed a long time with the rapidly unfolding events surrounding the European sovereign situation and the G20 summit generating a lot of market volatility. Greek PM Papandreou survived the vote of confidence on Friday with a majority of three and is now trying to form a government of National Unity. With opposition leader Samaras still calling for elections, this political impasse may well continue for the time being. Greece is widely considered to ‘run out of money’ in mid-December; while this may continue to unnerve the market over the possibility of a hard default, a month is probably an eon in politics and a lot could change very quickly. The same could be said for developments in Italy. PM Berlusconi remains under pressure and media reports suggest he has lost his parliamentary majority after a party rebellion on Friday. European and international policy makers continue to pressure Italy to undertake the necessary reforms to reduce the country’s debt level. The IMF will step in to monitor Italy’s efforts to implement austerity and growth-boosting measures, but the fund’s offer of a loan was rejected by the prime minister. Relatedly, over the weekend, ECB’s Mersch was quoted as saying that the ECB had debated whether to continue buying Italian debt if a step-up in the reform effort was not forthcoming.

With Greece once again likely to dominate newsflow, the question of whether G-Pap will step aside, as he promised, will be one everyone will demand to see answered. Especially Europe. As Reuters reports, "the European Union turned up the heat on bickering Greek politicians on Sunday to agree a crisis coalition, demanding progress towards backing an international bailout deal in the next 24 hours. In a sign that Greece's political deadlock may be easing under EU pressure, a senior socialist said Prime Minister George Papandreou had made clear he would resign once a coalition deal was done, possibly as soon as Sunday night." Yet the career politician has pulled the last gambit and has thrown the "coalition" government choice straight in the arms of his nemesis, New Democracy's Antonis Samaras, and the president: "Greek Prime Minister George Papandreou has asked the president to host talks between himself and opposition leader Antonis Samaras after a Sunday cabinet meeting, a source at the prime minister's office quoted the premier as telling his cabinet." In other words, if nothing is resolved, G-Pap can tell a furious Europe, "we tried" and blame the opposition, in yet another attempt to simply win political brownie point. Yet time is running short for a final solution: "With euro zone finance ministers due to meet on Monday, senior socialist lawmaker Telemachos Hitiris said: "Everything must be done within the day, otherwise tomorrow it will be hell." How many times have we heard that before. And it very well may be hell, however it will no longer come from Greece but from Italy, whose 10 Year bonds closed at the lowest price ever and where a margin raise by LCH now appears imminent, making another step function move lower almost inevitable. Either way, Greece will be fun to watch as all the hopium has been spent and no more cans can be kicked.

What’s at risk, of course, is the whole concept of post-World War II universal  European representative government after the fall of Communism.

Laissez-faire or 'leave it along' is what needs to happen for the greater good of the consumer economy vs. the Wall Street "trader economy".

Going back to the annals of brokeback Europe, we learn that gold after all is money, after the G-20 demanded that EFSF (of €1 trillion "stability fund" yet can't raise €3 billion fame) be backstopped by none other than German gold. Per Reuters, "The Frankfurter Allgemeine Sonntagszeitung (FAS) reported that Bundesbank reserves -- including foreign currency and gold -- would be used to increase Germany's contribution to the crisis fund, the European Financial Stability Facility (EFSF) by more than 15 billion euros ($20 billion)." And who would be the recipient of said transfer? Why none other than the most insolvent of global hedge funds, the European Central Bank...There are three observations to be made here: i) when it comes to rescuing insolvent countries, Germany is delighted to sacrifice euros at the altar of the 50-some year old PIIGS retirement age; ask for its gold however, and things get ugly; ii) the Eurozone, the ECB and the EFSF are dead broke, insolvent and/or have zero credibility in the capital markets, and they know it and iii) due to the joint and several nature of the ECB's capital calls, while Germany may have had enough leverage to tell G-20 to shove it, the next countries in line, especially those which are already insolvent and will rely on the EFSF for their existence once the ECB's SMP program is finished, may not be that lucky, and in exchange for remaining in the eurozone, the forfeit could well be their gold.

And so another exchange decides to follow in the CME's (clarified) footsteps, and lowers Initial Margins for all in order to facilitate the onboarding of just clients with orphan MF exposure. Probably more important is that the ICE demonstrates how this can be done in a way that does not generate speculation and confusion, and avoids follow up clarifications, due to the counterintuitive nature of increasing initial leverage in the aftermath of an exchange filing bankruptcy due to excess leverage. And as usual, the real question is what would happen in the counterfactual? Would the market really tumble and would liquidations truly be pervasive on Monday is the contract transfer price is not lowered? Is liquidity in the market (and hence leverage) really that low (high)?

Believe in free market capitalism? Then move your money ...

Three months ago, in exchange for the ECB's expansion of its sterilized monetizations of bonds to include Italian BTPs, allegedly the only backstop that has prevented Italian bonds from experiencing an all out collapse to date, Italy was presented with a list of strict "austerity" demands, among which were spending cuts, higher revenues and labor reform. Since then none of these has occurred... or will occur, simply because Berlusconi has no control over the government, yet neither does anyone else, although everyone in the local government enjoys having a scapegoat for the total chaos. It appears that the ECB has just made it clear that the status quo is about to end, unless Italy does in fact push with something. And unlike other cases, where politicians on both sides of the table are happy to spout rhetoric while knowing well that nothing will change, in this case, courtesy of Italy largely untenable debt profile in which €166 billion in debt and interest are due in 2012, the ECB will have no choice but to play hard ball. Reuters has just confirmed that, reporting that  The European Central Bank often discusses the possibility ending the purchase of Italian government bonds if it concludes Italy is not adopting promised reforms, ECB Governing Council Member Yves Mersch said. "If we observe that our interventions are undermined by a lack of efforts by national governments then we have to pose ourselves the problem of the incentive effect," Mersch said according to extracts of an interview with Italian daily La Stampa to be published on Sunday. In other words on Monday the market will have to not only digest the implications of what the implications of the Greek vote of confidence are (last we checked G-Pap is still PM, and likely will be for quite a while), but also what happens now that the ECB has issued an ultimatum to Berlusconi to get his house in order. The problem is that he can't. Not without stepping down, that is. At that point the Italian pseudo stability that everyone has been taking for granted knowing full well it is nothing but an illusion, will fall and expose all the rot underneath. At that point we will truly see just how "hedged" all those Primary Dealers are, who have perfectly offsetting short positions to all their longs.

Europe is finished. The region’s entire banking system is insolvent (with few exceptions). European non-financial corporations are running massive debt to equity ratios. And even EU sovereign states require intervention from the ECB just to meet current debt issuance, to say nothing of the huge amount of sovereign debt roll over that is due over the next 14 months.

Yes, times are going to get harder and an economic collapse is coming.

We are at a critical point as the worlds' economies continue to decline. Continued high unemployment and a stagnant economy will put pressure on the Administration and the Fed to do something. The implications are not good.

Yesterday, in what is the worst-phrased and most misleading press release to ever come out of the CME, the exchange issued a notice that going forward all Initial margin would be equal to Maintenance margin. Our gut interpretation was that "Unless we are completely reading it incorrectly, it is nothing short of a margin call for tens if not hundreds of billions worth of product." Judging by the broad response, our initial reaction is what a prudent, logical human being would assume: after all, it is precisely the undercollateralization of customer accounts, and general underfunding at MF Global that is what brought that particular company down. Well, we wrong wrong. The CME, it appears has taken a page right out of the European playbook, and less than a week after an exchange-cum-Primary Dealer collapsed due to excessive risk taking, the CME has followed up its vague press release from yesterday by inviting even more risk in lowering the initial margin. Why is this a cause for even greater concern? As the CME itself says, "Initial margins are set to provide an additional buffer against future losses in the account" - so going forward that buffer has been reduced by about 30%. But what is the reasoning provided by CME: "The intent and effect of these changes is to decrease the size of any margin calls resulting from the bulk transfer of MF Global customers to new clearing members, not to increase them." So basically the CME is implicitly putting all of its existing and current clients and customers at further risk by onboarding the accounts of those clients who, like lemmings, held on to their MF Global accounts until after it was too late. Because while the lower Initial margin may apply to MF accounts, it will also apply to any Tom, Dick and Harry beginning Monday, who will suddenly see a 30% reduced gating threshold to put on a position. Any position, no matter how risky.

I was recently challenged by a contributor to write something positive, and so I decided to write about the single most positive outcome of the current financial crisis in Europe: the complete collapse of the corrupt, predatory, pathological global banking sector and its dealers, the central banks. Exploring why this is so reveals the insurmountable internal conflicts in our current financial system, and also illuminates the systemic political propaganda which is deployed daily to prop up a parasitic, corrupting, pathologically destructive financial system. Our first stop is modern finance itself. Modern financial "products" and "instruments" are often highly complex and abstract, but the entire edifice can be distilled down to this: the system is based on the assumption that all risk can be hedged, and the difference between the initial position's yield/gain (i..e. placement of capital at risk for a gain) and the cost of hedging the risk of the wager to zero can be skimmed from the system risk-free. That is the entire system in a nutshell, and we can immediately see the advantages of this system over traditional Capitalism, where risk can be hedged but never to zero, and the return is correlated to the risk taken on.

The EFSF reminds me of the tooth fairy – there are those who believe because they are told it will work, and those who try to figure out how it will work, and come out on the non-believer side.  This week, we are supposed to start seeing some real details, although they are already down-playing that.  The prong that lends money to Greece, Ireland, and Portugal, so that they can pay back the people who lent them money in the first place, should be pretty straightforward.  Borrow money in the markets, lend it to those countries, those countries pay the banks that own their debt, so that those banks can buy more EFSF bonds, the next time EFSF has to lend money to the PIGs to pay back the banks to free capacity to buy EFSF bonds – straightforward doesn’t mean it isn’t bizarre....So the EFSF is offering €250 billion of binary CDS in some form to entice the market to buy €1 trillion of Spitaly paper.  I think Greece, Ireland, and Portugal are too far gone (the bonds trade at such a low % of face) that first loss protection does little to help them get new deals done.  The first prong will have to suffice for them.  While the bulls are all eagerly anticipating this tide of liquidity they are ignoring the fact that the EFSF pulled a deal this week!  They were supposed to do €5 billion of 15 year bonds, which became €5 billion of 10 year bonds, which became €3 billion of 10 year bonds,  which because a statement saying the deal was pulled because of market conditions.  For clarity, these are straightforward, non-leveraged, EFSF bonds, where 3 similar issues already exist, and the deal was pulled!  I am sure it was a matter of price, but still, how well does that bode for their bigger and far more convoluted scheme?

I vote, No Confidence.