Archive - Oct 2, 2011 - Story

With the weekend full of on-again-off-again comments from various European, Asian, and US politicians and central bankers with regard the chances of various incarnations of the EFSF solving all of our ills (or not), Nomura's Fixed Income Research team has what we feel is one of the most definitive analyses of the various options. We have discussed the self-exciting strange attractor nature of the endgame that will be a leveraged EFSF many times recently. The Nomura team, however, does a great job of breaking down various scenarios, such as Structural Weaknesses of EFSF 2.0, Proposals for an EFSF 3.0 (and their variants), Leverage-based options, and EFSF 2.0 as TARP and how these will result in one of three final outcomes: fiscal union, monetization, or major restructurings risking the end of the euro, as everyone searches for a steady state solution to the 'problem' of the eurozone.

While the most elegant solutions have no official sanction, we think the necessary political resolve is yet to be forthcoming, and the technical issues are challenging if not insurmountable for many of the legal workarounds, resulting in the need for yet another round of parliamentary approvals. Consequently, we see a significant risk that the market, looking for large headlines and enhanced flexibility, will be disappointed at least in the short run.

Two weeks after Bernanke agreed to invest unlimited taxpayer funds in the form of global FX swap lines to prevent a worldwide dollar funding squeeze arising from the Europen financial collapse, the Chairman appears to be getting cold feet. BusinessWeek reports: "The Federal Reserve Bank of New York may ask foreign lenders for more detailed daily reports on liquidity as the U.S. steps up monitoring of risks from Europe’s sovereign debt crisis, according to two people with knowledge of the matter. Regulators held informal talks with some of the largest European lenders about producing a “fourth-generation daily liquidity” or 4G report, according to the people, who asked for anonymity because communications with central bankers are confidential. The reports may cover potential liabilities such as foreign-exchange swaps and credit-default swaps, said one person. The U.S. has already increased the number of examiners embedded in these banks, the person said." In other words, not only after Bernanke's pledge to fund as much money as is needed to prevent bank defaults around the world, is he actually going to have enough information to determine if there is any danger of this money not getting repaid. Well, better late than never. But at least we can permanently set aside any latent questions over whether European banks have liquidity problems. When even the Fed no longer believes you, you have far bigger problems than just liquidity (except for Dexia: liquidity there may well be the largest problem, but at least it won't be for long).

Presented without comment.

Back on Friday, when we closed out the Dexia long sub CDS trade, we said "We expect a partial or complete nationalization to be announced imminently, which in addition to all other side effects, would lead in a Bear Stearnsing of all accrued profit." Sure enough, here is the Sunday Times on the very topic... And while a nationalization of Dexia, which now appears a matter of hours if not days, will be bad for anyone still long the bank's CDS (it should trade down to pari with Belgium tomorrow, just as Bear CDS trades in line with JPM), it is pretty horrifying for SovX and Eurocore CDS in general, now that a bank which holds assets amounting to 180% of Belgium's GDP, is about to be nationalized by the very same country. Anyone who is still not long Belgium CDS, this is probably your last chance to get on that particular train. Of course, if one is waiting patiently in line at a Dexia ATM machine, one is forgiven.

Previously, we brought you parts one, two and three of the Canadian must see documentary "Meltdown." In this final episode "After the Fall", we hear about the sheikh who says the crash never happened; a Wall Street king charged with fraud; a congresswoman who wants to jail the bankers; and the world leaders who want a re-think of capitalism. As one world leader handles the crisis through denial, other leaders try to re-think capitalism. Even though the causes of the 2008 meltdown are now clear, there is no magic formula to stop it from happening again. The world has to start planning for the next crisis, even as we recognise that this one is not over yet.

The September Swiss National Bank balance sheet update is out and while it reportedly indicates balances at the end of August, it appears that the SNB intervention in the FX market (i.e. the currency peg) started early, which would make sense as the first peg rumor hit on August 11. As a result, as the chart below shows, the latest central bank balance sheet to be completely devastated as a result of currency wars is that of Switzerland, where both Foreign Currency Investments and the total balance sheet increased by just under 50%, the biggest such monthly increase. In fact, in September, "aggregate short and long positions in forwards and futures in foreign currencies vis-a?-vis the domestic currency (including the forward leg of currency swaps)" increased by $92 billion CHF or just about $100 billion - a whopping 20% of Swiss GDP! And this is the capital at risk for Switzerland to avoid having its currency trading a parity with the euro since the bulk of this increase is due almost certainly purely to EUR purchases. And here is the bad news: since the bulk of the purchases were made in the 1.40+ area, we can't wait to find out just how NZZ and other Swiss financial publications will react tomorrow when they learn that the SNB has experienced an immediate 5% drop in its "assets" courtesy of the subsequent plunge in the EUR. And with the SNB's total balance sheet at a record (?) CHF 365 billion, something tells us that the days of this latest attempt at repegging the Swiss Franc to some arbitrary number are coming to an end, and with that Hildebrand's futile attempts at preventing parity.

At the Friday close, there was a spurt of rapid EUR selling at the close, taking the currency to the lowest since January 2011, at 1.3367. It turns out it was not a fat finger - with a spate of traditionally euro negative news over the past 48 hours, most notably yet another negative Greek deficit revision which will make the Troika's job that much more difficult in justifying the need to fund the next IMF bailout payment, the EURUSD is now even lower premarket at 1.3344. With the rumormill thoroughly exhausted, and with nobody in Europe having any credibility left whatsoever, we fail to see what can catalyze a move higher before the Asian open, which will likely not be a pretty way to start the final quarter of the year.

As the Greek parliament meets to finalize huge public sector job cuts, Reuters is reporting that Greece will miss the deficit targets set in its EU/IMF bailout this year and next... We would say "again" but at this point "as usual" makes far more sense, Why this should come as a surprise to anyone is beyond us but the next steps by the Troika (as again and again targets are not met and yet still bank-extending-and-pretending-funding is provided) will be fascinating as they switch from carrot to stick and back to carrot perhaps. Assuming, of course, the "wildcat strikes" at any and all government institutions by government workers about to be sacked, allow Troika member access at some point in the near to long-term future. Although using numbers conceived on napkins as a replacement will be nothing new to either Greece, Eurostat or the Troika. Add to this the comment from the Deputy Leader of the CSU (one of Merkel's tri-party coalition) that Greece would find it easier to recover outside the currency bloc and rhetoric remains high, as do expectations for an inverse surge in the EURUSD at open in a few hours. The biggest winner: Qatar which just snuck in some recycled petrodollars into Greece, which will last the kleptocorrupt government about 1 week, in exchange for Greek gold.

Over the past week one of the more hotly debated and market moving topics was the resurgence of speculation that China may be on the verge of a "hard landing." To a large extent this was driven by renewed concerns that the country's debt load, especially at the local government level, will be a substantially greater hindrance to growth and hence, concern than previously thought. This was paralleled by concerns that Chinese growth will likely slow down substantially more than previously expected, even as inflation remains stubbornly high. The result: a move wider in Chinese CDS in the past week whose severity was matched only by a similar move around the time of Lehman, when the world was widely seen as ending. Concerns that delusions about decoupling are precisely that (courtesy of 3 out of 4 BRICs printing a contractionary sub-50 ISM also led to the biggest drop in the Hang Seng index since 2001, after it tumbled 22% in Q3 as fears that a Chinese slow down would impact all developing economies with an emphasis on East Asia. Yet if a Hard Landing is all it took to disturb the precarious balance in which China always somehow always ride off into the sunset having rescued the entire world, we wonder what would happen if the market started expressing concerns that a Hard Landing is the optimistic case, and nothing short of a Crash Landing may be the baseline. Because according to the Economist, which informs us of a very troubling development out of China in which foreigners may be about to face a new entitlement funding tax for all domestic workers beginning October 15, and hence a surge in overall labor costs, then a "Crash Landing" may well be in the cards for the world's biggest marginal economy.

In his latest edition of "The Privateer", Bill Buckler has an enlightening 'compare and contrast' between that one species that will every so often engage in acts of such sheer stupidity, it will blindly follow the herd, oblivious of the near certain resulting doom, right over the cliff, and lemmings...

We have discussed the dynamics of the credit-equity-vol relationship for many months in the hope that it broadens investment horizons and opens traders' eyes to a bigger picture of global risk appetite. Following (and understanding) the debt-equity relationship has proved, in general, a very useful instrument in an investor's toolkit and Barclay's Capital this week points to just how dislocated European credits are relative to stocks (having underperformed) and while we may not be quite as exuberant as them in the call to add credit exposure here (as we see more structural than cyclical concerns ahead), we cannot argue that on a relative-value basis. However, arguments for significant re-allocation from bonds to stocks simply do not make sense (from both valuation and risk perspectives) - no matter how many times Pisani tells us so.

A very disturbing precedent, for the already frayed domestic financial system, was set in Greece over the past few days, where as the linked story from On-News.gr explains, an unemplyed Greek woman who owed a little over 26,000 euros to two banks, Eurobank and National, received a full debt discharge on her outstanding loans. As the blog logical concludes, this decision will probably be adhered to in thousands of similar cases. Furthermore, it should be noted the woman had a perfect payment record for 18 years, and only fell behind when she lost her job. Imagine the sheer panic that would ensue if a comparable legal decision vis-a-vis ordinary consumer debt were to occur in the US - that would be a supreme court resolution for the ages. In the meantime in Greece, a one-two punch arrives: deposits being drained and moved overseas, and bad loans being outright erased from the balance sheet by court order. At least both sides of the balance sheet are declining so there will be no way for banks to fudge their capitalization and make it seem that loan writedowns are actually a beneficial thing for book equity.

We continue the Meltdown series by presenting part three out of four: Paying the Price, which looks at how the victims of the 2008 financial crash fight back. A protesting singer in Iceland brings down the government; in France a union leader oversees the kidnapping of his bosses; and thousands of families are made homeless in California.