Archive - Oct 28, 2011 - Story

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.

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.

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.

With the EFSF, Italian and Spanish debt all creeping higher in yield today and a disappointing Italian auction, we take a deeper dive into the mechianics of the EFSF and the paradoxically weak impact it may have as sovereign risk deteriorates. The [EFSF] idea works well when people aren’t thinking there is a real chance of default, but as that increases, the EU may wish they had stuck to their original plan of having raised 440 billion of cash that they could lend directly.  Basically, if the markets deteriorate, the first loss protection, is worth more, but provides less leverage.

Wondering how it was possible for Q3 GDP to post such a substantial beat yesterday driven by a surge in Personal Consumption expenditures? Wonder no more: in the last quarter, the US consumer literally tapped out, bringing their savings rate from a 2011 high 5.3% in June to 3.6% in September, after the BEA reported that while spending increase was in line with expectations at an unsustainable 0.6%, income was just barely above unchanged at 0.1% on expectations of 0.3% confirming that as far as the economy is concerned, the consumer is just getting worse and worse off. This is the lowest number since the depression started back in December 2007! The only problem is back then it had been lower and was rising in anticipation of the fallout from the Great Financial Crisis, this time it was modestly higher and is now plunging. Very soon deleveraging Americans, whose homes are getting cheaper by the day, will have no savings left to use for useless trinket purchases. How does GDP "grow" then?

The German constitutional court has already played a substantial role in the country's participation in the European bailout. Back in  September when noting the first participation of the court in the European rescue machinery we noted that "giving the Bundestag’s Budget Committee the final say over the use of the bailout fund is welcome from a democratic point of view, but will add another element of uncertainty to the eurozone crisis. However, so far the Budget Committee has consistently taken the government line on the bailout, albeit reluctantly, and it remains to be seen whether it dares to exercise its new power." It appears the court has once again decided to step up only this time not in a favorable light, after, as Spiegel reports, that the court has "issued a temporary injunction banning the nine-person committee in the Bundestag from taking any decisions on the deployment by EFSF of German taxpayer money." In addition to this, the Court also put the whole German fast-track approval process in jeopardy after it expressed "doubts about the legality of a new panel of lawmakers set up by the German parliament to reach quick decisions on the release of funds from the euro bailout mechanism." This is hardly the ringing endorsement the EURocrats needed to hear from the only power in Europe with the funds to keep the EMU together.

• Chinese vice finance minister said details on the expansion of the European bailout fund is still unclear, adding that purchases of EFSF bonds are not on the G20 agenda. Also, EFSF’s Regling said he does not expect to reach a conclusive deal with Chinese leaders during his visit to Beijing
• The German Constitutional Court halted the use of a special parliamentary committee that was recently created to decide on changes to the Eurozone’s bailout fund in emergency situations
• Meanwhile, a German senior coalition lawmaker said the Constitutional Court's decision means the EFSF secondary market bond purchases will be de facto impossible until a verdict, as Bundestag plenary cannot meet confidentially
• Lacklustre BTAN auctions from Italy dented appetite for risk

Earlier today Italy had an extended bond auction in which it sold 3, 6, 8, and 10 year bonds. The auction did not go quite as planned. The reason: far less than the maximum €8.5 billion target was raised, all the Bids to Cover slid and all the yields soared with a particular emphasis on the 10 Year BTP which everyone is following with great interest as it sternly refuses to trade inside of 6% despite all the worthless promises with the word "trillion" in them, lobbed in Italy's general direction from Europe, which knows too well that if the Italian bonds complex goes, so does the rest of Europe. As Reuters summarizes: 'Italy paid the most since joining the single currency to sell new 10-year debt on Friday in the first euro zone bond auction after European leaders agreed new steps to tackle the debt crisis. The auction yield on Italy's March 2022 BTP bond rose to 6.06 percent from 5.86 percent a month ago."  So... when is the next "Italy bailout" summit?

The reason why the EURUSD took a big step lower in the past minutes is because Fitch has come out with a note in which it has assigned an AAA rating to the amended EFSF program. That in itself is not an issue, what is however, to the market is the announcement that a 50% Greek haircut would be an event of default. That said this is not to be confused with an ISDA determinations committee ruling that CDS has been triggered: we now know this will never happen and is the reason why basis trades across the board are exploding as all sovereign CDS is effectively being unwound. Regardless, the market does not seem to be liking the fact that someone's head is not stuck in the sand. Fitch also adds that it is critical that ECB carry on bond purchases, something which neither the ECB nor Germany have agreed to. It also adds that Greek PSI deal is a necessary step, and that the effectiveness of the summit deal depends on details. This is important considering Greece was barely able to get 85% acceptance in its 21% proposed haircut. The 50% will be even more interesting. Fitch concludes that the market is likely to see further market volatility. That is a given.