Archive - Feb 17, 2012 - Story

First comes the CACs. Then the forced debt exchange offer. Finally - default: as defined by both the rating agencies and ISDA, together with triggered CDS.

In a 60-36 vote, Senate just passed the payroll tax extension, previously voted through by Congress. From Reuters: "The U.S. Senate on Friday passed legislation extending a tax cut for 160 million workers and long-term jobless benefits through December, clearing the way for President Barack Obama to sign the measure into law. The Senate approval by a simple majority vote followed the House of Representatives' approval earlier on Friday. The legislation, which also extends current payment rates to doctors through the Medicare health care program for older Americans, will add $100 billion to the U.S. deficit and is aimed at further stimulating the economy." As a reminder, all this means is that a repeat of the debt ceiling fiasco is now virtually assured before the presidential election as discussed here, which explains the GOP's willingness to pass this through as fast as possible with no offsetting spending cuts. As for the benefits of $1000/taxpaying household, the recent rise in gasoline prices has already offset those. One can only hope that crude prices are as susceptible to successful central planning intervention as all other assets, or else many more extensions will be needed before the year is over.

Credit markets in Europe remain significant underperformers relative to equities this week, despite some short-covering yesterday that narrowed the gap. Global Financial Systemic Risk is rising again - dramatically. It seemed that the dramatic shift from early to mid-week was enough to scare some action back into the market and we can't help but feel that the rallies in Spanish and Italian govvies (on what was very likely thin trading) was all central banks, all the time. Today saw stocks rally in Europe to new post-NFP highs while credit leaked wider off its open and closed on a weak tone into the US long-weekend. The end of the week felt much more like covering to flat than any aggressive re- or de-risking which seems appropriate given the rising risk of binary events and an inability to hedge those jumps.

For their sake, we hope at least the answer from the Fed is "yes." Yet it is quite ironic that the subtext of this paper is that Monetary Policy can actually fail, when, get this, people don't grasp all the nuances of monetary policy. In other words, it is not the Fed's fault when it fails - it is the people's fault: "we fi?nd evidence that the relationship between unemployment and interest rates is not properly understood by households in the lowest income quartile, and by those with no high school diploma." Cue Kartik Athreya to explain to us all why only Ph.D.s understand the complexities of monetary policy when it works, and why it is those without a highscool diploma that are at fault, when it doesn't.

In a late, and somewhat underplayed, story from the WSJ, it appears that we may finally get some answers on exactly what former-Treasury-Secretary-to-be Geithner knew and sanctioned in the lead up to the Lehman fail. More specifically how JPMorgan illegally siphoned billions of dollars from Lehman in the final days, potentially via Geithner's FRBNY-overseen tri-party repo market. We discussed this at length almost two years ago as the FRBNY was concerned at the ongoing risk of the market being structurally vulnerable to a repo run and furthermore why Lehman's suit against JPMorgan had grounds. Critically, with Geithner being the man at the helm of the entity that approved repo entry and exit and in the final stages clearly sided with JP Morgan as collateral calls rained down, it makes sense to at least find out what he knew and decided - under oath.

While there is precious little in terms of detail coming out of the latest and literally greatest "fake" bond story in history, the BBC has been kind enough to release the pictures of the boxes that the supposedly fake bonds were contained in. While we reserve judgment on the authenticity of the bonds, what we wonder is whether the boxes were also fake. Because while we can understand why someone would counterfeit the Treasury paper itself, what we don't get is why someone would go the extra effort to also create a "fake" compartment in which to store it. In this case a compartment that is property of the "CHICAGO FEDERAL RESERVE SYSTEM." Perhaps Fed uberdove and Chicago Fed President Charles Evans will be kind enough to explain why Versailles Treaty Chicago Fed crates are floating around in Europe (and filled with $6 trillion in supposedly fake bearer bonds)?

While Greece and Europe continue sinking ever deeper into the colonial quicksand of Pax Goldmania, Iceland, which blew up, pushed its banks into bankruptcy, and arrested its corrupt bankers, is well on its way to being the world's only normal country.

• ICELAND RATINGS RAISED TO INVESTMENT GRADE BY FITCH
• FITCH UPGRADES ICELAND TO 'BBB-'; STABLE OUTLOOK
• FITCH DOES NOT EXPECT ICELAND TO SLIP BACK INTO RECESSION
• FITCH SAYS ICELAND GOVERNMENT DEBT PEAKED AT 100% OF GDP IN '11

Too bad the Goldman colony of Greece (and soon everyone else - thank you first lien "bailout" debt) will not see headlines such as these written about it any time in the next century.

And just a little bit more on yesterday's story of the day, which a few recent journalist grads took as positive having absolutely no clue about the very basics of a simple restructuring process, and in turn fed it to the 18 year old math Ph.Ds who program FX trading algos that ran away with it in the form of a 150 pip gain, when in reality it was all negative. As the WSJ reports, the only sane person in Europe, did get it: Bundesbank's Jens Weidmann "voted against the proposal, according to a person familiar with the matter." As we expected. Why? Go back to our story on subordination and what it means as the ECB creates an ever more junior class of bond holders. For those who hate long sentences, the WSJ gets it right this time: "The move could rankle investors and turn them away from the peripheral euro zone bond market, blunting the impact of a possible approval of a Greek aid deal and plentiful cash from the ECB." Of course, those who don't react to idiot headlines, and every upticks courtesy of algobots, knew that long ago. But in this stupid market, it takes hours, if not days, for the progressively dumber investor base to comprehend what is going on.

A well-known bond expert just blasted the following summary of today's "market positive" and supposedly just completed ECB bond swap: "THE EQUITY MARKETS MAY RALLY ON THIS NEWS BECAUSE THEY ARE FOCUSED ON A DEAL GETTING DONE BUT ANYONE IN FIXED INCOME SHOULD NOW CONSIDER RETCHING UNDER THEIR DESKS AS WE ALL JUST TOOK ONE OF THE BIGGEST SCREWINGS OF OUR LIVES THAT MAY WELL NOT BE A SINGULAR EVENT."

While we have long-argued that the discussion over the use of Apple's cash pile is somewhat circular (lower cash equals higher risk, less ability to withstand any shock, and investor perception growth/value shift) in its 'value' for the company, Bloomberg's always-sharp Jonathan Weil has a slightly different tack on the mega-firm's accounting conventions and why it may not be so cheap. As he points out, analysts (and talking heads) persistently argue that the firm's value is cheap at 14.3x T12M earnings (in line with the S&P) in spite of far higher growth (revenues and earnings). Competitive threats are often cited, future uncertainty of the consumer comes up, and the use of the cash argument we already mentioned but as Weil highlights, it seems that Apple's less than conservative accounting methods (that they lobbied for and heaven forbid Obama would re-consider a tax-the-rich opportunity) with regard to booking the revenues of bundled products more quickly than it used to (which caused, for instance, 2009 revenue to jump 44%). So while there may indeed have been record demand for the i-everythings, record 'blow-out' earnings is as likely a symptom of accounting inflation as unpaid mortgage cash being put to work. It seems the market realizes this and so the next time we are told to 'buy-the-dip as Apple is cheap', remember there is a reason for that 'cheapness' - that, as Jonathan so eloquently points out "not all iEarnings are created equal" as economic and accounting realities diverge once again.

Back in the summer of 2009, a peculiar story circulated when two Japanese individuals were arrested trying to smuggle $134 billion in US bonds into Switzerland from Italy. The story quickly died down after it was subsequently reported that the bonds were merely fake bearer bonds. Nobody heard much about it since then. Until today, when out of the blue we get a new story which blows that one out of the water. According to Bloomberg, "Italian anti-mafia prosecutors said they seized a record $6 trillion of allegedly fake U.S. Treasury bonds, an amount that’s almost half of the U.S.’s public debt." From here the story just gets weirder: "The bonds were found hidden in makeshift compartments of three safety deposit boxes in Zurich, the prosecutors from the southern city of Potenza said in an e-mailed statement. The Italian authorities arrested eight people in connection with the probe, dubbed “Operation Vulcanica,” the prosecutors said. The U.S. embassy in Rome has examined the securities dated 1934, which had a nominal value of $1 billion apiece, they said in the statement. Officials for the embassy didn’t have an immediate comment." ...And weirder: "The individuals involved were planning to buy plutonium from Nigerian sources, according to phone conversations monitored by the police." ...And really, really weird: "The fraud posed “severe threats” to international financial stability, the prosecutors said in the statement." Ok great, however one thing we don't get is just how can $6 trillion in glaringly fake bombs be a "threat to international financial stability."

It is no secret to those who follow the daily nuances of global monetary policy that the primary reason for Europe's deplorable fate has little to do with liquidity, and everything to do with an ever diminishing base of money-good assets, which in turn is a solvency problem when run through the cash flow statement and balance sheet. Need an explanation for the ever declining collateral thresholds by the ECB? There it is: assets in Europe are generating ever lower returns, which means that an ever lower inverse LTV has to be applied to them by monetary authorities in order for the asset holder to get some return. And with trillions in incremental cash needs, before all is said and done, the ECB (and various regional central banks, as was discussed last week), will be forced to accept virtually anything that is not nailed down as collateral for 100 cents on par (not amortized) value. Yet while observing the symptom is simple, the diagnosis is much more difficult. In other words, why is Europe's asset base getting progressively worse. Courtesy of Goldman we may have found the answer. As the following chart shows, the average age of assets in years in Europe, has just hit a record high. The implications of this are substantial, and explain so very much about the core problem at the heart of the European quandary.

Bailout somehow seems too nice of a word.  It implies working together, giving a helping hand, making a real effort to help someone out.  As we read the headlines coming out of Greece for the past 2 weeks, all we can think of is, how do you say “squeal like a pig” in German. The market is happy because it looks like PSI will go through and that in theory will be enough to convince the Troika to send money to Greece, so long as they live by the latest austerity package.  That all seems fine, we guess, but looking beneath the headlines, it seems far worse than that.

Bernanke, and his recent inflation targeting plan, should be delighted with today's CPI number which while missing headline expectations of a 0.3% increase M/M and printing at 0.2%, rose 2.9% year over year, just higher than consensus, although down from December's 3.0% - the primary reason for the "miss" being a drop in utility gas services courtesy of April weather in January and February. On the other hand, core CPI continues trends ever higher, and is now up 2.3% Y/Y, an increase of 0.2%, in line with expectations, and up from December's 0.1%. This was the highest Y/Y number since September 2008. The good news is that the possibility of further QE is still embedded in the number. The bad news, is that WTI is about to take out $103 courtesy of the global central bank pump discussed yesterday, and allegations that CPI reflects merely some irrelevant hedonically adjusted number spring up again.

In spite of the fact that the Greek story has been out there for almost 2 years now, it still drives the market. Virtually all of the big moves this week came on the back of Greek headlines so it is impossible to argue that it is “priced in”. My best guess is that a resolution (which the market believes is most likely) sparks a 2%-4% rally. A default (which I think is most likely) sparks a 5%-10% decline. So at these levels I will be short as I think the most likely move is lower, and the move lower is likely to be bigger. With the market being choppy, being nimble remains a key....The market has a tendency to do well after the credit guys leave on holiday shortened trading days. So with the desire to believe that Europe will not let Greece default (in spite of evidence to the contrary) the markets may remain in rally mode for the day because no one wants to miss the imminent resolution of the crisis. I am far more convinced that we will get some very disappointing headlines because the situation really doesn’t work, and the tone of Europe has switched from “No Default” to “No Disorderly Default”.