The Equity Markets Are Ignoring Screams of FUD (Fear, Uncertainty and Doubt) in the European Money and Credit Markets: Enter Lehman Fiasco v2.0!!!

For those who have been following me in the Asset
Securitization and Pan-European Sovereign Debt Crisis series this may
be old news, but let’s go through the exercise anyway. It looks as if we
are back to those non-sense games being played by those that manipulate
the market. Taking a look at Bloomberg.com’s front page, you’ll see “Stocks,
U.S. Futures Rally on Economic Outlook; Yen Weakens, Bonds Decline” (hey,
good times are here again) followed directly by “Banks
Deposit Record $394 Billion With ECB, Avoiding Loans to One Another”(hey,
isn’t this the exact same environment wherein Bear Stearns, then Lehman
Brothers collapsed leading the Treasury Secretary Hank Paulson to
proclaim the end of the financial world was coming?). Then there’s “Covered
Bond Sales Surge; Transocean Tumbles: Credit Markets“: Sales of
covered bonds are accelerating as investors seek debt backed by
collateral amid concern about the creditworthiness of governments and
banks.

Okay, let’s take this by the numbers….

Banks
Deposit Record $394 Billion With ECB, Avoiding Loans to One Another

June 3 (Bloomberg) — Overnight
deposits with the European Central Bank rose to a record
yesterday as the sovereign debt crisis made banks wary of lending to
each other.

Banks lodged 320.4 billion euros
($394 billion) in the ECB’s overnight deposit
facility at 0.25 percent, compared with 316.4 billion euros the
previous day, the Frankfurt-based central bank said in a market notice
today. That’s the most since the start of the euro currency in 1999.
Deposits have exceeded 300 billion euros for the past five days.

Banks are parking cash with the ECB
amid investor concern that a 750 billion-euro European rescue package
may not be enough to stop the crisis from spreading and spilling into
the banking industry. The ECB said on May 31 that banks will have to write
off more loans this year than in 2009 and their ability to
sell bonds may be hampered as governments seek to finance fiscal
deficits.

“The banking crisis is back,” said Norbert
Aul, an interest-rate strategist at Commerzbank AG in
London. “The news flow over the past few weeks has spooked banks and
since nobody knows how exposed individual financial institutions are,
it’s deemed safer to park cash with the ECB rather than lend it on.”

This is not just FUD (fear, uncertainty and doubt), the banks KNOW
that their peers are walking, talking time bombs. Let’s reference the
situation in the US with The
Next Step in the Bank Implosion Cycle???

So,
How are Banks Entangled in the Mother of All Carry Trades?

Trading
revenues for U.S Commercial banks have witnessed robust growth since
4Q08 on back of higher (although of late declining) bid-ask spreads and
fewer write-downs on investment portfolios. According to the Office of
the Comptroller of the Currency, commercial banks’ reported trading
revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the
least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8
quarters.

High
dependency on Forex and interest rate contracts

Continued
growth in trading revenues on back of growth in overall derivative
contracts, (especially for interest rate and foreign exchange contracts)
has raised doubt on the sustainability of revenues over hear at the
BoomBustBlog analyst lab. According to the Office of the Comptroller of
the Currency, notional amount of derivatives contracts of U.S Commercial
banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9
trillion in 2004 with interest rate contracts and foreign exchange
contracts comprising a substantial 84.5% and 7.5% of total notional
value of derivatives, respectively. Interest rate contracts have grown
at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex
contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04
to 2Q-09.

In
terms of absolute dollar exposure, JP Morgan has the largest exposure
towards both Interest rate and Forex contracts with notional value of
interest rate contracts at $64.6 trillion and Forex contracts at $6.2
trillion exposing itself to volatile changes in both interest rates and
currency movements (non-subscribers should reference An
Independent Look into JP Morgan, while subscribers should referenceJPM Report (Subscription-only) Final –
Professional, and JPM Forensic Report (Subscription-only)
Final- Retail). However, Goldman Sachs with interest rate contracts
to total assets at 318.x and Forex contracts to total assets at 11.2x
has the largest relative exposure (see  Goldman Sachs Q2 2009 Pre-announcement opinion
2009-07-13 00:08:57 920.92 Kb,   Goldman Sachs Stress Test Professional 2009-04-20
10:06:45 4.04 Mb,  Goldman Sachs Stress Test Retail 2009-04-20 10:08:06
720.25 Kb,). As subscribers can see from the afore-linked
analysis, Goldman is trading at an extreme premium from a risk adjusted
book value perspective. 

As
a result of a surge in interest rate and Forex contracts, dependency on
revenues from these products has increased substantially and has in
turn been a source of considerable volatility to total revenues. As of
2Q-09 combined trading revenues (cash and off balance sheet exposure)
from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or
9.5% of the total revenues while the same for GS and BAC (subscribers,
see  BAC
Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb)
stood at $(196) million and $433 million, respectively. As can be seen,
Goldman’s trading teams are not nearly as infallible as urban myth
makes them out to be.

 

Although
JP Morgan’s exposure to interest rate contracts has declined to $64.5
trillion as of 2Q09 from $75.2 trillion as of 3Q07, trading revenues
from Interest rate contracts (cash and off balance sheet position) have
witnessed a significant volatility spike and have increased marginally
to $1,512 in 2Q09 compared with $1,496 in 3Q07. Although JPM’s Forex
exposure has decreased from its peak of $8.2 trillion in 3Q08, at $3.2
trillion in 2Q09 the exposure is still is higher than 3Q07 levels. Even
for Bank of America and Citi , the revenues from Interest rate and forex
products have been volatile despite a moderate reduction in overall
exposure. With top 5 banks having about 97% market share of the total
banking industry notional amounts as of June 30, 2009, the
revenues from trading activities for these banks are practically
guaranteed to be highly volatile in the event of significant market
disruption – a disruption aptly described by the esteemed Professor
Roubini as a rush to the exit in the “Mother of All Carry Trades” as the
largest macro experiment in the history of this country starts to
unwind, or even if the participants in this carry trade think it is
about to start to unwind.

We are talking a fair
amount of exposure here. Do you remember my favorite JPM grapic from 
An Independent Look into JP Morgan.

Click graph to enlarge 

 Cute graphic above, eh? There is plenty
of this in the public preview. When considering the staggering level of
derivatives employed by JPM, it is frightening to even consider the fact
that the quality of JPM’s derivative exposure is even worse
than Bear Stearns and Lehman‘s derivative portfolio just prior to their
fall.Total net derivative exposure rated below BBB and below
for JP Morgan currently stands at 35.4% while the same stood at 17.0%
for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all
know what happened to Bear Stearns and Lehman Brothers, don’t we??? I
warned all about Bear Stearns (Is
this the Breaking of the Bear?: On Sunday, 27 January 2008) and
Lehman (”Is
Lehman really a lemming in disguise?“: On February 20th, 2008)
months before their collapse by taking a close, unbiased look at their
balance sheet. Both of these companies were rated investment grade at
the time, just like “you know  who”. Now, I am not saying JPM is about
to collapse, since it is one of the anointed ones chosen by the
government and guaranteed not to fail – unlike Bear Stearns and Lehman
Brothers, and it is (after all) investment grade rated. Who would you
put your faith in, the big ratings agencies or your favorite blogger?
Then again, if it acts like a duck, walks like a duck, and quacks like a
duck, is it a chicken??? I’ll leave the rest up for my readers to
decide. 

If you had to take a guess, who do you think those European banks
have hedged their exposure with??? Once it comes to the safety and
“record profits” of the big banks, ie. JP Morgan, et. al., all I can say
is Don’t Believe the Hype!The potential blow up has the
capability both reaching the Bourgeuois and rocking the boulevard, as
my man Chuck D so eloquently put it. Now, back to the Bloomberg article…

Tensions

Money market tensions are resurfacing
even after the ECB started buying government bonds and said it would
offer banks as much cash as they want for up to six months. The measures
accompanied the European Union rescue package, agreed on May 10, to
counter the worsening debt crisis and promises by Greece, Spain and
Portugal to rein in their budget gaps.

Hmmm, why would these Euro banks be so skitttish, untrusting
(unstrustworthy) and shy even with an explicit, unlimited, and direct
indemnification and subsidy from the ECB? Let me count the ways….

1. Smoking
   Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer
   Beware!
2. Financial
   Contagion vs. Economic Contagion: Does the Market Underestimate the
   Effects of the Latter?
3. Lies,
   Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!
4. As I Explicitly
   Forwarned, Greece Is Well On Its Way To Default, and Previously
   Published Numbers Were Waaaayyy Too Optimistic!
5. How
   Greece Killed Its Own Banks!
6. Introducing
   The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right
   on the money for 5 months straight!
7. With Europe’s
   First Real Test of Contagion Quarrantine Failing, BoomBustBloggers
   Should Doubt the Existence of a Vaccination
8. What
   We Know About the Pan European Bailout Thus Far
9. As I Warned Yesterday, It Appears the Market Is Calling
   the Europeans Bluff – It’s Now Put Up Or Get Put Down
10. How the US Has Perfected the Use of Economic
    Imperialism Through the European Union!
11. PIIGSlets in a Bank: Another European Banks-at-Risk
    Actionable Research Note
12. Sovereign debt exposure of Insurers and Reinsurers
13. “With the Euro
    Disintegrating, You Can Calculate Your Haircuts Here”
14. What is the Most Likely Scenario in the Greek Debt
    Fiasco? Restructuring Via Extension of Maturity Dates

Money market rates are rising, with the euro interbank offered
rate, or Euribor,
for three-month loans yesterday increasing to 0.704 percent, the
highest this year. Banks borrowed 9 million euros from the ECB at the
marginal rate of 1.75 percent, the central bank said today.

The efforts by the EU and the ECB failed to allay investor
concerns. Fitch Ratings lowered the credit grade of Spain, the euro
area’s fourth largest economy, to AA+ from AAA on May 28. Standard &
Poor’s in April cut Greece’s debt to junk and lowered the ratings on
Portugal and Spain.

Portuguese 10-year government bonds fell today, increasing the premiuminvestors
demand to hold the debt instead of benchmark German bunds.

The yield on the Portuguese security rose five basis points to
5.08 percent as of 8:56 a.m. in London. The spread over bunds widened
six basis points to 231 basis points, according to Bloomberg generic
data. Spain’s yield
over Germany was unchanged at 177 basis points.

Speaking of Portugal, did you see those nasty McNasty
haircuts???!!!

You think those are ugly? You ain’t seen nothing yet! See Introducing
the Not So Stylish Portuguese Haircut Analysis. I will try to
release the update Greece haircuts for subscribers today, and they are
even uglier. In the process, there’s a chance I’ll release the overly
optimistic edition (wherein the debt/GDP ratio was still over 140%, even
with the haircuts) published earlier to the public. Check BoomBustBlog
later on today and tomorrow for details.

Comments

[eccitante]

World Collapse Explained in 3 Minutes

http://www.youtube.com/watch?v=NOzR3UAyXao

[whiteshadow]

"significant market disruption"

greece, gold, fall of euro, 1000 points drop...

What event or events would cause the significant market disruption....

btw Mr. Reggie, I did send you an email with resume but never heard back....would appreciate greatly if I could join your team.

[williambanzai7]

CONTAGION WARNING:

http://williambanzai7.blogspot.com/2010/06/ftc-warning.html

[moneymutt]

Thanks Reggie, awesome information, but no, your graph isn't cute...its horrifying.

I keep thinking the cards must fall, and then they intervene...it seems to me JPMorgan is too connected just to be simply taken out by market swings...any thoughts their ability dodge this once again with political connections, or are you saying its beyond that?

[Spitzer]

Still, why is there nervousness in corporate's  when on a fundamental basis, the biggest dog in the room is still the treasury market ?

[Wyndtunnel]

I have been waiting for 30 years for a collapse so that I might have a better chance at getting ahead... Can we please get it over with already??  I'm not going to live forever.

[jkruffin]

JP Morgan is going to be the next Lehman and Bear Stearns.  Its just a matter of a major event setting off the domino effect.  The FED has been trying to do anything and everything it can, even outside the laws of this nation to prevent it, yet JP Morgan will still collapse and cause worldwide damage.  Damage to nations and our own country that will make Bear and Lehman look like nothing really happened.  No business should get to this point of derivative exposure and leverage.  NEVER.  But now that we are here, and when it collapses, no amount of bailout from Benny boy is going to work.

[RockyRacoon]

After nearly two years since the greatest financial malfeasants in history and ten years since the last public example of financial crime, the public haven’t seen a single CEO sentenced to hard time for the financial meltdown. They have not had their thirst for revenge quenched by a single high level court case. Instead, the public infuriatingly witnesses politically crafted theater in congressional hearings that go nowhere, read watered down legislation that is replete with even richer lobbyist-authored loopholes and only occasionally see small headlines of quiet settlements with insulting token amends payments. Why? Were there no crimes committed? No laws broken?

EXTEND & PRETEND:  It's either RICO Act or Control Fraud.

RACKETEER INFLUENCED AND CORRUPT ORGANIZATIONS (RICO) ACT

Under RICO, a person who is a member of an enterprise that has committed any two of 35 crimes—27 federal crimes and 8 state crimes—within a 10-year period can be charged with racketeering.   Racketeering activity includes:

• Any act of bribery (lobbying?), counterfeiting (naked shorting?), theft, embezzlement, fraud, obstruction of justice, money laundering,

• Embezzlement of union funds (talk to the SEIU about Interest Rate Swaps!);

• Bankruptcy fraud or securities fraud (where do we begin!);

• Money laundering and related offenses;

• Acts of terrorism (Financial - High Frequency ‘flash crash’ Trading?).

• 
  

On March 29, 1989, financier    Michael Milken was indicted on 98 counts of racketeering and fraud relating to an investigation into    insider trading and other offenses. Milken was accused of using a wide-ranging network of contacts to manipulate stock and bond prices. It was one of the first occasions that a RICO indictment was brought against an individual with no ties to organized crime. Milken pled guilty to six lesser offenses rather than face spending the rest of his life in prison.   On September 7, 1988, Milken's employer,     Drexel Burnham Lambert, was also threatened with a RICO indictment under the legal doctrine that corporations are responsible for their employees' crimes. Drexel avoided RICO charges by pleading    no contest to lesser felonies. While many sources say that Drexel pleaded guilty, in truth the firm only admitted it was "not in a position to dispute the allegations." If Drexel had been indicted, it would have had to post a performance bond of up to $1 billion to avoid having its assets frozen. This would have taken precedence over all of the firm's other obligations—including the loans that provided 96 percent of its capital. If the bond ever had to be paid, its shareholders would have been practically wiped out. Since banks will not extend credit to a firm indicted under RICO, an indictment would have likely put Drexel out of business. Is this really what is behind too big to fail prosecution?

[FASB 666]

That's the worst case of "hat head" i've ever seen !!!

[Rider]

What I am wondering is why with these "2 years in 2 minutes" wild currecy fluctuations, this have not blown up already?

What is preventing it to blow?

[Mitchman]

Reggie, this is the type of analysis at which you have no peer.  It is absolutely great.  However, I have one question which I ask out of sheer ignorance.  Is it the notional amount of contracts that matters or is it the net settlement amount?

[Reggie Middleton]

Read the report attached to the link, there's a lot that goes into it. The number you probably want is the market value vs the carrying value, with proper attention paid to counterparty risk.

[Mitchman]

Thank you.

[DavidC]

I'm just wondering what shenanigans might take place to keep the markets up in time for the mid-terms in the US.

Even before that I see a rally today on the expectation of good numbers tomorrow, even if they are nonsense.

Do I think the market should be going higher? Errm, no...

DavidC

[Ripped Chunk]

Now playing everywhere:  EPIC COLLAPSE (rated PG 13)

[WaterWings]

Starring the inmates of ADX Florence Supermax Facility and Timothy Geithner.

[Reggie Middleton]

The European fiasco has already affected the US and European corporate bond markets. Reference

01:43

Bond New Issues Shut on Concerns Over Europe Bank Concerns

Here is a somewhat contrary perspective:

04:47 Mutkin Doubts Libor Concerns, Sees `Stacks' of Liquidity