Slowly even those staunchest critics of reality, namely undercapitalized and insolvent French banks, are coming to grips with the truth that they are going to see massive losses on their tens of billions of French debt exposure. The FT reports that the French stock market regulator has told French banks to apply realistic assumptions to their Greek debt haircuts. Because through today, French banks only used the 21% agreed upon haircut at the July 21 (and even that number is likely greatly overstated). So where are Greek bonds trading now? Oh about 30 cents on the dollar (70% haircut) , which means at the end of the day French banks will see about three time more losses on Greek holdings than provisioned. And the market, which is not all that stupid, knows this and has been punishing French banks. This is precisely what regulators are trying to avoid. The problem, as is well known courtesy of daily fruitless discussions between Sarkozy and Merkel, is that "French banks have more cross-border exposure to Greece than any other country, mainly through subsidiaries owned by Crédit Agricole and Société Générale. BNP Paribas holds the most Greek sovereign bonds among private sector investors, with €4bn of exposure...French banks argued that limiting themselves to 21 per cent was justified because trading in Greek government debt was so subdued, making market prices unreliable." Uh, what? Those billions in Greek bond volumes, where the 1 year yields 184% in dozens of daily trades, are "subdued" and "unreliable?" Why not just buy the bonds then and take advantage of the illiquid arb then? What's that? Crickets? Oh ok. In the meantime, what is certain is that after the ECB, France is the country most exposed to a Greek admission of reality (even truncated, assuming a 60% haircut which is still generous). Which of course confirms, once again, our thesis that the only source of EURUSD stability in the past two weeks have been French banks liquidating assets, and using the feedback loop of rising asset prices from FX EUR repatriation to sell even more to a willing market.
Berlusconi Screws Over The Wrong Person: ECB Shake Up Imminent Following Big French-Italian Relations SNAFU?Submitted by Tyler Durden on 10/21/2011 - 14:00
Just when one thought the Italian PM could not possibly come up with yet another massive SNAFU, he does it once again. This time however he may have screwed over the wrong (non-underage) person. Last night, after the FT had previously leaked (incorrectly once again) that the Italian head would pick ECB executive Lorenzo Bini Smaghi to head the Bank of Italy following Mario Draghi's departure to head the ECB, Berlusconi instead chose a relatively unknown Ignazio Visco to head the Italian Central Bank. The move, while largely symbolic as it hardly matters who is in charge of the Italian bank but is of great import from a "national pride" perspective, managed to infuriate French leader Nicholas Sarkozy, who had previously made it clear he would advance his support of incoming ECB head, former Goldmanite and current Bank of Italy head, Mario Draghi, only if Bini Smaghi would be pulled and his seat would be vacated to allow a Frenchman to enter the ECB. That did not happen. So with the latest faux pas out of Berlusconi, he is now poised to destabilize not only Italian-French relations, but the percevied stability of the ECB if the Frenchman decides to make it an issue vis-a-vis his support of the incoming President. All in all, this is yet another reminder of the total and utter chaos that dominates Europe every single day. And somehow the broad public is supposed to believe that Europe can come up with a solution to an insolvable math problem...
To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price fixing, which leads not to prosperity but to disaster.
Talk about launching ESM early and in conjunction with EFSF has helped the market rally. On Page 1, the ESM will have an effective lending capacity of 500 billion (footnote 2) During the transition from EFSF to ESM, the combined lending capacity will not exceed this amount. Somone better ask Finland and Slovakia whether they are prepared to fund both? Are stocks as strong as they are because Algo's are good are reading headlines, but suck at finding termsheets and reading them?
Bloomberg has just disclosed a statement from the German Budgetary Committee which is critical to the future shape of the EFSF:
- GERMAN CDU/CSU PARLIAMENTARY SPOKESMAN SCHARLACK SPEAKS ON EFSF
- GERMAN BUDGET COMMITTEE SETS CONDITIONS FOR EFSF LEVERAGING
- BUDGET COMMITTEE SAYS EFSF REPOS MUSTN'T RAISE GUARANTEES
- GERMAN BUDGET COMMITTEE SAYS EFSF LEVERAGING MUST EXCLUDE ECB
So far so good... But this...
- BUDGET COMMITTEE SAYS EFSF GUARANTEES MUSTN'T EXCEED EU211 BLN
...Is not good. If this is the core guarantees that can be levered up to 5x assuming a 20% first loss guarantee, it means barely $1 trillion can be insured. This is nowhere near enough to backstop the just noted €1.7 trillion in future debt rolls, not to mention the €X billion in bank recaps. It also means that a French downgrade, with S&P noted earlier is contingent on the country not falling into recession, an event which even Goldman has said previously is assured, would put the full weight of the European rescue squarely on the shoulders of Germany.
It's time to forget about Europe's headlines for 15 minutes and refresh what is really going on in Europe, and why European leaders are scrambling day to day to come up with a solution to what is ultimately an intractable problem. Technically, the problem, as explained below, is manifested in three distinct symptoms, which exist in a self-referencing feedback loop that amplifies good input signals when times are good, and incremental debt is ample, and vice versa, or become a toxic spiral where one problem is amplified in the other two, when the system is caught in a deflationary spiral, until the entire system is threatened by collapse. The three "problems" are summarized best in a chart by Morgan Stanley's Huw Van Steenis (see below) in what we have dubbed the "Triangle of Terror" - these are i) Bank Solvency, ii) Sovereign Stress, and iii) Bank Funding Stress...Yet the core problem at the very heart of European instability, is nothing more than, you guessed it, excess debt, €1.7 trillion worth of it to be precise: this is how much debt has to be rolled over the next 3 years, and also explains the magical €2 trillion number needed for the EFSF as only something that big can i) backstop the debt roll and ii) insure the needed bank recap, which in reality needs more like €400 billion but that is the topic of a different post. And without the abovementioned support pillars of bank solvency, funding and sovereign stress being address and fixed, in a credible manner and at the same time, this debt will not be able to roll, and effectively lead to systemic European insolvency. And that, in a nutshell, is what the issues facing Europe are. Everything else is headlines, smoke and mirrors.
The ongoing squeeze in US equities, evident in the significant outperformance of the most-shorted-name indices from Goldman relative to market indices, continues to keep domestic wealth effects ticking along nicely while US credit and European equity and credit markets do not seem to have got the same memo. While this rally, seemingly predicated on the fact that Europe 'get's it' finally (and admittedly some talking head chatter about the number of earnings beats - which we argue is useless given previous discussions of the wholesale downgrading of expectations heading into earnings), the US equity market is the only market to have made new highs this week, is outperforming its credit peers in the US (which is simply ignorant given HY's relative cheapness if this was a risk-on buying spree), and most wonderfully - is hugely outperforming the European financials, European sovereigns, European IG and HY credit, and European equities. Did US equities become the new safe-haven play of the world? Perhaps this week, but we suspect that won't end well - at least from the experience of the last decade or so.
Visualizing The True Cost Of The First Bank Bailout: $3.5 Trillion And Rising At Over $1 Trillion Every YearSubmitted by Tyler Durden on 10/21/2011 - 11:09
In his latest letter to clients (which we will present shortly), Diapason's Sean Corrigan has one chart that explains beyond a shadow of a doubt what the true cost of the (First) Great Financial Crisis, the failure of Lehman, and the bailout of the US financial sector, is. The premise is ridiculously simple: the chart below compares the trendline of US debt before and after the Lehman from September 2008, and the rescue of everyone else who unlike Dick Fuld, was in Hank Paulson's good graces. What is immediately obvious is that US debt is currently $3.5 trillion higher than where it would be had America's banks not received a rescue. That is Sean's conclusion. It is however incomplete. The truth is that this is a proportional increase which if extrapolated into the future, means that every year the US will incur well over $1.2 trillion each and every year as a result of bailing out the banks. That is the true cost to Americans regardless of what Tim Geithner may claim. But note how we said First. Unfortunately, the Second Great Financial Crisis, that of bailing out insolvent sovereigns, is currently and process. And when all is said and done, the global cost in terms of new "trendline" debt will be many more trillions in incremental debt every year. And despite what economic voodoo theories say, near infinite debt always ends in near infinite pain. It will this time too. Guaranteed.
We wish there was something tangible we could attribute the sudden surge in the E-Mini S&P contract to, but we can't. This is just the latest repeat of the hope as an upside catalyst thesis. Oh, and QE3 of course. We are confident, that unlike all previous times, the market's hope that math does not matter when bailing out insolvent countries, will be justified.
MBS Monetization Expectations Good For Massive 0.04% Plunge In Mortgage Spread, Sure To Unleash Refi Tsunami... Or NotSubmitted by Tyler Durden on 10/21/2011 - 10:07
Anyone who actually read Daniel Tarullo's speech yesterday setting the stage for a new round of MBS monetization would be forgiven to expect a major drop in mortgage rates. After all the Fed board member said, "by increasing demand for MBS, such a program should reduce the effective yield on those MBS, which in turn should put downward pressure on mortgage rates." There is no way he can be wrong, after all he is a Fed member (although no Ph.D., instead he has an uber-valuable J.D.). And there is no way the market can not be pricing in what is now obvious. So how does the 10 Year UST- 30 Year mortgage spread look like this morning post the "pricing in" - well it is tighter. By a whopping 0.04%! Surely this epic move in spreads will be the catalyst that unleashes hundreds of billions in refinancing activity and pushes the value of the US mortgage market higher by trillions of dollars. Or not. As the second chart below demonstrates, Operation Twist, whose purpose incidentally was just what Tarullo is suggesting less than 2 months after QE3 Lite came on the scene, has now been a total disaster. As the Mortgage Brokers' Association reported on Wednesday, the MBA mortgage applications index was down 15% in the week ended Oct. 14. This was the year's biggest decline! Worse, the refi index was down a massive 17% in the week! What does this mean? Well, that we have reached a point where prevailing rates on Mortgages have absolutely no impact on either refis or home prices at this point: anyone who could have refied, has already done so, probably many times over. Everyone else is simply not eligible. But yes, MBS monetization will sure help... all those banks that have loaded up on MBS in anticipation of just this (like Bill Gross as we first speculated back on October 11) to sell them right back to the US taxpayer. And, of course, all those who have been wisely stocking up on precious metals in anticipation of just this latest episode of Fed idiocy. Remember: as we have been saying since day 1: the Fed knows only one thing. To Print. And it will. Over and over and over.
Curious what the talking heads will be discussing all weekend parallel to the joke that is the European Summit #1, not to be confused with summit #666? Here is the answer, courtesy of the FT Deutschland, where not too subtly, right next to a lede saying "the Euro rescue has turned into a farce", the publication has for the first time, set its price not in zEURo.qq but in Paul Tudor Jones' favorite currency: the Deutsche Mark, or 4.11 DM to be precise. And courtesy of the FTD, we now know the When Issued exchange rate for the EURDEM is: 1.95, the same as was locked at the EUR inception. Said otherwise, stick a fork in the euro, it's done.
The USD just dumped across all major pairs after the recent support in the USDJPY at 76.65 was just broken, leading to a huge plunge first in the Dollar-Yen, to a fresh post WW2 lowm and then in all other pairs. It is unclear what is driving this: probably some combination of QE3 expectations and technical trading now that the bottom has been taken out. The signal is irrelevant: it all originates at the central banks these days anyway. Expect imminent chatter of BOJ intervention to protect its exporters.
To go alongside today's best headline from Bloomberg, "Euro Leaders Begin Six-Day Marathon to Reach Agreement on Debt-Crisis Plan" which naturally begs the question whether Greece's rotund Venizelos will be part of the 144 hour run, here is our suggestion for caption contest of the day.
It is time for our first semi-surreal news of the day (full blown will be any headline out of Europe that things will be ok). Per Bloomberg, Europe is living “on borrowed time,” according to Sharon Bowles, chairwoman of the European Parliament’s economic and monetary affairs committee. "The next time leaders meet there has to be progress on all key elements,” Bowles said at the AFME European Government Bond Conference in Brussels. Euro bonds are probably more “a medium and long-term issue” rather than an immediate solution, she said. They may be easier to implement “when better times are restored,” she said. Which is funny, because the WSJ just reported that "Europe's efforts to deliver a comprehensive plan to resolve the euro-zone debt crisis were in danger of unraveling ... as disagreement between Germany and France over virtually every point." Additionally, the only calculator in Europe's possession appears to have made it to Belgium and Spain, both of which have made loud noises demanding that the ECB play a major role in the EFSF, considering that both countries are also now virtually locked out of the debt markets and hence insolvent. But if there is one thing everyone in Europe agrees on, it is that America has to bail it out. Again from Bloomberg, "Euro region leaders must talk to the International Monetary Fund to discuss its involvement in European Financial Stability Facility operations and can’t take any decisions on the subject at an Oct. 26 summit, a German government official said in Berlin today, speaking on condition of anonymity." Sorry American taxpayers, if you thought your tax dollars would be limited to only funding US banker bonuses...you were wrong.
Stocks hit their low on October the 3rd. They bounced on announcements and beliefs that Europe finally “gets it” and will “solve” the sovereign debt crisis. The S&P hit a low of 1075 and a high of 1233 and is back to about 1220, which is still a healthy 13.5%. Yes, there is more going on than the European crisis, but clearly the belief that the problems in Europe are solved has played a big role, especially in the financials where the return is over 17%. It seems like the market has gotten ahead of itself, and these 5 charts show why.