Is The Entire Global Banking Industry Carrying Naked, RISKY, Unhedged "Risk Free" Sovereign Debt? Quick Answer: Probably!Submitted by Reggie Middleton on 11/03/2011 12:59 -0400
Here I discuss the chances of Goldman Sachs succumbing to an MF Global/Lehman/Bear Stearns style bank run. Impossible, you say? Don't bet the farm on that one, son!
Europe's core, call it Germany, is now caught in a war of reverse attrition on three fronts: with Greece, with Italy, and as of today, with France. And unfortunately for the European monetary union, Europe, call it Germany, is losing. While the focus continues to be on G-Pap for the second day in a row following his shocking referendum announcement, the real diversion remains Italy, where the government is in as much of a state of chaos as that in Athens, and whose bonds, while not yet trading at Greek levels (remember when the Greek 1 year hit 100% two months ago? Today it is at 225%... and tomorrow the two year will be at 100%), are far, far greater in amount, and the only thing preventing their collapse so far has been the ECB, whose monetizing assistance has been contingent on Italy passing and enforcing austerity measures to deal with its runaway debt to GDP of over 120%. Unfortunately, when BTPs open for trading in 7 hours, the ECB bid may not be there, or any bid for that matter, because as the WSJ reports, "Italian Prime Minister Silvio Berlusconi on Wednesday failed to issue growth-boosting measures demanded by European Union authorities ahead of the Group of 20 summit, raising further doubts about the government's willingness to pass economic reforms aimed at restoring investor confidence in the country." Now that the ejection of Greece is virtually certain, perhaps it would be a prudent idea for what little remains of the healthy European core to kick out all the stragglers before everything becomes infected, and before French bonds trade at yields indicative of a sub-IG credit, thus ending the myth of any European union for good?
With Tim Geithner having proven repeatedly and beyond a reasonable doubt he has insurmountable intellectual challenges, many have wondered just who it is that makes the real decisions at the US Treasury? The answer is, The Treasury Borrowing Advisory Committee, or the TBAC in short, chaired by JP Morgan and Goldman Sachs, which meets every quarter, and in which the richest people in America (here is its composition) set the fate of the US for the next 3 months in the form of a very much irrelevant report to TurboTax (link). What is of huge importance, however, are the minutes, which unlike the FOMC, are released immediately following the meeting. Below are the full minutes from the latest TBAC meeting held yesterday, just released by the US Treasury (and yes, the issuance of FRN Treasurys, corporate cash hoarding as well as the resumption of the SFP program are both discussed - like we said: these guys run the world) as well as the critical associated powerpoint.
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?
Mortgage principal writedowns may sound like a political panacea, until we consider the effects not only on borrowers, but on banks, and taxpayers, as well...
We all know the news by now: "MF reported its biggest quarterly loss ever yesterday, after having its credit ratings cut a day earlier by Moody’s Investors Service on concern that the broker won’t meet earnings targets and may not be able to manage investments in European sovereign debt. The company’s shares fell 48 percent. “It’s aggregated risk,” said Richard Repetto, an analyst at Sandler O’Neill & Partners LP. The positions in Europe, the further downgrade potential and the quarterly loss, combined to discourage investors, he said." Here is where it gets worse: "Analysts at KBW Inc., led by Niamh Alexander, wrote in a note yesterday that the Moody’s downgrade and lower earnings could cause a ripple effect on the company, raising borrowing costs and triggering collateral calls. “It also exposes MF to collateral calls of up to $5 million,” the note said. “We believe it could also prompt lenders to reduce financing, clients to withdraw assets and trigger the need to recognize losses on certain bilateral over- the-counter and off-balance sheet transactions." Well, judging by the bond yield chart below, MF is done (further confirmed by WSJ reporting that the company has hired restructuring expert Evercore Partners). The only question is whether that ever so handy uber collateral puller, Goldman Sachs, so critical in the extinction of Dexia and of course AIG, will be the party responsible for the death of MF Global? Considering who the current head of MF is, and his "key man status" in the prospectus of the company's recently bonds (which are plummeting today), we somehow doubt it.
Today was one of those days when the PT lifestyle was... less than glamorous. It took nearly 24-hours of travel dealing with weather delays, in-flight diversions, and mind-numbing airline incompetency... but I've finally arrived to Mongolia. As I write this, it's a balmy -7 Celsius (19F) outside. Despite the terrible weather, I'm excited to spend the next several days here sniffing around a few private placements and hopefully having some killer barbecue. More on Mongolia next week, let's move on to this week's questions. First, Jennifer asks, "Simon, you've been writing a lot lately about the prospect of social unrest in the developed world, including the US. You suggest that international diversification is a great way to protect against this threat. But if there's social unrest in the US, won't there be total chaos everywhere else?" Not by a long shot. I'll explain--
Following a report overnight from the WSJ that S&P would likely downgrade the credit ratings of France, Spain, Italy, Ireland and Portugal if the euro zone slips into another recession, which many economists say is likely, the entire overnight session was dominated by yet another period of fear and loathing out of Europe, further pressured by escalating uncertainty over EU summit after another meeting is called for Oct. 26. The headline scanning brigade will focus on Belgium where at 2 pm local time EU finance ministers will meet in to hammer out groundwork for the Oct. 23 EU summit. The result of concerns that absolutely nothing is resolved led to spreads for everything blowing out: at one point, France 10-yr Yield was up +6 bps to 3.21% (the widest spread over bunds at 119.01 since 1992), Italy 10-yr yield rose +3 bps to 6.05%, highest since Aug. 5, and the spread over bunds widens to euro-era record of 402 bps or most since 1996 and lastly the 10-yr Spain spread over bunds was +4 bps wider to 5.57%, with the Bund spread at 355, just tight of the August record of 398 bps. Still this was enough for the ECB to intervene and as the chart below shows, to purchase Italian BTPs en masse for the fourth day in a row, this time with a sizable amount, even as it is now confirmed that ECB interventions hav a several hour half life. And since the EURUSD and thus futures are now driven off the BTP price, everything rose when at 4 am Eastern the ECB began its daily intervention. Alas, at this point even 8 year olds realize that these are short-term liquidity measures while the long-term solvency problem is merely getting worse.
Following two poor bond auctions in the overnight session from Spain and France, things once again looked set to fall apart in both the stock futures and the FX (EURUSD) markets until the latest deus ex appeared after the latest report by international creditors on Greece’s finances recommended paying the next installment of aid to Greece as soon as possible. Naturally: after all such a payment is merely passthru funding which Greece hardly sees one sent of, and the bulk of the capital is immediately recycled to creditors in the form of interest expense and debt maturities. Bloomberg quotes “The Commission services recommend the sixth disbursement to Greece to take place as soon as possible: as soon as the agreed prior actions on fiscal consolidation, privatisation and labour market reform, which were announced by the government, have been legislated,” the report by the so-called troika of officials from the European Central Bank, EU Commission and IMF said. Of course, were the Troika to allow full disbursement without any "stern" warnings over the deterioration in the Greek economy, in which nobody works any more, the Finance Ministry is occupied and a general strike is the "new normal", it would have been beyond farcical. Which is why the Troika noted that the Greek debt ratio, which exceeded 140% of GDP at the end of 2010, will remain “at very high levels for many years,” according to a draft report by the Troika. “If fiscal consolidation and privatization targets are respected, and growth responds to structural reforms, the debt ratio may start declining from 2013 onwards...When compared with the outlook of a few months ago, the debt sustainability has effectively deteriorated’." And it will continue deteriorating because Greece now knows too well it can demand anything and everything from Europe and it will get it, since nobody at the Troika can ever refuse to fund the insolvent country's monthly pre-alimony payment.
The European headlines continue to roll in. As far as I can tell, they either hired someone to play devil's advocate, or for the first time since at least July they actually tried to translate some of their words into action. They are running into legal roadblocks, death spiral scenarios, the reality that once they give the money to the PIIGS that the power reverts to the PIIGS, that everything is circular and self-referencing, that debt markets in the end can decouple from CDS markets, that Germany and France are going to see borrowing costs spike (even after the ECB rate cut), and that there are so many holes to plug - bank capital, bank bonds, PIIGS debt, Belgium debt, something about Dexia that no one even remembers, voters are against it, Greece isn't going to fool anyone, etc.
No surprises this time in the overnight sessions with treasuries higher into the New York open as Moody’s signaled France’s Aaa rating is at risk and China’s economy grew at the slowest pace in two years, both events reported previously and still occupying the market. Futures are down solidly ahead of Bank of America (which Bloomberg has been caught doing some big shennanigans - see below) and Goldman. More on why numbers on our screen are red, aside from the horrible Crocs guidance of course, is below, courtesy of Bloomberg.
UPDATE: EURUSD loses 1.3750
On Oct. 13, 2011, Standard & Poor's Ratings Services lowered the long-term rating on the Kingdom of Spain from 'AA' to 'AA-', while affirming the short-term ratings at 'A-1+'. The outlook is negative. The transfer and convertibility assessment remains 'AAA', as it does for all members of the eurozone. The negative outlook reflects our view of the risks to Spain's economic growth linked to private sector deleveraging, external financing pressures, and their impact on budgetary consolidation. We could lower the ratings again if, consistent with our downside scenario, the economy contracts in 2012, Spain's fiscal position significantly deviates from the government's budgetary targets, or additional labor market and other growth-enhancing reforms are delayed. Conversely, we could revise the outlook to stable if, consistent with our upside scenario, the government meets its budgetary targets in 2011 and 2012, risks to external financing conditions subside, and Spain's economic growth prospects prove to be more buoyant than we currently assume.
Philly Fed dissenter and rebel Charles Plosser, said something stunning during a Q&A session at the Zell/Lurie Real Estate Center at Wharton. When asked what he thought of Operation Twist, his response: "it is fiscal, not monetary policy, and does not have much credibility ....Treasury debt issuance could undo much of the effect of the Fed's attempt to lower borrowing costs, known as 'Operation Twist', Plosser said. "It doesn't have a whole lot of credibility attached to it." While we have no doubt that Twist has no credibility and both the Fed and the market will figure this weakest link out within a month, forcing the Fed to proceed, over the 3 dissenters pseudo-dead bodies, with much more LSAP, it is somewhat shocking to hear confirmation that the Fed itself now sees its duties as those of the legislative, or the body tasked with writing America's laws and funding required amounts of money via debt issuance. Granted, it is well known that America's congress is now in a state of perpetual impasse with no further stimulus likely to come as long as the GOP controls the Congress and Obama is president. But at least the American people (deserving as they are of their representatives and president) pick those in congress. The last time we checked, the "popular election" of the Fed chairman is not in the purvey of the US constitution, and the only capacity given to public representatives is to veto his nomination. Everything else is decided in a banker-filled conclave. Which then begs the question: has the Fed admitted the archaic concept of the US republic is now over and done with?
Michael Lewis’ latest piece in Vanity Fair, “California and Bust,” begins with a lengthy defense of Meredith Whitney’s prediction that there would be a wave of defaults in the municipal bond market. I was not planning on writing a response to his article – frankly, defending Whitney’s call at this point is very much like defending Harold Camping’s prophesy on May 22nd, after even the most gullible people have realized that they euthanized their pets for nothing. Who really cares about the intransigent believers that remain, for whom a forceful narrative has always been more relevant than facts?