Capital Markets

Something amusing happened in today's global capital markets: while European bond markets, especially in the periphery, are sliding following the Spanish downgrade and the Italian bond auction, one market has soared: that of Greece, which is up nearly double digits (not all that meaningful when you are at 20+ year lows), and whose bankrupt and deposit-free banks are up 20%. Which in turn is pushing US futures higher despit the Spanish record yield. What has caused this spike? Nothing but more political rhetoric and jawboning. Specifically, overnight Kathimerini reported that "Stefanos Manos, the leader of the small liberal party Drasi, claims that leftist SYRIZA will not scrap Greece’s bailout if it comes to power because it is the only way it can guarantee salaries for its supporters in the civil service." Well, yes. Tspiras never said he will scrap the bailout. He merely said that he will end the memorandum in its current format. The decision then, and as always, would lie with Germany and the ECB, what to do about this latest Nash Equilibrium defection. In other words, the ultimate decision-maker was never Tsipras, and in fact even ND's Samaras has repeatedly said he would renegotiation the terms of the Greek bailout. But in this centrally-planned, robotically-traded market, confusion over cause and effect is to be widely expected.

There was a time in 2011 when every European auction, particularly those in Spain and Italy, was followed with great interest due to a morbid fascination that it may well be their last. In 2012 this time has come much faster than last year. Earlier Italy sold a total of €4.5 billion in 3, 7and 8 year bonds which was at the top end of the range of expected issuance. The problem was in the unsustainable yields this debt sold for:

• €3 billion in 2015 bonds, B/C 1.59 vs 1.52 in May 14, yield soared to 5.30% vs 3.91% a month ago
• €627 million in 2019 bonds, B/C dropped from 2.27 on April 27 to 1.99; yield soared from 5.21% to 6.10%
• €873 million in 2020 bonds, B/C dropped from 2.08% on May 14 to 1.66%, yield soared from 5.33% to 6.13%

Presenting JPMorgan's CEO Jamie Dimon's prepared remarks for tomorrow's debacle: The truth, the whole truth, and nothing but the totally unvarnished version of the truth that will fulfill Jamie Dimon's obligations to sit through a few hours of snide remarks, condescension, and bating. It does seem however that our initial perspective on this being a systemic risk hedge (i.e. a 'delta-hedged' senior tranche position as opposed to some easily managed and understood pairs trade) that rapidly grew out of control due to risk control inadequacies, is absolutely correct - though we suspect that is as close to the real truth anyone will ever get.

Jose Manuel Barroso, President of the European Commission, thinks Europe needs a unified banking system.

But how can financing be a solution for a Zone with a fatal fundamental flaw? Banking cannot save the euro-Zone. This proposal is only the distraction du jour.

Europe continues be unable and unwilling to look at the core problem in the Zone which has morphed into huge competitiveness differences that are creating havoc.

The easiest fix for this is a break up. For the Zone to survive this will require a lot of cooperation and frankly it does not seem close to doing it.

A land grab shrouded in a banking takeover, wrapped in a financial crisis "rescue." As always, insiders get first dibs.  (And, yes, there is an MF Global connection.)

The financial elite - using academe for intellectual cover - want you to believe that markets are efficient, as defined by the Efficient Market Theory (EMT). Neoliberal economic philosophy is based on the belief that neoclassical economic theory is correct. That is, that “markets are efficient”. Wall Street touts markets as trustworthy and infallible, but that faith is misplaced. Gullible US politicians believe that markets are efficient and defer to them. Therefore, US politicians abdicate their responsibility to manage the overall economy, and happily for them, receive Wall Street money. Mistakenly, the primary focus during the 2008 credit crisis is on fixing the financial markets (Wall Street banks) and not the “real economy.” The financial elite are using this “cover-up and pray” policy—hoping that rekindled “animal spirits” will bring the economy back in time to save the status quo. This is impossible because the trust is gone. The same sociopaths control the economy. A Federal Reserve zero interest rate policy (ZIRP), causing malinvestment, and monetizing the national debt with quantitative easing by the Fed, and austerity for the 99% to repay bad bank loans has not worked—and doing more of the same will not work—and defines insanity.

"Risk on, risk off" might be the most essential hallmark of the current market, but just focusing on the day-to-day whims of capital markets ignores longer term changes to investor risk preferences.  Nic Colas, of ConvergEx looks at the topic from the vantage point of gender-specific investment choices.  For example, more women are participating in deferred compensation (DC) plans, and the data from millions of 401(k) accounts tells a useful story.  Their retirement accounts still lag those of their male counterparts in total value and they remain a bit more risk-averse. But for the first time in at least a decade they are more likely than men to contribute to a retirement account and are contributing a greater percentage of their earnings. You’ll never see pink or blue dots on the “Efficient Frontier” of academic models, to be sure.  However, both empirical data and psychological studies do point to subtle – but notable – differences in how men and women consider the classic risk-reward tradeoff inherent in the challenge of investing. Nick suggests it may make sense to reconsider the notion that continued money flows into bonds and other safe haven investments are really "Risk off" market behavior.  At least a piece of it may well be "Risk shifting," driven by the demographic and psychological factors as assets controlled by women are clearly increasing. "Risk off" may well be "risk shift."

A week ago, Zero Hedge first presented the now viral presentation by Raoul Pal titled "The End Game." We dubbed the presentation scary because it was: in very frank terms it laid out the reality of the current absolutely unsustainable situation while pulling no punches. Yet some may have misread the underlying narrative: Pal did not predict armageddon. Far from it: he forecast the end of the current broken economic, monetary, and fiat system... which following its collapse will be replaced with something different, something stable. Which, incidentally, is why the presentation was called a big "reset", not the big "end." But what does that mean, and how does one protect from such an event? Luckily, we have another presentation to share with readers, this time from Eidesis Capital, given at the Grant's April 11 conference, which picks up where Pal left off. Because if the Big Reset told us what is coming, Eidesis tells us how to get from there to the other side...

Less than an hour ago Zero Hedge was happy to point out the glaringly obvious.

Bernanke speech will have nothing in it

— zerohedge (@zerohedge) June 7, 2012

Shortly thereafter, Bernanke confirmed it. Now it is Wall Street's turn to join in.

A month and a half after the SEC took a much-deserved break from watching taxpayer-funded pornography, and stumbled on the scene with its latest pathetic attempt to scapegoat someone, anyone, for its years of gross incompetence, corruption, and inability to prosecute any of the true perpetrators for an event that wiped out tens of trillions in US wealth, by suing Egan-Jones for "improperly" filing their NRSRO application in what was a glaring attempt to shut them up, the only rating agency with any credibility has done what nobody else in the history of modern crony capitalist-cum-socialist America has dared to do: fight back. We have only three words for Sean Egan: For. The. Win.

That former San Fran Fed chairman Janet Yellen would demand more easing is no surprise: she used to do it all the time. That Fed Vice Chairman, and Bernanke's second in command, Janet Yellen just hinted that she is "convinced that scope remains for the FOMC to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions", and that "while my modal outlook calls for only a gradual reduction in labor market slack and a stable pace of inflation near the FOMC's longer-run objective of 2 percent, I see substantial risks to this outlook, particularly to the downside" is certainly very notable, and confirms everyone's worst dream (or greatest hope assuming they have a Schwab trading platform or Bloomberg terminal) - more cue-EEE is coming to town.

The ascendency of behavioral economics over its “Classical” cousin is one of the more notable effects of the market turmoil of the last five years.  Simple constructs like “Every marginal dollar has utility” have given way to more nuanced explanations that incorporate how human beings really make decisions about the tradeoffs between money and deeply held emotions and beliefs. But even with this realization, academia still seems to have a choke hold on the studies that expand our knowledge of this new discipline.  Nic Colas, of ConvergEx, adds to the discipline’s canon with some examples of common street scams around the world. The comparisons he makes to recent events in the capital markets are fairly obvious, whether they be failed IPOs or the strategies used by weaker sovereign nations to negotiate with stronger ones.  The point here is not to call out anyone as inherent ‘Criminal.’  There are plenty of laws – and diligent regulators - surrounding the capital markets, after all.  Rather, the examples here are simply a lens that allows us to examine the nuances of human behavior with greater understanding. As the old saying goes, 'The proper study of mankind is man.'  Even when it is a con man.  And in the case of behavioral economics, perhaps especially so. 

First Moody's cut the most prominent Austrian banks, and now it is Germany's turn, if not that of the most undercapitalized German bank yet: "The ongoing rating review for Deutsche Bank AG and its subsidiaries will be concluded together with the reviews for other global firms with large capital markets operations." Punchline: "Frankfurt am Main, June 06, 2012 -- Moody's Investors Service has today taken various rating actions on seven German banks and their subsidiaries, as well as one German subsidiary of a foreign group. As a result, the long-term debt and deposit ratings for six groups and one German subsidiary of a foreign group have declined by one notch, while the ratings for one group were confirmed. Moody's also downgraded the long-term debt and deposit ratings for several subsidiaries of these groups, by up to three notches. At the same time, the short-term ratings for three groups as well as one German subsidiary of a foreign group have been downgraded by one notch, triggered by the long-term rating downgrades."

• Spain Seeks Joint Bank Effort as Pressure Rises on Merkel (Bloomberg)
• Banks Cut Cross-Border Lending Most Since Lehman: BIS (Bloomberg)
• Shirakawa Bows to Yen Bulls as Intervention Fails (Bloomberg)
• Merrill Losses Were Withheld Before Bank of America Deal (NYT)
• Investors Brace for Slowdown (WSJ)
• China's lenders ordered to check bad loans (China Daily)
• Obama Seeks Way Out of Jobs Gloom (WSJ)
• Noda Reshuffles Japan Cabinet in Bid for Support on Sales Tax (Bloomberg)
• China to open the market further (China Daily)
• Australian Industry Must Adapt to High Currency, Hockey Says (Bloomberg)
• Tax-funded projects to be more transparent (China Daily)

If the U.S. Federal Reserve were a hedge fund, its phones would be ringing off the hook with prospective investors wanting fresh allocations and Ben Bernanke would be zipping around the French Riviera in a gold-plated helicopter.  The Fed’s multibillion-dollar position in Treasuries is nicely in the money with the recent moves to record lows risk-free yields, after all.  But it’s policy outcomes, not returns, that the Fed is after.  By that measure, the current record low payouts in “Safe Haven” bonds (U.S., Germany, U.K, for example) are troublesome.  There is, of course, the worry that they portend a global recession.  This concern cannot be waved away with the notion that a worldwide flight to quality totally upends the bond market’s historical function as a weather-vane of economic expansion and contraction.  Beyond this concern, however, Nic Colas of ConvergEx sees two further worries.  The first is that the Fed has needlessly compromised its independence by pursuing bond purchases that, in hindsight, were unnecessary in the face of the current economic outlook and investment environment.  The second is that interest rates have been demoted to a supporting role in kick starting any global economic recovery. As with unfriendly aliens unpacking their bags at a landing site, the move to record low rates around the world is a truly menacing development. Historically, low interest rates have generally sparked economic recovery.  In the current environment, this gas-down-the-carb approach seems to have simply flooded the engine of growth.  Other factors are at play, as I have outlined here. The real answer is simply more time.