CDO

A few days ago, when we explained that the current iteration of the European bailout plan is nothing but a repeat of the failed MLEC off-balance sheet plan, which was supposed to prevent the subprime bubble from exploding, we wondered just why Europe has settled on this plan. Now we know: it appears that it was the rating agencies, arguably well-padded with $100 bills to compensate their collective conscience, who suggested that this is the only format of perpetuating the global ponzi without Greece being declared an Event of Dafault. Per Reuters: "The whole charm of the French model is that it was worked out in a such way that it will be fine with the rating agencies." There it is: expect headlines to slowly start leaking from S&P et al that the MLEC part deux will actually not be an Event of Default, and so Europe has the all clear to continue kicking the can down the road for several more years courtesy of money that is literally created out of thin air, and pledged by assets that no longer generate virtually any cash flows.

Yesterday during his press conference, the Chairman uttered his latest lie: "We have asked the banks to essentially do stress tests and ask, looking at all their positions, all their hedges, what would the effect on their capital be if -- if Greece defaulted...The answer is that the effects are very small.” Enter Aflac to prove that the half life of Bernanke's lies is now under 24 hours. From Bloomberg: "Aflac Inc. (AFL), the largest seller of supplemental health insurance, may issue as much as 100 billion yen ($1.24 billion) in debt as it records losses tied to investments in banks from Greece, Ireland and Portugal. Second-quarter losses on the assets will probably be about
$610 million, the Columbus, Georgia-based insurer said today in
a statement." Additionally, Aflac CEO Amos has added invesments in public utilities and Japanese government debt to minimize the company's exposure in Europe. Yet what is truly hilarious is that as the EFSF's spokesman Christof Roche just announced in commenting on the sale of 2016 bonds from the CDO, "Asian investors bought 46.5% of the bonds issued yesterday." In other words, by transferring exposure to Japan, Aflac is merely gaining exposure to Europe through yet another insolvent government. But such is life in the unwind phase of the biggest global ponzi ever conceived, in which the smallest mark to market event on the global financial balance sheet in which everyone's assets are someone's else liabilities and vice versa, will launch the biggest house of cards collapse in history.

There's a reason yesterday's announcement that JPM Chase would 'settle' for a fine of $156.3 million, while neither admitting nor denying any wrong-doing, thereby forking over the whopping equivalent of a normal person's weekly grocery budget, pisses people off. Because it's a marginal fleabite on the teflon hand of the nation's second largest bank in terms of punitive pain, and absolutely meaningless in altering the grand scheme of toxic securities creation or complex financial institution business as usual.

• Poll: 44% of Americans Say Worse Off Under Obama (Bloomberg)
• QE 2 Proves No Silver Bullet (Hilsenrath)
• China’s Money Rate Rises to More Than Three-Year High as Banks Hoard Cash (Bloomberg)... hmm, where have we heard this before...
• Europe’s Threat to Asian Exports May Force Slower Interest-Rate Increases (Bloomberg)
• Fed Frets Over Fiscal Recklessness Behind Calm of 0.09% Yield (Bloomberg)
• Greek Two-Year Government Notes Rise After Papandreou Wins Confidence Vote (Bloomberg)
• Plan to Ease Way for Unions (WSJ)
• PIMCO's El-Erian predicts Greece, others will default (Reuters)
• IMF: Spain needs bolder job-market reforms (Businessweek)

• SEC TO HOLD CONFERENCE CALL TO DISCUSS ENFORCEMENT VS JP MORGAN
• JP MORGAN TO PAY $153.6M TO SETTLE SEC CHARGES
• JP MORGAN TO SETTLE SEC CHARGES ON MISLEADING IN CDO ON HOUSING
• SEC CITES MISLEADING INVESTORS IN CDO TIED TO HOUSING MARKET
• KHUZAMI: JPMORGAN FAILED TO DISCLOSE MAGNETAR'S ROLE, INTERESTS
• KHUZAMI: JPMORGAN HAS REIMBURSED INVESTORS IN TAHOMA CDO
• KHUZAMI SAYS SEC MISLED INVESTORS IN SQUARED CDO

Done and done. And now JPM is off the hook for ever and ever. In other news JPM made $153.6 million in profits since you clicked on this post. Of course, that's irrelevant as Bear Stearns will be stuck with the bill.

In other news, www.bangbus.com shares are surging on a rumor of an imminent $153.6 million investment from an unknown source

Goldman's business model is designed around the exploitation of secrecy. Secrecy is organizing principle that governs modern credit markets. Credit default swaps, privately placed structured securitizations (e.g. CDOs), and hedge funds have all flourished-- they dominate the debt markets--because they are all designed to exploit secrecy. They all create extraordinary profits by keeping the rest of us in the dark. So in late 2006, if you wanted to find out what was happening in this newly created synthetic RMBS market, you couldn't find out much of anything. You couldn't find out anything about who bought or sold any CDO, or what was in any CDO, or how any CDO performed, unless Goldman or some other CDO underwriter deemed you sufficiently worthy of their selective disclosures. You couldn't learn anything from the sales or trading activity of mortgage bonds, because the related trading in credit default swaps was kept hidden beneath the surface. You didn't know anything about the trading activity related to the ABX indices, since that, also, was kept secret. And since the privately-held company that owned the ABX, CDS IndexCo LLC, operated in total secrecy, and since the privately-held company that published the price of the ABX, Markit Group Limited , operated in total secrecy, you had no way of knowing the extent to which the price of the ABX was manipulated through round-tripping, side deals with synthetic CDOs, or anything else. The only thing you knew, your only link to the illusory "reality " of market sentiment, was the quoted price of the ABX. And you might happen to know that the Chairman of CDS IndexCo was Brad Levy, a managing director at Goldman, which, along with a handful of other banks, controlled CDS IndexCo and Markit Group. Both the FCIC and the Levin subcommittee disclosed a wealth of information that others with a more skeptical bent can scrutinize in depth. This information poses a direct challenge to Goldman's dissembling, and to the moral hazard of access journalism, which is no substitute for the full transparency of a free and open marketplace of ideas.

According to flashing headlines, the CDO better known as the European Financial Stability Fund will be increased to guarantee €780 billion in the future, up from €440 billion currently (the same EFSF which currently sees Greece, which has no money left at all, guaranteeing €12.4 billion of European bailouts). This was largely expected previously as many had noted that the EFSF in its current form is insufficient to cover the liabilities of Spain once the country is swept away to the Greek insolvency tsunami. Alas, for the EURUSD which is seeing this as good news, and has surged on the announcement, this development actually means that Europe is taking proactive steps to fund Spain imminently when the house of cards start falling potentially as soon as Tuesday night. This is nothing but a Spain, and then Italy, backstop. However, for Italy to be covered, expect the total covered amount to be €1. 5 trillion. Did the Eurozone just blink?

From the Telegraph (UK): Moves by [UK] stronger banks to cut back their lending to weaker [EU] banks is reminiscent of the build-up to the financial crisis in 2008, when the refusal of banks to lend to one another led to a seizing-up of the markets that eventually led to the collapse of several major banks and taxpayer bail-outs of many more.

This is exactly what I've been crowing about for 2 years. It's actually much worse than Lehman... Much Worse!

Indeed, the next Crisis is coming. And it will make 2008 look like a picnic. Why? Because this time around the Crisis will involve entire countries, rather than just banks (see Greece today). It’s going to be really REALLY bad. And I would argue that 99% of people are completely ignorant of it.

When Zero Hedge first reported that the fund most exposed to the Sino Forest collapse is the once fabled and infallible (especially when it gets to pick the CDO portfolio it shorts) Paulson & Co, we suggested that the fund has lost $500 million on this one investment, pushing the firm deep into the red, and further calculated that the firm's flagship Advantage Plus fund was down about 13% for the year. Boy were we off. As the WSJ's Greg Zuckerman reports, Advantage Plus fund "lost more than 13% in the early part of this month, through June 10, leaving it down 19.65% for the year, according to two investors briefed on the performance...One problem for Mr. Paulson: The recent collapse in shares of China forestry company Sino-Forest Corp. The timber company has tumbled 80% since late May, amid allegations by a short seller of questionable accounting, which the company has denied. That collapse has resulted in a paper loss of more than $500 million for Mr. Paulson's firm, based on holding figures as of April 29 from FactSet Research. Paulson & Co. owned nearly 35 million shares of Sino-Forest, according to FactSet." Which means that rumors that Paulson, in addition to being long the stock, is also heavily long the firm's bonds which last traded just south of 60, are likely correct, and the Chinese fraud may have well cost the firm almost as much as it made on the now infamous Abacus CDO. And to think Zero Hedge predicted back in November that the Chinese fraudcaps would snag some very high profile targets. Little did we know that the complete lack of diligence characterizing most retail momo investors would befall the one fund that up until this point had basked in a halo of invincibility. At this point we would not be at all surprised if LPs, seeing a 20% plunge in their P&L, pull their capital from Paulson and put it in Muddy Waters, whose flawless track record is based purely on research and not on allegedly shady manipulative practices or economies of scale.

• Fed Officials Discuss Explicit Inflation Target (Bloomberg)
• No Fed Shift Seen at June Gathering (Jon Hilsenrath)
• China Developers’ Outlook Lowered to ‘Negative’ by S&P as Credit Tightens (Bloomberg)
• SEC probes Merrill CDO sale (FT), Is Andrew Ross Sorkin already drafting explanation how Merrill was not, repeat NOT short anything? Or is Bank of America just not a Dealbook sponsor?
• The Economy Is Now Immune to Keynesian Crack (Peter Schiff)
• Rosenberg '99%' sure of U.S. recession (Forbes)
• China Inflation Heading for 6% Shows Danger for Wen Extending Rate Pause (Bloomberg)
• White House wants business to aid in debt cap fight (Reuters)

Some thoughts by David Schawel at Economic Musings who follows up on our observations from a week earlier regarding the possibility for a major Treasury collateral scramble if and when Basel III is ever implemented, and the implications for US Treasury demand. "In my opinion, the implications of this are crystal clear: banks will obviously need to dramatically ramp up their holdings of these securities (mainly treasuries) in order to comply with the LCR ratio. This could provide a significant tailwind to treasury demand over the near to intermediate term. S&P says it best, “We believe there is a risk that this standard is too conservative- to the point where it could create a shortage of liquid assets…"

By the time the "too big to fail" banks and their lobbyists get through with the rules, banks will be relatively free to pursue lending practices that existed before the crash.

Watching international financial policy persisting on a concept to fight debt with more debt in an environment where official GDP growth rates only remain positive because of ridiculously low deflators, while interest rates apart from those central bank help for banks via laughingly low interest rates begin to surge everywhere else, this observer begins to wonder if one can expect anything else than a fast-rolling, simultaneous European banking collapse. Engulfed in more exponentially rising debt on public and private levels than ever before there simply cannot be another end of the longest growth cycle in history than a simultaneous collapse of international banking when lending freezes up due to fears about the real creditworthiness of the respective counter party. Globalization will have made it possible.

Is it ethical for the American homeowner whose mortgage has been securitized to default, even If they are not financially distressed? First, consider it is unlikely that marketable, fee simple, insurable title can be obtained as a result of fulfilling the obligations of the related promissory note. On the contrary the titles to some 60 million homes in America are badly clouded. Secondly, encouraging investment in an asset class that has been artificially inflated, then deliberately destroying the price of the asset, as part of a separate profit making scheme is unethical, and any agreement based on this type of fraud is grounds to consider the original debt instrument used in the agreement null and void. Fortunately these grounds are unnecessary, as increasingly US courts are ruling that these mortgages are already invalid for numerous other reasons.