Covenants

We recently asked:"are there really unpredictable market shocks or are investors paid not to care? To us, all signs point towards the next currency reset. We think monetary authorities are compulsively destroying the current global monetary system; they simply have no choice if they are to keep it afloat in the short term." With Bernanke not attending Jackson Hole, we think the choice for next Fed Chair may have profound economic implications, and that it would not require expertise in econometric modeling, credit policy management, and maintaining the public perception of economic stability. We think the next Fed Chairman will oversee a conversion of the global monetary regime. Neither growth nor austerity nor gloom of night will stay these currencies from their appointed devaluations. Bank balance sheets must be preserved; ergo sufficient inflation must be manufactured. We think the dull but persistent economic malaise amid increasingly aggressive monetary intervention policies will soon engender fear among the not-so-great washed – net savers. We think all should question whether we are 100% wrong. If not, then prudence dictates some allocation to properly held precious metals. (Presently, it is less than 1% of all global pensions.)

In all of the tortuous moments that have taken place with the European Union the one thing that has become apparent is a radical change of mindset. In the beginning there was a kind of democratic viewpoint. All nations had a voice and while some were louder than others; all were heard. This is no longer the case. There is but one mindset now and it is decidedly German. It is not that this is good or bad or even someplace in between. That is not the real issue. The Germans will do what is necessary to accomplish their goals. There is nothing inherently bad or evil about this but it is taking its toll on many nations in Europe. It is the occupation of Poland in a very real sense just accomplished without tanks or bloodshed as money is used instead of armaments to dominate and control a nation. Politically you may "Hiss" or you may "Applaud" but there are consequences here for investors that must be understood. First and foremost is that they will not stop.

The IMF offered Cyprus a bailout with no specific amount or even range and no time period while in the process gutting confidence in the banking system by robbing depositors and imposing losses on bondholders. A Damn good plan if I ever heard one!!

Choice excerpts: "Have we forgotten what a bank is & what they are used for?" "The rules haven't been changed, they've been revealed!" Liar... Liar... Ass on Fire!!!

One of the most interesting issues of what has happened in Cyprus is where was the problem three weeks ago? There was not a mention, not a hint of anything that was wrong. All of the banks in Cyprus had passed each and every European bank stress test. The numbers reported out by the ECB and the Bank for International Settlements indicated nothing and everything reported by any official organization in the European Union pointed to a stable and sound fiscal and monetary policy and conditions. The IMF, who monitors these things as well, did not have Cyprus or her banks on any kind of watch list. In just two weeks' time we have gone from not a mention of Cyprus to a crisis in Cyprus because none of the official numbers were accurate. Without doubt, without question, if this can happen in Cyprus then it could happen in any other country in the Eurozone because the uncounted liabilities are systemic to the whole of Europe.

I was a little early, but just as I promised, those European bank runs are coming as expected. Wait until I release my newest EU crash analysis, Lehman x 3, nearly guaranteed!!!

Deposit Insurance at a bank, any bank in Europe, is now meaningless. A bond indenture, any clause, any paragraph, any promise or assurance; now meaningless. The notion of private property, land, cash, house; now meaningless. The European Union will take what they want as they deem it necessary and the IMF will follow along. The question has been asked, during the last few days, why the bond holders of Cyprus were not tagged along with the bank deposits. We can answer the question. Virtually all of the Cyprus sovereign debt is governed under British law and so the EU did not pursue this course. Greece came first. Lesson one and "shame on you." Cyprus comes second and now "shame on me." What will come next? What will you tell your partners or your shareholders when they say, "You should have known." You will have no excuse!

Let's get some things straight and look what has happened directly in the face. There was no tax on the bank accounts in Cyprus. There still is no tax; the Cyprus Parliament has not passed it and will not vote on it until tomorrow so whatever action takes place it is retroactive. Next, this was not enacted by Cyprus. The people from Nicosia did not go to the Summit and ask to have the bank accounts in their country minimized to help pay the bills. Far from it; the nations of Europe, Germany, France, the Netherlands and the rest, demanded that this take place, a "fait accompli," the President of Cyprus said and Europe annexes Cyprus. Let's be quite clear; the European Union has confiscated the private property of the citizens in Cyprus without debate, legislation or Parliamentary agreement. Pay attention please. The European Union and the European Central Bank and the IMF have just advocated the confiscation of private property for their own indulgence.

I've got that whiff of rotten eggs again.

Those who traded credit in the frothy days of 2007 will recall that virtually every piece of new paper, including LBO debt, would come to market with the skimpiest of creditor protections, i.e., "covenant lite" which to many was an indication that money was literally being thrown without any discrimination in the last epic chase for yield, just as many were preparing for the imminent market backlash. Which they got shortly thereafter. Judging by the amount of covenant lite loans issued in 2012 as a percentage of total and compiled by Brandywine Management, which just surpassed the credit bubble frenzy of 2007 at more than 30% of total issuance, the bubble in credit is now well and truly back - a job well done Federal Reserve, just 5 years after the last credit bubble.

For the fourth year in a row we continue our tradition of summarizing what you, our readers, found to be the most relevant, exciting, and actionable news of the year, determined simply by the number of page views. Those first eager for a brief stroll down memory lane of prior years can do so at their leisure, by going back in time to where the top articles of 2009, 2010 and 2011 are recapped. With that out of the way, here is what readers found to be the most popular posts of the past 365 days..

Bigger Tax Payer Bank Bailouts Cometh? If You Think Taxes Are Gonna Be Higher You Ain't Seen Nothing Yet! I welcome one and all to show me how it will not be so.

Since 2009, outside of the megabanks in Europe, the bulk of the rest of the financial system has been completely shut out of the unsecured financing markets. One of the workarounds to this liquidity problem was the reclamation or retention of covered bonds issued by the Eurozone banks themselves, but these are constrained by strict allocation rules. Once the bank reaches that defined upper bound, where it is already close to exhausting this route, the bank will be forced to find a further alternate means for funding its existing loan portfolio. We discussed the issuance of self-referential or ponzi bonds previously since - can you really “own” your own liabilities?  Since circular logic pervades the current realm of central banking, this is wholly unquestioned.  In reality, retained covered bonds are just the accounting gloss on direct monetization of past and existing mortgage loans. Covered bonds as collateral to the ECB is an extremely important bridge holding the shaky liquidity system together as it is now; as the shortage of 'good' collateral increases, banks that do not possess enough “good” collateral have self-selected themselves for extinction and resource re-allocation.  There is no economic argument for maintaining self-selected bad banks.  Free markets demand their extinction.  Anything short of that will result in escalating and perpetual liquidity and solvency crises until the real economy is freed from the yolk of bad banks and their dis-intermediation. There is no real wonder as to why we have exactly that right now – the intrusion of politics done in the name of economics.

Over two weeks ago we first described what at that point was merely the hint of trouble at Australian mega-miner Fortescue which is slowly but surely losing the fight with insolvency courtesy of plunging iron ore prices, whereby it was once again proven that bonds always have a better grasp of the situation than equities. Sure enough the cash crunch which we predicted was imminent at Fortescue, has since hit the company over the past several days, as the firm is currently in dire liquidity straits, desperate to renegotiate covenants and get waivers that allow it to continue operations even as creditors get the short stick (in exchange for some serious money upfront). It is unknown whether it will succeed, although judging by its halt from trading until next week by which point it hopes to restructure its debt, things are certainly not rosy for the megalevered iron-ore company. In retrospect, FMG AU is lucky to be alive as is, having had a comparable near-death experience back in 2007/2008: should its bondholders end up owning the equity, so be it. However, another far more troubling and certainly underpriced covenant renegotiation has struck, this time impacting Chinese conglomerate Sany Heavy Industry, a company which is the Chinese equivalent of US Caterpillar and Japanese Komatsu, which is owned by Liang Wengen who is mainland China's richest man with a $10 billion net worth, and which is so big and diversified that under no circumstances should it be forced to request covenant waivers, especially not under a soft-landing scenario for China. And yet this is precisely what it did.

Two weeks ago when we posted "The Kangaroo In The Metals Mine: Fortescue Trying To Raise $1.5 Billion From 20 Banks As Iron Prices Implode" we observed several developments in the bond prices of Australian mega iron miner, and fourth largest in the world, Fortescue, which suddenly found itself in dire need of cash which is always a first step to insolvency, which made us comment that just "like that we are back to those days of 2008 when the Chinese demand collapse meant any day could be FMG's last. Happy days are back again." Not really. We added that "as usual, the bond market is the first to get the memo that the landing is going to be a hard one. We give the farce that is known as equities about 4-6 weeks before they too get the memo." We were actually wrong: it took just two weeks for equities to finally figure out what we were warning about. From Reuters: "The world's no.4 iron ore miner Fortescue Metals Group Ltd has asked lenders to waive debt covenants if iron ore prices remain under pressure, the firm said on Thursday, after its shares suffered their worst loss in almost four years. Like other Australian miners, Fortescue's earnings have come under pressure from a plunge in commodity prices caused by weak demand in top consumer China. This has squeezed its ability to service its long-term debt, which stands at $11.3 billion." Of course, those who read our August 31 report, and were positioned accordingly and ahead of the market, made 20% in two weeks.