Credit Default Swaps

Greed; corporate arrogance; lobbying influence; excessive leverage; accounting tricks to hide debt; lack of transparency; off balance sheet obligations; mark to market accounting; short-term focus on profit to drive compensation; failure of corporate governance; as well as auditors, analysts, rating agencies and regulators who were either lax, ignorant or complicit. This laundry list of causes has often been used to describe what went wrong in the credit crunch crisis of 2008-2010. Actually these terms were equally used to describe what went wrong with Enron more than twenty years ago. Both crises resulted in what at the time was the biggest bankruptcy in U.S. history — Enron in December 2001 and Lehman Brothers in September 2008. Naturally, this leads to the question that despite all the righteous indignation in the wake of Enron's failure did we really learn or change anything?

"At all times, ultimate collateral and ultimate money remain crucial reference points in modern financial markets, but the actual instruments are important only in times of crisis when promises to pay are cashed rather than offset with other promises to pay.... Our world is organized as a network of promises to buy in the event that someone else doesn’t buy. The key reason is that in today’s world so many promised payments lie in the distant future, or in another currency. As a consequence, mere guarantee of eventual par payment at maturity doesn’t do much good. On any given day, only a very small fraction of outstanding primary debt is coming due, and in a crisis the need for current cash can easily exceed it. In such a circumstance, the only way to get cash is to sell an asset, or to use the asset as collateral for borrowing."

Any backwardation in gold at all is serious. Recently, a related phenomenon has occurred: the GOFO rate has gone negative.

The catch 22 is that the Fed cannot exit now without markets and asset classes free-falling with markets at hundred year highs!

The Chairman is about to take the lectern to discuss bank structure and competition at the SIFI conference at the Chicago Fed. His prepared remarks are likely to be a little less exciting than the Q&A where the world will be watching for the words "buy, buy, buy", "mission accomplished", or "taper". Charles Evans will be his lead out man. Finally, since Bernanke will be discussing shadow banking, or the source of some $30 trillion in shadow money always ignored by Keynesians, Monetarists and Magic Money Tree (MMT) growers, a topic we have discussed over the past three years, here is the TBAC's own summary on how Modern Money really works.

The euro continues to not get the memo. After days and days of attempted jawboning by Draghi and his marry FX trading men, doing all they can to push the euro down, cutting interest rates and even threatening to use the nuclear option and push the deposit rate into the red, someone continues to buy EURs (coughjapancough) or, worse, generate major short squeezes such as during today's event deficient trading session, when after France reported a miss in both its manufacturing and industrial production numbers (-1.0% and -0.9%, on expectations of -0.5% and -0.3%, from priors of 0.8% and 0.7%) did absolutely nothing for the EUR pairs, it was up to Germany to put an end to the party, and announce March factory orders which beat expectations of a -0.5% solidly, and remained unchanged at 2.2%, the same as in February. And since the current regime is one in which Germany is happy and beggaring its neighbors's exports (France) with a stronger EUR, Merkel will be delighted with the outcome while all other European exporters will once again come back to Draghi and demand more jawboning, which they will certainly get. Expect more headlines out of the ECB cautioning that the EUR is still too high.

The debate about the usefulness of sovereign credit default swaps (SCDS) intensified with the outbreak of sovereign debt stress in the euro area. SCDS can be used to protect investors against losses on sovereign debt arising from so-called credit events such as default or debt restructuring. With the growing influence of SCDS, questions arose about whether speculative use of SCDS contracts could be destabilizing - and this caused regulators to ban non-hedge-related protection buying. The prohibition is based on the view that, in extreme market conditions, such short selling could push sovereign bond prices into a downward spiral, which would lead to disorderly markets and systemic risks, and hence sharply raise the issuance costs of the underlying sovereigns. The IMF's empirical results do not support many of the negative perceptions about SCDS. In particular, spreads of both SCDS and sovereign bonds reflect economic fundamentals, and other relevant market factors, in a similar fashion. Relative to bond spreads, SCDS spreads tend to reveal new information more rapidly during periods of stress, admittedly with overshoots one way or the other. Given the current apparent 'stability' in many nations' bond market spreads, the chart below suggests an alternative way of judging what the credit market thinks - the volume of protection bid - and in this case some interesting names emerge.

Debt-serfdom and the dominance of Financial Power are two sides of the same coin. Let's be clear about three things: 1. Too Big to Fail financialization is the metastasizing cancer that has crippled democracy and capitalism; 2. Financialization feeds on expanding debt and cannot survive without it; and 3. Debt is serfdom. Debt is the mechanism of the Financial Powers' dominance and the chains of our serfdom. Eliminate debt and you eliminate the foundation of banks' power and the financial bondage of serfdom. Though it would dearly love to, the State cannot force anyone to take on debt except as taxpayers. We do not have to remain debt-serfs, nor accept our servitude as unavoidable or fated. Debt = serfdom. There is another way to live, frugally, with only short-term debts that are paid off in a few short years. We either accept the consumerist-narcissist debt-serf programming or reject it. We are neither victims nor bystanders. The choice is ours.

This is the third and last of three articles we are posting on the price suppression of gold. In the first article we showed that, under mainstream economic theory, the suppression of the gold market is not a conspiracy theory, but a logical necessity, a logical outcome.  Mainstream economics, framed by the Walras’ Law, believes in global monetary coordination which, to be achieved, necessitates that gold, if considered money, be oversupplied. The second article showed, at a very high (not exhaustive) level, how that suppression takes place and how to hedge it (if my thesis is correct, of course). Today’s article will examine the systemic impact of this suppression and test the claim of the gold bugs, namely that physical gold will trade at a premium over fiat/paper gold, commensurate with the credit multiplier created by the bullion banks. (Hint - it is)

On April 13, 2012 Jamie Dimon described the situation at the CIO as massively overblown and said it was just "a tempest in a teapot." A few days later, the head CIO trader, Javier Martin-Artajo, when speaking to the former JPM Chief Investment Officer, Ina Drew, had a less sanguine description: "and, and, you know, things like this, it's like the twin towers falling down." Let's agree to disagree and just compromise on "tempest in a towering inferno." But that's not the point of this post. The point is in the same transcript we learn that it was none other than Ina Drew who told Artejo that "it would be helpful, if appropriate, to get, to start getting a little bit of that mark back" and instructed the Spaniard to go ahead and "tweak" the daily P&L on the CIO portfolio by "an extra basis point." Nothing like your supervisor telling you to fudge marks just to demonstrate that the "curve is starting to trend."

Waste and Fraud Are the Real Causes of the Deficit

Deutsche Bank co-CEO: “In this uncertain world, I cannot exclude anything."

My colleague and erstwhile nemesis Gonzalo Lira posed the question above in a recent essay, and it is indeed a most puzzling one.  Given that the world’s central banks — joined most recently by a shockingly reckless Switzerland — are waging all-out economic war by inflating their currencies, shouldn’t gold be soaring?

"Jesse Litvak arranged trades for customers as part of his job as a managing director on the MBS desk at Jefferies.  Litvak would buy a MBS from one customer and sell it to another customer, but on many occasions he lied about the price at which his firm had bought the MBS so he could re-sell it to the other customer at a higher price and keep more money for the firm.  On other occasions, Litvak misled purchasers by creating a fictional seller to purport that he was arranging a MBS trade between customers when in reality he was just selling MBS out of his firm’s inventory at a higher price.  Because MBS are generally illiquid and difficult to price, it is particularly important for brokers to provide honest and accurate information. The SEC alleges that Litvak generated more than $2.7 million in additional revenue for Jefferies through his deceit.  His misconduct helped him improve his own standing at the firm, as his bonuses were determined in part by the amount of revenue he generated for the firm." 

A week ago, when Wells Fargo unleashed the so far quite disappointing earnings season for commercial banks (connected hedge funds like Goldman Sachs excluded) we reported that the bank's deposits had risen to a record $176 billion over loans on its books. Today we conduct the same analysis for the other big two commercial banks: Wells Fargo and JPMorgan (we ignore Citi as it is still a partially nationalized disaster). The results are presented below, together with a rather stunning observation.