Moral Hazard

The Paradox Of Merkelism And ING's Not-So Grand Bargain

Despite another weekend of hope-driven chatter of a support-the-profligacy, print-til-we-die, mutually assured destruction game of chicken, we remain as far from the fiscal federalism, that we discussed earlier in the week (and the four critical questions that need to be answered) as ever. As we embark on yet another critical week in Europe's (and perhaps the world's future), ING addressed a critical aspect of the conundrum - that of Merkel's (read Germany's) reluctance to step on the gas and save the known universe. While attempting to quantify the price of break-up and the pay-now or pay-later perspective, they describe perfectly the 'Paradox of Merkelism' in that the core countries' attempts to limit their exposure have served only to increase it. They further worry that while a plan for a Grand Bargain may appear, this may rapidly give way to the recognition that the reality is not so grand - the bargain would still have to be delivered.

How The U.S. Will Become a 3rd World Country (Part 2)

The United States increasingly resembles a 3rd world country in terms of unemployment, lack of economic opportunity, falling wages, growing poverty and concentration of wealth, government debt, corporate influence over government and weakening rule of law. Federal Reserve monetary policies and federal government economic, regulatory and tax policies seem to favor the largest banks and corporations over the interests of small businesses or of the general population. The potential elimination of the middle class could reshape the socioeconomic strata of American society in the image of a 3rd world country. It seems only a matter of time before the devolution of the United States becomes more visible. As the U.S. economy continues to decline, public health, nutrition and education, as well as the country’s infrastructure, will visibly deteriorate. There is little evidence of political will or leadership for fundamental reforms. All other things being equal, the U.S. will become a post industrial neo-3rd-world country by 2032.

Second Biggest Dow Points Week Ever Ends On Weak Note

A 787 point gain on the Dow this week, second only ever in absolute points gained to w/e 10/31/08, ended on a disappointing note as equities gave back significant early gains around the NFP print to end the day practically unch (128pts off the highs). Equities underperformed credit on the day with another strangely impressive (given NAV and HY spread differentials) outperformance by HYG. On a medium-term basis, equities began to revert back to where broad risk assets are more supportive but on a short-term intraday basis, risk assets (most notably EURJPY, AUDJPY, and TSY levels and curves) were in a more aggressive derisking mode. ES definitely maintained strength for longer than many expected today before giving it all back into the close, but financials (especially the majors) were surprisingly positive today even after such a good week - quite a squeeze.

Walk Thru For The Upcoming European Treaty Changes - Is A Redemption Fund The "Transitory" Hail Mary?

Once again today was marked by ongoing disagreements over the form of any and every solution (or non-solution) to the 'problem' that is the Euro-Zone. At every corner, the EU Treaties are dragged up as impediments to the free-and-easy save-us-with-your-printing-press arguments (among others). Credit Suisse provides an excellent summary of the relevant sections and while their perspective is that the Treaties do provide some flexibility for the ECB to extend its operations (and the incumbent introduction of much stronger fiscal watchdog measures), Euro-bonds will (no matter what and certainly noty a slam dunk for success) require a full Treaty change - a process that could take years. There are currently three options being discussed for the Stabilittee bonds - all of which have more than short-term time horizons for any potential implementation and so we suspect, as CS mentions, that the talk of the Redemption Fund from the German Council of Economic Experts will grow louder as an interim step.

Squid Vs Merkel

As the hopes and prayers of every European central banker (and long-only manager) rest on age old battles; 'good vs evil', 'woman vs man', 'Germans vs the-rest-of-us', we found today's helpful note from The House Of Squid very amusing. Goldman, in their puppet-masterly way, suggest (in an ever so logical manner) that perhaps Mrs. Merkel should allow for the print-fest and provide their right-hand man Draghi with the ammo he needs to have that discussion.

"There are no easy choices and it would have been, no doubt, better if the ECB had never got in the position it is in now. But the current situation demands a careful weighing of the risk involved with any decision taken. The inflationary risk thereby seems to be getting an unduly high weight in the consideration of German policy makers."

Bundesbank's Jens Weidmann Discusses The ECB's Role As An Overthrower Of European Rulers, Bashes EFSF Incompetence

One of the last remaining Germans at the ECB, Jens Weidmann, gave an interview to the FT earlier today, in which the president of the Bundesbank, shared some pragmatic responses to questions about the depths of ECB intervention in the capital markets. The man who on Tuesday clinically stated explicitly that the "ECB can't print money to finance public debt" (to which he adds today that "this is a very fundamental issue. If we now overstep that mandate, we call into question our own independence"... odd, never prevented the Fed from questioning its own independence), follows up with some much needed clarity on just where the ECB sees itself in the coming weeks and months, touches on the rumor that sent stocks surging on Friday, namely that it would proceed to fix interest rates (it won't), and shares some rather amusing observations on the recent revelation that the ECB has become a weapon of political (de)stabilization: after all it took the ECB's bond buying program - the SMP - just two days of not buying Italian bonds for Silvio Berlusconi to resign after BTPs hit an all time rock bottom price. Yet the most amusing slap in the face of the Eurocrats is precisely what we mock every single day, namely the perpetually changing nature of the EFSF on a day to day basis, confirming the cluelessness of the continent's leaders, and which has cost Europe all credibility in the face of capital markets, explaining why the EFSF has to resort to not only buying its own bonds, but issuing terse statements denying anything and everything: "EU governments have decided how to finance the EFSF. They agreed on guarantees for the EFSF and, in their last meeting, on two options on how to leverage the EFSF – by an insurance model or a special purpose vehicle. Instead of working on implementing these approaches, we now have the next idea that is completely out of the realm of what has been discussed previously. I don’t think it builds confidence in crisis resolution capabilities if from week to week, from one meeting to the next, you are questioning your last decision."

Goldman On Italy - Part 3

This morning brings the latest, or the third, in the ongoing pitch book of Italian bonds by Goldman's Francesco Garzarelli, in which the strategist hopes that third time will be the charm for calling the bottom to the BTP collapse (sold to you, Goldman client). What apparently has Goldman confused is how its former employee Mario Draghi has let BTP spreads hit the record and unsustainable levels they did yesterday. To wit: "We were actually quite surprised not to see more forceful intervention by the central bank in secondary markets after the LCH announced it would raise initial margin requirements (and wrong in assuming it would have helped keep the Italy vs. AAA spread close to 450bp – it closed yesterday at 500bp over, but is now back at 450bp)." Here Goldman confirms what we suggested on Monday: that the ECB is now nothing but a policy enactment and dictator overhaul tool: "In this context, Italy still has to comply fully with the ECB’s ‘requests’ dated August 8, while Greece’s commitment to more austerity in exchange for financial support has continued to sway (at the time of writing, news that former ECB no. 2 Papademos would take the helm is encouraging)." Even so, the future to Goldman is quite cloudly :Granted, one positive collateral effect of market tensions has been to precipitate a political shakeup in Italy. But the collateral damage created by the price shock in Italian bonds to the stability of the EMU project (aggravated by explicit talk of countries being expelled from the single currency) is high and quite lasting. It will probably take a leap forward into deeper forms of fiscal risk-sharing (Prof Monti is a long-time proponent of Eurobonds) to get the market properly functioning again." OTOH, Barclays has done the math, and as we pointed out a few days ago, is not surprised.

Guest Post: Hard Evidence: Bailed-Out Banks Take More Risk

Moving from this granular level to a bank-wide basis, the authors found that the CPP banks increased asset risk (using ROA & earnings volatility as proxies) while decreasing their leverage (perhaps because they knew that regulators would be keeping an eye on this metric in addition to the capitalization ratio.) What does all this mean and how should this shape actions in the future? The bail-out itself increased our chances of having the bail the banks out all over again. Moral hazard is no longer in the realm of the abstract. Further, my guess is that the bailed-out banks took on more risk so that they could earn enough to speed repayment of the aid and therefore escape the onerous strings attached. So perhaps the limits on executive compensations, dividends, etc. in a perverse way increased our chances of having to bail the banks out all over again.

CME Issues Clarification On Margins: To Usher More Risk, Less Liquidity In MF Aftermath

Yesterday, in what is the worst-phrased and most misleading press release to ever come out of the CME, the exchange issued a notice that going forward all Initial margin would be equal to Maintenance margin. Our gut interpretation was that "Unless we are completely reading it incorrectly, it is nothing short of a margin call for tens if not hundreds of billions worth of product." Judging by the broad response, our initial reaction is what a prudent, logical human being would assume: after all, it is precisely the undercollateralization of customer accounts, and general underfunding at MF Global that is what brought that particular company down. Well, we wrong wrong. The CME, it appears has taken a page right out of the European playbook, and less than a week after an exchange-cum-Primary Dealer collapsed due to excessive risk taking, the CME has followed up its vague press release from yesterday by inviting even more risk in lowering the initial margin. Why is this a cause for even greater concern? As the CME itself says, "Initial margins are set to provide an additional buffer against future losses in the account" - so going forward that buffer has been reduced by about 30%. But what is the reasoning provided by CME: "The intent and effect of these changes is to decrease the size of any margin calls resulting from the bulk transfer of MF Global customers to new clearing members, not to increase them." So basically the CME is implicitly putting all of its existing and current clients and customers at further risk by onboarding the accounts of those clients who, like lemmings, held on to their MF Global accounts until after it was too late. Because while the lower Initial margin may apply to MF accounts, it will also apply to any Tom, Dick and Harry beginning Monday, who will suddenly see a 30% reduced gating threshold to put on a position. Any position, no matter how risky.

Morgan Stanley On What Happens Next In Greece, And Why It Is All Very Euro Negative

Friday’s confidence vote in the Greek parliament will be extremely important in our view and will likely set the pace of the anticipated EUR decline over the coming months. Greek Prime Minister Papandreou could now find it difficult to win a confidence vote (due Friday 10GMT) given the defections from the government leave only the slimmest of majorities (just 151 votes in the 300 parliament). If the Greek PM fails to win the confidence vote then the government will fall. There is the possibility for a new Government under a different PM or the formation of a unity government. But these outcomes seem unlikely given that the opposition is strongly in favour of new elections. While new elections will delay the vote on the new budget reform measures and potentially delay the next round of bailout funds from the EU, this is likely to be seen as one of the most positive (least bearish) outcomes for the EUR as it will avoid a referendum. There could even be an initial relief rebound for the EUR on any news that a referendum is being avoided, by the continued uncertainty and delays with regard the passing of the new budget measures and payment of EU bailout funds will likely keep the EUR under pressure over the medium term. Indeed, most of the options under discussion in the market are EUR negative in our view. A victory by Papandreou in the confidence vote on Friday is likely to be seen as the most bearish for the EUR, opening the door to a referendum and the potential rejection of the bailout package by the Greek population.