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Guest Post: Marked and Unmarked Bonds
Via Peter Tchir of TF Market Advisors
Every "solution" to the European debt crisis, whether it is ECB purchase, EFSF, Eurobonds, or BRIC's, fails to account for the fact there are really two types of bonds out there. There are those that are trading and marked, and those that remain on some bank balance sheet unmarked.
That is a key distinction. If all Greek bonds were marked at 45 (or even had 55 points of reserves held against them) then there would be a lot of potential solutions. You would need any of these specialized entities. Some big total return bond fund, or some large hedge fund could buy the entire universe of Greek bonds. Then they could sell them back to Greece for a nice little profit. Surely the IMF or someone would lend Greece the money to buy the bonds back, or within enough collateral and a high enough coupon, some big total return fund that is underweighted treasuries, could lend Greece all the money they needed to buy back those bonds.
The problem is, not all the bonds can be purchased at that price, not without forcing the banks to recognize the losses. That is why no solution of some new buyer of bonds really fixes anything. They can buy up the existing "marked" bonds, but that will mostly generate profit for the current holders. The amount they can accumulate is too small to improve the situation in Greece of the other countries. The percentage of marked bonds is just too low. Too many of the bonds are unmarked or massively under reserved. Banks selling them would monetize the losses, exactly the same as if there had been a default. Most of the banks that hold these bonds in non mark to market accounts are exactly the sort of banks that will be desperately seeking capital if they took the write downs.
Until the banks write the positions down enough, the system is operating with too many hidden losses. New money doesn't help address sovereign issues much because it only addresses the bonds that are already priced reasonably well. It doesn't encourage banks to take the losses, and doesn't let enough debt be restructured to change the path of insolvency. So governments can try and balance between pretending sovereigns are okay or that the banks are okay, but at some point it is going to break. I think very few investors are prepared for the magnitude of losses some banks will have due to finally marking their Greek exposure down. More than that, is it will crystalize everyone's focus on how mismarked are their other sovereign exposures are. That focus on how bad are the marks on other sovereigns will be the real catalyst for another leg down, but realizing losses on Greece will be what gets investor to focus on that issue again.
We have seen ECB purchases for almost 18 months now. The were not able to save Greece from insolvency. Their purchases did not reduce the coupons on bonds that Greece had already issued, and except for brief bounces in price, their purchases are dwarfed by failed austerity measures and declining GDP in the country. Worse than that, the ECB effectively takes bonds out of the "marked" pool and puts them back in a non mark to market book. The ECB cannot do anything with these Greek bonds. Offering to sell them back to Greece at the price the ECB paid is a joke as they are massively underwater on their Greek purchases. Marking them lower is not an option either since they cannot afford to take a hit without getting the EU members to post some fresh capital.
So far, most purchase programs, have failed to help through any auction of new net debt. When the ECB and China have aggressively participated in auctions of debt that is being issued to pay off maturing debt, the results have been okay. New net debt auctions haven't been so good - witness the Italian auction this week. Since these countries are all running current deficits, they need to issue new net debt. Keeping the coupon down on that might have a minor impact, but the reality is, intervention has not been helpful on that front. In the long term, solvency issues will play a greater role in determining bond prices than some new source of funds.
The buyers also have to be careful. The ECB thought Greece was a liquidity crisis. The ECB now has a very dubious balance sheet, that has so far escaped to much scrutiny, because they were wrong about Greece. As Greece has gotten worse, more people are questioning whether the ECB will need additional funds and whether the ECB is even acting independently or is just trying to cover up its own prior mistakes. Any country that is thinking of buying PIIGS debt runs the risk of getting sucked down along with the PIIGS. Sure, if the economies grow, taxes increase, debt decreases, etc., the investments will have worked. But just buying some bonds, whether in the secondary market or primary market, does not ensure any of those wishes will come true.
Does China really want to run the risk of losing their hard earned reserves? Sure a Greek default would hurt their sales into Europe. An Italian one would hurt as well. On the other hand, a default 2 years from now, once China owns 50% of the debt, would hurt China a lot more. Lending more money doesn't guarantee a favorable outcome. Greece has shown bond investors that. Assuming that some other country or entity will close their eyes, buy a bunch of bonds, and hope for the best, is a very weak reason to get long. There are more, and worse alternatives for the BRIC's than sovereign defaults in Europe, mainly sovereign defaults once they own most of the debt. I think they see that as a real risk, and that is why the BRIC's seem more interested in the mythical eurozone bonds, because they are happy to give as much money as Germany and France agree to pay back, beyond that, they are going to be careful.
The EU is spending time trying to figure out how to crush sovereign CDS. Outright bans, higher margin requirements, Central Bank selling of protection (Faros Trading has done some work on that). Some or all of these may be implemented. Selling CDS would be interesting as it should drive that thinly traded market a lot tighter, and would raise USD for the ECB since the names trade with good up front premiums and trade in dollars. It is worth watching out for if you are short the market via CDS. The EU should be very careful of what they wish for, even Mr. Geithner today said he was against banning CDS. The last Italian bond auctions seemed to have a good bid from CDS traders covering shorts (at least temporarily). Crushing the CDS market make give short term relief, but is also likely to make the next move down, faster and bigger than it would have been otherwise, and will lack the joy of having a scapegoat to try and pin the blame on.
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That sure is a lot writing you're doing for a pretty simple situation. Here's an idea for you Pete: Buy Gold(physical) then go to the sidelines then get popcorn for the fireworks. Later we'll talk about rebuilding...
no reason why these pesky little details should be a problem now that European trading is closed. Nothing but green skies ahead...until Europe reopens of course.
Ponzi on Wayne?
Ponzi on Garth.
Take a very good look at the numbers on the DOW and the S&P today. It could very well be the last time you see these numbers for many years.
So the bottom's in, eh?
Sounds plausible to me ... bring on the M-flation!
Yes, please elaborate. Those of us in cash and PMs want to know if you are calling a bottom here. If so, who is buying?
Problems with bonds? No.
Doesn't matter...there is a conference call coming up between Ponzi masters. Everything will be fine momentarily.
What prevents Greece from quietly buying back those bonds at 45 on the open market?
Oh right, they are broke and no one will lend them any money because they are a basket case.
i just bought them all, bitchez!
be careful, angry, i hope time this right.
p.s. nice rack.
Same type of whackjob market ramp as yesterday. Little tiny moves down after every jump up. I wonder if the moves are following any type of predictable pattern. We know the markets are being run by the algo autopilot so there must be patterns that come from the programmed behavior.
I wonder if we'll get the same crazy head and shoulders half hour repeating patters from yesterday?
My question is, Can a crappy plastic homemade soda machine that is now 50% off at major retailers still provide enough support for a stock up almost 20% in a week based on nothing but pure algo driven speculation? Can the stock make it back to its all time high right before the real earnings destroyed the stock? Because you know this quarter must be better right?
I think that the fact there is any demand for a crappy home soda machine is more indicative of a larger problem.
I wonder how long until we try it on plants? Cause its got electrolytes!
pods
+ Idiocracy
Questions regarding 2 points:
1. Where do you get that? Did you make that up? One thing would be to hypothesize an issue which is reasonable in the key of "some could be held without being marked" and another is to boldly proclaim with a large degree of confidence that majority are not marked down. For example, go through NBG statements, they keep marking down Greek debt.
2. An asset is worth what someoen is willing to pay for it. There is no reason that bank A can find a counterparty B which would do a total rate of return swap on the greek bonds assuming they are worth close to par. No sale happens, but it's off the books for some period of time.
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1. Too many of the bonds are unmarked or massively under reserved.
2.Banks selling them would monetize the losses, exactly the same as if there had been a default.
Just dump them on pension plans and get the tea party to blame it greedy workers when the plan goes bust.
Try editing better. Try editing period.
If one person or entity bought all the Greek bonds...then they would default...because it would only hurt one person or entity..now it hurts a lot of people...Banks, Pensions..individuals..whoever...so kicking the can keeps the votes..
fuck the votes it keep the bank from going bankrup and not being able to keep buying bonds
When you realise that out of all the daily transactions on the world financial markets only 5% concerns the real economy; the rest feeds the ponzi financial economy, you realise the level of financial criminal irresponsibility that the current markets generate for their Oligarchs, big and small. In pure fiat smoke...
here's the deal:
banks can't lose
the rest of us can and do
ok but wait a minute, this means that we will have to QE to infinity in order to let banks slowly devalue their bond holding over the years, for if they had to do it all together it would break the system, am I correct?
BNP Paribas is apparently sitting on the biggest pile of unmarked shit. Why weren't they dinged today? Some pipe dream about asset dispositions?
Patience willyboy. Today SocGen got a taste. Tomorrow maybe it'll be BNP. They're all dead men walking.