Guest Post: Waiting For Lehman

Tyler Durden's picture

Submitted by Gonzalo Lira

Waiting For Lehman

In Samuel Beckett’s play Waiting for Godot, the four main characters wait in vain—Godot never arrives.

In the financial markets, the same thing is happening now—we are all waiting for Lehman: That sudden bankruptcy-crisis-calamity which sets off a whole series of credit events, which in turn causes massive sell-offs, plunging markets, collapsing confidence, and ultimately—just like the bankruptcy of Lehman Brothers did back in 2008—shoves the entire global financial edifice right up to the very edge of the cliff.

To the edge—and perhaps this time over it.

We have good reason to be waiting for Lehman—our current situation is simple and stark: Sovereign nations and individual citizens are over-indebted—to the point where they cannot pay back what they owe. We all know that this overindebtedness at the sovereign and individual level is going to end, and end badly: Worse than 2008.

So along with everyone else, I’ve been waiting for Lehman—and fruitlessly trying to guess which will be the Lehman-like event this time around. Will it be the bankruptcy of Dexia? BofA? UniCredit or SocGen or one of the Spanish banks? Will it be a war in the Middle East? Bad producer index numbers from China? A fart by a day-trader in Uzbekistan?

When will Lehman arrive!?!?

But lately, my thinking has changed: Like the characters in Godot, I think that we’re waiting in vain. The Lehman-like event will never arrive because it won’t be allowed to arrive. So this miserable slog we are going through will continue—indefinitely. (Yeah, I know: Sucks to be us.)

My thinking is based on two assumptions: One, that the central banks and government financial authorities and regulators around the globe are absolutely terrified of a repeat of a Lehman-type bankruptcy or trigger event. And two, that those self-same central banksters and government drones will do absolutely anything to prevent another Lehman-like credit event from setting off another cascade of consequences.

And when I say “absolutely anything”, I’m not using hyperbole: Fuck principles, fuck the law, fuck legal constraints, fuck even basic long-term economic and fiscal health—or sanity. The clowns running the circus were so freaked out by the effects of the 2008 Lehman bankruptcy and the domino-effect that it triggered, that they will not let it happen again—ever. Come what may.

Hence, this endless Waiting for Lehman: This endless slog of ad hoc solutions and fiscal half-measures that brings us only tension and misery—and erodes our economy even further.

But this certainty that the bureaucrats in Washington and the eurocrats in Brussels and Frankfurt will do absolutely anything to avoid a Lehman-like event adds something key to the equation:

Predictability.

Since we know how the central banks and economic leadership will react—that is, if we start from the assumption that the political/economic leadership will do absolutely anything to prevent a major credit event from taking place—then we can predict what they will do in the three main areas of weakness:

  • Sovereign debt and the possibility of default.
  • Financial sector weakness and the possibility of insolvency.
  • Geopolitical crisis and the possibility of another Oil Shock.

What follows is a discussion of those three areas of weakness—and what the central banks and economic leadership will do about each of them.

A Sovereign Debt Default

We all know the score, insofar as sovereign debt is concerned:

National governments—as well as local ones—went on a spending spree during the good times before 2008. They over-promised entitlements and services, while at the same time cutting taxes—thus placating the electorate with the promise of something for nothing. They financed the inevitable shortfall with cheap sovereign debt. Hence the massive fiscal deficits during boom years.

Now, of course, we’re dealing with the hangover.

Because of the recession and the concomitant high unemployment, tax receipts have dropped—drastically. Hence the hole of the governments’ balance sheets—which was big to begin with—becomes massive during these bad times, requiring even more money—

—thus pushing sovereign nations closer to default and bankruptcy.

The nations most in debt, and therefore most likely to default, are well-known—Greece, Portugal, Spain, Italy. But there is also the issue of local government over-indebtedness and default in the United States, China, the various “strong” European nations, etc. No nation is exempt from this problem—which will come due.

Or will it?

If we assume that the central banks and government regulators will do absolutely anything to prevent a Lehman-like event—in this case a sovereign debt default—then their course of action becomes abundantly clear: They will do for the big economies what the Europeans have been doing for Greece. They will hand out more loans, backed by assets that are less and less trustworthy, in exchange for more promises of austerity and fiscal responsibility that everyone knows will not be kept.

Greece is the poster-child for this pernicious approach: Ever since April of 2010, when the Greek issue first reared its anencephalic head, the European Commission, the IMF and the European Central Bank—the so-called “Troika”—have been struggling to “fix” the Greek situation by giving Greece more debt with which to tide the country over until their situation “turns around”.

But the problem, of course, is that the Greek economy is not getting any better.

And every fix has failed, because the Greeks fail to live up to their side of the bargain: They fail to implement the austerity measures they promise, they fail to raise the taxes that they say they will (tax avoidance in Greece is on a par with Argentina, or Delaware-based corporations)—

—yet the Troika still tries to fix Greece with more loans! Every time! Even now, this past week, Angela Merkel and Nicolas Sarkozy say they are close to “fixing” Greece. The very epitome of Einstein’s dictum that insanity is doing the same thing over and over, yet expecting a different result—the Troika’s living it in the flesh!

So: Is the Troika crazy, under Einstein’s definition?

No: Because the Troika’s aim is not to fix the Greek situation—the Troika’s aim is to prevent Greece from becoming the Lehman-like event.

This is exactly what the Federal Reserve, the European Central Bank, and the assorted financial bureaucrats will do with every other major sovereign debt that is out there: They will keep on lending it money, so long as it prevents a default.

So what’s the upshot for us small fry?

Here comes the boring money-grubbing stuff, where I discuss what the above policy approach will mean for small investors—which I have thoughtfully edited out for you Gentle Readers uninterested in such mundane affairs. For you Godless materialists, you can read the full version here.

A Major Bank Bankruptcy

The major European and American banks are all exposed to the bad European sovereign debts—the European banks directly by way of actually owning this crap, the American banks indirectly via their sale of credit default swaps on the bad European sovereign debts.

The weak banks seem to be Dexia, Bank of America, UniCredit, Société Générale, BNP Paribas—though nobody really knows.

Why doesn’t anybody know for certain how weak these guys actually are? Because following the 2008 Global Financial Crisis, the financial authorities made the banks’ balance sheets more opaque—that is, less transparent.

In the United States, the suspension of FASB 157—which essentially allowed American banks to mark to make-believe—was just one of the policies implemented to, quote, “shore up the financial sector”. A similar process took place in Europe.

The Orwellian/Absurdist rationale was, “If nobody can see how weak a big bank really is, then it is no longer weak—therefore, it is strong”. (Beckett would have been so proud.)

Hence Bank of America: It is impossible for anyone outside the bank to really say for sure how weak BofA really is—but there are some mighty powerful clues. In the last two months, Warren Buffett lent them $5 billion, at usurious terms—then BofA sold its very lucrative stake in China Construction Bank for $8.3 billion—then BofA announced the lay-off of 30,000 employees, representing a yearly savings of some $5 billion.

All told, Bank of America raised north of $18 billion. Does anybody ever raise that kind of cash just because they feel like it?

No they do not. Likely as not—though this I cannot prove—someone must have told BofA to raise that kind of capital. (Methinks it was Tiny Timmy Geithner, but again, I have no proof, merely a speculative mind.)

On the European front, the Belgians and the French have just finished nationalizing Dexia. They didn’t call it “nationalization”—I would characterize it as “cannibalism”: The French, Belgian and Luxembourger governments essentially bought the local (profitable) pieces of Dexia for a song, and left all the crap in “Dexia”, de facto creating a bad bank carrying all the euro-trash. The bullet-points of the deal are here.

Q.: Was there a Dexia credit event?

A.: No. There was no Dexia bankruptcy—hence no Dexia default—hence no Dexia credit event.

Hence no crisis. The Dexia nationalization/cannibalism wasn’t big on the radar of the American commentariat, but it was important: One of the biggest banks of Europe was broken up over a weekend, with nary a ripple in the global credit markets. Significant? Very. Now that the strong parts of Dexia have been stripped away, and the bad parts are locked into the much small “Bad Dexia”, the unwinding and ultime bankruptcy will not wreak havoc on the French, Belgian or Luxembourger economies. There will be no triggering of American-written credit default swaps.

In short, there will be a big yawn, when “Bad Dexia” finally goes under in a year or two—which is precisely what everyone wants.

Thus these are the twin models of how other teetering banks will be managed: In Europe, their profitable units will be stripped off the cancerous skeleton of the bank, and then grafted onto existing (and State-controlled) local banks, leaving behind the “bad bank” with the name of the failed institution—like Dexia.

In America, the bank will be recapitalised, even as it is shrunk. Insofar as Bank of America is concerned, apart from all the cash they’ve raised through these deals, there is a lot of talk that the Merrill Lynch investment banking unit—which BofA bought at the height of the 2008 crisis—will be spun off and/or sold. My bet is Merrill will indeed be spun off—and right soon.

So once again: What’s the upshot for us small fry?

Once again: Boring stuff about money and contrarian bets. For you rubberneckers, you can go here to read what I wrote about where the money’s at. For everyone else: Move along, nothing to see here folks.

A Geopolitical Crisis

At this time, the most obvious potential crisis is the Middle East—specifically, a possible war with Iran.

At SPG, we already discussed in detail the financial effects of such a war. So I won’t bother going over it again here.

Needless to say, the conclusions were not pretty.

Is there the real possibility of such a war? Well, considering all the noise and trial balloons coming out of Israel, war with Iran seemed at one point inevitable—

—but lately, the tide has most definitely turned. Any notion of “all options on the table” insofar as Iran is concerned is starting to go over like a lead zeppelin.

Take this latest “Iranian plot”—the supposed attempt to assassinate the Saudi ambassador to the U.S. (huh? I mean really, why bother): Some people behind the curve are still growling about attacking Iran, and using this “plot” as an excuse to beat the War-with-Iran drum.

But this latest “Iranian plot” has been met by the American government and Capitol Hill with calls for sanctions and more diplomatic isolation—but not with calls to bomb Tehran. The more plugged in of the American nomenklatura aren’t taking seriously any talk about war with Iran.

Why? Because an American (or Israeli) war with Iran would break Europe. The U.S. doesn’t import Iranian oil, much less depend on it—but Europe does, especially Italy. Recall the oil consumption figures of the SPG Scenario. And anyway, a cut in Iranian oil supply would hit global oil prices equally—disastrously.

An Oil Shock brought about by a war with Iran would hit Europe—which would hit American banks, due to their exposure to Europe. An Oil Shock—as the name implies—would drive up oil prices, further eroding the global economy. An Oil Shock that hits Europe would likely kill the euro, as inflation would skyrocket.

In fact, any hiccough in the Middle East which hits oil prices would be disastrous for the global financial sector, as well as the global economy.

And the Western central banksters and assorted bureaucrats and eurocrats know this.

Therefore (and of course, barring any unforeseen calamity), there will be no war with Iran any time soon. The financial leadership will make sure to quell any such notion of war with Iran.

In fact, now that Gaddafi is dead, not only will there be no war between the West and Iran—the United States and/or Europe will actively help wipe out any Middle Eastern protests that threaten oil production. In other words, the West will try its utmost to end the Arab Spring.

Increasingly—especially as the Libyan rebels show themselves to be less pro-Western than people have fooled themselves into believing—there will be the notion of “better the Devil you know than the Devil you don’t”. And if this approach means siding with bloody dictators and betraying quaint notions of democracy, human rights, etc., in order to shore up the availability of oil, well . . . too bad: The global economy and the banksters’ bonuses are more important than the lives of a few million ragheads.

So once again, and for the third and final time: What’s the upshot for us small fry?

Once again—and for the third and final time—I won’t bore you with the details. It’s just a tedious discussion of oil prices, and where they will likely go in the near-term future. But if you want to bore yourselves silly, read the full post here.

Conclusions

The situation we find ourselves in reminds me of the First World War: The European diplomatic situation back then was tied up among all the nations of the continent by way of a series of pacts, alliances and coalitions of mutual assistance. They were wrapped up so tightly that, when a relatively minor event happened—the assassination of Archduke Franz Ferdinand—it set off a chain reaction of obligations and consequences that eventually led to the whole continent going up in flames.

The same thing is going on today, with regards the global financial markets: Everyone is obligated to everyone else, by way of credit instruments. Therefore, if one of these obligations is broken—that is, a default by one of the European countries, or a cash hole in one of the banks, or a spike in oil prices that creates a hole in someone’s balance sheet—the entire rickety structure is going to go up in flames.

The central banks and the government authorities and regulators have made it clear that they will do absolutely anything to prevent this outcome: They will prevent a Lehman-like event from taking place, no matter what.

In other words, they have made things predictable for us all.

Insofar as these three areas I have outlined above—sovereign debt, weak banks, geopolitical crisis—there are tremendous opportunities, bought and paid for by way of this predictability.

The fact that the markets will be waiting for Lehman allows people like us—who realize that Lehman will in all likelihood never arrive—to make some bets which could pay off big. The investment strategies I outlined above for each of those cases make it clear how lucrative it could potentially be.

So long, of course, as Lehman never arrives. But caveat emptor: If Lehman does arrive, all bets are off.