Lehman

Update 2: Draghi just killed IMF lending proposal - "lending money to IMF to buy Euro bonds is not compatible with the treaty" - EURUSD now in free fall.

Update: two additional comments, i) that the ECB is not the IMF, and that lending to the IMF would be very complex legally, and ii) that the liquidity situation is comparable to post Lehman have sent everything plunging to overnight lows. Lastly, Draghi just kicked the ball in Europe's court. This is about to get very ugly fast.

It was all going so well until Draghi dropped the coded 'less' bond purchases 'no bazooka' bomb-shell at which EURUSD, BTPs, European bank stocks, and ES all stalled instantly and started to revert to pre-Dragozel levels. BTPs are holding up the best for now, though almost entirely retraced, but a 1% up and down roundtrip in ES was enough for many to see the schizophrenic market at its best.

As the attached chart showing USD liquidity swap line usage by the ECB, or more specifically by European banks, we have now seen a surge to levels last seen in August 2009. However, more importantly this is where the usage was for the first time after the failure of Bear Stearns, and when everyone thought all had been fixed... until Lehman came. We are there now, in other words, we have just experienced a behind the scenes Bear-type event. What is disturbing is just how fast the rate of change was this time around compared to before, when it took months to get to $50 billion. Now, it was one week. When "Lehman v2.0" hits and it will hit, the next step function in the Fed's global bailout will be so big and so fast, it will induce vertigo.

Here is video outlining precisely how MF would collapse due to Fed policy, made at the beginning of the year! This wasn't hard to see coming. How many of you are willing to bet that MF Global will NOT be the Lehman of 2011? Let me rundown a few hard, painful and accurate observations that you guys who fell for that rough ass bear market rally might have overlooked.

Do you really think Europe, which is even MORE insolvent that the US, is somehow going to experience a different ending from the Bazooka move? They’re in far, FAR worse fiscal shape that the US was in 2008 (including unfunded liabilities, REAL Debt to GDP levels for most EU members is north of 400%... heck even Germany’s is over 200%).

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.)

Due to the rampant misinformation and disinformation (please recognize and appreciate the distinct difference) being bandied about, I've decided to run the #s 1 more time and put it right here in this post.

'Nuff said!

We won't spend too much time to dwell on the following pamphlet of sheer "buy, buy, buy" desperation from Barclays' Sandeep Bordia, suffice it to say that we now know which would be the first European blue light special "rescuer" of Lehman to go under courtesy of a massively wrong bet on PrimeX should the "illiquid" market continue to flounder. Which it will. We will add, however, that it would be damn poetic, not to mention hilarious, if while long and wrong bets on Subprime is what detonated Lehman, then being John Holmes'd in Prime is what leads to Barclays' bankruptcy (and we do already know that Barc is the bank with the second largest capital shortfall in Europe courtesy of that other bank which hopes to pick up the pieces upon blue's implosion, Credit Suisse). It would appear that the vultures are already circling... And where the vultures are, the squid can't be far behind.

Sarkozy and Merkel continue to make "plans" for what to do... The reality is all they're doing is playing for time while they prepare for a Greek default. Indeed, German officials recently told the Telegraph that a "hard" default for Greece is coming which will feature investors taking a 60% "haircut" on their investments in Greek bonds. 

In a surprisingly candid yet traditionally schizophrenic interview on ARD 1 show GuntherJauch, Angela Merkel once again sent the same mixed messages that have forced Berlusconi to smile to her face while saying less than flattering things, ahem, behind (no punt intended) her. While on one hand she said that default is an option under the post-2013 Euro rescue fund and emphasized that a euro-area sovereign insolvency can not be ruled out, she also made it clear that Europe continues to have no Plan B. According to Reuters, "allowing Greece to default on its debt now would destroy investor confidence in the euro zone and might spark contagion like that experienced after the bankruptcy of Lehman Brothers in 2008, German Chancellor Angela Merkel said on Sunday." Obviously this is not new, and our humble interpretation is to continue to telegraph to the market how unstable the Eurozone is so there are very little expectations and more EUR short squeezes can be accomplished, as well as not pricing in anticipation that emergency liquidity conduits, currently being implemented, actually succeed in case they actually do. Of course, should Europe really succeed in ejecting Greece without Europe imploding which is the interim end game here that would certainly send the EURUSD to well over 1.50. Alas, we put chances of that happening at about 1%.

Yesterday's downgrade of BAC was potentially problematic for credit markets.  I am less concerned about the holding company downgrade.  Downgrading the bank to A2 from Aa3 could become problematic.  That is the entity most derivative counterparties will face.  A2 is still fine, but I suspect many counterparties will be having meetings over the next few days to discuss how comfortable they are facing BAC as a derivative counterparty.  It might be wrong, and unnecessary, but it is something that will be occurring.  BAC should be doing everything in their power to address this potential risk immediately. The risk of ratings downgrades to a bank is twofold.  On a basic level, it may reduce the flows they see as counterparties prefer to trade with higher rated entities for their derivative trades.  That is manageable.  The bigger, and far more problematic issue, will be if firms cut their lines to that bank.  This would cause banks to unwind or assign existing trades, or to buy protection on the downgraded banks to "hedge their hedge".  Protection buying would drive their spread higher (if this was all exchange traded, it wouldn't be an issue).  Unwinds could force the bank to raise some cash.  Most hedge funds will have one way collateral agreements with banks, so that on any positive mark to market, they are posting collateral to the bank, which the bank can typically use "rehypothecate".  Hedge funds will unwind or assign profitable trades, which will force the bank to return collateral to the hedge fund.  It is a subtle, but painful, way for a bank to experience a run.  It happened with Bear and with Lehman. 

Lately it is hard to avoid talk about the Lehman "Moment".  It almost makes you think that the world fell apart the weekend Lehman filed for bankruptcy protection.  But that's not the case at all.  Stocks sold off that first day, bounced the second, had another sell off, but by the Thursday, they actually closed higher than the Friday before Lehman filed.  From there they generally went down. Often painfully swiftly, though the rallies were just as sharp.  It wasn't until March of the following year that we hit the lows - a full 6 months after Lehman.

Strawman-of-the-night: G7 OFFICIAL SAYS EUROPEAN GOVS WEIGHING TALF-LIKE PGM: CNBC.

"A few good banks is better than a lot of bad one."--Jim Cramer

Whille the past week was full of economic news, most of them decidedly negative, it is next week that the house of cards could finally come unhinged. In what will be the event of the week, Germany's Constitutional Court is set to rule on the legality of the seemingly endless bailout pledges made by Merkel. If they rule against the bailouts, that would be Europe's version of a Lehman moment. Next on the docket you have Italy which has recently been softening its austerity program. Berlusconi needs to show increased leadership by solidifying his pledge towards consummate austerity in an effort to improve his country's finances. Financial markets have recently taken notice of these negative developments. Investors knew that the jobs report wouldn't be pretty, however, yesterday's large selloff was actually due to renewed euro zone jitters. If the Eurozone does blowup, all bets are off.