CDS

Today, despite the announcement by Chinese Vice Premier Li Keqiangin in Madrid that China is willing to buy as much Spanish debt as that of Greece and Portugal (but not Ireland), or roughly €6 billion each, CDS in both the core and the semi-periphery, are back to record levels (El Pais and Reuters sources). Spain was last seen trying to catch up with Illinois, somewhere in the mid 300s, while Belgium also took out record wides at 225 bps. On one hand this is beneficial news for Spain, now that China is seemingly instituting its latest sphere of influence, but in reality is just doing all it can to precent the euro from collapsing (and thus killing Chinese exports to its second largest trading partner, the EU) and with net issuance in the country expected at just €47.2 billion, Spain may have well gone the distance to plugging as much as 13% of its net funding needs for the year. However, and what is spooking markets more, is that, as we reported yesterday, today European Commissioner Michael Bernier will publish a “consultation
paper” outlining ways to shield taxpayers from banking crises, chief among which is the renewed floating of the debt haircut idea.

Today, in a 3,500 word oeuvre, the NYT's Louise Story has done an expose on some of the key development in the CDS market. For those who may not have the patience of reading the whole thing, we provide an abridged summary...

One of the recurring topics on Zero Hedge since inception has been that Goldman's flow/prop operations, simply by dint of their massive, monopolistic size, allow the firm to manipulate various securities, among which equities, structured products, and especially CDS. And while the firm has migrated to a more wholesale market manipulation paradigm when it comes to equities due to the far smaller bid/ask spreads, requiring the need for Goldman to become either an SLP on the NYSE, or to create market manipulating algorithms, such as that it is currently accusing Sergey Aleynikov of stealing, where the firm has always excelled has been in the far thinner, and far more profitable, courtesy of wide bid/ask margins, CDS market. Today, we get confirmation from Senator Carl Levin, to whom it appears Goldman has the same trophy value as SAC to the New York District Attorney and Federal Task Force, that Goldman was engaged in precisely the kind of CDS manipulation we have previously alleged the company was involved with.

As the idiot market relishes in yet another day of foolish self-delusion that the most globalized market in history can simply decouple between the two largest economies in the world (Europe as a whole is far larger than China), things are starting to stir beneath the surface in Europe. While it is now given that no state will be allowed to default, no market will be allowed to trade down, and no bank will ever be impaired as long until the current flawed economic fundamentalist religion is violently overthrown, the question now becomes (just like it did in the America in late 2008) how far down the foodchain with the global Bernanke put stretch? Case in point: Italian insurance company Assicurazioni Generali (CDS ticker: ASSGEN). The proximal reason - today the company's CDS spread has gone vertical, wider by 34 bps on the day, or about 20%, to 184 bps. Why is this happening? Simple: ASSGEN has total assets of €423 billion, and more worrisome, a fixed income portfolio of €262 billion, of which 93% is European-bond based (Italy 28%, France 22%, Germany 25%). We all know what has happened to Italian bond prices in the past weeks: as of today, Bund spreads have just hit a fresh all time high. But all this is irrelevant since the bank must have a capital buffer to accommodate the losses. After all, what idiot would run a company with almost €300 billion in Euro-facing bond exposure and not factor for deterioration in risk after the events of May... Well the ASSGEN CEO may be just such an idiot. The company's balance sheet as of 9/30 discloses that the firm had a mere €10 billion in tangible capital (excluding €10.7 billion in intangible assets). So let's recap: €262 billion in Euro bonds on.... €10 billion in tangible equity! A 26x leverage on what is promptly becoming the most impaired asset class in the world. We are amazed that it has taken the market so long to realize that European insurers are the next shoe to drop, and doubly amaze that instead of trading points up, ASSGEN is only 184 bps. We give it a week.

The sovereign widening wave continues to push away from the periphery and deeper into the eurocore. While yesterday it was Italy's turn to see its spreads surge, today it is Belgium. At last check the country of monk ale and fries is flirting with 200 bps, following a 3/6 month auction of €2.8 billion bonds which was (not very) surprisingly weak: the 3-month T-Bill auction for €1.425bln came at a plunging bid/cover of 1.48 vs. 3.52 previously even as the yield jumped to 0.864% from 0.784% previously, while the 6-month €1.370 billion Bill also experienced a slump in its bid/cover of 1.54 vs. Prev. 2.67, yielding 1.000% vs. 0.901% previously. Net result widespread widening, with Italy once again taking the head at 25 bps wider to 272 bps (see chart). The bad news is that the EURUSD has once again collapsed to below 1.30, after which the next stop is John Taylor's (and certainly not John Stolper's) 1.26 target. The only good news is that just like in the US, stocks continue to be resilient in the face of massive sovereign onslaught. This will not last, to quote Market News: "Brokers suggest there is a degree of asset re-allocation taking place, where shares have become a relatively less risky asset class, while Eurozone government bond yields have ballooned. It's an interesting idea, but also looking at yield returns, you could argue that funds may start to flow from equities to government bonds in Europe given that yields have become quite comparable." In other words, very soon the Fed will need to "stabilize" not only US stock prices but European ones as well.

Perhaps if CNBC could pretend for a second that there was more to the economy than (disappointing) Black Friday channel checks it would realize that there is a complete massacre in European CDS spreads. At last check the Iberian Peninsula was the target of a tactical CDS nuke, with Spanish and Portuguese CDS widening by 23 and 36 bps respecitvely, to 354 and 538 bps. The second tier of bailoutees is also expected: Belgium and Italy, both of which are wider by just over 16 bps, hitting 178 and 232 bps. And lastly, even the core is no longer safe, as Austria and Germany were both about 5% wider to 87 and 50 bps each. Bases are widening as cash bonds are lagging today. The reason for the move, which should be completely expected to all Zero Hedge readers, is as Market News reports, that "a growing school of thought believes that - without major debt restructuring for Ireland - the current solution is just buying time. Many traders also fear that the interest rate applied to the new cash of 5.83% is unmanageable for the Irish economy." In other words start your Portugal, Spain, Belgium, Austria bailout countdown timer.

Although since Ireland is now also wider on the day, it is not really contagion. It is more failed bailout. And the EURUSD is now below Friday close. The market now believes the Irish bailout has failed.

Earlier today Moody's finally woke up from its slumber, threatening it would do a "multi-notch downgrade, albeit one that would leave the country still with an investment grade rating", which the people who have made a business model of being behind the curve said is now the most likely outcome of the review of Ireland's sovereign credit rating. Moody's (which rates Ireland Aa2 and has the country on review for downgrade) said that an aid package from the European Union and the International Monetary Fund would shift the burden of supporting Ireland's banks onto the Irish sovereign, and would therefore be "a credit negative for Ireland." Apparently bankruptcy is not covered under the "credit negatives" for Ireland. And while what Moody's does or thinks is completely irrelevant, what the Irish Green party (whose prior opinion we presented in a very distinct clip last night) has announced it will quit the Irish government in January, leaving PM Brian Cowen without a majority in the government, and leaving the door open for elections, and thus a complete undoing of the bailout. Looks like yesterday's announcement will be the shortest rescue in history. CDS is already seeing that, as Irish CDS was last seen lifting offers of 520 and wider, after a 507 close on Friday. And Futures already following the action. It will be another busy day for Brian Sack.

I love big arbs. It means markets will be moving.

According to the ECB, borrowings by Irish-based lenders’ from the European Central Bank rose to €130 billion as of Oct. 29, up almost €10 billion from €121.1 billion at the end of September. Adjusted for size, this is roughly equivalent to US banks borrowing a few hundred trillion from the Fed, give or take a few trillion. "Pass thru" institutions include both international and domestic banks in Ireland. In other words, the ECB continues to buy the bonds issued by Ireland, to provide the funds to Irish banks so they can buy their own bonds, and when all this fails, the ECB can step in and provide money to the government directly. Elsewhere, the CDS of Anglo Irish bank blew out by 20% yesterday, and have surged by over 10,000 bps since the end of October to nearly 13,000. Luckily, the end game is known: Ireland will be bailed out by the ECB, the country will become another Greece, lying each and every day about its deficit and economic recovery, until yet another country gets mauled. At some point the Fed/ECB/IMF's rescue ploy will fail. Then, it will be best to be far away.

It has been a few month since everyone was throwing the word "contagion" around just to sound smart. Prepare to get a whole lot more of that. PIIGS CDS are now at a fresh all time record, way wider than during the May days, that lead to the flash crash and Greece's bankruptcy. All this means that the fair value of the market is now even lower than where it was on May 6, but the tail risk has been internalized by not only US but European taxpayers. That rubber band will snap again. Just a matter of time.

Repeat after us: gold is not a currency. But, just in case we are wrong, pretty soon one may see it accepted as pseudo legal, non-federal reserve note equivalent just about everywhere. First: the ICE, where "Gold bullion will be permitted for initial margin only and will be accepted by the clearing house by electronic transfer in increments of 1 troy ounce, and will be priced daily using the London Gold Fixing Price in US Dollars." In other words, the ICE will gladly take your gold. Period.

Ambac Financial Group has just filed for Chapter 11, using a filing which is so fresh it even forgot to lock the input forms (see attached). The case is 10-15973 in Southern District of New York. The actual filing is not surprising, as we noted earlier that Ambac was likely going to file imminently. What is also not surprising is that the form 1, erroneously, lists assets of between 0 and $50,000 and liabilities of over $1 billion, even as Exhibit A clarifies assets as $394.5 million and liabilities of $1.6824 billion. Obviously someone was in a rush. Keep in mind this is a stock that Cramer was previously pitching to his very few viewers. Ambac's bankruptcy lawyers are Dewey and LeBoeuf, and Blackstone gets the coveted role of financial advisor. None of the relevant unsecured creditors have been disclosed as most are in DTC form, with BNY listed as custodian. Yet one definitive loser in the Ambac bankruptcy is none other than 'our' own New York Fed. As the Maiden Lane I holdings list as of June 30, when the Fed consumed Bear Stearns most toxic 'assets' and gave Jamie Dimon a clean sheet to buy the clean stripped bank for $10/share, it also adopted a bunch of Ambac CDS. And as of June 30, the Fed held $10 million in ABC CDS. Now that there is a credit event, it will be impossible for the Fed to continue claiming that its rescue portfolios are doing just swimmingly (or so we hope, for BlackRock's sake). Furthermore, the Fed will be forced to payout on the CDS which will likely end up pricing in the settlement auction somewhere very close to zero, implying a near total wipe out on the entire $10 million in short CDS. And lucky Fed: as of March 31, the Fed had actually held a net $50 million in ABC short protection, so in Q2 it covered $40MM worth of short protection. So now all eyes turn to Ambac soulmate MBIA... where the Fed is short $84 million worth of CDS.

As we pointed out earlier, the Irish 10 Year just hit an all time high of 503 and has continued leaking higher. The main catalyst according to several trading desks is the following RIA Novosti report which says that Russia, demonstrating far more prudence than a recently insane China, has stated that it is excluding Ireland and Spain from possible sovereign wealth fund investments: "Russia has excluded debt-saddled Ireland and Spain from the list of
countries whose securities can be used as investment targets for
Russia's sovereign wealth funds, the Finance Ministry said on Wednesday. The Finance Ministry, which posted the respective orders on its website
on Wednesday, said it had shortened the list of sovereign wealth fund
investment "to reduce risks in the process of the funds' management." It appears Russia is gearing for the inevitable jettisoning of a peripheral Eurozone country now that Europe will be forced to take drastic measures to lower the euro following today's QE2, something China appears to not be able to grasp just yet. And while the Irish cash treasury curve is getting increasingly flat, it is still upward sloping. Which is more than one can say for the CDS curve, which just like Greece, went inverted, and the 10 Year is now trading 40 bps inside the 3 Year. Which brings us to our trade recommendation of the day: just like in Greece cash was slow to catch up to synthetic, the expectation is that both curves will eventually overlay. However, as Greece taught us playing cash/CDS basis trades can result in some very dramatic liquidity induced flame-outs, we suggest sticking to either product on both sides of the hedge: namely - establish a cash flattener (sell 10 Year at 7.462%, buy the 3 Year at 5.330% for a pick of 210 bps), hedged with CDS steepener (sell 3 Year at 559 bps, buy 10 Year at 515 bps, for a net of 45 bps), both on a duration neutral basis . Assuming both curves pancake, one would stand to make about 165 bps. Of course, a simpler trade is just to put a flattener on for 3s10s cash.

The bloodbath in fin CDS is even worse than what is going on in equities. Bank of America is currently at the widest it has been in 2010.The latest rack is provided below, and the LTM 5 year Sr CDS spread is charted below. Yet the biggest bloodbath continues to take place in woefully underreserved HR Block, which is certainly not too big to fail, and which was about 30 bps wider on the day, now at 720/691. On the chart below, HRB's spread is on the right axis. Will the little tax preparer that almost could be the first casulaty that sets off the TARP 2 starter pistol?