default

When it comes to the markets one can easily ignore the fact that the world is one big ponzi and things, as we know them, are coming to an end as long as the can can be kicked down the street at least one more time. In other words, without a hard deadline, there is nothing that can force change upon a system already in motion, no matter how self-destructive. Unfortunately, the clock in Europe is ticking as a deadline approaches, and somewhat poetically, the place where it all started is where it may end. In March Greece faces a redemption cliff: if by then the €130 billion promised to it by the Troika as per the July 21 second bailout, is not delivered, it is game over - first for Greece which will default, then for the ECB, which will be forced to write down holdings of Greek bonds, in effect wiping out its equity and credibility, and lastly, for the Euro, which will see a core member leaving (in)voluntarily.

If there is one lesson to be learned from the Japanese experience with deleveraging over the past few decades it’s that deleveraging cycles have there own special rhythm of reflationary and deflationary interludes.  Pretty simple thinking as balance sheet deleveraging by definition cannot be a short term process given the prior decades required to build up the leverage accumulated in any economic/financial system.  If deleveraging were a short term process, it would play out as a massive short term depression.  And clearly any central bank would act to disallow such an outcome, exactly has been the case not only in Japan over the last few decades, but now also in the US and the Eurozone.  We just need to remember that this is a dance.  There is an ebb and flow to the greater (generational) deleveraging cycle.  Just as leveraging up was not a linear process, neither will the process of deleveraging be linear.  Why bring this larger picture cycle rhythm up right now?  The recent price volatility we’ve seen in assets that can be characterized as offering purchasing power protection within the context of a global central banking community debasing currencies as their preferred method of reflation for now, specifically recent the price volatility of gold.

How many of those millions of dollars in cars does the "Foreclosure King" still have? How is he able to stay so warm and cozy in his castle on the intercoastal in Ft.Lauderdale staring out at his 100 foot yachts and where is the Florida Bar in all this?

In his latest letter, Bill Gross, obviously for his own reasons, essentially channels Zero Hedge, and repeats everything we have been saying over the past 3 years. We'll take that as a compliment. Next thing you know he will convert the TRF into a gold-only physical fund in anticipation of the wrong-end of the "fat tail" hitting reality head on at full speed, and sending the entire house of centrally planned cards crashing down. "How many ways can you say “it’s different this time?” There’s “abnormal,” “subnormal,” “paranormal” and of course “new normal.” Mohamed El-Erian’s awakening phrase of several years past has virtually been adopted into the lexicon these days, but now it has an almost antiquated vapor to it that reflected calmer seas in 2011 as opposed to the possibility of a perfect storm in 2012. The New Normal as PIMCO and other economists would describe it was a world of muted western growth, high unemployment and relatively orderly delevering. Now we appear to be morphing into a world with much fatter tails, bordering on bimodal. It’s as if the Earth now has two moons instead of one and both are growing in size like a cancerous tumor that may threaten the financial tides, oceans and economic life as we have known it for the past half century. Welcome to 2012...For 2012, in the face of a delevering zero-bound interest rate world, investors must lower return expectations. 2–5% for stocks, bonds and commodities are expected long term returns for global financial markets that have been pushed to the zero bound, a world where substantial real price appreciation is getting close to mathematically improbable. Adjust your expectations, prepare for bimodal outcomes. It is different this time and will continue to be for a number of years. The New Normal is “Sub,” “Ab,” “Para” and then some. The financial markets and global economies are at great risk."

Is idiosyncracy the substitute for a fledgling Sovereign Bond Market?  Including our recommendations for 2012

The issue of Germany and its approach to ameliorating the overleveraged balance sheets of its southern neighbors will dictate the direction of sovereign spreads in 2012. The direction of sovereign spreads will also determine the direction of risk premium spreads in the leveraged finance markets— both bonds and loans. Defaults in the leveraged finance market will and should be an afterthought to the systemic risk factors inherent in sovereign and next-of-kin bank credit spreads. Therefore, forecasting default rates should take a backseat to a better understanding of German Kultur and thought that will shape the euro-zone sovereign finance structure in 2012 and beyond. The most recent European Union summit highlighted that we are left with some of the same issues that confronted the great empires prior to World War I—the battle between “English liberalism with its emphasis on individual freedom and self-determination and Prussian socialism with its emphasis on order and authority.”

The bond market has always had clever names for bonds in specific markets.  Eurobonds, Yankee bonds, Samurai bonds, and now, Ponzi bonds.  I’m not sure what else to call these new bonds, but Ponzi bonds seems as good as anything. NBG issued these bonds to themselves, got a Greek government guarantee (how can a country that can’t borrow, provide a guarantee?) and took these bonds to the ECB to get some financing.  The ECB won’t buy National Bank of Greece bonds directly, they won’t buy Hellenic Republic bonds in the primary market, but they will take these ponzi bonds as collateral?  Greece, and Italy, is sacrificing the people and the country for the good of the bank. The market had made some attempt to charge banks with bad risk management, awful assets, and opaque books, more than they charged the country they were domiciled in.  But rather than let the market (and common sense) rule, a mechanism to let banks fund themselves cheaper than the countries they rely on, was created. Asides from giving Ponzi a bad name (at least until the ECB just admits that they are printing faster than even Big Ben) this is tying the banks and the countries ever closer.  A long, long, time ago (1 month) it was conceivable that a bank could fail and the sovereign survive.  That is becoming less clear.

History is full of other examples of once proud nations that, facing problems for decades (or even centuries), completely unwound in a matter of years. The Ottoman Empire. The  Ming Dynasty. Feudal France. The Soviet Union. Bottom line, when the real change comes, it comes very, very quickly. Think about the pace of change these days. It’s quickening. Europe is a great case study for this– when concerns about Greece first surfaced, European leaders were able to contain the damage. There was disquiet, but it soon dissipated. Fast forward to today. We can hardly go a single day without a major, market-rocking headline. And European politicians’ attempts to assuage the damage have a useful half life that can be measured in days… sometimes hours now. Like the Ottomans, the Soviets, the Romans before them, Western civilization is entering the phase where its rate of decline will start looking like that upside-down hockey stick.

Stock futures are up sharply after another week of unprecedented volatility. Although last week was relatively tame, only 13 times in the last 60 years has the S&P 500 had a down 1% day during the week between Christmas and New Year's.  We managed one of those days last week.  We also had a 1% positive day.  Futures are strong and looks like stocks will open above 1272 (where they closed on Jan. 3, 2011). Not only does volatility remain elevated, the stories are about the same. We have some new acronyms to contend with, but ultimately the European Debt Crisis (it is both a bank and sovereign crisis) and the strength of the US economy and China's ability to manage its slowdown are the primary stories. Issues in the Mid-East remain on the fringe but threaten to elevate to something more serious with Iran flexing its muscles more and more. So what to do?  Prepare for more headlines, more risk reversals, and more pain.

When it comes to corruption, cronyism and general muppetry in Washington D.C., the only real question is 'where does one start?' Yet one has to start somewhere to conclude with a list of the ten most corrupt and despicable marionettes in D.C. Which is precisely what JudicialWatch has done in its annual compilation of the "Top 10 Most Corrupt Politicians in Washington D.C." for 2011. And confirming what everyone knows, that both the left and right are merely irrelevant names for the same general social affliction, or should we call it by its true name - wealth pillage - the split is even between democrats and republicans. In no particular order, the winners of 2011 are...

When losing is "winning".

Based on its debt maturation cycle I expect we’ll see an Italian default within the next six months. Indeed, no matter what happens with Greece, Italy will make sure that the EU in its current form no longer exists within the next year.

Last time when Jefferies' (which is not MF Global although it is just as a big question market in the TBTF category, and as a reminder is not a Bank Holding Company, being the last pure play investment bank left out there) stock had a $9 handle, it triggered a -20% circuit breaker and forced a short covering squeeze. This time it is far more methodical. At this time Leucadia is underwater on both of its recent purchases, all past and future Jefferies press releases have been priced in and will be irrelevant in the future, and Handler only has half of his original gross sovereign book left to sell (into a bidless market and thus generating more major P&L losses).

Citi's Willem Buiter whose succinct analysis a few weeks ago sealed the coffin of the worthless EFSF, has just come out with another knock out punch this morning after telling Bloomberg TV what everyone else knows is true, but is terrified to say out loud: namely that, "time is running out fast." He adds: " I think we have maybe a few months -- it could be weeks, it could be days -- before there is a material risk of a fundamentally unnecessary default by a country like Spain or Italy which would be a financial catastrophe dragging the European banking system and North America with it. So they have to act now." In sum -  a rehash of the Deutsche Bank pitchbook to the ECB we posted earlier, only in Mutually Assured Terms that would make even Hank Paulson blush. At this point Germany has an option: tell Europe to take a hike, or go balls to wall in bailing out 250 million European's early retirement packages. The ball is in Merkel's court, who unlike Citi, JPM, DB, and everyone else, has to worry about this fickle, and potentially pitchfork bearing, thing called "voters."

Troubled Jefferies & Co does not have actively traded CDS referencing it, which is probably a good thing. It does, however, have cash bonds and while its equity price remains above the lows from two weeks ago, bond prices are cratering and just traded at record lows. The 8.5% of 2019s are actively trading around $92-95 (having fallen from $110 in two weeks and $120 in three months). This price represents a yield of 9.5% (or a z-spread of 823bps!). Translating the asset swap spread of 756bps from this bond into a CDS contract, we see a cumulative 65% probability of default (over the next 8 years) being priced into the market (assuming a 40% recovery). It certainly seems like the bond market is much more nervous of JEF than the equity market for now!