default

There's an enduring myth that the U.S. has never defaulted on its debt, but that's merely a function of how default is defined. When Treasury abrogated the gold clause in 1933, holders of U.S. debt suffered serious losses, and as evidenced by the dollar's decline versus gold since 1971, Treasury has been a serial defaulter ever since. Assuming a default of the haircut variety, this has been the global norm for at least two centuries, and if the U.S. were to default in this way, it's not something we should fear. Post WWII the largest economic powers were regularly in default of the haircut kind, and the global economy boomed.

The alternative title for today entry is: Ireland, please drive a stake through the heart of the vampire banks which have the world by the throat. The entire controlled demolition of the Eurozone's finances can be summed up in one phrase: privatize leverage and profits, socialize losses and risk. The basic deal is this: protect the bank's managers, shareholders and bondholders from any losses, while heaping the socialized losses and risks on the taxpayers and citizens. While there are murmurings of "forcing bondholders to share the pain," any future haircut will undoubtedly be just for show, while the Irish pension funds are gutted to bail out the banks.

Today the myth of a popular, democratic government in Ireland collapsed for good. After an impromptu poll of 500 people nationwide found that a "substantial majority" of the people, or 57%, wants the State to default on debts to bondholder, what it ended up getting was precisely the opposite. Why? "Last night that the Irish delegation
negotiating with the EU-IMF last week raised the issue of default. "The Europeans went completely mad," a senior government source said." Of course, this is a reason for the Europeans not to want an Irish default, not for the Irish. And last time we checked, the Irish government represented its people, not the interests of Brussels. As America showed all too well, we expect every banker in the world to threaten perpetual damnation for Ireland should they decide on doing what is right for its people (and so very wrong for another year of record banker bonuses). Then again, with elections in Ireland imminent, it is almost certain that there will be a massive popular overhaul of the government, and all bets at that point will be off whether the ECB can dictate terms to a brand new, and far more loyal, government. To quote to Independent: "In Dublin, there is barely concealed outrage at the interventions of Ms Merkel
and at the position adopted recently by the European Central Bank, which
precipitated the arrival of the EU-IMF team in Ireland."The ECB f**ked us," one government official in Dublin was reported
yesterday to have said." We wonder how soon before rhetoric finally shifts to action.

Next year, IMHO, we are going to see a further sharp decline in residential home prices as the tide of foreclosures begun in the past year starts to clear the courts and move to market via involuntary sales. The same thing is happening in Spain, by coincidence.

As a disclaimer to this update, I just want to reiterate once again that I firmly believe that the Euro is not viable, at least certainly not the way it is designed and I think the flaws in its conception are so profound that dissolution makes the most sense. With this assumption in mind, let us look at what the solutions are to the current woes. The individual bail-out route is not an option. When dominoes fall in panic the speed at which they fall tends to accelerate exponentially. Rewind the tapes to late July 2007: American Home mortgages files. The market goes on to make new highs but in January Bank of America takes over otherwise soon defunct Countrywide and by March Bear Stearns is belly up. The forced hand out to JP Morgan appeases the market temporarily, but by early September Fannie and Freddie are de facto nationalized, and so is AIG, Lehman collapses, Wamu is taken over by JP and at that point the government has no choice but backstop the entire system. Well, this is not unlike what we are witnessing here: We first had Iceland in November 2008, then Greece in the spring of 2010, now Ireland. Make no mistake if you let that fester enough or decide to bail them one by one without attempting a larger scale resolution by January Spain Portugal and possibly Italy will have been downgraded several notches, LCH will have raised the margins on all those bonds, and French and German banks will start dragging their country down the same slope. - Nic Lenoir

This is an extensive post designed for those who want to truly comprehend what I perceive to be both the root causes and the practical solution to the Irish sovereign debt problems and the threat of Pan-European possibly global financial and economic contagion.

Harrisburg, PA, whose bankruptcy is now about a year overdue, has just hired bankruptcy counsel: New York law firm Cravath, Swaine and Moore. The financial advisor has not been decided yet although the pitches there must be fast and furious, and probably involved every single bankruptcy advisory firm which recently has had exactly zero work courtesy of Ben Bernanke providing convertible DIPs at negative rates. Cravath took a tricky strategy to beat out other law firms: it would advise the city pro bono on its imminent Chapter 9. But don't think of it as money lost: think of it as league table credit, which will send the firm to the top of the ranks, and allow it to charge $1,000 an hour when the muni dominoes start tumbling left and right: after all Harrisburg is just the proverbial cherry pop. After it - the deluge. And the bankruptcy advisory vultures are already licking their chops over what will make the Lehman fee bonanza (now in the billions) seem like Greenspan's stingy monetary policy compared to Bernanke's global paradropping of Bennies.

In September 2008 the US came to a fork in the road. The Public Policy decision to not seize the banks, to not place them in bankruptcy court with the government acting as the Debtor-in-Possession (DIP), to not split them up by selling off the assets to successful and solvent entities, set the world on the path to global currency wars. By lowering interest rates and effectively guaranteeing a weak dollar through undisciplined fiscal policy, the US ignited an almost riskless global US$ Carry Trade and triggered an uncontrolled Currency War with the mercantilist, export driven Asian economies. We are now debasing the US dollar with reckless spending and money printing with the policies of Quantitative Easing (QE) and the expectations of QE II. Both are nothing more than effectively defaulting on our obligations to sound money policy and a “strong US$”. Meanwhile with a straight face we deny that this is our intention. It’s called debase, default and deny.

This is the math, the reasoning and the logic behind a nearly inevitable default by Greece. Why hasn't this been present in the mainstream media?

Maybe, just maybe, this will light a fire under the ass of Attorney General of Florida and force him to initiate an injunction on the law firms that perpetrated the frauds… What is it that William Black said?

“The Best Way to Rob a Bank Is to Own One“

Well How about this…

“The best way to stop a criminal investigation is to become one of the investigators“

Old school private equity guy-turned-hedge fund manager, Michael Tennenbaum, was on Bloomberg TV, discussing his perspectives for the distressed debt market (yes, such a thing did once exist, before HY bonds of 20x levered companies starting trading at par+). And all those who believe that courtesy of the Fed's intervention in every market there will never be another bankruptcy, let alone a bond yielding more than 10% take heart: according to Tennenbaum a full $50 billion in distressed debt may go Chapter in the next two years, although this is probably more good news for all the mini restructuring boutiques who overhired last year only to see the administration make bankruptcy illegal. The math: "Over the next five years $1.2 trillion in non investment grade debt comes due, of which $200 billion are due in the next two years, and of that a quarter or $50 billion are issued by companies rated rated B or lower. The experience that we and others have had is that this leads to default." Of course, Tennenbaum is a traditional debt-for-equity investor is more than incentivized to see this occur: he is currently sitting there doing nothing, as not only does nobody need DIPs or other rescue financings (why, when you can issue new B3/B- debt at 8%), but no company is willing to part with equity when every pitchbook it sees tells it can progressively refi current debt into paper that may eventually pay a 0.001% coupon. On the other hand, this, as well as every other contrarian outlook is predicated on the assumption that the Fed will be able to control the demolition of the US economy, which it won't. Which is why we are confident that not only will Mike be correct (eventually), but the full amount of HY paper that will default will boggle the mind when the dominoes really collapse. Until then, study learn (and earn) the Bernanke Moral Hazard Put: learn it and love it.

And the euro seemed so happy after its recent surge, that it completely forgot it is backed by an insolvent continent. Luckily, here's Ireland to remind us stuff is much, much worse than expected. According to the Irish Independent the Labour Party, Eamon Gilmore, came very close to suggesting that Ireland is considering defaulting on its debts "when he talked about the Government "negotiating'' with bondholders in Anglo Irish Bank." Additionally, the same newspaper also reported that Ireland is on the verge of calling in the IMF for a bailout, citing "a report from Barclays, one of Europe's largest banks, said Ireland may yet need financial help from the IMF or the EU if conditions got any worse. But a spokesman for Finance Minister Brian Lenihan said last night: "The Government's strategy for dealing with the economic and financial challenges has been commended by the EU Commission, the European Central Bank and many other international experts." In other words, domino #2 has at most a few more days. Net result of all this: Irish-Bund spread explode, and gold hits a new all time high of $1,282.

An interesting observation that has developed over the past year is the ballooning spread between default risk for the US as a standalone entity (based on the country's CDS spread, which was last seen just inside 50 bps), and the cumulative risk of the constituent states that make up the US, once again based on their own standalone spreads, when adjusted by GDP contribution. This can be seen on the chart below. The computation takes the 16 states with quoted spreads from CMA (with the remaining states assigned the US spread itself), juxtaposed to the CDS of the US itself. As is evident, the spread continues to widen, and at last check was around 100 bps, just marginally tighter compared to the all time wides seen in June of 2010 when it hit over 120 bps. In retrospect this should not be all that surprising, as the general US CDS looks at the country as a whole, and gives benefit to the possible intervention that the Fed can (and does) do on a daily basis to prevent increasing default risk to the US as a whole: after all the US can always monetize its own debt, while California... can't. Nonetheless, if these spreads continue to diverge, we expect that convexity alone will start dragging the CDS of the US wider as well.

British-style military impotence, Habspurg-like default or French-echoing revolution?

There is one major problem with putting houses of card back together - they tend to fall...over and over. And while abundant liquidity in May and June served as an artificial prop to return European core and PIIGS spreads to previous levels merely as mean reversion algos took holds, the second time around won't be as lucky. CDR's Tim Backshall was on the Strategy Session today, discussing the key trends in sovereign products over the past few months, noting the declining liquidity in both sovereign cash and derivative exposure (we will refresh on the DTCC sovereign data later after its weekly Tuesday update). Yet the most interesting observation by Backshall is the declining halflife of risk-on episodes, which much like the SNB's (now declining) interventions, are having less of an impact on the market, as ever worsening fundamentals can only be swept under the carpet for so long before they really start stinking up the place, and indeed, as Tim points out at 5:30 into the interview, even the IMF now realizes that soon the eventual second domino will fall, and it is better the be prepared (via the previously discussed infinitely expanded credit line), than to have to scramble in the last minute as was necessary in May. In other words, the storm clouds are gathering and only fools will invest in risk asset without getting some additional clarity on what is happening in Europe. The bottom line as Backshall asks is: "do they default now or default later." And that pretty much sums it up. Buy stocks at your own peril.