default

We finally agree Greece will default. Why can't we all agree on the turmoil likely as a result? European CRE will get C-R-U-S-H-E-D in a volatile rate storm.

Wonder why the Greek 2 Year bond just plunged, sending its yield to a laughable all time high 39.09% (a 312 bps move today alone)? Wonder no more. According to the ECB's Ewald Novotny the central bank has folded to German demands, and will now allow a "temporary" Greek default. Of course, what happens next will be a complete freeze in capital markets (see the chart below which shows borrowings on the ECB's Main Refinancing Operation while itis still available) but who cares: the central planners think they have it all under control.

Many associate exploding CDS as a feature of backward third world countries, or, as they are better known these days, PIIGS. It may thus come as a surprise to most that the default risk of not only the US, which we reported had recently hid a multi year high, but especially Germany and the UK have surged by well over 50% in the past month. In fact, Germany, by most objective evaluations, an economy that is far more resilient and productive than America's, has in the past 3 days seen its CDS surge to a level 10 basis points wide of the US. And if not the actual economy, what then? Why such monstrosities as Deutsche Bank and Commerzbank, which as reported previously have caused many to doubt are as viable as the stress tests represents, and whose combined asset bases are well over the total GDP of Germany. As the for the UK, after trading at around 55 bps for months, the spread has jumped to nearly 80 bps. So as Sigma X indicated earlier that it may now be time to shift attention to the UK, have the vigilantes already succeeded in penetrating all the way to the very core of the Eurozone? Or, courtesy of ISDA's criminal abdication of its responsibilities by pre-determining that no development in the future of Greece would be an event of default, perhaps the only natural response now is to buy protection on those names which have not blown out to ridiculous (read 600 bps or wider) spreads. Which, however, is very bad news for the Eurozone core, as going forward investors will simply hedge peripheral cash risk with core synthetic: a process which will result in the eventual wipe out of both instruments. But that's precisely what happens when the CDS administrator and "regulator" decides to play ball with the central planners instead of the siding with market participants: unintended escalating consequences galore.

What started off as a simple, if very much illegal, information gathering protocol (and yes, NOTW is most certainly not the only organization that hacked voice mails), and has since escalated to an epic shakedown of one of the world's most legendary media companies in which Murdoch himself now appears on the verge of leaving the company, appears set to ultimately result in a historic parliamentary collapse, with the Prime Minister of the UK David Cameron seen as the ultimate fallguy. As English booking agency reports, "David Cameron's odds of leaving the Cabinet have been slashed by Ladbrokes. The bookies have taken a steady stream of bets on the PM leaving office with the odds dropping from 100/1 to 20/1 and now 8/1 in a matter of hours." In other words anyone who bet that the shuttering of the NOTW was merely the first step in the News Corp. scandal and that it would reach as high as the pinnacle of UK leadership, has made a return well over 10 times in the past several days. And yet, as the Economist chimes in with a late night piece, the departure of Cameron at this point is far from certain. Which is arguably a far worse state of affairs: if there is anything the markets hate, it is uncertainty. If Cameron was sure to stay or go, it would have no impact on the UK's economy and financial markets. As it stands, and with Murdochgate getting worse by the minute, we would not be surprised to see UK CDS follow the US and Germany to multi-year highs, as the UK now openly becomes yet another target for the bond vigilantes who relish precisely this kind of uncertain inbetweenness.

Herman Van Rompuy just tweeted the following:

I have decided to convene a meeting of the Euro area Heads of State or Government on Thursday, 21 July, at 12.00 in Brussels. Our agenda will be the financial stability of the Euro area as a whole and the future financing of the Greek programme. I have asked the preparatory work to be brought forward inter alia by the Finance Ministries.

Perfect timing for the announcement of a "soft" Greek default: just a day before the US debt ceiling legislative deadline. Are we going to see a major market crash next week just so everyone is reminded of what all is at stake?

But the Johns in Washington (they are technically Johns, not prostitutes, since they are pimping the American people out) and the slavestream media will keep up their circus act regarding the debt ceiling being the only important issue ...

Gee, you think?

So much for the market "completely ignoring" the total chaos and complete cacophony out of the tragicomic DC soap opera which is transitioning into less of a comedy and into more of a tragedy with each passing day. For everyone still wearing rose-colored glasses here's a refresher: stocks dropped, the S&P expressed in dollar terms, or adjusted for loss in dollar purchasing power is now negative for the year, bonds tumbled despite a "strong" auction driven almost entirely by Direct Bidders on the margin, and, the kicker, US CDS is now at 56 bps: US default risk is now the highest since February 2010.

Barney Frank, fresh from being caught on live TV picking his nose during Bernanke's Humphrey Hawkins presentation, had a decidedly more sour outlook on the prospects for the debt ceiling. Spoiler alert: in tried and true fashion, the drama king blamed it all on the stupidity and inexperience of republicans. Asked when there is a chance the US will be put into default: "Yes. I take the freshmen republicans and people like Michelle Bachmann
at their word. I don't think they're kidding. I think they fundamentally
misread this situation as Bernanke, a Bush appointee after all, made
clear today. I think there are people that frankly have an unreal view
of the world. They believe that this is somehow a fake and that you can
push a button and make a lot of these debts go away. I believe there are
a substantial number of Republicans who are opposed to a huge debt and a
further group of Republicans who understand why it's important to raise
the debt limit, but are afraid of losing a primary to someone." Recapping Frank's view: why deal with a problem under my tenure, when very soon there will be a congressman who will replace me and he, or more likely she, can deal with the sordid mess I created. And this is not even counting the trillions in GSE off-the-books debt of which Frank was one of the key people responsible for letting it be the catalyst that blew up the credit bubble when Fannie and Freddie were nationalized just under 3 years ago.

The European financial system, like the others, is efficient but is not robust. It makes the most of what it has and runs on a razor edge between efficiency gains for individual agents and horrendous systemic losses. It depends crucially on the performance of its sovereign assets. System survival depends on one hand whether or not counterparties can absorb the necessary haircuts and on the other, whether fundamentals of debtor nations are strong enough to stand on their own. Spain and Italy will have to stand on their own, because when Greece goes, Ireland will most likely go, which will in turn set off a critical mass such that the nation who dictates monetary policy (Germany) will be taking care of its own self.

Last Wednesday we cited from a Reuters report, according to which the last ditch Greek MLEC/CDO rescue operation, would be welcome to S&P and Moody's as "The whole charm of the French model is that it was worked out in a such way that it will be fine with the rating agencies." Because absent a decree of no EOD, the whole thing is pointless. Well, as often turns out, this was yet more wishful thinking on behalf of some bureaucrat, masked as fact. S&P has just come out with the following: "In recent weeks, a number of proposals relating to this  topic have surfaced, and the particulars in some cases are evidently still  in flux. This credit comment looks at the most prominent of the recent proposals, put forward by the Fédération Bancaire Française (FBF) on June 24, 2011, in the context of our criteria for evaluating distressed debt exchanges and similar debt restructurings (see Related Research below). In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria" and specifically: "we believe that both options represent (i) a "similar restructuring"
(ii) are "distressed" and (iii) offer "less value than the promise of
the original securities" under our criteria. Consequently, if either
option were implemented in its current form, absent other mitigating
information, we would likely view it as constituting a default under our
criteria." Goodbye MLEC 2 - as expected you were just as useless as your first iteration back in 2007.

A few days ago, when we explained that the current iteration of the European bailout plan is nothing but a repeat of the failed MLEC off-balance sheet plan, which was supposed to prevent the subprime bubble from exploding, we wondered just why Europe has settled on this plan. Now we know: it appears that it was the rating agencies, arguably well-padded with $100 bills to compensate their collective conscience, who suggested that this is the only format of perpetuating the global ponzi without Greece being declared an Event of Dafault. Per Reuters: "The whole charm of the French model is that it was worked out in a such way that it will be fine with the rating agencies." There it is: expect headlines to slowly start leaking from S&P et al that the MLEC part deux will actually not be an Event of Default, and so Europe has the all clear to continue kicking the can down the road for several more years courtesy of money that is literally created out of thin air, and pledged by assets that no longer generate virtually any cash flows.

With mainstream acceptance of my presumptions of the potential of serial sovereign debt defaults, its time to take a more realistic look at how it may happen & the potential consequences.

On the day when the flawed euro experiment will get its first popular pseudo-referendum, it is only logical that prominent euroskeptic Nigel Farage would sound off on how he sees things for Greece, Europe and the currency union, and why he believes the current situation is nothing short of slavery: "Listen to Borges state: "We really believe that many of the current problems result from incomplete integration. In the process of developing monetary union like the United States, which is a fully integrated monetary union, you have obstacles that magnify the problem." What he seems to forget is that final fiscal and monetary union in the US only happened after the then bloodiest war in history, in a country that was already united by language law and customs. It is extraordinary that the IMF is suggesting that this economic crisis is in any way synonymous with what was happening in the US in the 1840s. The only slavery here is of the people to the Eurocrats dream. For without democratic control, we are left with something akin to slavery."

When we said over two weeks ago that the second Greek bailout is Dead On Arrival, we were, as sometimes happens, just a little ahead of the curve. S&P has just confirmed that a "voluntary debt restructuring" would be characterized as an event of default from the rating agency's point of view, which is the most disastrous outcome, as it would impair the collateral held by the ECB and be the true catalyst for a liquidity freeze, while anything ISDA decides on whether Greek CDS is triggered and if a rating agency default is an ISDA determination Event Of Default, is almost completely irrelevant, as discussed in our CDS myth debunking post over the weekend.