default

John Taylor was on Bloomberg TV Friday, and in this extended version of his interview, the head of the world's largest currency hedge fund said that the euro will fall, equities could head lower, credit spreads will widen sharply and government bonds will rally.

Of America’s 11 million homeowners with negative equity, a majority live in the four sand states where the real estate bubble was concentrated--California, Florida, Arizona and Nevada. Over three million live in California and Arizona, where a borrower can hand over the keys to the lender and walk away. These are two antideficiency states, where the lender has no recourse beyond the collateral property. So of course it makes sense that wealthy homeowners would default on their mortgage loans. They live where in places home prices were the highest and the fell the steepest, and where the consequences of default are the least onerous. The New York Times overlooked the “where” and “why” of the story. The wealthy are also less dependent on consumer credit. They can buy cars for cash; and charge expenses on their debit cards. So for them, it’s easy to make a fresh start. But the mortgage debt doesn’t go away. It’s simply pushed off to the banks insured by the Federal government. The rest of us pick up the pieces.

It's official. Illinois, the fifth most populous state in the U.S., has overtaken Iceland in the default risk category. Will other U.S. states follow?

Following up on our earlier observations on the Spiegel article about Germany change in posture vis-a-vis the European Stability Fund, here are some additional summary thoughts from Thermidor.

And now the latest joke - the increasingly more incorrectly named "stress" tests being conducted in Europe are now officially confirmed to be anything but. As Market News reports: "Planned stress tests for European banks will cover their resistance to a crisis in the market for European sovereign debt, but not the scenario of a default of a Eurozone state since the EU would not allow such an occurrence, a German newspaper reported Wednesday." Now that is some serious downside stress testing. Of course, by the time the stress tests are found to have been a joke, and the country hosting the bank blows up just becase the bank's assets are 3x the host nation's GDP, and the country is forced to bankrupt, it will be far too late. So let's get this straight - the very issue that is at the heart of the liquidity crisis in Europe, namely the fact that a bankrupt Greece has managed to destroy the interbank funding market in Portugal and Spain, and the other PIIGS, and has pushed EURIBOR and other money market metrics to one year stress highs, and forced the ECB to lend over $1 trillion to various central and commercial banks, will not be tested for? Fair enough - if the ECB wants to treat the CDS vigilantes as a bunch of idiots, only to be hounded in the press with derogatory words as "Wolfpack" and much worse, so be it. But it certainly should not be surprised if this is latest show of idiocy by Trichet's henchmen serves as the springboard for the latest round of spreads blowing up across Europe.

Ironically even with Greek CDS surging by 60 bps to 909 bps this morning, the biggest mover in percentage terms is not the bankrupt Mediterranean country but Europe's "stablest" one -  Germany, whose default risk has spiked by 9.19% according to MarkIt. Without splitting hairs, Europe is a sea of red this morning as the ugly specters of default and complete lack of credibility in the EU administration raise their ugly heads again.

One of the oddest phenomena over the past two years has been the relative outperformance of European bank CDS compared to their transatlantic counterparts. Well, this peculiar relationship has now ended. European banks are finally, on average, riskier than American ones. Investors have finally realized that "regulatory capitalization" in Europe is an even more ephemeral concept than in the US. Furthermore as JPM pointed out yesterday, not only do European banks use more leverage, but the "the larger size of Europe’s banks argue against using simple GDP weights to assess potential risks to global markets.  Due to a buyer’s strike over the last month, European banks now have 3.5x as much debt to issue than U.S. banks over the remainder of the year." Also, as we have been pointing out every single day for the past week, European banks, or at least those that have excess liquidity, have been storing more and more of their euros with the Central Bank, instead of lending it out. Add to this the relentless rise in EUR Libor, and this trade should have been a no-brainer for months.

Poor, poor Europe. Every room one shines a light in, the cockroaches don't even bother to scurry to safety any more. Yet what is glaringly obvious takes a media-reported soundbite to awake people. So is the case with Hungary today. After opening 7 tighter, Hungarian CDS are now 14 bps wider to 277bps. As the attached chart shows, the Hungarian Forint is now in freefall. Yet if investors are concerned about Hungary, they should take a look at some of its less lucky Eastern European neighbors which, just like Hungary, have been considered to be strong for so long.

Libor is now at 0.53%, eurodollars are plunging, new Fed-ECB rescue facilities are rumored to be imminent, Germany is set to introduce a ban on naked shorting of all stocks, and sovereign risk is exploding: it will be a fun day. Spain, Italy and Korea are all more than 20% wider on the day, as the contagion virus is spreading faster and faster toward the heart of Europe.

On the other hand ...

With its CDS at 875, today, Greece is riskier than dictatorical (but Fed Free) Venezuela and perpetually bankrupt Argentina. All the hedge funds who went long Greek bonds with or without protection are getting destroyed. And some very prominent names did. We are waiting for the latest HSBC report to confirm this.

Country         Spread       CPD

• Greece:       874.22      50.66
• Venezuela:   841.28     44.57
• Argentina:    832.50     43.17
• Pakistan:      708.40     38.22
• Ukraine:       601.41     34.24

No, you are not looking at Portugal or Greek CDS. BofA starting to rumble too: CDS hits 163.

As I warned, Greece is ever closer to default (a default that is damn near guaranteed) while Ireland is probably in worse shape!!! Financial contagion begets economic contagion which breeds more financial contagion...

Probably not the best words to use when trying to diffuse a ticking time bomb.

SCHAEUBLE SAYS WOULD REGRET LETTING EURO COUNTRY DEFAULT
SCHAEUBLE SAYS EURO FOUNDERS COULDN'T IMAGINE SOVEREIGN DEFAULT

The market should dutifully ignore this if it knows what's good for it.

And why not - after all it's all the rage among those waiting in line for iPads so they can be first to buy "The Steve Jobs Guide for Deadbeat Dummies Trying To Learn To Read Good." Now that Obama has given his blessing to an entire generation of Americans to tear up contracts (very appropriate coming from a contract law professor), the follow up to moral hazard is resulting in not just individuals and companies, but entire nations simply opting out of paying their dues. Evans-Pritchard reports that after today's ludicrous rates on 3 and 6 month Bills the tide may be turning in Greece, with both parties in the country finally realizing its creditors will do everything in their power to bleed it dry, at "usurious" rates. With economic growth negative for a decade and debt interests quite certainly positive, the marginal difference will destroy not only economic output, but sink Greece ever more in debt, as existing creditors fund capital shortfalls at maturity (or default) by ever increasing interest rates. Greece has the option to stop funneling domestic capital to Germany later (inevitable) or sooner (if it finally makes the right decision).