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Guest Post: Enter The Swan

We know the U.S. is a big and liquid (though not really very transparent) market. We know that the rest of the world — led by Europe’s myriad issues, and China’s bursting housing bubble — is teetering on the edge of a precipice, and without a miracle will fall (perhaps sooner, rather than later). But we also know that America is inextricably interconnected to this mess. If Europe (or China or both) disintegrates, triggering (another) global default cascade, America will be stung by its European banking exposures, its exposures to global energy markets and global trade flows. Simply, there cannot be financial decoupling, not in this hyper-connected, hyper-leveraged world.

All of this suggests a global crash or proto-crash will be followed by a huge global money printing operation, probably spearheaded by the Fed. Don’t let the Europeans fool anyone, either — Germany will not let the Euro crumble for fear of money printing. When push comes to shove they will print and fiscally consolidate to save their pet project (though perhaps demanding gold as collateral, and perhaps kicking out some delinquents). China will spew trillions of stimulus money into more and deeper malinvestment (why have ten ghost cities when you can have fifty? Good news for aggregate demand!).

Time To Load Up On Denmark CDS - Moody's Cuts Nine Danish Financial Institutions: Luxor Thesis In Play

Last time we looked at Denmark it it was in the context of Luxor Capital which had some very ugly things to say about the Scandinavian country in "Rotten Contagion To Make Landfall In Denmark: CDS Set To Soar As Hedge Funds Target Country." Now, 6 months later, Moody's has finally gotten the memo: "Moody's Investors Service has today downgraded the ratings for nine Danish financial institutions and for one foreign subsidiary of a Danish group by one to three notches. The short-term ratings declined by one notch for six of these institutions. The rating outlooks for five banks affected by today's rating actions are stable, whereas the rating outlooks for two banks and for all three specialised lenders affected by today's rating actions are negative  The magnitude of some of today's downgrades reflects a range of concerns, including the risk that some institutions' concentrated loan books deteriorate amidst difficult domestic and European conditions, with adverse consequences on their ability to refinance maturing debt. The latter concern is exacerbated by structural changes in the terms of Danish covered bonds and the mix of underlying assets that lead to increased refinancing risk. While Moody's central scenario remains that financial institutions show some resilience to what will likely be a prolonged difficult environment - and the revised rating levels for most Danish financial institutions continue to reflect low risks to creditors - today's rating actions reflect the view that these risks have increased."

Is Germany's CDS Pricing A 6% EUR Devaluation?

Whether the market is expecting more significant deterioration with the European debacle or somewhat perversely a rapid-response by the ECB (with its flood of EUR overwhelming USD), it appears the USD-denominated Germany CDS spreads are once again pricing in notable devaluation in the EURUSD exchange rate. Given the US and (almost explicitly given its dominance) Germany are more currency issuer than user, default risk is not the main driver of the CDS spread but currency re-/de-valuation (some might call it inflation) is much more of a factor. After EURUSD and German CDS being tightly coupled for months, last summer-to-fall's Eurocalypse disconnected them as the CDS market led exchange-rate lower. It seems with the current dislocation that USD-denominated (and EUR paying) German CDS are expecting EURUSD at around 1.1750 - or a 6% devaluation of the EUR. With today's dismal confidence data seeming enough bad data to spark QE3 hopes over here, we can only imagine the relative size of print-fest the two central banks will need to create in order for CDS to be correct.

Guest Post: The Financial Reform: A Mayan Prophecy?

While the Spanish government feverishly attempts to wrap up the country’s euphemistic financial system reform, the ever-expanding black holes, multiple balance-sheets restructuring with infinite amounts of public funds and reiterated calls for the need to further consolidate financial institutions seem to be setting up the stage for a self-fulfilling prophecy of Mayan proportions.  Hopefully, this time around, we can learn from the not-so-ancient Mesoamericans’ hard-learnt lessons of the dangers implied in the state breaking the rules of free market capitalism when bailing out institutions and interest groups at the taxpayers’ expense. If we don’t, at least the endgame should not take anyone by surprise.

We're Not In Wonderland Anymore, Alice... And The True Greek Debt/GDP Ratio Of 421.7%

With all of the talk of Greece leaving the Eurozone and forfeiting the Euro as its currency; what if it does not? That, my friends, is now the question. The current estimation of Greece’s GDP is $308.3 billion. All of the debt of Greece, direct, derivatives and guaranteed is $1.3 trillion giving the country an actual debt to GDP ratio of 421.67%. You may recall all of the talk, all of the pandering words spit out by the IMF and the European Union that the new austerity measures would take the Greek debt to 120%; all nonsensical and a nonfactual expression of a very fantastic and fairy tale imagination. If someone has actually stepped through the looking glass I suspect it is Christine Lagarde. Perhaps she is Alice’s granddaughter? In my estimation she must have eaten some of the cake because her reputation has dwindled as she and Greece fell down the rabbit’s hole.

If Greece Was California...

For all its rhetoric, the current situation in the Eurozone should be very familiar to most Americans: after all it is merely a Federalist organization just missing one key feature: Federalism. At least for now. Whether Europe will succeed in reversing 20 centuries of nationalist pride, a multitude of languages, religions, cultures, histories, and superficial solidarity and friendliness covering generations of broad-based enmity, blood feuds and hatred, which is precisely what will be required (because the monetary union was merely half of the game) remains to be seen. It is likely that the stock market will force this resolution sooner than most expect. Then the question becomes: will Europe truly become the United States of Europe. And if so, what would the current Greek travails look like if they were transplanted to the state of California: another place which may soon be in dire need of a bailout. Luckily Jefferies' David Zervos has performed just the thought experiment: "let's assume the European monetary system structure was in place in the US. And then imagine that a US "member state" were to head towards a bankruptcy or a restructuring of its debts - for example California." The results are below.

Europe Is Fighting the Wrong Battles Again

Europe continues to fight the wrong battle, and continues to spread contagion risk. It is clear that Greece has had a solvency issue now for over 2 years.  The ECB and Troika chose to treat it as a liquidity problem.  Maybe, they could have argued that in early 2010, but by the summer of 2011 it was obvious to any credit observer that the problem was solvency, yet they continued to treat it as one of liquidity.  That is scary because if they fail to see the problem correctly now, they will fail miserably.  Not only is the problem clearly solvency, but now forced currency conversion has been added to the mix. Any "solution" from the EU must now address that risk, and it is not the same as solvency.  Programs that can protect against solvency may do nothing for the redenomination risk. We keep playing with scenarios and find it hard to find out where a Greek exit doesn't result in a steep sharp decline in the market.  We could go through more ideas of ECB intervention, but in the end most will have flaws.  Dealing with currency conversion risk is huge.  Dealing with the contagion risk that has been created by the EFSF is huge. Will Europe force Greece out thinking they have a plan; that fails miserably and sparks the miserable series of consequences we’ve outlined?  Sadly, yes.

Phoenix Capital Research's picture

 

Put another way, those Greek bondholders who DIDN’T go for the Second Bailout, just got their money back at 100 cents on the Dollar (compared to those who DID go for the Second Bailout and lost 70% of their money). This has shown the ECB and EU bureaucrats to be complete and total liars. It also shows the entire bailout/ austerity measures process to be garbage. 

Marc Faber Sees 100% Probability Of Global Recession In 2013

From around two minutes into this CNBC clip, Marc Faber brings the conversation back into sharp focus. Noting that "whenever everybody focuses on just one thing - Greece and Europe in this case - there are other things that are far more important - such as a meaningful slowdown in India and China - going on that are being ignored". But remaining on the topic of Europe, Faber consistently opines that the next event risk will be the Greek exit - even though Faber suspects strongly that Germany will cave to Eurobonds eventually - as he comments that the longer the delay of a restructuring/default/exit/euro-bonds takes the higher the probability of a gigantic systemic failure. This subject brings up (at around 3:30) an interesting perspective that the European market would be oddly relieved (not plunging 50%) if Greek exited the Euro as there would be some clarity (though Faber adds that bank and insurance stocks would likely be crushed). At five minutes in though, Faber ramps up the rhetoric noting that while stock indices are not performing terribly, there are many economically sensitive (and luxury) stocks that are down very significantly - which suggests to him that the huge asset price run of the last decades in come to an end prompting the question of the day from CNBC's Cramer-stand-in "You're not looking for a recession in the US are you?" Faber, in his calm, thoughtful way responds, "I think we will have a global recession late this year, early next year", to which a stunned Wapner asks for odds (surely 30%, 50%?) of this recession - "100% certainty" comes the reply to leave Wapner throwing in the towel on any positive spin as Faber suggests the only 'investment' in this case is 'Cash USD' and investors must own some gold.

European Stocks On Verge Of 50%-Off Greek Light Special

It seems the clarion call for central bank intervention to save us all is growing louder as following Citigroup's imploring letter earlier in the week, SocGen has done its homework on the impact of a Greek exit from the Euro and finds Euro Stoxx could drop by 50% under a contagion scenario. They believe the reason why the eurozone market is holding up relatively well - despite the rising risk of a Greek exit - is that contagion has not really spread yet, which is then 'discounted' away based on expectations of a central bank put to save the world. In the case of a disorderly break-up (the only kind there can be realistically in our view), they expect eurozone profits to decline for two years, a rise in bond yields (raising cost of funds), a rising equity risk premium, and the implicit drop in P/E multiples. A Greek exit alone (with no contagion) would likely knock 10% off Euro Stoxx but the significant rise in correlations across the euro-zone suggests the idiosyncratic becomes systemic very rapidly.

As Bankia Bailout Costs Grow Exponentially, Is A Stealth Bank Run Taking Place... And What Happens To Ronaldo?

Note the following sequence of events, bolded numbers, and dates:

  • Bank Of Spain Formally Nationalizes Bankia, Says Insolvent Bank Is "Solvent", Adds There Is No Cause For Concern, Zero Hedge, May 9
  • Spain is taking over Bankia by converting its 4.5 billion euros of preferred shares in the group’s parent company into ordinary shares, BusinessWeek, May 21
  • Spain said on Wednesday its rescue of problem lender Bankia would cost at least 9 billion euros ($11 billion), as the government tries to clean up a banking system that threatens  to drag the country deeper into the euro zone crisis, Reuters, May 23   
  • Bankia SA will have to ask the Spanish government for more than 15 billion euros as part of its effort to restore its financial health, state-owned news agency EFE reported Thursday, citing financial sources, Dow Jones, May 24

Hopefully we aren't the only ones to notice how the bailout cost has oddly doubled almost on a daily basis.

Phoenix Capital Research's picture

This is the REAL DEAL for Europe. Anyone who has some kind of counter-argument to these points either doesn’t understand the political environment we’ve entered (even Central Banks are fed up with bowing to political pressure from politicians) or is simply hoping that by ignoring these realities they (the realities) will go away.

In Europe, It's All About The Bank (Run)

The word 'encumbrance' has received a lot of headlines in the last few months - and rightfully so - after we pointed out the impact that LTROs had in subordinating senior creditors of European banks. As Morgan Stanley points out, this is a considerable problem for bondholders as 'in a wind-down scenario, senior unsecured holders have recourse to fewer assets and hence face a higher loss given default (LGD)'. In understanding just how bad things are for European banks, it is important to focus on 'how much loss-absorbing capital there is beneath you in the bank’s liability stack, as this is the capital that will take losses before senior creditors in the event of a bail-in' which means looking at deposits as well as secured encumbrance. What is very apparent from the pictorial representations of banks’ liability structures is that rather than encumbrance from covered bonds/LTRO etc. the bigger issue for encumbrance of senior unsecured investors is the potential threat from depositor 'runs'. The hope of another LTRO is limited by collateral as policy-makers are well aware that, in a world where failing banks are to be resolved through resolution frameworks and senior creditors are to take losses to shield taxpayers’ funds, banks may not have enough ‘bail-in-able’ debt, given their growing reliance on secured funding sources. With deposits increasingly impaired - and/or the potential for contagious bank runs if we see Grexit, Europe's problem is 'all about the bank runs' now and we were told yesterday how far off that is - though the crisis 'event' may bring deposit guarantees (and the implicit exchange of sovereignty for monetary support) sooner.

The gEUR.QQ: "The Only Winners Are Foreign Banks"

In a brief though detailed clip, Stratfor's VP Peter Zeihan discusses the risk of contagion from Greece and the 'creative' - if not self-centered - suggestions for a solution to these problems. Earlier in the week we described Deutsche's suggestion of a dual currency - the GEURO - and that is where Zeihan focuses, noting that "The Greek economy is as deliciously non-competitive as the German economy is hyper-competitive" - this mismatch is the core of the crisis. The GEURO (trading as gEUROQQ on the pink sheets) plan doesn't address this mismatch but extends it just a little longer while bailout funds will continue to funneled through Athens to the country's lenders (read European banks) but private capital would be unlikely to flow and without outside capital, they would be unlikely to stimulate the growth they need to regain any kind of solid footing. Greek debt levels to GDP would rise (not fall) under the plan as EUR debts would remain but GEURO incomes (devalued) would be the source of GDP - making a long-term recovery even less likely. The only winners - simple: foreign banks who have exposure to Greece. The Stratfor VP goes on to note that the vast bulk of Greek debt is held by the ECB, IMF, and the Greeks (Greek banks) adding that private losses would not be catastrophic in the event of another Greek default - though we point out that it is the contagion effects (as we have so critically established in the past) that makes the Greek imbroglio so important to watch.