The reason that the 2008 debacle happened was very simple. The derivatives market, the largest, most leveraged market in the world. Today, the notional value of the derivatives sitting on US banks’s balance sheets is in the ballpark of $234 TRILLION. That's 16 times US GDP and more than four times WORLD GDP. Of this $234 trillion, 95% is controlled by just four banks. And they are... the TBTFs.
Things are certainly speeding up, and it is my conclusion that we are not more than a year away from the next major financial and economic disruption. Alas, predictions are tricky, especially about the future (credit: Yogi Berra), but here's why I am convinced that the next big break is drawing near. In order for the financial system to operate, it needs continual debt expansion and servicing. Both are important. If either is missing, then catastrophe can strike at any time. And by 'catastrophe' I mean big institutions and countries transiting from a state of insolvency into outright bankruptcy.
As Greece Sells 3 Month Debt At Record 4.1% Yield, CreditSights Explains The Negative Downstream Effects Of A Greek RestructuringSubmitted by Tyler Durden on 04/19/2011 06:29 -0500
Even as Greek debt hits new and improved daily record highs each and every day, with the Bund spread for 10 years hitting a ridiculous 1,140, the country continues to pretend it has capital markets access. Although in theory it still does. Even with a Greek restructuring now virtually assured, although as the CreditSights note below notes this would be a political suicide event, the country still managed to sell €1.625 billion of 3 month Bills at the stunning rate of 4.10. Reuters reports: "Greece sold more than 1.6 billion of three-month debt on Tuesday, raising funds to roll over 800 million euros ($1.14 billion) of maturing government paper later in the month, with yields rising above 4 percent. It was priced to yield 4.10 percent, up 25 basis points from an auction in February and around the rate of about 4.2 percent Greece pays on its EU/IMF bailout loans." Yet even with the "attractive" yield the Bid To Cover plunged from 5.08 to 3.45, as the only bidders were banks themselves propped up by the ECB and China: according to PDMA foreign investors accounted for 36% of the issue.
Friedberg Mercantile Group Q1 Commentary: Views On Asset Allocation And Gold In A Stagflationary EnvironmentSubmitted by Tyler Durden on 04/18/2011 16:44 -0500
Importantly, this inflationary episode, which threatens to last as long as the U.S. does not raise nominal interest rates above present rates of inflation (or, more to the point, real rates above the growth rate of the economy), has serious recessionary consequences, especially when wage and salary costs lag prices. In other words, what is being touted as a constructive element, the fact that labour costs are not showing signs of inflation, is reason to believe that the economy will soon be hit by another wave of retrenchments, as consumers are hit by shrinking real paycheques. Recessionary pressures in the U.S., adumbrated by downward revisions to second-quarter GDP forecasts in recent weeks, are being reinforced by economic weakness in the U.K., which is already undergoing a more severe bout of inflation, and the Eurozone (with the exception of Germany), which is in the grips of extremely high unemployment and negative growth per capita and stifled by excessive debt, rising taxes, and, believe it or not, low money supply growth. Consider, too, that most of the emerging markets are engaged in belated and not always conventional forms of monetary tightening in a desperate but ultimately futile hope of reducing inflationary pressures without disrupting real economic growth, and the resulting mix, you might guess, can only spell global economic trouble.
Things like this don't all happen at once, today just happens to be a day that the S&P happens to mention that we are standing dangerously close to the ledge. Brazil was much smaller than Greece when they defaulted in 1983 and they took the US economy down with them...
So it starts. Where will it end?
Putting its money where its mouth is, Dagong has a long-standing, negative outlook on US debt that doesn’t pull any punches. From its November 2010 report: “In essence the depreciation of the U.S. dollar adopted by the U.S. government indicates that its solvency is on the brink of collapse, therefore it wants to cut its debt through the act of devaluation with the national will; such a move has severely harmed the interests of creditors.” Following suit, S&P stunned financial markets this morning by revising its US outlook to ‘negative’, citing politicians’ inability to address medium-term and long-term challenges. In total contrast, US News and World Report published an article a few days ago entitled Why you should buy U.S. Treasuries,” which amounts to the worst advice I’ve seen in years.
In a very unstunning development which would expose all those Greek and EU proclamations about a solvent Greece for another relentless barrage of lies, it appears that Germany is now resolved to not only restructuring Greece (and with certain Greek bonds trading around 60 the market has effectively thrown in the towel), but has provided a timeframe in which this should occur: "German government sources said on Monday Greece will likely restructure its sovereign debt before the end of summer, putting a time frame to recent speculation that sent the euro to its lowest in two weeks. "Decisive voices within the federal government expect that Greece will not make it through the summer without a restructuring," one high-ranking coalition source told Reuters. "That does not mean that the federal government is striving for (a restructuring) but such a step will probably not be avoidable," he added, echoing views from other coalition sources." Supposedly the thinking in Europe is that banks should have built up a sufficiently large capital buffer to where the permanent impairment of Greek senior debt will not lead to another bank run. The question however is how well has Europe considered any other unpredictable consequences, which by definition, are "unpredictable." Recall that the financial system nearly ended after the Lehman bankruptcy following the freeze in money markets: a side effect that nobody had expected at the time. What will happen this time around when Greece becomes the first "Lehman" in the sovereign realm, and just how many trillions will have to be invested to undo "unforeseen" consequences?
As part of the broadly bipolar risk [ON|OFF] market stampede, Spain probably could have picked a better day to attempt to sell €4.7 billion in bills than just after the weekend when the market realized there is no way out for Greece than default. Alas, it did not, and the result was not pretty. Per Reuters: "Spain paid substantially more to issue 12- and 18-month Treasury bills on Monday compared with last month as uncertainty hovered over a Portuguese bailout and speculation intensified about Greek debt restructuring. The sale was at the low end of the Treasury's target range of 4.5 billion to 5.5 billion euros ($6.51 billion-$7.95 billion) and comes ahead of a closely watched long-term debt auction on Wednesday of bonds maturing in 2021 and 2024." Specifically, the Spanish Treasury was forced to pay 2.77% for its €3.5 billion 12 month Bill, 64 bps more than the 2.128% paid in a comparable auction in March, and making matters worse was a tumble in the bid to cover from 2.4 to 1.6. The weakness was mirrored in the auction of €1.2 billion in 18 month notes, which priced at 3.364%, up 93 bps from last month, with the BTC tumbling from 3.5 to 2.0. And one can wonder what the outcome would have been had the Fed or other central banks not been selling puts on the Spanish curve (because if he is doing it off the balance sheet in the US, there is nothing really preventing Bernanke from taking his curve manipulation tour global). And yes: Spain is next. "Investors are turning their attention to Spain as the next weakest link in the euro zone chain after Portugal said it would seek aid from the European Union and the International Monetary Fund, the third to fall after Ireland and Greece."
And so we see another tipping point in action: while absolutely nothing has changed in the fundamentals of Europe's insolvent peripherals, today, for the first time since early January, we are seeing an absolute bloodbath in the risk gauges of the European periphery. As the PIIGS list below shows, spreads are surging, and while it is no surprise that Greece is now trading north of 1200 bps following a weekend full of Greek default chatter, the important observation is that Spain and Italy are once again in the default mix.
- Portugal 615 (+15) - officially insolvent
- Italy 156 (+13)
- Ireland 588 (+21) - officially insolvent
- Greece 1225bp (+89) - officially insolvent
- Spain 250 (+16)
$1 Billion of Gold Bars Taken Delivery Of By Pension Fund Due to Risk of COMEX Default and ShortagesSubmitted by Tyler Durden on 04/18/2011 05:59 -0500
Concerns that the sovereign debt crisis may be entering a new phase and the risk of contagion has seen peripheral eurozone bonds fall sharply and the euro fall against major currencies and gold today. Sovereign debt risk, global inflation concerns, geopolitical risk, disappointing European earnings and concerns about Japan's coming reporting season have seen equities weaken and new record nominal highs for gold and silver (all time and 31 year). Greek bond yields have continued their relentless march higher and have risen above 14.07% (10 year) and Portuguese debt (10 year) has risen to a euro era record over 9.27%.Spanish and Irish debt are also under pressure this morning. Gold is increasingly being seen as the superior currency in a world of trillion dollar and euro deficits and bailouts. Indeed, the printing and electronic creation of billion and trillions of the major paper currencies is increasingly making gold and silver the currencies of last resort. One of the largest pension funds in the world, the University of Texas Investment Management Co (which manages the endowment for the Texas teachers pension fund), has realized this and has put 5% of the pension fund into gold bullion (see news). The fund has previously expressed concerns about the counter party risk in ETFs. However, the reason given for opting for taking delivery of 100 oz gold bars in a warehouse was that if the holders of just 5 percent of COMEX futures contracts opted to take delivery of the metal, there wouldn’t be enough to cover the demand leading to a COMEX default. The risk of a COMEX default increases by the day and appears to be moving from the realms of the “conspiracy theory” to that of “of course we knew it would happen, it stands to reason and was inevitable.” A COMEX default would have serious ramifications for the dollar and all fiat currencies as it would further erode trust in central banks, fiat currencies and today’s monetary system.
The early Finnish votes are in and it does not look good for Portugal. As Reuters reports, Finland's anti-euro True Finns made huge gains in an election on Sunday, raising the risk of disruption to an EU bailout of Portugal. The right-leaning National Coalition topped the ballot, gaining just over a fifth of all votes. Party leaders will start talks soon on forming a new government. The problem is that as the anti-euro moniker indicates, the True Finns are pretty much hell bent on vetoing the Portugal bailout which means the ongoing annexation of Europe's periphery by Olli Rehn is about to finish (and yes there is a finish-Finnish joke in there somewhere). Per Marketwatch: "Early results Sunday from Finland’s parliamentary elections suggest the anti-EU bailout True Finns party will hold the second-most number of seats and could even be part of a coalition government. Such an outcome may mean the EU’s planned bailout of Portugal is vetoed by Finland, a move that would roil the euro-zone markets. With half the votes counted the True Finns were on 19% support, and on course for 41 seats, tied with the Social Democrats and one seat less than National Coalition Party’s predicted 42-seat haul, the BBC reported. Finland is the only euro-zone country that requires bailouts to be approved by its parliament. Strong gains by the True Finns could derail a planned rescue for Portugal." What this means is that Goldman Sachs' European analysts will be scrambling all night to come up with loophole to European law that will not result in an epic plunge for the European currency, as apparently not even that sage among sages, Thomas Stolper, whose 2010 batting average of 0.000 made his contrarian calls manna from heaven in the past year, could anticipate this Black Swan. We will keep you informed of all the sell-side spin as it starts trickling in.
There are many ways this can end badly and only a few it can end well.
It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking CrisisSubmitted by Reggie Middleton on 04/15/2011 09:27 -0500
I’m fresh back from my trip to Amsterdam where I lectured hundreds of ING institutional clients/staff on the potential of a European banking collapse. Below are a few clips from the first of two lectures. The admonitions look to be quite timely as Greek spreads to Bunds break the millenium mark and head to the North Star. For those who haven't connected the dots, these bonds are held on many EU bank balance sheets as risk free in the hold to maturity category, and are levered up many, many times. Who's larger, the peripheral EU states or Lehman Brothers?
The market rallied a bit in the afternoon as rising new claims for unemployment missed analyst guesses by...