Sovereign Risk

Ponzi's are not just of Italian origin!

Spreads were mixed today with the major US indices managing modest gains as HY outperformed IG. This spread compression is optically misleading though as, in general, curves flattened in 3s5s and more technically indices outperformed weak single-names as the theme of the day appeared to be skew compression and profit-taking. Modest short-covering and single-name (sovereign and corporate) repricing was the mood of the day and while we rallied it seemed like there was very little conviction to it (despite IG closing at the day's tights) - though well off yesterday's tights.

Notice how many central bankers, analysts, pundits, banks and politicians said the debt problem was not only contained to Greece, but was also solved and all should move on. Uh huh...
I believe what we are seeing is just the beginning, and what the world saw with the collapse of Lehman was simply a microcosm of what happens when actual sovereign states threaten to fail!

Help those most in need
Yes, you read that correctly! Greece killed its own banks. You see, many knew as far back as January (if not last year) that Greece would have a significant problem floating its debt. As a safeguard, they had their banks purchase a large amount of their debt offerings which gave the perception of much stronger demand than what I believe was actually in the market. So, what happens when these relatively small banks gobble up all of this debt that is summarily downgraded 15 ways from Idaho.

For those who have forgotten the implications of the highly leveraged and opaque financial holdings (the true value of which rests at the mercy of market sentiment) and can turn blind eye to the highly volatile nature of the trading revenues combined with a literal tsunami of regulatory pressure and potential litigious onslaught (all issues which we have repetitively brought up in the past as what appears to be the sole voice of contrarian reason), Goldman Sachs holds a strong investment proposition. However, if fundamental considerations such as the company’s solvency, true economic profit (not the accounting earnings you hear preached from your brokerage’s sell side marketing propaganda cum research reports) and the sustainability of income are to be considered, GS should NOT appear among the preferred lot.

Moody's Investors Service has taken the following rating actions on covered bonds issued by Greek banks:
 
- Mortgage covered bonds issued by National Bank of Greece S.A. ("NBG"): Downgraded to Aa2 and placed on review for further downgrade; previously on 31 March 2010 downgraded to Aa1;
 
- Mortgage covered bonds issued by Alpha Bank S.A. ("Alpha"): Aa2 placed on review for possible downgrade;  Previously on 31 March 2010 downgraded to Aa2;
 
- Mortgage covered bonds issued by EFG Eurobank Ergasias S.A. ("EFG Eurobank"): Aa2 placed on review for possible downgrade; previously on 31 March 2010 confirmed at Aa2.

"In the depths of the 2008 crisis it was the governments that stepped in to provide a guarantee on financial assets. It was the governments that backed our savings accounts, money market funds, day-to-day business banking accounts, as well as debt issued by US banks. But what happens when confidence in the government guarantee begins to erode? We’ve seen what happened to Greece. Leverage inherent in the banking system elevated a bank run, equivalent to a mere 3.6 percent of deposits, into another full blown banking crisis. In our view it’s time for investors to acknowledge sovereign risk. The ratings agencies can opine all they want, but it seems clear to us that the only true AAA asset to protect your wealth is gold. " Eric Sprott

Earlier we pointed out the surge in CDS on a variety of PIIGS banks, mostly in Portugal and Spain. Now we know why: Goldman's Charles Himmelberg has just reiterrated his call for Long CDS on local banks in Portugal, Spain and Italy, hedged by selling Main (iTraxx) protection. It is our view that as accounts plough into this trade and as bank spreads blow out, it will only accelerate the funding complexities, the bank runs and the inevitable collapse of the financial systems in all of the other imparied peripheral countries, ultimately leading to the collapse of the EMU. Will Goldman be accused next of destroying Europe? Stay tuned.

In true fashion Moody's wakes up the day of bankruptcy. The new rating? A whopping A3.

EURUSD drops right back below 1.33.

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...

Spreads managed to hold onto modest widening today in the US as IG underperformed HY, indices underperformed intrinsics, single-name activity was extremely muted, and low beta underperformed high beta. Notable underperformance in Europe, spreading idiosyncratic sovereign risk to SovX to FINLs to Main and up to XOver was not enough to upset the optimistic US investor today, though it was one of the least convicted days in a long time.

I still have a deep, deep concern about the leverage in the banking system. I look at the inability of governments who are spending vast amounts of money to generate much growth in GDP. I can give the example of running a $1.5 trillion deficit last year and GDP goes up $200 billion. So we are not getting much bang for the buck but we still owe the buck at the end of the year. I also worry about what's going on in China. The Chinese government has asked the banks to cool down their lending, the latest data in March show that lending has gone down from $300 billion per month to $100 billion. That's $2.4 trillion a year less. And obviously it has to have an effect on their economy as the lending of $2 trillion did positively last year. When you look back at China in 2009, they had a $4 trillion economy, they lent $2 trillion to people, they had a $600 billion stimulus: those should generate some GDP growth. I am not even convinced that 10% growth which would be $400 billion is a good response to all the measures that were taken. - Eric Sprott

SocGen's Dylan Grice is out with another must read report summarizing the Greek situation: in short, so much time and effort is injected in preserving the Greek status quo (so far unsuccessfully, even after 4 rounds of bailouts) as it is small enough that it could, in theory at least, be helped. If it goes, the next countries to follow will be simply too big to be bailed out. Just recall the $500 billion expansion in the IMF's NAB. The world is slowly realizing the dominoes can not be stopped, and as much capital must be locked away as possible in advance of the next major risk flaring episode. Which is also why stocks are currently going to the moon: the resultant crash in the stock market once the reality of just how ugly the global mess is will lead to large double digit drop in the market. Which is why getting to the highest possible level from which to plunge makes all the sense in the world...

Russia and China have also formed alliance to help each other increase their clout in global affairs. Underneath the geopolitical and trade pacts, this newly elevated Sino-Russian alliance seems to also suggest the beginning of an economic paradigm shift for both countries.

Total. Soap. Opera. Rumors of a Moody's Upgrade to AAAAA+++ vastly exaggerated

Fitch Ratings-London-09 April 2010: Fitch Ratings has today downgraded Greece's Long-term foreign and local currency Issuer Default Ratings to 'BBB-' from 'BBB+'. The Outlook is Negative. The agency has simultaneously affirmed Greece's Country Ceiling at 'AAA' and the Short-term foreign currency IDR at 'F2'.