Comments from Eurocalypse, the Resident BoomBustBlog Credit Trading Guru...

These are comments from one of the traders that frequently contribute to BoomBustBlog. Enjoy!

Comments from Eurocalypse, the resident BoomBustBlog credit trading guru...

Update of the updated: Trendline broken in French bonds: today again Italy coming in but France is still moving out… hardly surprising.  Just as i said... and stocks i think will break out up, even if that seems contradictory.

Update: I wrote this this morning. Markets react really fast. Huge move in French yields today. See charts on Mish blog. The declining trend line broken now 10yr 3.47. 3.75 or even 4.00 in a matter of few days. 4.80 is where France starts to spiral out like Italy, Greece, etc... Now the ECB monetizes massively or its massive defaults. Time is running out. My 2 cent guess is EFSF won’t even have time to do anything significant before the ECB steps in massively...

picsay-1319726495The most important development is that the Eurocalypse is in full panic mode and Italy blowing up. The inferno machine is now running full speed and there is little way back for it to now. When Italian bonds yields rise 70bp a day, roughly getting hit 4% in price, worse than stock indexes, its game over. VAR is too high, all traders, portfolio managers MUST exit, ECB is the only real bid in size (for how long ?); and sooner or later Italy has to show the white flag and ask for a bailout, but we all already know how big the problem is… So what can happen from here short term and long term?
Looking at the short term dynamics, the Run must be in full mode. Simply put, confidence is gone, basta. Everybody is trying to take its chips off the table, selling brings in more selling, no more bids means auctions failing or getting filled at higher and higher yields. France will inevitably get hit.
What are the levels to watch to see how close we are from the end? I think the bond market is again the thing to watch. Well, 3.30 on 10Y French bond would break an intermediate downtrend line. As bunds are still in a bull market, that would signal the total end of French banks seen as fly-to-quality bonds, though they still keep some of that status with yields still in the low 3% handle. Then we’d go rather quickly to 3.75% or even 4%. Breaking 4.8% the highs of 2008 means total chaos and signals for good the bailout/default scenario for French bonds.

So we still have some time (but probably not much).

Italy is too big to fail, the only possible plan at this stage, which would be quick enough to implement is for ECB to adopt heavy "QE" and buy bonds seriously, I mean 2x, 5x or 10x more than they do. Fast printing… Pure monetization of debt… And all the problems that might go with it. The problem? The Germans don’t seem to want to agree on that. Neither do the French.
Think of what the impact could be to European financial stocks if that happens, though. Very bullish, at least potentially.

The EFSF and adding more debt to sustain insolvent borrowers never worked and won’t work.

Reggie here: Let me remind everybody that the EFSF is supposed to be a trillion euro vehicle, but its first 4 billion euro offering #FAILED!, followed by a barely completed 3 billion euro offering at sweeter terms. Okay, 3 million euro down, and just 997 million euro to go before we find out that this structure was a total #FAIL to begin with… Remember the question I posed several months ago? What Happens When That Juggler Gets Clumsy? - BoomBustBlog

man_jugling_money

 

The EFSF can’t even borrow decent amounts on the market, if the ECB would be the only one to buy it; why not simply buy Italian bonds instead? Much simpler and not adding more debt to the system (but adding more phony "money").

I think your blog (BoomBustBlog) and ZH so forcefully and perfectly demonstrate that the whole system is insolvent with just minimal haircuts from sovereigns. Because banks are too leveraged, and because (gov’t. but also private) debt in the system is unsustainable. All the evidence anyone needs is right here, and you’ve demonstrated as well that runs are quite possible, and the rational things for investors to do is to try to escape the chaos by removing their money from the weakest banks and countries, but that poses a prisoner’s dilemma. If everyone does the same, then we’re sure it will happen! The weakest is finished, but then, like in 10 Little Indians or any “B” rated “slasher” movie, the 2nd weakest is soon to be the next victim, and so on. Italy or banks are not (much) more (really or potentially) insolvent today than a few months or years ago. There is no magical number like 100%, 120% debt to GDP ratio that makes things SUDDENLY unworkable… It’s the realization of all this by investors, individuals and bankers alike.
Actually I am must more pessimistic than you, Reg. I’ve been thinking for a while, USSR 1989 or better put, Capitalism 2012. In USSR in 1988 nobody had a real clue that everything would be over in less than a year. I think it’s the same here. People don’t disappear, all factories don’t close, but a massive change and chaotic transition occurs. I expect the same in Europe, with some revolution or coups in some countries, big institutional changes, massive defaults and bankruptcies in both banks and (the leveraged) corporate sector, returning to some state-nations, or forming of several blocs, but EMU won’t exist as it is even in 1 year (most realistic analysts say 5 years..). As you demonstrated, I think it goes further than EMU and we can include UK, US and perhaps even Japan; all the western world with it, with a short 1-2 year lag at the very most. I’m not forecasting (nor hoping for) war, but that’s become my main scenario.

However, saying everything’s fucked up, it’s the bankster’s faults etc., misses the point and isn’t really constructive. That’s what I’d like people to discuss more on blogs. For example what’s the good of saying gold will go to 5000$ and making fun of fiat money? Who will it help ? What will it fix? If tomorrow gold was 5000$ would the crisis be over? It will only help those who have gold, or those who are buying now, taking money away from the fools who sell.

The only thing about gold and fixed (no) money supply system is that there SHOULD be some discipline, but in a gold system, one who owns GOLD initially is squeezing the money supply, and manipulates it in its favour, accumulating in time more and more of it, to the expense of other nations/people and dominating them. No wonder that just the TALK of returning to some gold system entices central banks to accumulate more than its neighbour just in case this happens. The bubble stage is only starting there.

The current monetary system was built on the assumption that gov’t debt was a riskless asset, debt will be always repaid, and more importantly that debt always could be repaid with more debt. Truth be told,  in nations where the gov’t can tax or print the money as it wants, indeed there is no absolute need for it to default (but it could strategically be a good idea if the lenders are mostly foreigners for example; but it could just heavily tax foreign holders or default on them only which is the same). So defaulting by printing/ inflation was always possible.

 

So its only too natural that the answer to Is The Entire Global Banking Industry Carrying Naked, Unhedged "Risk Free" Sovereign Debt Yielding XXX%?


My quick answer is NATURALLY !!! Any extra Euro of deposit in a bank gets marginally invested in those gov’t bonds, I’d say it’s almost the analog of the law of conservation of Energy in Physics as gov’t debt is the biggest and most liquid debt instruments.

If the banks didn’t then the states would never been able to borrow money in the first place.

The reason??? Because if most people don’t know that their pension funds and life insurance are invested in bonds, they ignore even more that their deposits are invested indirectly in those very same instruments, even though most would say “No!” if they had the choice !!!

So governments put in a lot of regulations to help this situation and extend the numbers of possible buyers of (this) debt, ex. risk-free weightings for banks, tax-free for this or that, allowing derivatives, etc...
Now with regulation asking for more capital, and volatility exploding, there is no more capital to buy debt, gov’t or corporate, any more.

So, what is the proposed solution to that ? Recapitalizing banks with borrowed gov’t money so they can buy gov’t debt ? That seems stretched and very inefficient to me and adding more debt to debt makes it worse, we all know that.

I would also add that an indirect effect of recapitalizing banks, and ever-adding debt is to make banks even bigger and more cannibalizing. After all, banks revenues should be proportional to their deposits and to existing debt. When this is the only thing growing faster than anything else, it is hardly surprising that banks profits (becoming acknowledged paper and virtual profits as opposed to real losses) and bankster’s revenues and bonuses are going higher and higher.

If people don’t want bankers to be rich, don’t bank! Move your money out of your bank. If you think footballers or rock stars are too well paid, don’t watch football or buy rock records! So basically the drug addict is complaining that the drug dealer is too rich.

My view is that gold or something else won’t solve anything. If not, then what would?
One of the ZH articles that I really liked, but must search to find it, was a chart of existing debt across countries, with who owes what to who, and how looking at NET debt, how this could be solved.

The real meaning of this debt crisis is:
- the market is not working anymore because of too much debt and due to current debt dynamics and current prices of goods and FX, imbalances keep on growing to an unsustainable state.

Reggie here: and the constant manipulation by politicians and central bankers that have all but destroyed the concept of true, market-based price discovery. See Do Black Swans Really Matter? Not As Much as the Circle of Life.

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the "Peak" phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality...

The result of this "Great Global Macro Experiment" is a market crash that never completed. BoomBustBlog subscribers should reference File Icon The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance.

- Financial assets are not worth what we think they are. One should include deposits in the financial assets category.
The only way is for everybody to acknowledge that. Now Italian bonds are trading 87 of par, it won’t help at all to recapitalize banks with public money for the 13 missing points as the gov’t will need to borrow this money which those banks will buy. Nonsense!

So it’s either better to assume they will be reimbursed to par with direct printing by the ECB, and magically, the need to recapitalize banks disappears (true, there is private debt to account for as well) or to default.
When defaulting, well shareholders will be wiped out and bank debt holders will be wiped out. If we keep the analysis to banks and gov’ts only, we see that interbank debt doesn’t hurt anymore if we let every bank fail!

The ZH/Mish camp or others claim that banks should fail. This omits to say that yes, probably billionaires or rich investors who necessarily have big assets will lose a lot if that happens, but Mr. Smith’s pensions, life insurance plans are wiped out too, and his deposits as well.
Owners of banks are not a group of mysterious people with big cigars living like Dr. No in some far islands. It’s mostly us.

Instead of disorderly defaults, if we really want the rich to pay for the mess, the best is to tax assets heavily, not to let the market default disorderly. I think also people up there should really think about closing banks and a debt jubilee plan, thinking how much people will lose and in what proportion, because now it’s all about that. The loss is in front of our eyes. The more we delay the situation, the more money will try to run out of the system.

I don’t think there is a unique solution. It involves a mix of  defaults, restructuring , heavier taxes not only on revenues but on assets, austerity from the gov’t, whatever works; and bigger focus on real production and wealth - making stuff, developing technologies, solving real problems as opposed to financial problems. Financial problems should be among the easiest to solve, it’s just math and 0s on computers, after all !

Also just a remark, It’s just an aberration a lot of people become homeless and poor in the US or Spain for example with all the overbuilding ! There must be a lot of empty homes, even the poorest should/could have a roof! If nationwide values of houses are divided by 2, will that make people poorer? The contribution to GDP of house building and anything related to it would be divided by 2 but who cares? GDP is not a good, nor anywhere near perfect, indicator of wealth creation. The stupid focus on GDP is also one of the many explanations why we’re having so many bad economic policies everywhere in the world. People would have more money to spend...

The 2 major problems, house prices (because mortgages account for so much debt), and gov’t spending (because gov’t spends more than it takes in) and thus assets related to those, need to be solved, and everything I believe can jump start again, better than ever before, without the need for revolutions, conflicts...

Other than that, I have to mention, that tomorrow is 11-11-11. only once every 100 years if you think of it. If you believe in numerology ( i think it DOES affect markets, as well as TECHNICAL ANALYSIS that some people think is VOODOO), a trader friend of mine says there is a very rare BUYING signal in Italian bonds, coming from BOTH weekly and daily DEMARK sequentials.  Not the end of the story, but a return to 6.25% for example would NOT change the major trend, not even a return to 5.75%. Shorts beware.
Also I’m still bearish on the EUR as I’ve been for a while, but stock markets I believe are heavy but trading like the markets want to be long. The 1220-1240 breakout zone on SP is holding for the moment, and even on European indexes, were not seeing new lows despite all the negative headlines. I believe stocks are technically bullish and for longer than many people think, because investors fear missing any rally (look how in October many HFs underperformed), and because there is a strong probability of ECB in full QE mode, monetizing heavily gov’t debt.

I’m pessimistic, I think debt monetization is not a good idea, if we go this way, I’d prefer to see pure monetary printing (equivalent to CB buying a perpetual gov’t debt with 0% or little interest) as at least accounting for that is simpler and doesn’t add debt, but I think it’s a real possibility that cannot be discounted. Furthermore if monetization is not accompanied by real reforms, it’s just can kicking and the problems will get much worse later.

the most important developments is the Eurocalypse in full panic mode and Italy blowing up. The inferno machine is now running full speed and there is little way back now for it to stop. When Italian bonds yields rise 70bp a day, roughly getting hit 4% in price, worse than stock indexes, its game over. VAR is too high, all traders, portfolio managers MUST exit, ECB is the only real bid in size (for how long ?); and sooner or later Italy has to show the white flag and ask for a bailout, but we know how big the problem is so what can happen from here short term and long term ?

Well, looking at the short term dynamics, the Run must be in full mode. simply put the confidence is gone, basta. everybody is trying to take its chips off the table, selling brings in more selling, no more bids means auctions failing or getting filled at higher and higher yields. France will inevitably get hit.

what are the levels to watch to see how close we are from the end ? i think the bond market is again the thing to watch. well 3.30 on 10Y french bond would break an intermediate downtrend line. as bunds are still in a bull market, that w3ould signal the total end of french bank seen as fly-to-quality bonds, though they still keep some of that status with yields still in the low 3% handle. then wed go rather quickly to 3.75% or even 4%.
breaking 4.8% the highs of 2008 means total chaos and signals for good the bailout/default scenario French bonds.

so we still have some time (but probably not much)

Italy is too big to fail, the only possible plan at this stage, which would be quick enough to implement is for ECB to adopt heavy "QE" and buy bonds seriously, i mean 2x, 5x or 10x more than they do. fast printing. pure monetization of debt; and all the problems that might go with it. problem, germans do seem they want to agree on that. neither do French.
think of what the impact could be to European financial stocks if that happens. very bullish potentially.

EFSF and adding more debt to sustain insolvent borrowers never worked and wont work. the EFSF cant even borrow decent amounts on the market, if the ECB would be the only one to buy it, why simply not buy Italian bond instead ? much simpler and not adding more debt to the system (but adding more phony "money")

I think your blog and ZH and so forcefully and perfectly demonstrate that the whole system is insolvent with minimal haircuts from sovereigns. because banks are too leveraged, and because (govt but also private) debt in the system is too much. The whole evidence is here, and youve demonstrated as well that runs are possible, and the rational things for investors to do to try to escape for the chaos by removing their money from the weakest banks and countries, but thats a prisoner dilemna here. if everyone does the same, then were sure it will happen ! the weakest is finished, but then, like in 10 little indians or any slasher movie, the 2nd weakest is soon the next victim and so on. Italy or banks are not (much)more (really or potentially) insolvent today than a few months or years ago, there is no magical number like 100%, 120% debt to gdp ratio that makes things SUDDENLY unworkable, its the realization of all this by investors, individuals, bankers alike.

Actually i am must more pessimistic than you. Ive been thinking for a while USSR 1989, Capitalism 2012. In USSR in 1988 nobody had a real clue that everything would be over in less than 1 year later. i think its the same here. People dont disappear, all factories dont close, but a massive change and chaotic transition occurs. I expect the same in Europe, with some revolution or coups in some countries, big institutional changes, massive defaults and bankruptcies in both banks and (the leveraged) corporate sector, returning to some state-nations, or forming of several blocs, but EMU wont exist as it is even in 1 year (most realistic analysts say 5 years..). but as you demonstrated, i think it goes further than EMU and we can include UK, US and perhaps even Japan, all the western world with it, with a short 1-2 year lag at the very most. Im not forecasting (neither hoping) war as well. but thats become my main scenario.

However saying everythings fucked up, its the banksters faults etc... misses the point and isnt really constructive. and thats what id like people to discuss more on blogs. For example whats good of saying gold will go to 5000$ and making fun of fiat money ? who will it help ? what will it fix ? if tomorrow gold was 5000$ would the crisis be over ? it will only help those who have gold, or those who are buying now, taking money away from the fools who sell.

the only thing about gold and fixed (no) money supply system, is that there SHOULD be some discipline, but in a gold system, one who owns GOLD initially is squeezing the money supply, and manipulates it in its favour, accumulating in time more and more of it, to the expense of other nations/people and dominating them. no wonder that just the TALK of returning to some gold system entices central banks to accumulate more than its neighbour just in case this happens. the bubble stage is only starting there.

The current monetary system was built on the assumption govt debt was a riskless asset, debt always repaid, and more importantly that debt always could be repaid with more debt.
and in nations where the govt can tax or print the money as it wants, indeed there is no absolute need for it to default (but it could strategically be a good idea if the lenders are mostly foreigners for example; but it could just heavily tax foreign holders or default on them only which is the same). So defaulting by printing/ inflation was always possible.

so its only too natural that the answer to

Is The Entire Global Banking Industry Carrying Naked, Unhedged "Risk Free" Sovereign Debt Yielding XXX%?


my quick answer is NATURALLY !!! any extra Euro of deposit in a bank gets marginally invested in those govt bonds, Id say its almost the analog of the law of conservation of Energy in Physics as govt debt is the biggest and most liquid debt instruments.

If the banks didnt then the states would never been able to borrow money in the first place. because if  most people dont know that their pension funds, their life insurance are invested in bonds, they ignore even more that their deposits are invested indirectly in those even most would say no if they had the choice !!!

so govts put in a lot of regulations to help this situation and extend the numbers of possible buyers of (this) debt, risk-free weightings for banks, tax-free for this or that, allowing derivatives etc...
Now with regulation asking for more capital, and volatility exploding, there is no more capital to buy debt, govt or corporate any more.

and what is the proposed solution to that ? recapitalizing banks with borrowed govt money so they can buy govt debt ? that seems stretched and very unefficient to me and adding more debt to debt makes it worse, we all know that.

I would also add that an indirect effect of recapitalizing banks, and ever-adding debt is to make banks even bigger and cannibalizing. After all, banks revenues should be proportional to their deposits and to existing debt. When this is the only thing growing faster than anything else, it is hardly surprising that banks profits (becoming acknowledged paper and virtual profits as opposed to real losses) and banksters revenues and bonuses and going higher and higher.

If people dont want bankers to be rich, dont bank ! move your money out of your bank. if you think footballers or rock stars are too well paid, dont watch football or dont listen to them ! so basically the drug addict is complaining that the drug dealer is too rich.

So my view is that gold or something else wont solve anything, what would ?
One of ZH articles that i really liked, but i must search to find it, was a chart of existing debt across countries, with who owes to who, and how looking at NET debt, how could this be solved.

The real meaning of this debt crisis is:
- the market is not working anymore because of too much debt and due to current debt dynamics and current prices of goods and FX, imbalances keep on growing to an unsustainable state.
- financial assets are not worth what we think they are. one should include deposits in the financial assets category.

the only way is for everybody to acknowledge that. Now Italian bonds are trading 87 of par, it wont help at all to recapitalize banks with public money for the 13 missing as the govt will need to borrow this money which those banks will buy. nonsense.

so its either better to assume they will be reimbursed to par with direct printing by the ECB, and magically, the need to recapitalize banks disappear (true there is private debt to account for as well) or to default.
When defaulting, well shareholders wiped out, bank debt holders wiped out. but if we keep the analysis to banks and govts only, we see that interbank debt doesnt hurt anymore if we let every bank fail !

The ZH Mish or others claim that banks should fail, omits to say that yes, probably billionaires or rich investors who necessarily have big assets will lose a lot if that happens, but Mr Smith pensions, life insurance plans are wiped out too, and his deposits as well.
Owners of banks are not a group of mysterious people with big cigars living like Dr No in some far islands. Its mostly us.

Instead of disorderly defaults, if we really want the rich to pay for the mess, the best is to tax heavily assets, not to let the market default disorderly. I think also people up there should really think about closing banks and a debt jubilee plan, thinking how much people will lose and in what proportion, because now its all about that. The loss is in front of our eyes. the more we delay the situation, the more money will try to run out of the system.

I dont think there is a unique solution. it involves a mix of  defaults, restructuring , heavier taxes not only on revenues but on assets, austerity from the govt, whatever works; and bigger focus on real production and wealth, making stuff, developing technologies, solving real problems as opposed to financial problems. financial problems should be among the easiest to solve, its just maths and 0s on computers after all !

Also just a remark, its just an aberration a lot of people become homeless and poor in the US or Spain for example with all the overbuilding ! there must be a lot of empty homes, even the poorest should/could have a roof ! if nationwide values of houses are divided by 2, will that make people poorer ? contribution to GDP of house building and anything related to it would be divided by 2 but who cares ? GDP is not a good and anywhere perfect indicator of wealth creation. the stupid focus on gdp is also one of the many explanations why were having so bad economic policies everywhere in the world. people would have more money to spend...

the 2 major problems, house prices (because mortgages account for so much debt), and govt spending (because govt spends more than it takes in) and thus assets related to those, need to be solved, and everything I believe can jump start again, better than ever before, without the need for revolutions, conflicts...

other than that, I have to mention, that tomorrow is 11-11-11. only once every 100 years if you think of it. If you believe in numerology ( i think it DOES affect markets, as well as TECHNICAL ANALYSIS that some people think is VOODOO), a trader friend of mine says there is a very rare BUYING signal in Italian bonds, coming from BOTH weekly and daily DEMARK sequentials. not the end of the story, but a return to 6.25% for example would NOT change the major trend, not even a return to 5.75%. shorts beware.

also im still bearish on the EUR as ive been for a while, but stock markets I believe are heavy but trading like the markets want to be long. the 1220-1240 breakout zone on SP is holding for the moment, and even on European indexes, were not seeing new lows despite all the negative headlines. i believe stocks are technically bullish and for longer than many people think, because investors fear missing any rally (look how in October many HFs underperformed), and because there is a strong probability of ECB in full QE mode, monetizing heavily govt debt.

Im pessimistic, i think debt monetization is not a good idea, if we go this way, id prefer to see pure monetary printing (equivalent to CB buying a perpetual govt debt with 0% or little interest) as at least accounting for that is simpler and doesnt add debt. but i think its a real possibility that cannot be discounted. Furthermore if monetization is not accompanied by real reforms, its just can kicking and the problems will get much worse later.