Mark Grant's Wake Up Call: Italy Has $211 Billion In Notional Exposure To Derivatives, And Other Trivia

From Mark Grant, author of "Out of the Box and Onto Wall Street"

Out of the Box: It's Me baby With Your Wake Up Call

Alarm clock starts ringing
Who could that be singing
It’s me baby, with your wake-up call!

                                         -Toby Keith, “How do you like me now”

Today is March 21, the day after the day that was enshrined in our memories as the payment on the Greek bonds was due. A red letter day that was crossed out by the EU bailout and not even a mention of it today in the Press. The end of the Ides of March or perhaps the beginning of something more ominous; et tu Brutus?


It was nothing more than a footnote in the Morgan Stanley financials; a $3.4 billion pay-out by Italy to settle a derivatives contract made in 1994. Say goodbye to 50% of the tax hikes imposed by the Monti government because that is what was wiped out by this payment. It is also interesting to note that that Mario Draghi, currently President of the European Central Bank, was the Director-General of the Italian Treasury when this derivative was formulated. Then comes the bomb, only mentioned in a brief article yesterday on Bloomberg, and not noted anywhere in the Press this morning. Marco Rossi Doria, an undersecretary in Monti’s administration, tasked with responding to a parliamentary interrogation on derivatives, admitted that the Italian Treasury had $211 billion in "notional" exposure to derivatives, which is around eleven percent (11%) of Italy’s total GDP. This new exposure, coupled with the work I did a few days ago and noted in my commentary of March 17, now brings Italy’s actual debt to GDP ratio to a whopping 144.3%.

The Unsustainable Path

I call the ball early; that is what I do. I do not sling around Gloom and Doom nor do I make any effort to make the next big call for self-aggrandizement. I stare at the facts, follow the deductive process down the road and present my conclusions. It is as simple and as complicated as that as I made my predictions on Greece, Portugal and Ireland. You may say what you like, attribute it to luck or my friendship with the Wizard but my predictions are in black and white and, once made, there for anyone to evaluate. So this morning I state, with a great deal of certainty, that regardless of the markets currently ignoring anything and everything, that we are on an unsustainable path that is going to whack us all on the backsides some quarters out. You cannot continue to play charades with the truth and present false data as accurate numbers without the Truth eventually springing out of Pandora’s Box and pulling on your ear lobes. Please note the increasing size of Target-2, the amount of loans made by the ECB, the decrease in the quality of collateral at the European Central Bank, the real debt to GDP ratios of Italy, Spain, Portugal, Belgium et al and it becomes readily apparent that the pyramid scheme constructed by Europe cannot and will not hold past some indeterminate point in time. Ponzi bonds and Ponzi schemes always work for a while but then the cat comes charging out of the bag, claws out, fangs bared and one bloody mess will be the final outcome.

“For that reason, when a prince conquers and holds his state, the means will always be considered honest. He will be praised by everybody; because the masses always accept what a thing seems to be and what they can get from it. And in this world there is only the mass, for the few find a place there only when the ground is taken from under the feet of the many.”

The Ways Out

There are only so many ways out of the mess we are facing. The EU/ECB could cut back on the loans but this would lead to carnage and the collapse of any number of European banking institutions so I discount this option. They can hope and pray for growth but Europe is in a recession that is barely supported by Germany’s Target-2 and pockmarked by the imposition of austerity measures so that this road is a dead end. That then leaves Inflation as the only realistic choice left and when you eliminate the improbable you are left with the correct answer; I think this will be the path trod by those on the Continent out of necessity. Now with TIPS at negative yields out to about 2026 you must seek other avenues. I point specifically to whatever Corporate bonds tied to Inflation that you can find and while it is early in the game and the deals are small and perhaps not as liquid as you might like; they are still the best option now in my opinion. Accumulate what you can because when the tyranny of Inflation begins you will be glad that you placed some money in this sector as your bullet maturities will be sitting in the tub soaking in a blood bath.

“Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.”

                                                                          -Sherlock Holmes