Posts Tagged ‘Banks’

Eric Sprott: Investment Outlook (April 2, 2013)

Wednesday, April 3rd, 2013

Caveat Depositor

by Eric Sprott & Shree Kargutkar, Sprott Asset Management

“If there is a risk in a bank, our first question should be: ‘Ok, what are you the bank going to do about that? What can you do to recapitalise yourself?’ If the bank can’t do it, then we’ll talk to the shareholders and the bondholders. We’ll ask them to contribute in recapitalising the bank. And if necessary the uninsured deposit holders: ‘What can you do in order to save your own banks?’” – Jeroen Dijsselbloem, March 26, 2013 1

A deal has just been struck with Cyprus. However, it was not the deal that Cyprus saw other countries receive. This was not the deal received by Greece, Italy and Spain. There were no bailed out banks in the aftermath. There was no transfer of risk from over-levered banks to the taxpayers. The risk was pushed back onto the banks. Their equity was wiped out. Their bondholders were wiped out. Their uninsured depositors saw their accounts raided for additional liquidity. It wasn’t just that the rules of the game had changed, the game itself changed. By raiding the depositors’ accounts, a major central bank has gone where they would not previously have dared. The Rubicon has been crossed. Going forward, this is expected to be the “template” for dealing with risky, over-levered banks and the countries which support them.

For the first time since the crisis began, we are faced with a new paradigm, or a “template”, for how a major central bank will address weakness in the financial sector. While the old template involved “bailing out” through transfer of risk from the corporate sector to the taxpayer, the new template calls for “bailing in”, whereby the risk is contained within the affected institution at the expense of equity holders, bond holders and finally the depositor.

How does the new template affect you?

This “template” is already being applied to the “too big to bail” banks in other developed countries around the world. A statement in the joint paper published by the FDIC and the Bank of England in December 2012 reads:

“An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company into equity. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailedin creditors would become the owners of the resolved firm…. Such a resolution strategy would ensure market discipline and maintain financial stability without cost to taxpayers”.2

Note the lack of the phrase “uninsured depositors” in this context, which opens the doors for both insured and uninsured depositors to be affected. In a similar vein, Canada’s recently released budget addresses the same problem. Page 144 of Canada’s Economic Action Plan 2013 reads:

“The Government proposes to implement a – bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers.”3

Likewise, New Zealand’s Open Bank Resolution policy allows for a “bail in” of afflicted banks by wiping out the equity holders first, the bond holders second and finally forcing a haircut on the depositors.4

Over-levered banks are not a recent development. We are faced with a banking crisis, seemingly once every generation. In a majority of cases, the bad banks were allowed to fail and newer, stronger banks took their place. However, the recent modus operandi of the central banks and policy makers allowed over-levered banks to get even bigger, rewarded risk taking with bailouts and let the inherent problem of unsustainability fester.

CHART 1: BANKS ASSETS – COUNTRY GDP
maag-march-2013-chart-1.png
Source: Capital IQ, CIA Factbook

We carried out the exercise of taking the largest banks, or in other words, the “too big to fail” banks in the G7 countries and added up their assets in relation to the host country GDP. For the layperson, a typical bank’s assets are primarily composed of the loans they have originated while the liabilities are primarily composed of deposits they have accepted. With the exception of the US, all G7 countries have banking systems that have become larger and in some cases dwarfed their respective economies.

Governments around the world are finally beginning to realize the gravity of the risk that exists in their banking sectors. The EU has decided to build upon the new template of the “bail-in” regime. The US, UK and Canada have all followed suit. This puts the onus squarely upon the depositor. The depositor is a lender to the financial institution that he banks with. However, most depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. Under the new “template” all lenders (including depositors) to the bank can be forced to “bail in” their respective banks. Several G7 countries already have provisions that allow troubled banks to be bailed in using depositor accounts. We have been vocal about our concerns over the state of the global financial system for the better part of the decade. The Greek tragedy is now being played out in Cyprus with a new twist as depositors have been unwillingly turned into sacrificial lambs. Given the size of the banking sector in most G7 countries and the burgeoning government debts, the ability of the governments to bail out their banks is severely constrained, especially considering the political headwinds that exist today. For this reason, we strongly believe that real assets trump a fiat currency in a “savings” account. It is not our intention to be alarmist here, merely to say, “caveat depositor”.

Footnotes:
1     Import Export Stats – US Census Foreign trade: http://blogs.ft.com/brusselsblog/2013/03/the-ftreuters-dijsselbloem- interviewtranscript/
2     http://www.bankofengland.co.uk/publications/Documents/news/2012/nr156.pdf
3     http://www.budget.gc.ca/2013/doc/plan/budget2013-eng.pdf
4     http://www.centralbanking.com/central-banking/official-record/2257939/rbnzarticle-
says-open-bank-resolution-helps-keep-banks-in-line

 

Copyright © Sprott Asset Management

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Default Risk Falls for US Banks and Brokers (Bespoke)

Tuesday, August 7th, 2012

by Bespoke Investment Group

Below are charts that show the change in default risk (5-year credit default swaps) over the past two and a half years for six of the most widely followed banks and brokers here in the US.  Over the past week or so, these financial firms have seen a pretty big drop in default risk as their stock prices have moved higher.

Morgan Stanley (MS) still has the highest default risk at 322 bps, followed by Goldman Sachs (GS) at 247 bps.  Bank of America (BAC) and Citigroup (C) are in the middle of the pack, while JP Morgan (JPM) and Wells Fargo (WFC) have the lowest default risk.  Wells Fargo (WFC) is the only company with a 5-year CDS price below 100 bps, clearly establishing it as the “safest” of the big US financial firms.

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Mike Mayo on Weill’s Call To Break Up the Banks

Thursday, July 26th, 2012

 

(h/t: Barry Ritholtz)

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LIBOR: Everything You Want to Know, but were Afraid to Ask

Wednesday, July 4th, 2012

 

by Peter Tchir, TF Market Advisors

How is LIBOR calculated?

The BBA provides pretty detailed analysis of the process. The key here is what the rate is meant to be. The contributors, are supposed to submit a rate for each currency they contribute for overnight, one week, two week, and monthly out to a year. The rate is meant to be:

“At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”

This is a bit like self-reporting your weight. The bank is supposed to submit a rate where they think they could borrow, not where they actually borrowed or where they would lend to other contributors. Right from the start the question raises questions that have been discussed for years.

How can a bank “know” where some other bank will lend them money? Can’t they use transactions? Can’t they get firm “offers” from other banks? Why not have the banks submit levels where they would lend to other banks?

The very nature of the question used to solicit rates tells you all you need to know. LIBOR has always had an element of “gamesmanship” if not outright lying.

In general, banks will tend to submit lower rates and attempt to artificially lower LIBOR. There are two reasons for this:

  • Signaling Effect – banks don’t want to say it would cost them more money to borrow than their peers because that would be admitting to weakness and may cause their lenders to pull back and create a financing freeze. Each contributor’s LIBOR indications are published so if a bank shows up with a particularly high estimate of what it would cost to borrow, it would attract unwanted attention. It may be the truth and should be evident in the CDS and bond markets, but for some reason banks remain concerned about the signaling impact and tended to skew LIBOR submissions lower than they should have been
  • Risk and P&L Impact – The big banks always have a lot of risk associated with LIBOR. It will affect their borrowing costs, it will affect what they receive on floating rate loans and it will affect the value of their interest rate derivative books. It might have other secondary impacts, but those 3 areas are big. It is probably safe to say that banks in general benefit from lower LIBOR, but that won’t be true for all banks and won’t be true for all days. There are occasions where banks may benefit from a higher LIBOR. If they have a disproportionately large amount of floating rate loans resetting on that day, they may benefit by having LIBOR higher that day, thus locking in slightly higher income for that period. Someone at the bank will know their exposure to the LIBOR setting on any day, and it would be hard to believe that on days when the exposure is large either direction, the group that submits it would be unaware of the potential P&L impact.

That is a dangerous concoction. A question that leaves a lot of wiggle room, and banks that may have strong incentives to use that “wiggle” room.

Controls and Actual Calculations

For me, the single most important rate is the 3 month USD LIBOR rate. It certainly impacts Americans more than any other rate calculated by the BBA. Here is yesterday’s submissions, and the calculation.

There are 18 banks that submit U.S. LIBOR. The 4 lowest rates and 4 highest rates are thrown out for purposes of the setting. Then LIBOR is set as the average of the remaining 10 rates.

You can see the wide discrepancy in rates. HSBC and Barclay’s clearly think they have easy access to money. SocGen and BNP seem to think it would cost them a lot of money relative to the others. There is no indication how much borrowing and lending is occurring in the interbank market, so there is no easy way for an outsider to tell if this reflects reality or not. JP seems conservative given that their 5 year CDS trades at 125 which is similar to HSBC’s 120 level. Barclay’s 5 year trading at 205 would indicate a possibly optimistic view of where they could get short term funding, and Citi and BAC barely behind JPM again seems a bit optimistic given their CDS trade at 235 and 250 respectively.

So by throwing out the outliers, and using a relatively large pool to calculate the average, the BBA attempts to mitigate the risk of any one bank skewing the setting. The problem is that it doesn’t do much if multiple banks collude to manipulate the setting.

If multiple banks have the same incentive to skew their own submission, and worse yet, communicate that to “friendly” banks, then the BBA methodology breaks down further.

The problems with the BBA methodology is there is no confirmation that the rate submitted is reasonable, and nothing is done to protect against group rather than individual bias in their submissions.

Lawsuit Heaven?

I don’t think this will turn into lawsuit mania. In spite of the huge notional amount of contracts and loans outstanding based on LIBOR, it may be difficult to pursue a case. We will go through the cases that might make the most sense in a moment, but here are the main reasons that I don’t think this will snowball into a massive amount of litigation

  • Individuals and Many Corporations benefitted from lower LIBOR settings. To the extent the bias was to artificially lower LIBOR, the direct impact would be to reduce amounts owed on floating rate borrowings. Anything where individuals as a class were hurt would expose the banks to big problems, as they would be getting sued by a group that would have a lot of jury sympathy. But in this case, individuals that had any LIBOR exposure, typically directly benefitted from any bias to make the rates low, as they borrowed in LIBOR and little of their investment income was based on LIBOR.
  • The duration of LIBOR is short. Even if you have a 10 year swap where you paid fixed and received floating, you would likely have to demonstrate that on each reset date, the bank colluded to move LIBOR setting against you. Maybe you can argue that the overall trend was enough to impact your mark to market, but that may be a stretch. Having to show that at each quarterly reset, on the day your contract resets, there was collusion, could be very difficult. The duration also comes into play on the damages side. Let’s assume you had a $10 billion swap (a reasonably big trade). If the banks all colluded against you on a particular setting and managed to move LIBOR by 10 bps (a big differential) your “loss” would be $2.5 million or 0.025% of notional. Not small, but another example of how the short term nature of LIBOR makes it hard to build a big claim.
  • The complexity of the process helps the banks as a group. How would you prove you were hurt by a particular bank? If a bank submitted a “bad” price, but was already in the outlier group, it would be hard to make a claim since it didn’t affect the calculation. If a banks “bad” price moved it from the calculation group to the outlier, it is only the difference between what would have been fair for them, and what the bank that is now being used submitted. It is really hard to show how much 1 bank affected the outcome. Larger groups caught in the act would be required, but this will be more difficult to find consistently, and remember to prove real loss, you would need that group collusion on each reset date. Then those banks would split the cost. That is ignoring the difficulty of proving what a “bad” price is. The question certainly allows for the defense tactic of “well, that’s what I thought it would be”, especially during periods where interbank activity went to zero and the banks were relying heavily on central bank funding.

It is easy to salivate over the potential lawsuits and the losses the banks might have, but a dearth of sympathetic victims, the rolling nature and short duration of LIBOR based products, the lack of a test to determine if a submission was “bad” and the complexity of the setting process make it far harder to bring successful lawsuits than the headlines might suggest.

The Consequences

I would expect more firings at banks. Clearly Barclay’s was not acting alone. In this environment, no bank is going to support an employee who was involved in this. The banks will defend themselves in court against lawsuits based on the letter of the law, but at this stage, none are going to fight to save staff that participated in schemes to move LIBOR (or at least those dumb enough to use e-mail and other recorded forms of communication).

Will other big heads roll? That to me is less clear, but is a possibility. I’m assuming like in most other things at big banks, if the people in charge are well-respected with no big internal rival, they survive, but if the person has been on the edge and has a group happy to force a regime change, we could see one.

Ultimately the LIBOR setting process will have to change. The current process is too vague. There have been some calls for an alternative to LIBOR, but with so many contracts outstanding, I think that is unlikely. It will be far easier to just amend the methodology and try to improve the existing LIBOR process rather than starting an entirely new rate series.

There will likely be some cases brought that get settled and cost the banks some money. If anything, I suspect municipalities might form the best class action. I think many did enter into pay fixed, receive floating swaps, so as a group they might have the size and sympathy to pursue something, though I bet the lawyers for the banks will gain the most, with lawyers for the plaintiffs coming in a close second, and the plaintiffs and banks wondering how they got sucked into spending so much on legal fees. I could be wrong on the lawsuit side, but even the evil side of me, has trouble figuring out how to make a strong case with big potential payouts.

E-mail: tchir@tfmarketadvisors.com

Twitter: @TFMkts

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Monopoly Money vs. Bernanke Money, is there a Difference?

Friday, June 8th, 2012

Occasionally I get an email from a reader that makes me pause and think. This is one of those times.

Reader Janet Dight writes …

Hello Mish

As per Ben Bernanke Monopoly Official Rules “The bank never goes broke. If the bank runs out of money, the banker may issue as much as may be needed by writing on any ordinary paper.”

Janet Dight
Clinical Psychologist

Monopoly Money vs. Bernanke Money

So what’s the difference between “Monopoly Money” and “Bernanke Money”?

The difference is theory vs. practice.

In Monopoly, there is no difference between theory and practice. The rules are the rules and they will be honored and enforced by the players in the game. Money is printed and handed out without any regard as to whether it might be paid back. There is no such thing as excess reserves. Players are always willing to put money to use. If players don’t put money to use, they will be bled to death by other players.

In the Bernanke’s world, the Fed can print as much or as little as it wants. What the Fed does print is a loan. That money must be paid back. Collateral (even if speculative) is required and discounts are applied. In Bernanke’s world, money is parked as excess reserves at the Fed if banks do not find good credit risks.

At times, it seems there is little difference between  “Monopoly Money” and “Bernanke Money”. It all depends on the willingness of banks to lend and consumers and businesses to borrow.

However, even when it seems there is little difference, there is a major difference between a bank giving money to players spend and loans that must be paid back.

Constraints are Key

Flashback November 23, 2010: Austrian economist Robert Murphy predicts “high inflation” and and writes a post Has Mish Deflated the “Inflationistas”?

My response which in retrospect has clearly carried the day was Failure to Consider Constraints – My Response to “Has Mish Deflated the Inflationistas?”

I invite you to read my detailed response to someone who was clearly wrong but here is the key snip.

Monetary Printing vs. Debt Deflation

There is $35 trillion in credit on the balance sheets of banks, little of it marked to market. Yet, in spite of the fact that Money Multiplier Theory is totally bogus, supposedly printing $600 Billion to is going to cause serious inflation.

The odds sure don’t look very good to me.

Practical Constraint Recap

  1. Ability of consumers/corporations to take on more debt
  2. Willingness of consumers/corporations to take on more debt
  3. Willingness of banks/credit companies to extend more credit
  4. Ability of banks/credit companies to extend more credit
  5. Unwillingness of the federal reserve to print themselves out of power
  6. Actions of other Central Banks
  7. Actions of Congress
  8. Demographics
  9. Global wage arbitrage
  10. Fed cannot create jobs
  11. Fed cannot give money away
  12. Fed is beholden to banks

In theory the Fed can cause inflation rather easily. In practice the Fed has to deal with many practical constraints.

Theory and Practice

Murphy claims “Bernanke has the power to raise prices if he so chooses”. Can he? With whose help? At cost constraints Bernanke can ignore?

In theory, the Fed can cause massive inflation at will. In practice, they can’t. As Yogi Berra once quipped “In theory there is no difference between theory and practice. In practice, there is.”

You can lead a horse to money, you can’t make him eat it. That’s the very important difference. It’s a question of attitudes.

The Fed can certainly encourage inflation by offering money at seemingly attractive rates, but it cannot force the issue.

Right now, neither consumers nor businesses want the risk. They are too loaded up with debt already, no matter how attractive the Fed wants debt to appear. It’s like trying to give a kid one piece of cake too many. At some point, extra frosting makes the cake look less attractive, not more. At that point the kid will not take another bite.

That is the point we are at now. The Fed is hoping Congress will eat more cake. It’s up to Congress, not the Fed, and I doubt Congress want to eat as much cake as the Fed needs.

Bernanke’s Deflation Prevention Scorecard

In case no one is keeping track, Bernanke has now fired every bullet from his 2002 “helicopter drop” speech Deflation: Making Sure “It” Doesn’t Happen Here.

Bernanke’s Scorecard

Here is Bernanke’s roadmap, and a “point-by-point” list from that speech.

1. Reduce nominal interest rate to zero. Check. That didn’t work…
2. Increase the number of dollars in circulation, or credibly threaten to do so. Check. That didn’t work…
3. Expand the scale of asset purchases or, possibly, expand the menu of assets it buys. Check & check. That didn’t work…
4. Make low-interest-rate loans to banks. Check. That didn’t work…
5. Cooperate with fiscal authorities to inject more money. Check. That didn’t work…
6. Lower rates further out along the Treasury term structure. Check. That didn’t work…
7. Commit to holding the overnight rate at zero for some specified period. Check. That didn’t work…
8. Begin announcing explicit ceilings for yields on longer-maturity Treasury debt (bonds maturing within the next two years); enforce interest-rate ceilings by committing to make unlimited purchases of securities at prices consistent with the targeted yields. Check, and check. That didn’t work…
9. If that proves insufficient, cap yields of Treasury securities at still longer maturities, say three to six years. Check (they’re buying out to 7 years right now.) That didn’t work…
10. Use its existing authority to operate in the markets for agency debt. Check (in fact, they “own” the agency debt market!) That didn’t work…
11. Influence yields on privately issued securities. (Note: the Fed used to be restricted in doing that, but not anymore.) Check. That didn’t work…
12. Offer fixed-term loans to banks at low or zero interest, with a wide range of private assets deemed eligible as collateral (…Well, I’m still waiting for them to accept bellybutton lint & Beanie Babies, but I’m sure my patience will be rewarded. Besides their “mark-to-maturity” offers will be more than enticing!) Anyway… Check. That didn’t work…
13. Buy foreign government debt (and although Ben didn’t specifically mention it, let’s not forget those dollar swaps with foreign nations.) Check. That didn’t work…

Now What?

I wrote about Bernanke’s Deflation Prevention Scorecard in April 2009.

Now, Bernanke is squealing like a stuck pig, begging Congress and China to help him produce price inflation in the US while still chastising Congress about a “fiscal cliff”.

For details on the upcoming fiscal cliff please see Key Words of the Day: “Nothing”, “Fiscal Cliff”, “Later”; Bernanke Speech Template; U.S. Fiscal Cliff and What to Do About It

Regarding points 8 and 9 above: the Fed did purchase treasuries and agencies, but admittedly without an explicit ceiling.

Question of Timeframe

The point of this post is not to lay into Robert Murphy or any other misguided Austrian economists.  I had forgotten about the above debate and found it searching my blog for “constraints“.

Also bear in mind that I happen to agree with the Austrian economists on most points of view except timeframe.

Their timeframe is way off because …

  1. They view inflation as an exercise in printing, completely ignoring the role of credit
  2. They ignore the changing attitudes towards lending by banks
  3. They ignore demographics and the changing attitudes of aging boomers headed towards retirement
  4. They ignore constraints on the Fed and constraints on banks
  5. They ignore the destruction of credit on the balance sheets of consumers and its effects on prices

Record Low Treasury Yields a Sign of What?

If massive inflation was coming 10-year treasury rates would not be yielding a record low 1.60% and consumers would certainly not be deleveraging!

Might massive inflation be coming down the road?

Certainly, but it will take a change in attitude by consumers and banks or massively reckless policies by Congress.

Interestingly, Congressional policies are indeed “massively reckless” just not reckless enough yet. The emphasis is on “yet”. I will not be a deflationista forever, but I remain one for now.

Looking Ahead

I remain extremely amused by countless emails from people who tell me about how wrong I am going to be.

They all miss my ability and willingness to change my mind! At some point I am going to change my tune. History suggests I will be far too early rather than late. Time will tell.

For now (and as I have been saying for as long as I have been blogging), hyperinflation or even “big inflation” is nonsense.

Constraints and Attitudes are Key

For now, attitudes, deleveraging, demographics, and the destruction of the value of credit on the balance sheets of banks absolutely and without a doubt overwhelm Bernanke’s ability to do anything meaningful about it.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

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National Acronym Day in Europe. Don’t Underestimate the ECB

Wednesday, May 30th, 2012

 

National Acronym Day in Europe – Don’t Underestimate the ECB

by Peter Tchir, TF Market Advisors

May 29, 2012

So the EC wants the ECB to bypass the EFSF and use the ESM to recap EU banks? That was the rumor that shifted global stock markets by 1% in a matter of minutes?

It has been awhile see we looked at the EFSF Flowchart or had a detailed look at the EFSF Guidelines but it looks like it is time to dig a bit deeper into what is possible and what is not.

The ESM is not yet up and running. There was talk that it would be done by June or July of this year, but in typical EU fashion I don’t think much progress has been made towards that promise. So right now the EU is stuck with EFSF and the potential to set up the ESM.

The EFSF actually has a lot of powers. I’m not sure exactly why it is such a big deal if the EFSF (or ESM) invests directly in banks or lends money to countries to invest in banks. In theory the countries could lose on their bank investment but pay back EFSF loans? That is a possibility but it would seem more and more likely that if the bank rescues fail the sovereign is dead anyways, so the market might be reacting too much to that distinction.

The bigger problem is that the EFSF is not well set up to leverage itself. The EFSF is technically the entity that could be buying bonds in the secondary market. It is supposed to have taken over that role from the ECB, yet it hasn’t done that. Why not? It is possible that they haven’t figured out a good way to leverage the EFSF and therefore would get minimal bang for the euro by buying bonds in the secondary market without leverage. The same issues apply to its role in the primary markets. Yes, the EFSF can intervene in the primary markets, but again, had very convoluted leverage schemes, which would never work.

The problem isn’t so much what the EFSF is allowed to do, it is how constrained it is in terms of leverage and access to funding. There is almost nothing that can be done about how EFSF is set up at this stage, nor should there be. That messed up entity should be put out of its misery.

Europe’s big hope is to actually launch ESM and launch it with a banking license. If ESM can be launched, and it can get a banking license, then the EU has a powerful tool. The ESM is allowed to do all the things the EFSF can do – participate in new issues and the secondary market and lend to countries for them to support their banks. Without a banking license its firepower is limited. With a banking license it can leverage itself to a very high degree and can tap all the cheap funding already in place and whatever new programs the ECB decides to launch.

So worry less about any “new” powers the ESM might have and worry about 1) the ESM actually getting funded, and 2) the ESM getting a banking license. Germany was very resistant to the idea of the banking license. I assume they still are, but they have already given the ESM all the powers it needs, and has endorsed leveraging the capital, so a banking license might not be out of the realm of possibility.

With a banking license, the ECB can do a lot to help the ESM. The LTRO deals did a lot for the banks. They really have reduced the pressure on European banks. In spite of the fact that Bankia is a total mess, we are not reading headline after headline about how BBVA or SocGen or even DB are in trouble. The banking system is in much better shape than last year because of LTRO.

The market got carried away with the promise of LTRO as a sovereign debt savior. The market, more than the ECB, created the idea of banks buying lots of sovereign debt. That was never going to work because the banks that would do it, already had too much exposure to their national sovereign debt. It created a potential death spiral. Taking the concept of the “carry” trade and LTRO out of the banking system and into the ESM might have more of an impact.

The market has lots to worry about, whether it is China, Facebook, Banking Regulations, Fiscal Cliff, whether American Idol is rigged, economic data, etc., but we are still very much at the mercy of policy intervention. Strong signals of new QE for the U.S. seem more likely by the day, and in Europe, there is likely to continue to be a lot of contradictory comments, but banking license for the ESM seems more plausible than many of the other rumors (like Eurobonds or Greek Exit) and would be a powerful catalyst for a bounce in European equities.

The credit markets and CDS in particular seem tired. They don’t seem to have the energy to compete with the swings in equities. So far IG18 has traded in about a 1 bp range in spite of the gaps in equity futures. Even MAIN, right in the center of it all, has traded between 173 and 175.5. The high yield market, and HYG and HY18 both had big days yesterday, with cash up as much as 1%. We will likely see some give back there, but there really is no evidence that retail is giving up on high yield and there isn’t as much leverage in the market as there was in 2011 as hedge funds have been cautious and banks have cut their exposures.

Spanish and Italian bonds are definitely getting crushed today, but with Spanish 10 years above 6.5% and Italian 10 year bonds nearing 6%, the potential for intervention rises. The secondary market is affecting the primary market, which is driving up the cost of funds, creating more pressure on the budget deficits. The countries are painfully aware of that, as is the ECB. One ongoing frustration for the ECB is their inability to translate their short term rate setting of 1% into the sovereign debt market. They are looking for ways to ensure that policy can impact all sovereigns because without that occurring it makes their job far harder than the Fed’s where treasuries instantly respond to the Fed rate decisions.

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The Facebook IPO: A Note to Mark Zuckerberg; or, With “Friends” Like Morgan Stanley, Who Needs Enemies?

Thursday, May 17th, 2012

 

by Dan Ariely, Behavioural Scientist, and author of Predictably Irrational, and The Honest Truth About Dishonesty

I just received this letter from a friend in the banking industry. He prefers to remain anonymous (you’ll see why soon enough).

Dear Mark,

There’s been a lot of ballyhoo recently about your IPO and your choice of investment bankers. Indeed, a war was fought by the banks to win your “deal of the decade.”  As reported in the press, the competition was so intense banks slashed their fees in order to win your business. Facebook is “only” paying a 1% “commission” for its IPO rather than the 3% typically charged by the banks.

Congratulations, Mr. Zuckerberg! On the surface it appears your pals in investment banking have given you a quite a deal!… Or have they?

Let’s take a closer look and see what you’re getting for your money.

To start, your bankers have the task of selling 388 million Facebook shares to the public. In return, these banks will receive $150 million for their efforts.  Morgan Stanley will get the largest share of that amount—approximately $45 million. But is $45 million all that Morgan Stanley makes off your deal?

Before we answer this question, let’s first dissect the sales pitch that Morgan Stanley probably gave you to justify “only” the $150 million fee. We’ll look at what they told you, and then what that actually means.

1) We will raise the optimal amount of money for the company, for our 1% fee. (Translation: How great is it that Zuckerberg believes he got a great deal by getting us down to a 1% fee! We can’t believe he got hoodwinked into agreeing to any level of what are actually variable commission fees.)

2) The definition of a successful deal is having a good price “pop” on the first day of trading. This will make all parties happy and you, Mark, look like a rock star. (Translation: No one benefits more than us if Facebook’s share price rises significantly on day one. That first day price “pop” will take money directly out of your pocket and puts it in ours and those of our “best friends”—not yours or the public stockholders. We will, at almost all costs, make this happen.)

3) This is a very complicated process, especially for such a large company, but we are here to successfully guide you through it. (Translation: It actually takes the same amount of work to do a large IPO as a small one. Thus for approximately the same amount of work we’re doing for Facebook, we sometimes get only $10 million—$140 million less than we’re making on Zuckerberg’s IPO.)

4) We will perform due diligence on your company to make sure the business and its finances are as they seem. (Translation: While it certainly does take some time and effort to perform reasonable due diligence, Facebook is a very large and well-known company, and we have done this same procedure hundreds of times.)

5) We will write a prospectus that outlines Facebook’s strategy, business plan, financials, and risks, and we will get it approved by the SEC. (Translation: Per the regulatory guidelines, a prospectus is largely a boilerplate document; for the most part, it’s just a lot of cutting and pasting.)

6) Once this prospectus is completed and with input from the Facebook team, we will come up with “the range” or the approximate price we think your IPO shares should be sold at to the fund managers. (Translation: The price of your IPO will be determined by where and how we can best optimize our (secret) profits on the deal.)

7) We believe the best shareholders are large fund managers, as they will become long-term holders of Facebook stock.  However, at your request, we will allocate 25% of the IPO shares to sell to individual investors. (Translation: There are 835 million Facebook users worldwide. One could argue that what is best for Facebook would be to let all of Facebook’s legally eligible customers enter orders to buy Facebook stock. Then through the broker of their choosing, they could enter the quantity of shares they want to buy and the price they want to pay, just like the fund managers do—or are supposed to do. More on this scenario below.)

8) Our 10-day sales process will begin. For this important “road show,” you will be introduced to our large fund manager clients. These fund managers will receive our pitch for why they should buy your stock, and we will assess their interest and at what price. (Translation: Far from being long-term holders, many of our large fund manager “best friends” will, as soon as Facebook shares start trading, sell (or “flip”) for a windfall profit on all the underpriced shares we’ve given them. We’ll enable this by creating a perceived “feeding frenzy” for the stock by putting out an artificially low initial estimate ($28 to $35 per share) for where we think the IPO will be priced.  We will then raise that estimate during the road show. Rumors about this begin to circulate over the next day or so.)

9) At the end of the road show on the night before the IPO, we will review the overall supply and demand for the stock and then “price” the shares. This is the price at which the large fund managers will receive their “winning” Facebook shares. (Translation: The price of the stock is already known. For the past few years, Facebook shares have been actively trading on such venues as SecondMarket and SharePost.)

10) And finally, we will put a mechanism, called a Greenshoe, in place that “supports” your share price after the IPO. (Translation: Thank God Zuckerberg doesn’t understand one of the greatest investment banking profit enhancing creations of all time—“The Greenshoe.” The Greenshoe will likely be our most profitable part of this deal.  It’s a secret windfall, and although we market it to Facebook as a method to stabilize its share price, it’s really just another way for us, with little effort, to make huge amounts of money.)

We’re not done yet, Mark. Now, I’d like to dig a bit deeper into what’s going to happen and show you all the additional ways your banker friends and their large fund manager clients are going to make oodles of money off your deal.

1) Morgan Stanley only gives Facebook shares (“golden tickets”) to their best client “friends.”  In other words, it’s no coincidence that Morgan Stanley’s biggest fund manager clients get the bulk of the shares offered in this kind of deal.

2) How do you become best friends with Morgan Stanley?  There are lots of ways, such as trading tens of millions of shares with them or using the firm as your prime broker.

3) I’m sure there are a lot of conversations going on right now between Morgan Stanley’s salespeople and their clients. These conversations are probably along the lines of (wink-wink) “before we allocate our Facebook shares, we’d like to ask first if you plan to do more trading with us over the next week to six months….”

4) Let’s assume that 50 of Morgan Stanley’s “best friends” trade an extra 2 million shares so they can get access to more shares of the Facebook IPO. Let’s also assume that the average commission these clients pay to Morgan Stanley is 2 cents per share. Well, those extra trades will dump an additional $2 million dollars into Morgan’s coffers.

5) Now comes the part where Morgan Stanley actually gives free money to its friends. If the Facebook IPO is like the majority of other recent Internet offerings, here’s what Morgan Stanley will likely do.  They know Facebook will be a “hot” deal. Especially, with all of the “5% orders” coming in, there will be huge demand for Facebook shares.  My prediction is that Morgan Stanley will “price” Facebook at approximately $40 per share.  This is the price at which Morgan Stanley’s “best friends will be able to buy the bulk of the 388 million shares offered.

6) Now let’s now assume that Facebook shares open for trading at $50—a lower percentage premium than Groupon’s opening share-price “pop.”

7) Let’s assume that one of Morgan Stanley’s “best friends” decides to sell 3 million shares right after the opening at $50 per share. That “best friend” will instantaneously make a $30 million profit.  That’s right, a $30 million profit.

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Voldemort, Volcker, and Magic (Tchir)

Friday, April 13th, 2012

 

by Peter Tchir, TF Market Advisors

Yesterday’s move seemed almost magical. Yellen spoke and the markets levitated overnight. Jobless claims were a big disappointment. Revisions hit the prior week’s number and yesterday’s number was much closer to 400k than to the almost mythical 350k the market had become used to expecting. The magic of BLS revisions have ensured that although numbers close to 350k were reported for at least 3 weeks, they have all been re-written as 360k or higher.

The markets briefly fell, but then stories of “gnomes” leaking China GDP started the markets higher again. That 9% GDP print turned out to be illusionary, as the real number came in at 8.1%, and since I see no reason for China to lie about it to make the data worse than it is, the real growth is probably even slower than that.

The weakness in sovereign debt over the past week finally made investors look behind the curtain of Draghi’s LTRO show, and they are underwhelmed. The fact that LTRO does what it is supposed to – ensure banks have access to money – is now a disappointment as too many people had believed that LTRO could do more than it actually could.

Which leads us to Voldemort and Volcker. How much of JPM’s earnings were a direct or indirect result of the activities of the CIO’s office. We may never know, especially the indirect part. I believe the primary trade they have on is long credit via tranches on IG9 vs short HY17 and HY18. The trade makes sense, both as a trade, but for JPM and their business in particular. It explains both the price moves in IG9 and the decompression of HY CDS in an environment that would normally see compression. He is big, but the “prop” trading people are worried about the wrong things. The Volcker rule was meant to limit prop bets on market making desks. Banks do need to take risk. Everyone, the Fed included, wants the banks to lend more, but each and every loan is a prop bet, and there is no profitable way to run a fully hedged lending book. Let the CIO and treasury run the bank.

Correlation desks, including the one at JPM should be looked at closely. If a desk buys a tranche and sells a corresponding amount of “delta” is that not a “prop” bet? As a market maker, they haven’t bought and sold something, they bought one thing, and sold another. Volcker should be looking at those positions and determining how much model risk should be allowed. A correlation bet is a bet like any other (just more complicated). The noise about IG9 is reasonable, just misplaced.

As yesterday’s magic dissipates, it is hard to see anything in the data that justifies the bullishness. I remain wary of the market, and certainly feel better today as being caught too short yesterday was painful. CDS indices are weak across the board. Spitalian 10 year bonds are both trading down today, and 5 year Spain now yields 16 bps more than 5 year Italy. A clear sign that the manipulation has run its course (the size of the Spanish bond market makes it far easier for the ECB and banks to control prices – at least for brief periods of time).

I will be looking to add HY17 or HY18 risk today. Not as a general risk on trade, but because if I am correct and they are part of the “whale” trade, they will be left alone by the big buyer and we can see some of that compression that should have occurred earlier this year. HYG and JNK are both back to “premiums” to NAV that seem unsustainable, particularly given the overall tone of trading so far today.

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€300 Billion of “Firewall” Money up in Smoke (Tchir)

Monday, April 2nd, 2012

 

by Peter Tchir, TF Market Advisors

Last week’s firewall headlines devolved into a “mine is bigger than yours” argument, as official headlines touted the highest possible number, and any reasonable analysis showed that the available money had only increased from €300 billion to €500 billion.  Far less than the official headlines and any analysis of how the EU cobbles together €500 billion leaves serious doubts about it ever being achieved (Spain and Italy are expected to contribute 30% of that amount, which doesn’t make sense since they are potential users of the firewall).  See here for a more detailed analysis of the “unused” firewall money and where it comes from.

What hasn’t been discussed much, is how useful is the firewall?  What did the €300 billion already spent accomplish?

At best, the firewall helps the markets, but does little for the real economy, and at worst, it hurts the economy by avoiding hard decisions and shifts risks and costs from the private sector who made the original bad decisions, to the taxpayers.

Greece, Portugal, and Ireland received €300 billion of firewall money or commitments already.  What has that done?

Greece defaulted on its private sector debt.  The new Greek private sector debt trades at 20% of face value, a level that is lower than the old Greek bonds ever go to – think about that – the New “restructured” Greek debt, trades at lower prices than the old debt ever did – hardly the sign of a good restructuring.  The economy is in shambles and has done nothing but deteriorate while the “firewall” was put in place.  The firewall in Greece did nothing to help the Greek economy, delaying the inevitable default made the economy worse, and Greece still has the same amount of debt outstanding (in part because the taxpayers have recapitalized the banks), so now they just owe that money to different (more powerful) entities so their bargaining position is even weaker.  A sad state of affairs and not a ringing endorsement of why anyone would want “firewall” money.

Portugal has not yet defaulted on its debt, but while accepting firewall money, they have also been busy at work letting the governments guarantee bonds issued by banks, so the banks can stay alive.  Just like in Greece, the first restructuring will leave Portuguese debt burden unchanged, it will just replace who they owe it to, and force the taxpayers into capitalizing the banks that have now completely developed a parasitic relationship with the country.  While Portuguese bonds benefitted substantially from LTRO and more promises that no PSI in Portugal would occur, both the 5 year and 10 year bonds have been weak the past few days, and still trade at prices 70 and 60 respectively, that indicate that restructuring is still to come.  The main hope for those bond investors is that somehow, they get paid out and the public sector takes the risk – as sad as that seems for taxpayers, it doesn’t seem impossible that that is what the EU would decide to do.

Of all the countries that have received “firewall” or “bailout” money so far, Ireland seems the closest to turning the corner.  The 10 year bond yields less than 7% and there is real talk about improvement in the Irish economy.  Having said that, they are already re-negotiating their payment schedule for their bank recapitalizations.  Yes, Ireland had actually been relatively okay until they threw taxpayer money at the banks without realizing what a deep dark hole they had gotten themselves into.  In all 3 of these countries, it is the state support for banks that is making the crisis worse, or in the case of Ireland, sparked the crisis.  The other issue with Ireland is that it is the smallest of the 3 countries that have needed help.  With only €121 billion of “official” government debt (all the guaranteed debt, hidden derivative debt, commitments of support, etc., are not readily available), it is much smaller than even Portugal with €171 “official” government debt.  One of our themes has been that smaller markets are easier to manipulate and the central bankers and politicians can hide problems longer there since the capital they are willing to throw at covering up the problems is disproportionately large.  I’m not saying that is happening in Ireland, but I would also be careful about reading too much into their bond yields, as the size of the market makes it much easier to manipulate.

So of the €300 billion spent already to “firewall” or contain Europe, it is hard to see what has been achieved.  Greece’s default, and bank recapitalization caused Greece to demand more firewall money.  As Portugal seems destined to head down the same path, they too will need more money and will take a solid bit out of that remaining €500 billion, when they convert bank losses into taxpayer loans.  Ireland seems most likely to be able to avoid needing more money, yet, having said that, they are re-negotiating terms of their existing bailout.  Hardly a successful use of €300 billion (not including IMF money).

The politicians will argue that they bought time.  That they have “saved” the banking sector.  That is the best they can come up with, that by delaying they made the default in Greece less problematic, and that by saving the banks, they make the future better.  I have argued all along that a default would not be catastrophic – the politicians didn’t do it when I first suggested – May 2010, but once they did allow the default to occur, it was far less painful than they would have led you to expect.  I have argued that keeping dead banks alive does little for future growth, while making the problems bigger.  I’m not the only one to say that, but I think Yalman Onaran’s “Zombie Banks” does a great job showing that time and again, the desire of politicians to delay the recognition of problems, particularly for banks, means the final tab for society will be much higher. The examples of this happening time and again are frightening (and recent), yet here we are trying to implement the same flawed policies.

How would the firewall work if Spain needed money?

It is great to talk about the “firewall” and just how big it is, but what happens if Spain starts to deteriorate.  The likely scenario would be that Spanish bond yields start climbing.  Let’s say that the 5 year bond gets to 5.0% and the 10 year gets to 5.75%.  They are currently at 4.1% and 5.33% so this move would represent a serious shift in concern, but still be nowhere close to the worst levels seen in November (or pre LTRO – maybe Europe should switch from calling this 2012 AD, to 1 ALTRO?).

The first line of defense would be some ECB Secondary Market Programme (SMP) purchases.  The ECB would go into the market to buy bonds.  Given the problems the ECB’s holdings of Greek bonds caused (full payment and separate laws), the EU may choose to use EFSF or ESM money to buy the bonds.  These entities are set up to work with the ECB, to buy bonds in the secondary market.  With all that has gone on, I believe that the ECB will direct the purchases, but won’t use their own balance sheet.  So any purchases will subtract from the remaining firewall.  It also means that Spain will be guaranteeing some portion of the money being spent to buy Spanish bonds.  For small size, say €20 billion or less, Spain will probably not opt to “step out”.  With all the overcollateralization built into the guarantees, versus funded amount, there will be political pressure for Spain to remain part of the bailout team, in spite of the ludicrously circular nature of that.  The argument will be that “secondary market purchases” are temporary, etc.   The market will buy into that at first.

So the Doika (EFSF & ESM) will buy bonds.  Initially this will scare the “speculators” who are short, and encourage the “investors” who will buy some bonds to participate in the potential short squeeze rally.  The fact that many of the “speculators” are the same hedge funds that become “investors” will be ignored.  We will see a rapid improvement in yields as dealers won’t fight the Doika, and fast money may even try to jump on the band wagon.  The rally will likely be short lived, and not too dramatic, as LTRO has already been priced in, and shorts aren’t as prevalent in the past, and this round of weakness has been caused by fast money being caught long and overestimating the longevity of LTRO, rather than a “bear raid” on the country.

So let’s say after the SMP, Spanish yields drift back to 4.50% for the 5 year, and 5.25% for the 10 year.  What has been accomplished?  What was actually done for Spain?

Did Spanish borrowing costs decline?  No.  The price of secondary market debt doesn’t affect Spain’s current budget.  Spain is obligated to pay the coupons agreed to when bonds are issued, the secondary market does not affect existing interest payments that Spain is due to make.  It might help control the cost of Spain’s new issues, but the country is already issuing almost 70% of their debt with maturities of 2015 or less, so keeping long term yields artificially low doesn’t have much of an impact there either.  Then why do it?

In theory, all borrowing in Spain will be benchmarked against sovereign debt.  So banks who borrow money for 5 years will pay a spread to 5 year Spanish yields.  Companies that borrow will also pay a spread over the 5 year sovereign rate.  So in theory controlling the 5 year sovereign rate affects all Spanish companies that borrow money for 5 years.  The same thing goes for the 10 year yields.  That is great in theory because typically banks and countries are creating new debt every day at a faster pace than the country is creating debt, so you effectively “leverage” the SMP money, because keeping the sovereign debt yields low, means all the companies in the country can borrow at a lower yield.  That might work in a “normal” environment, but we have moved so far past “normal” that it is laughable to believe this transmission works.  It obviously didn’t work in Greece, and hasn’t worked in Portugal, so why ignore that?  In Spain (and Italy) banks have become addicted to ECB funding.  They have grown addicted to issuing bonds to themselves, getting a guarantee from the country, and then taking those bonds to the central bank to get money.  They aren’t consistently issuing bonds to the public where the benchmark sovereign yield matters.  More than that, they have shifted their borrowing to ever shorter maturities.  The banks are borrowing more and more short term and they are definitely NOT lending money long term.  They are lending to companies long term, if at all.  The whole lending dynamic in the countries has broken down, so assuming traditional monetary policies work in this environment is just flawed.

So, other than calming the markets, at least temporarily, barely anything is done for the country, the banks, or the companies in Spain.

It might keep the cost of “hispabonds” down.  These are bonds that would be issued by regions, but come with a government guarantee.  On the other hand, these bonds might be the worst idea yet to come out of Spain.  All the existing ways of hiding debt – off-market derivatives, verbal guarantees, private side-letter guarantees, commitments to EFSF/ESM where not all commitments are used, have the benefit of being difficult to find, or to convince people that they have a real impact on the creditworthiness of the nation itself.  Hispabonds will attract attention to the fact that Spain is really issuing these bonds because the regions are in worse shape than the country.  It will be hard to convince people otherwise, as these bonds will be right out there in the open where anyone can see them.  Once the “guarantees don’t count” mantra has been breached, the potential floodgates of concern open up.  How big is Spain debt, really?  Not the “official” number, which is attractive, but the real debtload?  It is high, and growing quickly, and likely unsustainable.

But anyways, what is that would cause SMP to fail to hold.  Bad economic data?  Ever increasing unemployemt?  Failure to implement austerity?  Civil unrest?  Failure of a caja? Hispabonds?  Revelations of secret debt?  The list of potential catalysts is large.  All it takes is for one thing, and the market that is still positioned long can resume its sell-off quickly.  Remember, post LTRO, the banks are about as long as they can get and have to post collateral on mark to market losses on bonds they posted as LTRO collateral.  Foreign banks will remain reluctant to extend capital, since Greece showed that restructurings are based on what is politically expedient, and not what the rule of law was at the time you bought your bonds.

This weakness causes bonds to spike higher again, this time reaching 5.5% for the 5 year and 6% for the 10 year.  We see higher yields and a flatter curve as the market, caught long, realizes the last effort by the fire brigade failed to be sustainable.  Nervousness is creeping into the market.

This is likely where the politicians make things worse rather than better.  Some will start trotting out the “leveraged” EFSF/ESM concept.  A non-starter, that may spark a brief rally by the naïve who think it can work, only to be followed by more selling pressure as markets get nervous that Europe is heading back to the clueless stage.  The ECB will confirm that  no new LTRO is planned – since yields aren’t really that bad, and they too can see that LTRO is a double edged sword.  Renewed calls for austerity and dissention in Germany will add further concern.  People like myself, will legitimately show just how much debt Spain is obligated to pay, and now more investors will start to pay attention.  They will see that the guarantees are real.  By this time another €50 billion in firewall money will likely have been spent (€20-30 billion on Spanish SMP and some to Portugal and Italy as Spain isn’t deteriorating in a vacuum).  Rumors of law changes will abound.  Rumors that Spain is preparing to default on non-Spanish held Spanish bonds will occur.  There will be denials, but prudent foreign investors will be very fearful of getting involved in a deteriorating situation.

Long before the firewall money is spent, the outcome will come down to the ECB, France, and Germany.

What does the fire brigade do here?  It really is tricky.  At this stage, how do you stop the decline?  Buying more Spanish bonds and Italian bonds?  That will help, but not like the prior round, because now “speculators” who have been eyeing the horrific balance sheets of the caja’s, the regions, and the countries, will find ways to be short.  Spanish sovereign bonds may respond to more Troika purchases, but CDS will remain well bid.  Spanish bank and corporate debt that is beyond the maturity of LTRO will be attacked, not so much as a spread to sovereign bet, but one that sovereign yields will eventually spike.  The regions will become desperate for Hispabonds at exactly the time the market won’t buy them.  Although I believe Spanish yields will be worse than Italian yields at this stage, the Italian bond market will also be under pressure.  Guilt by association if nothing else, but sadly it is more than just guilt by association, in spite of recent progress, Italy has a lot of problems of its own, none of which is helped by increasing problems in Spain – the correlation is real.

What happens if Spain “steps out”?  If Spain decides it needs significant money to bail-out its cajas, regions, banks, and itself, then they will have to step-out.  That greatly increases the burden on Germany, France, and Italy.  Will they have the political will to take over Spain’s commitments?  Remember, even ESM is only partially paid in capital, so ESM and EFSF will be issuing guaranteed bonds into a market, that is experiencing growing concern with Spain and Italy.  Asides from the political will, does Italy have the economic capacity to step up its commitments if Spain “steps out”?  Does Spain “stepping out” create real risk that Italy too has to “step out”, leaving virtually the entire firewall up to Germany and France?  I think it does.  It is hard to see plausible scenarios where Italy can honor its commitments without getting dragged down.  They might not need to tap the firewall, but they may no longer be able to support it.

At this stage, all eyes will turn to the IMF and the ECB.  I continue to believe that the IMF is the most constrained.  Partly, their money is coming from reluctant donors, and partly because they do seem to do the most unbiased critical analysis of the situation (I’m sure what they discuss internally is far more morbid, than the already dire predictions they occasionally leak for public consumption).  So it comes down to the ECB.  The ECB will likely treat ESM as a bank or find some other way to fund programs so that these bizarre entities don’t have to rely on real markets for money.  Why ever rely on real markets for risk assessment and pricing when you have the power to print and sustain economically unviable positions far longer than anyone ever thought?

This will be the key.  It will once again fall to the ECB to come up with programs that “fix” things.  Or at least give the can another good kick.  Can they?  The ECB will have to print.  For the first time, it will become clear to everyone that if Germany and France can’t sustain the EFSF/ESM, then they can’t contain the ECB’s potential risk either.  The commitment of France and Germany to the ECB is joint and several, as opposed to the EFSF/ESM where each has exposure that is capped.  That risk will start to scare some sensible people.  Politicians will likely bring out the “if we don’t help them, we all die, scenario” but the reality, as throughout the entire crisis, will be that “helping” them ensure you all die down the road, rather than having just some serious injuries now.  Also, there will be a growing number of people, who may finally be listened to, that effectively argue that restructuring now, taking the losses and restarting with a sustainable system is the way to go.  They will only have to point to Greece and Portugal to make their point, and they will be able to clearly demonstrate that Spain’s roll in the bailout of those countries, only hurt Spain.  Too much of the bailout money goes to banks and insurance companies and not enough goes to fixing sovereign debt problems, or killing the banks that need to be killed so that others can survive.  Yes, we hear the trickle down argument, that hurting bank share prices, or the portfolios of insurance companies hurts the little guy, but after 5 years of trying that in the U.S. and Europe, maybe it is time to test the theory.  Most banks will not default if they have to take big hits on sovereign debt.

I for one, would like to see a much different approach to dealing with the crisis then has occurred so far, but in any case, this is where we likely get.  It will all come down to the ECB, with the backing of France and Germany deciding to go all in, or PSI (default) on a large scale.  But in either case, the €500 billion of unallocated money is just a myth and this problem will hit a critical point long before much more money is drawn down.

 

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Bianco and Biderman on Bonds and Debasement

Thursday, March 29th, 2012

James Bianco plays straight-man to Charles Biderman in this extended (and admittedly audio-challenged) discussion of the reality behind money printing, inflation, and the US Treasury market. Following our discussion of the deficit earlier, it seemed appropriate to listen to this back-and-forth as Bianco addresses who is really buying US Treasuries, how ‘money’ is created by the Fed for the banks, and where inflation is leaking into the system. “The day the Fed admits there is an inflation problem is the day they are too late” is how they summarize the temporary/transitory verbiage that the Fed needs to keep using to placate the masses. Gold (and TIPS) remain their preferred strategy as Bianco argues that putting the ‘inflation’ threat in context is critical – this is not about 14/15% comparisons, this is about investor expectation that we get 3% inflation with the Fed at ZIRP and intending to keep printing money – which is just as toxic. The two end with an interesting conversation on the simultaneous debt deflation and price inflation and the importance of not comparing either to their extremes by way of shrugging off concerns.

 

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