ITALY: As I indicated in my last post, this would be the next lightning rod. Berlusconi is the second major casualty on the political front, but he surely will not be the last. In America we are used to cranking up the money printing presses when a financial crisis is underway. We have the playbook and the mechanisms to do so. This is clearly not the case “across the pond”.
The ECB took a dramatic step in easing rates recently but it is a drop in the bucket compared to the magnitude of the problem. Here in the 80’s when hyperinflation was causing interest rates to rocket, the term “bond vigilantes” was coined. This term defined those buyers of debt who would “go on strike” and not finance companies or government debt. This is going on full tilt now with Italy and the troubled sovereign borrowers there.
Italy is too big to fail but also too big to bailout with available reserves. In my mind the only solution is a concession to “fiscal union” and pan-European guarantees of Italy’s debt (or I should say its new debt needed to refinance its old debt). In the case of Greece, the Troika was reticent to do this before actual reforms were in place. No chance of that now. The clock is ticking and the European version of “Chicken Little” is running for cover. Rates of 7% or higher are just not sustainable for Italy. We will see if the proverbial “rabbit can be pulled out of the hat” in here shortly.
MF GLOBAL: After the grinding bear markets of the 1960’s, there was a book written called Where are All the Customers’ Yachts? It referred to the fact that the markets had siphoned off the assets of investors. Now, the new MF Global title should be Where is All the Customer’s Money?
According to the golden rule that states customer reserves not be comingled in the basic business of a broker dealer or investment bank, all customer monies should have been walled off at MF Global. The facts are still dribbling in, but it appears MF used derivative positions to lever up its book 30+:1. (CEO John Corzine was quoted as saying, ‘We have to take risk’.) The leverage was employed in European sovereign debt (too big to fail…right?).
It is hard to believe that Corzine was at the head of Goldman Sachs. Goldman Sachs is one of the best in the business at managing risk. All the partners that I know there are very bright, successful and have a risk management orientation that is exemplary. You have to wonder if Corzine was boosted by the Peter Principal in his role there. After Goldman, he bought his way into politics in the State of NJ, but his mark in the Senate and then later as Governor of the State was dubious. He came to MF Global amidst much fanfare that it would become a junior GS. Not quite…
WHEN IS A DEFAULT NOT A DEFAULT? (Hint: when it is Greece)
I could write chapters on the market for credit insurance (known as CDS). This is the largely unregulated derivatives market for counterparties to bet on failure outright or hedge positions with this so-called “insurance”. Along comes Greece. The deal on the table does not define Greece as being in “default” since the 50% haircut was voluntary. Who determines this you ask? Well, it is determined by the ISDA which is a trade organization comprised of Wall St firms and major buy side firms. (No conflicts here, I am sure…)
Despite massive government intervention and regulation post-Lehman Bros., the enormous market for derivatives including CDS has been barely impacted. It was CDS and those parties like AIG who had the insurance exposure that almost brought down the financial system in 2008. Today, derivatives go largely unregulated. This speaks to the intense power of Wall St in lobbying for its self-interests.
In Greece, we now have a case where an economic default has been parsed to a non-default. This means that all of those investors who either hoped to profit and collect the insurance on Greece going under (or had hoped to hedge their long positions on the soverign debt), will not collect on that insurance. One has to wonder what implications that has for Italy and some of the other weaker sovereign credits.
“Curiouser and curiouser” said the Rabbit to Alice.
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