Central European Bonds: The latest twist on the European bailout comes from a move reported recently, whereby there will be a centralized issuance of Euro bonds backed by the 17-member Euro states. This is one step closer to fiscal union, but there may be some legal hurdles. Details are still sketchy (as are most promulgations these days from the ECU) but the theory behind the move is that the collective guarantee of the union members will lower towering costs of each of the weaker members. Germany, in classic Teutonic fashion, is balking at the notion of doing this.
Yield spreads have already widened out for France (which is still AAA) and even for Germany, which is considered the “gold plate model” country borrower. It is, however, still a zero sum game and the rating agencies will be watching this closely. Shifting borrower burden to the healthier Euro countries may not be at all popular with the stronger member states. If the guarantee was ever triggered and payouts were to occur, this will also be highly unpopular with the stronger EU countries.
Keep an Eye on the Rating Agencies…For decades, the rating agencies were not considered a good career path for an analyst. When I worked in the investment business, we looked to poach there for the best potential talent. Historically the rating agencies always lagged the curve in ratings downgrades. This culminated in the mortgage fiasco of 1998, when they lost all credibility with investors and regulators by falsely propping up the securitized mortgage market.
Now all of that has changed. The agencies are ahead of the market and making trouble for it. It started with Moody’s and the summer downgrade of US Treasury debt. Last week Fitch warned of trouble for the US banks as a result of Euro contagion. Portugal was just downgraded several notches to junk status. Currently Moody’s has France on the warning list for a downgrade of its much-vaulted AAA rating. The ratings agencies have nothing to lose by being vigilant and aggressive with their warning lists. This is sure to have a negative ripple effect on the markets. Stay tuned…
US Debt Reduction Super Committee: No surprise here that the politicians cannot cut the deficit. Worldwide, the politicians’ candy store is closing down. They can no longer spend their way out of problems. The Tea Party has helped make them accountable and the revenues simply are not there in a sluggish economy. The battle lines are being drawn (once again) on the tax side and attacks on the wealthy for not paying their fair share are back on the forefront of the liberal agenda.
The historical data on this front overwhelmingly favor the conservative stance. Tax increases on the wealthy will not make a difference. It is the entitlements that have to be dealt with and of course, this is the third rail on the political track.
How to be a 1%-er…The WSJ has printed an article stating that the demand for gold miners and the shortage of labor in Australia has caused miner’s annual wages in that country to exceed $200k. No college degree required. The Occupy Movement may want to post this on their website for those wanting to instantly jump the line from the 99%-ers to the 1%-ers. Indeed, since the printing of this article, a record number of people worldwide have inquired about mining jobs in Australia. So there is at least one tangible benefit to the run-up in gold prices..more money for those who can help find it!
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.
Trick or Treat
Halloween is upon us ? that season for trick-or-treat, the supernatural, the study of the occult, and the like. It was just before Halloween in 1991 that the perfect storm struck here in the Northeast. As of this writing, record breaking snow (for October) is hitting parts of the Northeast, while foliage is still in its splendor.
TREATS..
Well, the global equity markets got the TREATS this week (and for most of October for that matter). European leaders managed to cobble together a plan that made the markets virtually giddy with bullishness.? The devil is pretty prominent at this time of year, and for the European markets he is ?in the details?. The broad parameters of the bailout plan include: European banks ?voluntarily? agreeing to 50% haircuts on Greek debt (after having the shotgun pointed at their backs for weeks..), a boost of capital reserves to 9% (double where they are now), and a $1.4 trillion stability fund. There are some vague references to private investors (read: the Chinese) and of potentially leveraging the fund (i.e, more debt to fix too much debt already). Beyond this, there are almost no other details. Are we to believe that they have been at this for months and that is all they can tell us?
In the meantime, sights have turned toward Italy as the next lighting rod in the storm. Interestingly, there is a disconnect between the giddiness in the equity markets and the lack of enthusiasm from the European bond markets or from the credit markets here at home. Domestic high yield bonds have barely backed off their widest levels versus treasuries since the contagion fear started back in last August. Much is the same case for the European credit markets.
The Fed has been targeting zero interest rates and meeting that with a great deal of success. However for less quality corporations, borrowing costs have risen sharply since the summer contagion risk began. This trend bears watching. Likewise in Europe sovereign debt market yields barely budged. This is the real ?bell weather? indicator as this is the rate that governments must pay to refinance their heavy debt burdens. This implies that the bond holders and suppliers of capital are underwhelmed so far with the European plan.
TRICKS?
Halloween would not be Halloween without TRICKS. ?Bank of America is looming large in ?best in class? on the TRICKS list. ?Reliable sources indicate that B of A has moved derivatives from its Merrill unit to a bank subsidiary flush with insured deposits. The Fed indicated it favored the move while the FDIC has balked about it.
B of A does not believe regulatory approval is needed. Interesting. Why, you ask, would they bother doing this? Apparently the request was made by counterparties, who are concerned about their exposure.
Effectively then this moves the risk squarely back onto the taxpayers. Now, if the Occupy Wall Street movement was more organized and on top of this sort of thing, this could be real trouble for the establishment. You can be sure that the counterparties are none other than?Wall Street firms. I am an ardent capitalist at heart, but this strikes me as sub-rosa in all respects and not what was intended by FDIC insurance, particularly when the risk were taken at the broker/dealer level. The counterparties who demanded the action should also be disclosed.
The moral hazard ?put? seems alive and well despite all the regulatory fury post-Lehman Bros.
European Markets
After talking up expectations of a strategic fix for this weekend, Dr. Merkel is now deflating the expectations balloon, tipping off the market that this could last well into 2012. Clearly there is disagreement in direction between France and Germany (as has been the case for much of the crisis). The banks are also pushing back on capital reserves and write-down parameters for Greece holdings.
None of this news will help the European banking scene as funding sources will only get more difficult. The top three French banks are purported to have debt leverage of 250% of the GDP of France.
If this was not bad enough, the surprise news that Erste Bank of Austria was carrying its CDS exposure like an insurance policy liability (in other words, not marking it to market despite the fact that marks are readily available) is not giving investors further comfort in the European banks. This led to an additional 410m Euro charge. How much more of this creative accounting is going on at other European banks is open to speculation.
Other interesting news relating to the European crisis came out of the IMF this week. Emerging market countries are trying to get a funding vehicle going with the IMF to help on the bailout. They had hoped that the US would contribute as an indirect way for the US to help fund the bailout. The US balked however, maintaining that the problem needs to be solved by the Europeans. Given “Occupy Wall St” it is unlikely that there will be a lot of support for a further US bailout of any banks, much less European ones. It makes sense that the Emerging Market countries are interested in helping to resolve the crisis. The Chinese growth rate of exports to Europe has dropped by more than half.
In the meantime, the markets will likely be held hostage to the Europe Kabuki theater. If the drama continues well into 2012 as Dr. Merkle now implies, it will be hard for investors to refocus on the underlying fundamentals of the equity market with such a large overhang of macro news coming out of Europe.
Steve Jobs
Many tributes have come forth with the untimely passing of Steve Jobs, the visionary behind the digital revolution at Apple. Some have compared his contribution to the likes of Thomas A. Edison. I think it is greater. Jobs created new markets that did not exist except as a vision in his mind. He made Apple the largest capitalized tech company on the planet. He not only had vision but be was a master of sales and marketing. He had a Zen like ability to introduce new products and innovations.
His was a Horatio Alger story. After founding Apple he was fired from his own company. Steve went on to found Next but almost wiped out his entire Apple fortune there, before he saw the digital future of animated movies and bought Pixar from Lucas films. Like the prodigal son, he returned back to Apple. (This time he was clever enough to get a controlling stock interest before he purged the board). He joined forces with his arch enemy Microsoft and got a needed capital infusion from Bill Gates to advance the turnaround.
Jobs turned the music industry on its ear with the introduction of the IPod, converting free downloading Napster fans to those willing to pay 99 cents for a song on the slick new Ipod.Most people who contract pancreatic cancer would have had a short bucket list of exotic trips. Steve’s bucket list included the Iphone and the I Pad, to name just a few. He sold more phones than Nokia within a month of the I phone introduction.
He created a new industry in Applications (Apps). He understood before the phone makers did, that talking was a secondary use for the device. He created one of the strongest and most recognizable (and most profitable) brands on the planet.
With American is the twilight of its influence over the world economy, we need more Steve Jobs and more Apples. In his famous Stanford speech of 2005 He said “Your time is limited. Don’t let the noise of others opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. Everything else is secondary” A good lesson to live by.