It was once reported that Alan Greenspan, the Maestro of solipsistic reasoning, once said, “if you understood what I said, I must have misspoke.” The markets think they understood the basics of the GRAND EUROPEAN PLAN, but after reading through the many releases, I am not sure how the bail concoction actually will be deployed.Merkel gets the headline of the Greek debt holders being forced to accept a 50% haircut, thus pacifying the Bavarian Burghers and their demand for the rapacious capitalist bankers to absorb a greater share of the losses. Sarkozy walked out on his BALCONY and shouted ONE TRILLION EUROS FOR THE EFSF, while the markets breathed a new sigh of relief.
As readers of NOTES are aware, the EUROPEAN DRAMA was important only in the sense that it called the question of a new SOLVENCY CRISIS FOR THE BANKS, THUS ALLOWING THE FED AND OTHER CENTRAL BANKS TO MAINTAIN THE VARIOUS QE PROGRAMS AND POSSIBLY ENHANCE THE AMOUNT OF LIQUIDITY. As EUROSPEAK assuaged the fears of the global rent seekers, the floodgates of liquidity reopened and money was thrown at all sorts of risk-on assets. The speeches of Dudley, Yellen and Tarullo provided the backdrop for the global rally.
In a zero interest rate environment and the FED more concerned about UNEMPLOYMENT and DEFLATION, it was time to party like it was 2006. The problems that confronted the markets in July still confront investors, but easy money and calmer nerves promote the animal instincts. It seemed that the LONG DOLLAR POSITIONS, especially in the the EURO were hoping for a buy the rumor, sell the fact rally but the FED Governors were able to be the underlying, bigger story.
The biggest loser in today’s market action may well be ISDA. The International Swaps Dealers Association, the designer of the contracts for over-the-counter swaps was deemed to be no more then a pawn for the EU Nations. The CDS contracts on Greek debt will probably be deemed worthless as ISDA is being pressured by the EUROCRATS to not declare the 50% haircut a default. If the European governments can apply so much pressure to void contracts, what value is there in the CDS market?
There are going to be many questions as we go forward from the EU proceedings. The biggest question will still be: WHO IS GUARANTEEING THE TRILLION EURO BAILOUT PACKAGE? Mick Jagger may provide the best answer: “WHY AFTER ALL IT IS YOU AND ME.”
***An idea that seems terribly flawed: The U.S. Treasury is floating an idea of issuing a new floating-rate note in order to appeal to investors who fear that the goverment will be unable to control its profligate ways. This idea is plain stupid for at this moment when 10- and 30-year yields are so low, why wouldn’t you want to lock up borrowing costs and extend out your present duration? This idiocy would be similar to a home buyer taking out an exploding ARM with mortgage rates at 3.5%.
In a Bloomberg article, Campbell Harvey, a DUKE UNIVERSITY finance professor said, “IF rates go up it could cause problems for the government because they will have to pay a higher interest rate.” It seems so obvious that with the FED playing havoc with the bond markets and artificially driving rates lower, a borrower would want to take advantage of the situation and fix their borrowing costs for as long as possible. It seems that it is not only in Notes From Underground where 2+2=5.
Tags: Alan Greenspan, CDS, deflation, Dollar, Dudley, ECB, EFSF, EU, Euro, Europe, Fed, floating-rate note, ISDA, Merkel, Sarkozy, Tarullo, U.S. Treasury, unemployment, Yellen, ZIRP
October 27, 2011 at 6:37 pm |
Hey, Mr. Solipsism– I forgot what that word meant– now I know– bring on the SAT’s!
October 27, 2011 at 7:06 pm |
Hey I saw RED last night and it came up in the after conversation.I have looked up that word so many times and fail to remember it but it certainly fits the Maestro
October 28, 2011 at 8:13 am |
Yra, given that the bail out fund really isnt that large, and thus far they seem to have side stepped the CDS event would these bonds not trade to critical levels in short order?
My thoughts, and I have seen others in the same camp is that here you have CDSs bascially toasted. What happens to those who have paid premium for insurance and are now “voluntarily” taking a 50% cut. This does not compute. The other this is, and I admit I am no expert on CDS contracts, the fact that they are private in nature and OTC how could ISDA rule there was no event carte blanche? it would have to be on a case by case basis.
your thoughts are appreciated.
October 28, 2011 at 8:37 am |
Jimmy–you have to go back an examine the Bear Stearns period and what happened with all the CDS there as JPM filled the void and prevented the pay out on all that CDS–the idea of the private party was turned to less then meaningless when it ran into the political expediency of the European fascists—that was also the problem with the way Obama and company road roughshod over the GM bondholders.When political expediency overrides LAW we are on a very slippery slope—remember Kelo versus New London
October 28, 2011 at 10:14 am |
So taking this to the next logical step…
With ability of S&P, Moody’s, Fitch, etc. capable of destroying the market place with their poorly timed announcements, what are the chances that they take a few moments and think about how much more risk is inherent in banks IF the offsetting CDS insurance against their holdings are not allowed to be payed out due to political intrusion? It sure seems like the risk exposure on the books would be under-represented if the actual execution of a payout from a CDS were never allowed on government debt.
October 28, 2011 at 10:32 am |
thanks Yra.
Danny good point on risk. with CDS null, does this chnage VAR calcs at the firms?
October 28, 2011 at 10:34 am |
Yra-
Can we assume two things- 1. This rally in risk assets was due in part to what the previous comments discussed regarding CDS. If insurance is rendered un-triggered, it calls into question ALL insurance created by banks. Thus, the underlying assets that the derivatives were supposed to back (some CDS was traded naked of course) needs to be traded accordingly. 2- In sovereign world, hedgers will now pressure the interest rate futures market and its corresponding options.
If true, how do you see these affecting trading activity?
October 28, 2011 at 11:51 am |
MBS–I don’t know if you read the macro man ,but he posted a blog this morning detailing just that—the bond futures volume should explode as it is the best vehicle as a vanilla hedge and you actually get paid daily,so futures volume should explode which may mean that the BOT AM may be an interesting investment —but Wall street will always fins a way to try and hurt the transparent markets
October 28, 2011 at 1:14 pm |
MBS–for the last years I have written about the fact that the Italians have allowed Eurex to list Italian bond futures.It seems that the Italians are going to be the “pissing post” for anybody who wants to hedge .That is why the Italian/german spread is one of my indicators for risk on/risk off.And I think the bond futures at the CME are going to become very active.
October 31, 2011 at 9:23 am |
Yra –
I shared your confusion as to why Geithner would issue floating rate debt when fixed rate treasuries are at historic lows. After further consideration I have a few other thoughts as well.
1) How much would Bernanke love to swap his fixed rate treasury holdings for floating? Reducing the duration of the Fed’s portfolio, he would have more room to buy treasuries in the face of rising rates down the road. 2) Could this be a mechanism to restructure bank capital? Using floating rate debt, banks could earn a positive interest spread using the treasuries as the benchmark for mortgages. They would no longer have the duration and convexity problems of holding rotten fixed rate mortgages on their balance sheets. How’s that for “improved capital position/health?” Think of how much they could leverage up b/c they wouldn’t have that pesky duration mismatch between their assets and liabilities!