Everything that I blogged about last night appeared on the financial markets’ radar screens today. The non-issue of Deutsche Bank suddenly became an issue as investors became worried about the collateral that they were holding at Deutsche Bank. It was not “locusts” that caused the market to become concerned about Deutsche’s solvency but rather depositors and prime brokerage accounts that feared for their capital. Compounding the DB story was the rise of the price to hedge against a Deutsche Bank default, as well as the infamous COCO bonds that many European banks issued in an effort to enhance their capital ratios in deference to the Basel rules. You could purchase some of the Deutsche COCOs today for an effective yield of 12.7% but if the COCO bondholders are bailed-in, the COCOs will cease paying interest and the DEBT will be automatically converted to equity, thus further diluting existing shareholders.
I have warned against the COCO instrument for retail investors in a previous piece called “COO COO to own COCOs.” How Deutsche’s capital shortfalls will be resolved certainly has financial implications. What’s more important are the possible outcomes for Chancellor Merkel. The German leader made an egregious error over the weekend by playing to a populace electorate and proclaiming no financial aid for the crown jewel of the European banking system. As investors replay the words from the Euro Group President Jeron Djisselbloem, they will fear for their savings account in the German mega-bank.
There was a June 2013 Zero Hedge post referencing bail-ins for the resolution of the Cyprus banking crisis. Tyler Durden wrote a piece titled, “Europe Makes Cyprus Bail-In Regime Continental Template.” The faulty aspects of the bail-in plan, which purported to punish the wealthy Russians who maintained large-sized deposits in the Island banks the European finance ministers laid out this template of doom: “After seven hours of late-night talks, finance ministers from the bloc’s 27 countries emerged with a blueprint to close or salvage banks in trouble. The plan stipulates that shareholders, bondholders and depositors with more than 100,000 euros should share the burden of saving a bank.”
This TEMPLATE, if enacted, COULD BE a political nightmare for Germany. Early this week Merkel and Draghi denied the systemic nature of Deutsche Bank’s problems. If money leaves DB and heads to the mattresses nobody in Germany will sleep well. We’re treading wearily into the fourth quarter so please read the piece from January 11, 2016. (Click the headline to read the entire post.) I doubt Deutsche Bank will default but the mere discussion creates great angst throughout the world. The bottom line: Mario Draghi’s problems about a dearth of German bonds to buy will certainly be resolved. And for the Merkel and Schaeuble the lesson I learned long ago holds: When You Point The Finger At Someone Three Are Pointing Back At You.
You don’t have to be a weather man to know which way the wind is blowing, or so says Bob Dylan. As long as all things are emanating out of China it may be the time to dust off the sayings of Mao for as the talking heads are reminding us daily: “The East Wind Is Prevailing Over the West” in all things financial. THE PROBLEM FOR ME IS I DON’T ACCEPT THAT VIEW AND AM IN THE CAMP OF FORMER DALLAS FED PRESIDENT RICHARD FISHER that all roads lead to the FED and certainly the European Union for providing the tinder for a financial prairie fire. There has been so much volatility during the first six trading days of the year it is difficult to get a handle on what is algo-driven non-fundamental and what may be the commencement of a change in previous momentum trades. Today I will go through a list of POTENTIAL SPARKS TO IGNITE THE FLAMES OF A FINANCIAL FIRE so that we can be aware of what constitutes a genuine change in momentum: