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Tuesday, November 01, 2011

Too Big To Bail

That's the name of the game in the new era - numerous countries and trading coalitions have reached the end of their ability to continue faking it until they make it.

The Italian opera is about over. 10 year yields at 6.21%, and:
The European Central Bank was said by three people to have bought Italian debt today as it tries to stem financial-market contagion to the euro area’s biggest bond market. Two-year note yields still rose 28 basis points to 5.27 percent, the highest since 2000. The five-year rate rose to more than 6 percent, a premium of more than 5 percentage points compared with similar- maturity German debt.
It is now bad news for holders of Italian bonds if the ECB buys bonds. Since private holders of the securities have to assume that the ECB will be insulated from any eventual losses following the Greek pattern, private buyers take an implicit writedown every time the ECB or any guaranteed entity buys this debt. If other private entities buy debt, the yields may rise to invite buyers, but the loss expectation is still evenly spread.

Since Italy is about at 120% of GDP, yields averaging over 5% imply that debt servicing costs will rise to about 6% of GDP within a couple of years.

This is being blamed on the Greek vote, but it is due to the leadership's "solution" to the Euro crisis last week. In the meantime, Greek bonds being sold privately seem priced for an almost total loss (the yield on two years quoted at 82.82%), which does in fact make sense since it is impossible for Greece to pay its notes in the near term and thus the privileged entities are going to end up with a lot of notes. Since Greece needs about a 50% writedown, if the guaranteed parties end up with 30%, the private holders have 70% of total holdings with a 50% writeoff, leaving 20% in actual assets. Add any scheduled near-term interest payments funded by the privileged, and you get a figure depending on maturity.

So the Dragon now takes the helm of a gelded ECB facing a hopeless situation in Greece, a pending debt strike in Ireland and an Italy being shoved out of the Euro.

Corzine's shop goes bust, because the Europeans don't have to bail it, and you have to think that France is going to take a credit downgrade very soon, because surely France is going to have to pour some more capital into several large banks.

A pretty big question remaining is whether the implicit deal that money won't be pulled out of those Eastern bloc banking subsidiaries can hold. If it doesn't hold, then Europe is facing a pretty rough recession. Erste Bank is the bellwether - can it really boost its capital without pulling money back in? That's a huge jump in estimated capital requirements in just a few months. RZB and RBI are pretty much the same entity, and are standing in the Eastern bloc banking fall line. There is also feedback from the Greek banking crisis, because Greek banks were lending in chunks of the Eastern bloc also.

None of this really helps the US, much less China. The EU is a massive consumer of Chinese goods, and quite a lot of them go to the Eastern bloc. See 2010 data. Thus China would like to support the EU, but it certainly cannot afford to do so by buying debt that's mostly unsecured - for monies offered to Europe, it would want to be mostly secured. China has a pretty severe internal bad debt program, and its latest theory is that it will boost lending to small businesses to sustain employment. This will prove to be very expensive, because those small businesses don't have the profit margin they need to pay back debt and continue production.

The "unsinkable" Titanic was similarly difficult to bail. Sigh.
The Titanic - Why Did People Believe Titanic Was Unsinkable?

"It was the beginning of the twentieth century and people had absolute faith in new science and technology. They believed that science in the twentieth century could and would provide answers to solve all problems.

The sinking of the 'unsinkable' Titanic shattered much confidence in science and made people more sceptical about such fantastic claims."

Fortunately, the Euro is built on 21st century financial technology. Whew! ;)
The battle between debt deflation and printing has just
begun. My guess is that printing will be used to kick the
can. The lack of regulation in finance and the free trade
Policies have been a one, two punch.
MoM, do you have any details on the Irish debt strike?

Mark - all equity bubbles have at their beginning a mental bubble of confidence. That's what I look for. That's why I am so skeptical of China.
"Mark - all equity bubbles have at their beginning a mental bubble of confidence. That's what I look for. That's why I am so skeptical of China."

But... but... those Chinese are so savvy!
Gordon - well, they buried Lenihan (sp?), and I think the deal may have been interred with him. Mind you, everyone in Ireland always assumed they would renegotiate.

What happens next will depend on the EFSF bond offering. The call for an Irish referendum should surprise no one. At a minimum, Ireland wants to renegotiate the 5.8% interest rate. It is likely that losses will be pushed on bondholders now (not part of the original deal, and when Ireland pushes this outraged squeals start echoing around Europe). Merkel is running around frantically talking about no more haircuts. Haha.

My best guess is that the final form of all this will be that the EFSF will run short on its ability to raise funds, thus the value to Ireland of being able to draw on its credit line with them will diminish, and Ireland will push for, and eventually get, a reduction to about 4% and more cuts to bondholders, which will stiff some European banks.

The theory that China would ante up has been rebuffed, and now there is a big money crunch. They were even talking about tapping the North Sea funds for money. I'm thinking that won't fly either.
Mark, yeah, that's exactly it. And all the talk from the smaller home buyers in China last year about the government not permitting the housing market to fail was chilling.

The belief in a sure thing presages disaster.

"The belief in a sure thing presages disaster."

One of the best things that ever happened to me from an investment standpoint was the early failure of a sure thing. It happened at a time when I had little to lose (simply lost my previous winnings).

It taught me a valuable lesson about the realities of investing/speculating/gambling. The things we don't know are at least as important as the things we do know, and no matter how savvy we think we are there will be an infinite supply of things not known.

That brings me to my favorite George Soros quote.

"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected."

Making money off of the obvious is a dangerous game.
Or CW. When everyone thinks something is true that's when you need to do your own research.

Mark, I have found a Bloomberg opinion piece for you. Only you could do justice to the total idiocy of its opening paragraph:
Something is wrong when keeping cash in the kitchen cookie jar seems a reasonable substitute for your bank. It may feel rebellious -- your own little Occupy Wall Street act of defiance -- and even a bit savvy, given those checking-account fees, ATM fees, and monthly debit-account fees. That little depository institution atop your kitchen counter has big drawbacks, however, including a lack of federal deposit insurance, zero interest, and ease of access that could prove dangerous to your financial health.
Gordon - oh, yeah, the EFSF is not going through with the bond sale destined for Ireland funding. Delayed.
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