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Greece – Europe – Credit Spreads Worldwide – Stocks
February 11, 2012

So far, the Cassandras’ predictions of global collapse and failure have been proven false. Some of the most notorious bears are now turning bullish and revising their forecasts to the positive. Other “gloom and doom” holdouts are feeling the heat. We think that heat will intensify.

The key to watch is in the credit markets. Credit spreads tell a story of overwhelming liquidity being applied to the financial-system open wounds like a steroidal salve. Such treatment can alleviate interim pain. It is treatment for the symptom; it works for a while. It does not provide a permanent cure.

One can easily track the credit spreads of sovereigns around the world. We have listed both the “good guys” and the “bad guys” on our website, http://www.cumber.com/. We are following a concept first presented to us by Erwan Mahé, who is doing seminal work from his Paris location. We have expanded on his work to include sovereign spreads in Asia and South America as well as those in Europe, both in and out of the eurozone. We update these charts on a weekly basis, due to the continuous demand from clients and readers to view the data: http://www.cumber.com/content/misc/EU_Contagion.pdf.

Why have all the Cassandras been wrong? Because they ignored the power of central banks to cause credit spreads to narrow. The outcome is reflected in market movements and in certain sectors.

Banks are a good example. If you made bets on banks, you won. If you were a detractor of banks, you lost. This holds true in Europe, in the United States, and in many other places in the world. The European Central Bank’s ingenious concept of a three-year, 1% loan via LTRO (long-term refinancing operation) worked. It was successful because it allowed the banks to buy their own debt at a higher yield than 1%, book the difference in yield as income, and mark up the value of their own bonds to par. That process functioned as a mechanical way for there to be an addition to the bank’s capital. The ECB used a creative way to solve a portion of its eurozone and the Europe-wide banking crisis.

We believe that the Fed must take notice of the LTRO. It can give them another arrow in their quiver. It takes the Fed beyond 28 or 84 days into contemplative periods of transitional policy, from the present massive stimulus that is all focused on the short run. The ECB has given the Fed a monetary laboratory in which to watch a longer-term, transitional-workout framework.

We expect the ECB to do another LTRO within the next month. The size is unknown; the impact will be positive. The markets now expect it and are already pricing it in.

Credit spreads are reflecting transition from worldwide recession and double-dip forecasts to gradual and improving economic outlooks around the globe. Data supports this shift in the United States, as well as in other places in the world. It will happen in portions of Europe, but not in Greece. In other European countries we expect to see some gradual improvement.

The world has had enough gloom and doom. Investors have been terrified since the beginning of the crisis in mid-2007, when Bear Stearns said “We have a small problem with a couple billion dollars in a hedge fund; don’t worry, it means nothing.”

We have replaced meltdown of the type we saw after Lehman/AIG with “melt-up” of the type we have been seeing since March 2009. We have shifted from collapsing leverage and failure at the institutional level to central bank intervention of unprecedented size.

The G4 central banks (http://www.cumber.com/content/misc/G4_Charts.pdf) have taken the size of their collective balance sheet from $3.5 trillion to $9 trillion. That number is likely to rise. The G4 have extended duration so that the focus of their policy is not just in the overnight lending rate or in the very short term. Massive liquidity has blunted liquidity squeezes everywhere in the world.

However, the issue of solvency remains. Greece remains insolvent. It must work out its payment schemes or it will default. It will require austerity and hardship. Despite the protests of unionized workers in public squares, there is not enough money to pay on the promises that were made.

Workouts are not easy, whether they are in Greece or Harrisburg, PA. Workouts involve recognition of loss and economic pain. Deferring the workout only makes it worse. Greece and Harrisburg will learn this lesson the hard way. Default is even worse. Ask Argentines who are still recovering from their government’s policies. Ask the citizens of Vallejo, CA, who squandered $10 million in legal fees on a municipal bankruptcy and have lots of unfixed potholes to show for it.

Workouts, however, do not cause total collapse; in fact, they bring out strength. Ask the Scandinavian countries that avoided this financial crisis, having learned from their previous one. Ask Singapore, which has imposed governance standards. If we had Singapore law applied in the US, many in Congress and on Wall Street would be in jail for many years to come.

The biggest threat to financial-market pricing comes from periods of uncertainty, the sequence of ambiguous and conflicting views that alter investor perceptions. Uncertainty is the enemy of market pricing. Once you achieve clarity, markets adjust quickly to the new reality and move on. This will hold true in every city, county, and country. And it will apply to every banking system in the world.

At the present time, our US stock market ETF portfolios remain fully invested. We are concerned about a market correction, which appears underway. It is necessary, since we have moved dramatically higher from the October selling-climax low. The upward move has been at a sustained pace. We expect this to be a correction, not a market peak. We believe the financial sector is still attractive. As it repairs, it will become even more attractive.

We are going through huge transitional times. Never before have we seen coordinated, global central bank activity of this order or magnitude. By the end of this year, the G4 central banks will have expanded their balance sheets approximately threefold during the financial crisis. The negative and inflationary results of this activity may appear in the future. That remains to be seen. For the present, this is a very bullish construction for asset prices and equities in particular.

David R. Kotok, Chairman and Chief Investment Officer

Richmond Fed Economic Brief, “Where Are Households in the Deleveraging Cycle?,” by R. Andrew Bauer and Betty Joyce Nash. PDF

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Where Are Households in the Deleveraging Cycle?

This week officials from the Obama administration, the banking regulators, and state Attorney Generals announced a settlement of claims stemming from the financial crisis. The nominal amount put forward as the cost of the settlement is $26 billion, and in return the banks will be released from civil claims on origination of mortgages and the falsification of documents in the foreclosure process, or “robosigning”. This caps off a month of political noise on the housing situation which started at the State of the Union, when the president announced a task force on financial fraud headed by officials from his administration as well as New York Attorney General Eric Schneiderman.

An investigation, and a multi-billion dollar settlement. That sounds like a lot, until you put it into perspective. Here are the numbers. Roughly half of homeowners with mortgages are underwater, which means they owe more than they own, to the tune of $1 trillion or so. And housing values are still declining so far in this “recovery”, throwing more homes underwater. In terms of an investigation, the Savings and Loan crisis used roughly 1000 FBI investigators to uncover fraud — this task force taking on a crisis forty times more severe will employ 10 FBI agents.

There’s a reason this is so inadequate to the problem at hand. For the last three years, the policy has been to impose a political solution to a math problem. It hasn’t worked. America simply has too much mortgage debt to pay back. Serious economic thinkers across the spectrum, from Democrat Alan Blinder to Republican Martin Feldstein to New York Fed President William Dudley, believe that there is only one solution — writing down the enormous creaking mound of debt. This solution is currently off the table, because writing down these unsustainable debts could cost our fragile banks enormous sums of money and possibly lead to a restructuring of one or more of our major banks. Avoiding this clear policy choice has resulted in our economy falling into a Japan-style “zombie bank” torpor, with debts carried on the books at full value which everyone knows will not be paid back at par.

This crisis of American political economy in the form of excess mortgage debt is preventing a more powerful economic recovery. Three years after Ben Bernanke used the term “green shoots” to describe a recovering economy, job growth hasn’t really revived in any meaningful way. In fact, this is by far the worst recovery we’ve had since the end of World War II. The best way to measure this is not through traditional unemployment indices (which can be gamed), but by asking the question of how many Americans are working as a percentage of the population. In 2007, this was 63 out of 100. Today, it’s a full five percentage points lower. The ratio hasn’t been this bad since the early 1980s recession, and remember, we’re in a recovery. And the labor force participation rate is dropping, which is a long-term bigger crisis. [BR: Much of this is a function of demographics of the aging Baby Boomers; In terms of Job losses, the chart below is far more damning population ratio:

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Calculated Risk
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The housing market’s vicious deflationary cycle demands serious policy action to match the scale of the challenge. Dropping housing values lead to foreclosures, which damage housing values, and so on and so forth. According to Zillow, roughly half of homeowners with a mortgage are effectively underwater, which means they owe more on their mortgage than their house is worth. According to Zillow, 28.6 percent of all single-family homes with mortgages had negative equity in Q3 2011. And according to CoreLogic, “10.7 million, or 22.1 percent, of all residential properties with a mortgage were in negative equity at the end of the third quarter of 2011.” (Correction hat tip Calculated Risk)

So far, the alphabet soup laden set of programs (HAMP, HARP, Hope for Homeowners) put forward by the Bush and then Obama administration have been failures. And this is because, as the Congressional Oversight Panel noted as far back as March of 2009, the single best predictor of default risk is how much equity homeowners have in a home. Many Americans, though considered homeowners, are essentially “renters with debt” (as housing analyst Josh Rosner put it). And Amherst Securities Laurie Goodman noted that with our current housing trajectory, we can expect up to 10 million more defaulted mortgages over the next decade. These foreclosures impacts housing values, reduce consumer purchases, and costs municipalities money.

The proposals on the table to solve this problem aren’t inspiring. The meager mortgage settlement deal cut via furious and dramatic negotiations is unlikely to be meaningful. This settlement is essentially a continuation of previous alphabet soup housing programs, because it would not force banks to fundamentally restructure the trillion dollar underwater mortgage problem. It will generate headlines, but it will fail to address the extent of the problem. State attorneys generals have accepted the settlement for a variety of reasons, one of the most frustrating being that they are substantially under-resourced and this deal moves cash their war. This is not how to make good policy. And the housing market will continue to suffer if our political leaders cannot acknowledge the depth of the problem.

Instead, we need some serious discussion from both the Republican candidates and the Obama administration about how to write down mortgage debt. Some proposals would reduce principal, while giving the banks an equity appreciation stake in the home. Others would deal with the problematic accounting standards which allow banks to overvalue second mortgages, and imply that one or more large banks needs to be restructured by the government. These are worth considering. We think it’s important, regardless of how policy-makers reduce the debt, to force the banking system to appropriately value mortgage debt.

Anything less would simply continue the deflation and uncertainty in the housing market.

Ultimately, we need to look at our banking and housing system and engage in a ruthless yet compassionate evaluation of whether it is working to solve our national needs. Serious thinkers in both parties recognize that it isn’t, and that we should find a way to write down this mortgage debt. Only then will we head down a pathway to a healthier banking system, and begin generating the roughly thirty million jobs that will bring America back to full employment. It’s time that the major presidential candidates, and President Obama himself, be honest with the American public, and openly recognize this as well.

Yet Another Bailout for the Giant Banks … Homeowners Get Hosed Again

The 50-state settlement with the banks (Oklahoma didn’t sign, but supports letting the banks go scot-free) over mortgage fraud is a stealth bank bailout, according to many top observers. See this, this, this, this, this, this, this and this.

This is par for the course … All of Obama’s previous “mortgage relief” programs have really been stealth bank bailouts which screwed the homeowner. And see this.

For example:

Most independent experts say that the government’s housing programs have been a failure. That’s too bad, given that the housing slump is now … worse than during the Great Depression.

Indeed, PhD economists John Hussman and Dean Baker, fund manager and financial writer Barry Ritholtz and New York Times’ writer Gretchen Morgenson say that the only reason the government keeps giving billions to Fannie and Freddie is that it is really a huge, ongoing, back-door bailout of the big banks.

Many also accuse Obama’s foreclosure relief programs as being backdoor bailouts for the banks. (See this, this, this and this).

Settling prosecutions for pennies on the dollar is a form of stealth bailout. It is also arguably one of the main causes of the double dip in housing.

Manal Mehta is a Banking & Finance analyst with Branch Hill Capital; contact him at manal@branchhillcapital.com.

Why I Wouldn’t Invest in Banks: The Return of Exposure to Off balance Sheet Securitizations

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Why I Wouldn’t Invest in Banks by Manal Mehta

FT Alphaville gives us the Cliff note version of the national mortgage fraud bank settlement — available in easy to follow graphic or text form:

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Here is the breakdown:

Under the agreement, the five servicers have agreed to a $25 billion penalty under a joint state-national settlement structure.

Nationally:

• Servicers commit a minimum of $17 billion directly to borrowers through a series of national homeowner relief effort options, including principal reduction. Servicers will likely provide up to an estimated $32 billion in direct homeowner relief.

• Servicers commit $3 billion to an underwater mortgage refinancing program.

• Servicers pay $5 billion to the states and federal government ($4.25 billion to the states and $750 million to the federal government).

• Homeowners receive comprehensive new protections from new mortgage loan servicing and foreclosure standards.

• An independent monitor will ensure mortgage servicer compliance.

• States can pursue civil claims outside of the agreement including securitization claims as well as criminal cases.

• Borrowers and investors can pursue individual, institutional or class action cases regardless of agreement.

Source:
S.E.C. Is Avoiding Tough Sanctions for Large Banks
NYT, February 3, 2012

Click to enlarge:

>Source: Bianco Research

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Happy Anniversary! Here we are, exactly 5 years to the day from the beginning of the credit crisis.

Jim Bianco dates the crisis as formerly beginning on February 8, 2007 when HSBC’s Household International announced huge losses due to subprime lending. HSBC had to restate its 2006 earnings significantly lower. Bianco adds that while most people were asking what a subprime loan was, HSBC was “patient zero” of the crisis.

To underscore this was indeed the start, HSBC ended this lending unit March 2009, literally hours before the stock market bottomed.

Japans current account surplus declined for the 10th consecutive month in December. Exports were lower for the 3rd month on the trot, whilst imports rose yet again – for the 24th straight month. The current account surplus declined by approx 75% YoY, slightly worse than market expectations. The MoF states that Japan should maintain a current account surplus “for the time being” – “for the time being”, a definite Hmmmmm. Japans 2011 current account surplus was down some 44% YoY and the lowest since 1996 as Japan posted a trade deficit last year. With the nuclear problem, Japan’s need to import more energy will impact the trade numbers. The Yen (finally) is declining – above 77 against the US at present;

China’s PBoC is to provide assistance for 1st time home owners, though authorities remain vigilant on a general rise of property prices. Home prices declined in 52 out of 70 cities.

Fitch warn that a hard landing in China is a “key global risk”. Its forecast is for GDP to rise by +8.2% this year. However, China needs to grow by 7% – 8% to maintain employment and avoid social tensions.

It looks as if China will cough up to bail out the Euro Zone. Reports circulate that they may contribute (initially US$10bn, rising to US$100bn. Look, its simple. Europe is China’s largest trading partner – an European implosion will be an unmitigated disaster for China – forget the claptrap about “decoupling” – helping Europe out is in China’s best interests.

Chinese inflation data out tomorrow (they allowed an increase in diesel and petrol prices today, as production had declined in response to price curbs – the 1st increase in 10 months) and export data out on Friday. Both will be watched carefully;

A study by the South African Government states that nationalisation of the country’s mining sector (demanded by the youth wing of the ANC) would be an “unmitigated disaster”. Great. However, the study and the Mines Minister calls for more Union involvement in business decisions and for tax increases !!!!!.  Well that really is a big Hmmmmmm;

As usual Greece failed to meet its deadline to agree to the conditions imposed by the Troika on the additional bail out yesterday. However, the Euro Zone Ministers meet tomorrow – will that be the deadline? The acting Greek PM is to meet the heads of the main political parties yet again. However, a deal is expected.

The WSJ reports that the ECB will “sell”/”swap” its holding of Greek Sovereign bonds in order to reduce the amount of Greek Sovereign debt outstanding. The ECB is thought to own between E45bn – E50bn (not disclosed) and if they sell at their cost price, the overall reduction in Greek debt may amount to E11bn. If the ECB coughs up for Greece, why not for Italy, Spain, Portugal and Ireland. Clearly the ECB will have to extend its largess to these countries – the ECB currently owns E219bn of PIIGS bonds. Good for banks/insurance companies in those countries. Still think Bank of Ireland (Ticker BKIR) is looking good – bought some more.

I’m sure that the ECB will be delighed to get rid of its holding of Greek bonds – they would have taken a loss otherwise.

Just look at this Greek data re tax revenue.
Overall, revenues are down -7.0% YoY, as opposed to a target of +8.9%. VAT revenues are down -18.7%, as Greek business have simply withheld payments. Why may I ask is the Euro Zone providing additional bail out funds. Look, the reality is that Greece is a failed country, run by crooked, insane and incompetent politicians.
Don’t think I’m going to holiday in Greece anytime soon !!!;

German December’s trade surplus came in at a seasonally adjusted E13.9bn, in line with forecasts;

The British Retail Consortium announced that (non food) price inflation slowed to +1.4% in January YoY, from +1.7% in December – should provide additional ammunition for the BoE to announce additional QE by Sterling 50bn (some expect Sterling 75bn) tomorrow;

Mr Benanke’s advised the Senate Committee yesterday that unemployment remained a problem in the US, irrespective of Fridays NFP. He reiterated that the FED would hold rates at basically zero till well into 2014. No real surprise in yesterdays testimony. Still believe that the FED will go for QE3, though it may be a bit delayed;

Mr Santorum won in Minnesota, Missouri and Colarado – Romney won in Minnesota and Colarado in his 2008 campaign. Don’t know much about Mr Santorum, other than he is a “socially conservative” former Senator from Pennsylvania. President Obama’s reelection campaign managers must be delighted. Still believe that Romney will be chosen as the Republican candidate;

Some opposition from shareholders owning some 5.0% of Xstrata to the proposed merger with Glencore – however, they need to get to around 16.5% to block the deal.

Asian markets are up again, following a rise in US markets yesterday. The DOW is at its highest level since May 2008. European futures suggest a higher opening – indeed they are rising further, given the “better” Greek news.

Brent Oil has shot up to USU118.40, with the spread to WTI widening further – definitely a negative for both markets and inflation. Middle Eastern risks basically. Need to follow the Middle East more closely. Gold has risen to US$1753. The VIX remains at a (low) 17.65.

Euro is rising, given the Greek news – currently US$1.3270 (increased short), the A$ at US$108.33 (blast – shorted at just below US$1.08) and the 77.05 Yen against the US$.

Markets continue to be optimistic – too optimistic? beginning to believe that.

Still believe that EM’s, in particular, have risen too far too fast. Also remain extremely cautious on China. Todays results by BHP (down modestly in Aussie trading) did not inspire me with too much confidence – the 1st decline in BHP earnings in 2 years. The CEO talks about “volatility” Hmmmm. RIO results are out tomorrow, if I recall.

Just for fun, Portuguese 10 year bond yields have declined by some 400 bps recently – should have followed my own advice.

I cannot go into the details, as the entire conversation was off the record — with an adversary of Hank Paulson’s.

However, I can tell you that, despite disagreeing with the bailouts & TARP that was put into place under his regime at Treasury, Hank Paulson may actually be a decent guy.

When you look at the rest of the parade of folks who helped contribute to the crisis — from the people at Treasury (Paulson, Geithner, Summers, Rubin) to the Fed (Greenspan, Bernanke) to Senate (Gramm, Leach, Bliley, Schumer), there certainly is plenty of blame to spread around a bunch of unsavory characters. Greenspan deserves much more blame than Bernanke (I also believe Bernanke is a decent man).

But Paulson did a few things that are not known, and probably wont be publicly revealed until the end of this year — if at all. His subsequent actions since leaving Treasury have actually surprised me.

This actually comes from an adversary of his. I will reveal all when I get permission, or when the book comes out, if ever — and if not, well, you just have to trust my judgment on this.

More to come later . . .

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UPDATE:  February 7, 2012 4:57am

Geez, y’all completely misread this.Settle down.

I didn’t say I upgraded him to Saint — I thought he was an god-awful jackass who oversaw the greatest theft in history, transferring trillions from taxpayers to incompetent bankers. After leaving Treasury, Paulson did a few things that surprised me and made me think he was more decent than I previously did — thats all.

However negative I was previously about current Treasury Secretary Tim Geithner, after Monday’s lunch I am even more negative than ever.