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And then there were just 4 Euro Zone countries who retain their AAA rating, according to S&P – no doubt less in time.

Personally, I believe that the importance of the AAA rating is way overrated, particularly in the current circumstances.

S&P downgraded 9 Euro Zone countries on Friday 13th, including France – don’t you just love the date/timing – pure drama.

Indeed, Italy, Portugal, Cyprus and Spain were downgraded by 2 notches, with Austria, France, Malta, Slovakia and Slovenia by 1 notch – Cyprus (BB+) is also now in junk territory – so much for those Russians who used Cyprus – they will learn. In addition, S&P suggests that, in the event of a default, investors in Portuguese and/or Cyprus debt would recover between 30% – 50% of their assets, at the most.

The ratings agency reiterated its rating on Belgium, Estonia, Finland, Germany, Luxembourg, Ireland and Holland. All 16 countries have been removed from CreditWatch, suggesting that there will be no further downgrades in the near term. However, 14 of the countries (ex Germany and Slovakia, who regain their stable outlook rating), remain on negative outlook, which imply a 1 in 3 chance that their rating will be lowered in 2012/2013. Basically, of the Euro Zone, only Finland, Luxembourg, Holland and Germany have retained their AAA rating.

S&P stated that the “rating actions are primarily driven by our assessment that the policy initiatives that have been taken by the European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the Euro Zone”.

Greece’s credit rating is CC – forget Greece – I will be amazed if investors recover even 25% of par.

The downgrades were widely expected and were leaked during market hours on Friday. In addition, it is actually not as bad as it could have been – there was a risk of Holland and, more importantly, Germany would be downgraded, with France’s rating being cut by 2 notches. The markets took the news in its stride. Sure, there is likely to be some selling first thing on Monday, but I’m not sure that it will be widespread and/or prolonged.

LCH Clearnet raised the margin requirement on trading on (3.25 – 30 year) Italian debt FYI.

However, the more important issue is the (certain) ratings downgrade to the EFSF/ESM, now that there are only 4 remaining Euro Zone AAA countries and with the 2nd most important Euro Zone country (France) having lost its AAA rating. Oops. Monsieur Sarkozy start getting real.

Personally, I believe this could be the final nail in the coffin for Greece. Negotiations between Greece and its creditors collapsed on Friday – there is a serious chance that Greece will have to have to default and indeed, exit the Euro. Contagion issues then arise. However, the ECB’s 3 year LTRO has helped enormously (particularly in respect of yields on shorter Euro Zone dated debt) and, as you know, I expect the ECB to introduce QE in the 2nd Q – possibly even in the 1st Q. In addition, the question is – will the Euro Zone be better without Greece – personally, I seriously believe it.

A recent watering down of the “fiscal compact” (supported by Germany, who wants more flexibility !!! – this really represents double standards by Germany, yet again – Germany FYI has not met its Maastrict treaty commitments for the majority of the time, I would add) has not helped the case for the ECB introducing QE, but I remain convinced that its inevitable – I suppose the ECB could demand that countries stick to pre agreed fiscal targets, in return for them buying the relevant countries bonds.

With the Sovereigns downgraded, a number of Euro Zone banks are next. Having said that, I reiterate, I remain bullish the European financial sector – particularly for those who do not need to raise equity capital – given the ECB’s 3 year LTRO programme. Yes, I know you think I’m crazy, but……….;

Just imagine what would have happened if the ECB had not introduced its 3 year unlimited LTRO programme. Bloomberg reports that US money market funds reduced their lending to French banks by 97% (yes that’s 97% – no typo) in 2011. US, Japanese and Swiss banks have benefited from this shift. However, I repeat, the ECB’s UNLIMITED 3 year LTRO is a game changer. There is NO LIQUIDITY issue facing (virtually all) European banks – even INSOLVENT BANKS COULD WELL SURVIVE. By the way, French banks increased their use of ECB funding by 62% in the 4th QW 2011, according to the Banque de France.

In addition, the ECB policy is effective QE, by the back door, as banks (in particular those in trouble) play the short term (less than 3 year) carry trade – the really bust banks will play the longer term carry trade;

The Euro traded closed at US$1.2676, well below the E1.30+ in December 2011, but even this rate is questionable. My forecast of sub E1.20 looks good and getting better by the day.

The 2012 game is beginning – fortunately, as I expected. However, let me just add that 2012 is going to be a particularly difficult year to forecast – I will respond accordingly.

VOLATILITY WILL RULE.

The great news (or in your case, unfortunate news) is that my Internet problems, here in Goa, seem to be sorted out. Will need a few days to get back up to date though.

Have a great weekend. I am.

Today’s howler comes from the fundamental banking analyst community. Recall that this is the group who once existed to help investors decide where to place their monies. When that did not work out, their bosses morphed their business model towards generating IPO and syndicate business. When that failed, they moved towards driving short term institutional trading.

Today, I have no idea what their business model is.

Despite having missed 2011′s declining earnings per share for the biggest U.S. banks, they are forecasting an even bigger profit surge for 2012, according to Bloomberg:

“The six largest lenders, including JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC) and Goldman Sachs Group Inc. (GS), may post an average profit increase of 57 percent this year, according to 184 analysts’ estimates compiled by Bloomberg. A year ago, analysts predicted profit at the banks would climb 32 percent in 2011. Instead, earnings per share probably fell 18 percent as the economic recovery analysts counted on never took hold.

Improved trading results, more investment-banking deals, expense-cutting measures and lower credit costs will lead to the increase in earnings that didn’t materialize last year, analysts say. That may provide a boost to stock prices after financials were the worst-performing industry in the U.S. in 2011.”

Exactly how does one forecast improved trading results? “I really feel these guys are not only going to have a better trading environment in 2012, but they are going to get better insight, cleaner executions and be a whole lot luckier than they were in 2011” said no one at all.

Its not just the Bank Analysts who stunk up the joint. Wall Street Market Strategists did not do much better, as this WSJ graphic shows:

The takeaway is you better have your own approach for investing and trading, rather than relying on 3rd party guesses . . .

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Sources:
Bank Earnings Jump 57% in Analyst Forecasts
Michael J. Moore and Dawn Kopecki
Bloomberg, Jan 3, 2012  
http://www.bloomberg.com/news/2012-01-04/bank-earnings-increase-57-in-analyst-forecasts-which-proved-wrong-in-2011.html

Street Wary on Its Random Walk
Strategists, on Average, See 6.1% Rise in S&P 500 for 2012 as Worries Abound on Europe, Earnings
STEVEN RUSSOLILLO
WSJ, JANUARY 4, 2012
http://online.wsj.com/article/SB10001424052970204368104577139023088982182.html

Following a drop of factory output by -5.1% in October YoY, as compared with a forecast decline of just -0.7%, the Indian Rupee is tumbling – its down over 15% against the US$ YTD. The SENSEX is down approx 23% YTD, making it one of the worst performers of the Bric countries, though China is down roughly around the same percentage;

Well, you heard it first from Sarkozy – basically he is trying to defuse the impact of the impending French ratings downgrade, likely imminently. Remember that S&P suggested a possible 2 notch downgrade for France. A downgrade is considered a near terminal event for Sarkozy’s Presidential reelection hopes. The current favourite to replace Sarkozy is Francois Hollande, leader of the French Socialist Party, who may add a further complication to the recent Euro Zone “fiscal  compact”.

Other euro Zone countries will be downgraded, including Germany, if S&P carries out their threat Fitch joined S&P and Moody’s in threatening a downgrade for a number of Euro Zone countries, warning of a “significant economic downturn” in the region;

It looks as if Commerzbank needs a 2nd state bail out since 2008, according to German political sources, though Government officials have denied the story – the EBA suggests that Commerzbank will need E5bn. The EBA has ordered European banks to raise E115bn by June next year which, whilst not enough, will still prove to be a struggle. European banks continue to reduce leverage – current estimates suggest that the need to reduce their balance sheets by at least E2tr;

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After Moody’s did earlier today, Fitch is giving its thoughts on Friday’s EU summit. “It seems that a ‘comprehensive solution’ to the current crisis is not on offer.” They acknowledged the initiation of an “institutional and policy framework for a more viable eurozone and ultimately greater fiscal union, but taking the gradualist approach imposes additional economic and financial costs compared with an immediate comprehensive solution. It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond, until the region is able to sustain broad economic recovery.” Fitch didn’t define what a ‘comprehensive solution’ would look like however. On the ECB Fitch believes they are “the only truly credible firewall against liquidity and even solvency crisis in Europe.” “Hopes that the ECB would step up its actions in support of its sovereign shareholders as a quid pro quo for institutional and legal changes that gave the ECB greater confidence in the long run commitment of eurozone governments to fiscal discipline appear to have been misplaced.” It is this lack of ECB step up in its actions that I believe the markets are most upset with.

What is the function of Ratings Agencies? The answer to that question was most pithily expressed thusly: might

“The function of a ratings agency is to visit the field at the end of the battle and shoot the wounded.”

-John Heimann, Spring 1998
(former U.S. Comptroller of the Currency and later vice chairman of Merrill Lynch and chairman of the Financial Stability Forum)

Sourced from Brookings

*EUROPEAN FINANCIAL STABILITY FACILITY MAY BE CUT BY S&P

Old joke about Analysts:

You do not need them in a Bull market, and you do not want them in a Bear market.

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I was thinking about that in light of the S&P’s mass EU downgrade threat.

As always, the Credit Rating Agencies are quite late to the party. And consider that the European Central Bank, whose balance sheets are festooned with bonds from all of these countries, is somehow still AAA.

My bottom line about the rating agencies is they are worthless to investors.

Consider how the market actually reacts to these outlook and ratings downgrades. As an example, think about the downgrade of US debt from AAA to AA+, as the chart below reveals:

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Spot the Down Grade!

click for larger graphic

Source: Stockcharts

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As a reminder, the S&P downgrade was August 5th; US Treasuries have actually rallied since, then, sending rates appreciably lower, and making US borrowing costs less expensive. (Thank you sir, may I have another?)

Equity markets wobbled for a few months, then resumed what they were doing previously (going sideways).  Last I checked, the Euro was practically flat year to date.

Given the various downgrades, they seem to make a lot more heat than light. They do not seem to matter as much as we think to the markets they are actually rating — namely, debt. Its somewhat ironic that a downgrade of debt seems to have more impact in the equity markets.

Which leads us to telling question: Do the ratings agencies matter anymore? Have investors figured out that they are corrupted, conflicted, unable to honestly discharge their duties?

Or is it simply that they suck at what they do? Recall the downgrades of Enron, Worldcom, Lehman, AIG, and many others. It seems the markets force them to act, that Traders are issuing the call long before the analysts at Moody’s or S&P actually  downgrade a corporate or sovereign ratings.

We may not need the judgment of honest analysts in a bull market, or want them in a bear market, but it seems the answer to our headline question: When it comes to the ratings agencies themselves, investors seem to have little if any use for them anytime.

Source:
Over Rated,
Bloomberg Businessweek,
Nov/Dec 2011

There may be no honor among thieves, but there has always been some small measure of dignity — even respectability — amongst the con men of the equity markets.

Apparently, there is no such corresponding code of honor amongst commodity trading firms.

I refer of course to the debacle that is MF Global. How on earth could $633 million in customer accounts simply disappear?

As it turns out, quite legally.

The regulations governing these customer accounts are 25 plus years old, according to a few insiders I spoke with. They gave the firms an ability to hypothecate (lend) client money, so long as it was only used to legally purchase investment grade sovereign debt.

So that was what MF Global did.

As originally conceived, client monies were only supposed to purchase US Treasuries. However, so as to not offend trading partners (and other reasons), the regs were written so as to include any “investment grade sovereign” in the rules. Hence, AA rated European sovereign debt, despite the obvious fact that in 2011 they are obviously not the equivalent of US Treasuries, technically qualify. Whether this violates the obvious spirit and intent of the law will be for a judge to decide.

Of course, this raises another question: If the corrupt and compromised rating agencies had actually done their jobs — downgrade European junk to what it really was — would MF Global been able to empty client accounts? I suspect not.

Regardless, consider the Con Man’s Lament: The past half century of boiler rooms, accounting scandals, pump & dumps, backdated options, corrupted analysts, IPO spinning, derivative debacles, etc., have all come about for this simple reason: Brokerage firms cannot simply reach into client accounts and take the money for firm use.

This wasn’t a face-in-hand moment — Hey, why didn’t we think of that? — amongst equity criminals. Rather, it was a well understood rule that was enforced without question. “Borrow” money from a client account without their knowledge, go to jail for grand theft.

Consider:

• If the weasels at Stratton Oakmont or any other ’90s boiler room thought they could merely empty client accounts, they would have. Instead, they had to concoct enormous Pump & Dump schemes to dupe willing rubes out of the money.

• If Merrill Lynch could have merely grabbed billions from Orange County, rather than create an elaborate derivatives scheme that ultimately bankrupted the county, don’t you think they would have done that?

• Instead of the IPO spinning to capture assets and revenues that most of the major bulge bracket firms did int he boom times of the late 90s, wouldn’t it have been easier to merely leverage up client accounts?  Heads we win, tails you lose?

• Would any of the major accounting firms had to do such absurd audits of firms like WorldCom or Tyco? They worked hand in hand with Wall Street to help capture money. (But steal? Never!)

• Consider the side pockets developed by Enron with the help of McKinsey & Co. If there was a way to simply take client money, why would anyone bother going through all that trouble?

• Even the convoluted Lehman’s Repo 105 was a way to hide $50 billion per quarter from investigators and regulators. Had they been able to tap client monies, who knows how their saga might have ended.

Now, that may not sound like much, but it is worth considering. Neccessity being the mother of invention forced the very worst enterprises on the equity side to engage in all manner of deception and duplicity by morally compromised, ethically challenged bad actors. They had to do this, because they could not merely grab monies from client accounts.

It was a point of pride amongst equity con men that they did not merely steal. They cajoled, wheedled, scammed, and cheated, but they never stole.

Hey, what kind of people do you think we are?

Kiron Sarkar is an investor and advisor in London. Formerly in the M&A dept of N M Rothschild in London, he was head of M&A of Rothschild (Hong Kong) and worked on their international privatisation team. He worked as privatisation adviser to the UK Governments Know How Fund. Most recently, he was European Head of Media, Tech and Telecoms at CIBC World markets. Kiron has acted as a lead adviser in respect of over US$150bn of deals and has worked globally in both developed and emerging markets.

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Moody’s threatens to downgrade ALL Euro zone countries – hey, that includes Germany does it not. Off course it does. I really wonder what officials in the German Finance Ministry think of that – a bit of a shock – well, possibly stronger emotions than that, I suspect. However, why the surprise – in my view Moody’s is just reflecting the reality of the situation.

French newspaper reports (La Tribune) suggest that S&P may downgrade the country’s outlook to negative in the next few weeks – personally, I do not believe that France will be able to maintain it’s AAA rating, so no surprise. French unemployment rose to the highest since December 2009. Looks increasingly as if Sarkozy is “French toast” in next years Presidential elections – no great loss, but the likely winner (a socialist) – who knows what he will be up to. Basically, more
uncertainty – just hope (likely) that the euro zone issues will be sorted out before that – making it more difficult for the potential Socialist candidate to complicate the process.

The far more important point is that Germany is finally recognising that it is not financially immune. The other big issue is whether Germany comes up with a credible solution re the Euro Zone and, by default (maybe not the right word to use, given the current situation) for themselves.

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