ecb_logoThe pop media is reporting that Italian yields are falling relative to the last auction, but they are failing to mention that the relative yields on Italian debt as compared to the German Bund are already rising despite the ECB intervening and buying up Italian debt in the secondary markets in order to support its price. Historically, the ECB has failed to support bond prices of all indebted EU

nations it has tried to save since the beginning of the malaise. As I commented yesterday in Did You Know That The Upcoming Italian Auction Can Spark Contagion That Touches US Banks:

When the central bank began its bond program on May 10, 2010 -- buying 16.5 billion euros ofgovernment securities in a bid to support the Greek market -- Greece’s 10-year bond yields fell more than 4.5 percentage points to 7.77 percent. Ten weeks later, as the ECB’s spending dwindled to 176 million euros, Greek bond yields climbed to 10.43 percent. They reached as much as 18.18 percent today.

The bond-buying program didn't provide enough support to prevent Ireland and Portugal following Greece in requesting financial aid. Ireland’s 10-year yields fell to 4.72 percent on May 10, 2010, the day the ECB began buying, from 5.86 percent the previous trading day. They had climbed to 8.9 percent by Nov. 11, the week before the nation requested aid.

Portugal requested a bailout on April 6 this year as its 10-year yields surpassed 8 percent even after the ECB had spent 77 billion euros on government debt. Its yields climbed to a record 13.44 percent on July 11 as the central bank took a five-month pause from bond buying.

“The risk is that the ECB stays out of the market, yield spreads widen significantly and then trading out of Italy is a challenge,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “There’s a decent risk that investors will have to buckle up for a yield increase above 6 percent.”

Here's the take from BoomBustBlog trader Eurocalypse:

"Your piece on Italian auctions is right on spot. According to ZH, the auction went poorly (10Y @ 5.22% from 5% "ecb" levels), not surprising at all. We know already the scenario with Greece Ireland and Portugal, and this time it will happen even faster as every trader already knows what happened to those other countries.

We had the warning shot in when Italian bond broke 5% and traded quickly above 6% in july.

As I wrote before, Volatility in Italian bond and thus VAR went through the roof, 5 or 10 timest the previous levels. thus any trader in a bank or any portfolio manager has to cut losses and can't take any positions (or 5 or 10 times smaller than before if theyre stupid enough to go long). The only demand in the auction is from some passive domestic buyers, yet certainly not enough because that supply used to be balanced with non-domestic buyers, and perhaps some light profit taking from the few shorts willing to take off chips here.

The lack of auctions during summer could buy some time but the truth is out there and should be clear for anyone. The market will trade poorly and will be wary of ECB activity but we can only drift higher because of that supply until the bid totally dies off and its game over. It's only a matter of a few auctions from here. At some stage, the stock market, especially financials will notice.

I don't want to make any bearish bets in EURUSD on the back of that though. It wasn't a good idea in 2011. I keep the neutral stance developed before. The only solution would be for ECB to buy 10x more PIIGS debt than they do currently, but thats very, very unlikely to happen given how Germans see things today. As things get worse, as in Greece, we might start to see bank runs on Italian and Spanish names. that would really spell the endgame of the euro. thats the thing to watch"

Remember, we have identified one of the large American banks most susceptible to an Italian bond failure - by way of contagion through the French bank we identified as most susceptible to a major bank run

I have included a quick update for those subscribers who have been following and/or have a position in/against our bank run candidate, to be downloaded here:  French Bank Run Forensic Thoughts - Addendum and Update. Those who don't subscribe can get an idea of what we are doing by downloading the French Bank Run Forensic Thoughts - pubic preview for Blog.

Here are a few screen shots from the free public abridged version of our professional level document, that easily demonstrates the problem with the French banks cannot be solved by banning short selling or buying profligate state bonds. The problem is inherent in the banks themselves. Please click to enlarge to printer quality...

 French_Bank_Run_Forensic_Thoughts_-_pubic_preview_for_Blog_Page_02_copy

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Subscribers are urged to download and reread  Actionable Note on US Bank/French Bank Run Contagion after reading:

 French Bank Run Forensic Thoughts - Retail Valuation Note
 Bank Run Liquidity Candidate Forensic Opinion (the extensive professional note version of the document above)
 The Contagion Prone US Bank Forensic Review - Retail
 The Contagion Prone US Bank Forensic Review - Professional 

In the meantime here are some other interesting tidbits found in European news...

Finland’s Collateral Demand Leaves EU Faced With Rewarding Bailout Fatigue 30 Aug 2011: Finland' s demand for collateral on new Greek loans leaves European leaders... referring to Finland's agreement with Greece for protection. Collateral accords would be'' fatal...

The nerve of those damn Finn's. Can you believe they actually have the balls to demand (not plead, mind you, but actually "demand") collateral for a loan to a profligate state with a history of lying about its finances and not paying its loans back in full. The nerve of those people. Luckily, we have have Germany to set them straight and force them to use politics instead of math when making financial decisions that may hamper taxpayer and country...

Germany’s Hoyer Tells Finns to ‘Not Rock the Boat’ on Euro 29 Aug 2011: German Deputy Foreign Minister Werner Hoyer warned euro-area countries not to destabilize the currency after Finland ... The euro is'' of utmost importance to all of us in Europe, in particular for countries like Finland ... Hoyer was speaking after euro-area countries including Austria criticized the bilateral deal on collateral, unveiled on Aug. 16, struck by Finland ..

On Tuesday, 12 April 2011 I wrote "Weakening Revenue Streams in US Banks Will Make Them More Susceptible To Contingent Risks".  Today, CNBC runs this on thier front page today... Big Banks Forced to Cut Back Again as Economy Weakens: Battered by a weak economy, the nation’s biggest banks are cutting jobs, consolidating businesses and scrambling for new sources of income.

I believed this to be inevitable for we are still nowhere near a true economic recovery. The main source of lending for most US banks, the housing industry, is in a veritable depression. See Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!! and The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression. Even the news today points to more of the same... Pending Home Sales Fall 1.3 Percent in July from June. 

Big companies are firiing freely again while the main engine of US employment, the small business, exhibits a slowing in hiring in August as wages dip. The balance sheet draw is evident as some banks dump assets at firesale prices.... years after the alleged fire has been put out, while other banks simply refuse to come clearn with the truth... Dexia Sets A $5.1bn Provision For Loss On Trying To Sell The Same Residential Real Estate Assets Upon Which JP Morgan Has Slashed Provisions 83% to $1.2bn from $7.0bn 

Needless to say, it is nigh time to start to take another look at the big US banks.

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_01BoomBustBlogger and Director of Research at Paisley Financial, Mario Ricchio, writes on the abject futility of QE during a balance sheet recession. That is where I, and he, believe the US and Japan are right now. See my video take on this from a real estate perspective here. You can download Mr. Ricchio's report via this link, but in the mean time I would like to highlight some of the not so common sense remarks that I came across in such.   

The report relies heavily on the conceptual framework of a U.S economy in a balance sheet recession. Our main thesis rests on the belief that until U.S households repair their balance sheets and generate real income growth, they are in no position to drive a self-sustaining economic recovery. Monetary policy (including quantitative easing (QE)) produces limited results in generating real economic growth--- since the demand for credit and the lack of qualified borrowers remain the issue not the supply of funds. Instead, expansive fiscal policy, through increased government budget deficits, exists as the primary lever to raise economic activity, transfer real financial assets to the private sector, and ease the pain of the deleveraging cycle.

When the U.S housing bubble burst, the effects reached far beyond the decline in home prices and in construction-related employment. The nature of the economic landscape changed. As home values began their descent in 2006 against a backdrop of record mortgage debt, household net worth plunged primarily through a loss of home equity (see exhibit 1). Consumer attitudes shifted from conspicuous consumption to frugality. After several decades of leveraging up the balance sheet and living beyond their means, households started the process of deleveraging characterized by: debt minimization and reduction, increased personal savings, and lower consumption (see exhibit 2). The balance sheet recession commenced and how we look at the economic cycle must change.

THE PRECURSOR TO A BALANCE SHEET RECESSION

A debt-financed asset bubble precedes a balance sheet recession. Consequently, we begin by paraphrasing the thoughts of legendary hedge fund manager, Ray Dalio, on the cycle leading up to the collapse. A healthy economic expansion starts with a private sector (corporate or household) agent holding minimal debt. The private sector begins to see income rise at the pace of GDP. At this stage of the economic expansion, the majority of aggregate demand comes from cash-based income.
For example, let’s assume the private sector spends $1,000 of cash income (which contributes to the economy); now someone else has $1,000 of income. As the economy expands, the private sector feels more optimistic and decides to leverage up the balance sheet by going to the bank and borrowing $100 per year against $1,000 of income....

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_03

FEATURES OF A BALANCE SHEET RECESSION

DEBT MINIMIZATION

Since asset prices decline (eg. house prices) well below the value of corresponding liabilities (eg. mortgages), balance sheets become impaired (eg. negative equity or negative net worth). In order to repair balance sheets, the private sector moves away from profit maximization to debt minimization2. The deleveraging cycle ends up reducing funding needs. Unfortunately, with no borrowers, the economy loses aggregate demand equivalent to the sum of un-borrowed savings and debt repayment3 . Even in a zero interest rate environment, the private sector refrains from taking on added liabilities (see exhibit 3). This outcome renders monetary policy ineffective by creating a liquidity trap.

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On this very salient point, I must chime in with my own analysis and opinion...

Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!!

The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression! The MSM is Just Catching Up

September 1st, 2007: The very first post on BoomBustBlog tells the whole story for the next 6 years!

Thoughts on the US Publicly Traded Homebuilders - BoomBustBlog

I noticed that many pundits are focusing on single family residential market, most likely because it is in the news so often. It is bad, very bad. I am an ex-residential real estate investor who sold off in 2005 due to fundamentals that were totally out of whack. It appears that many do not see how precarious the commercial sector has become, with many deals being done at 2-5% cap rates (net profit yields) in Manhattan and many major metro areas, which is absolutely ridiculous considering the risk and illiquidity of these deals. The compensation for these deals are coming no where near justifying the risk. I am sure the excessive liquidity coupled with significant demand caused the cap rate compression, but the buyers fell for it assuming liquidity and demand would continue for some time. Well, corporate liquidity has just dried up, and many are stuck holding the bag with buildings that are yielding as low as half that of treasuries, yet easily quadrupling the risk. Some are even selling at lower cap rates in successful flips (reference the Blackstone purchase of Sam Zell's portfolio, which was totally overpriced, yet Blackstone managed to flip much of the portfolio over to speculators, some of which actually flipped it over to someone else at a profit – ALL in a period of a few months). This has now become nigh in impossible, but in an attempt to raise the cap rates, commercial rents have skyrocketed to all time highs in the major metro areas, causing significant pressure on corporate profits (I have inside knowledge of this affecting MAJOR public and private firms who are looking to expand and are getting squeezed).

And now, on to small residential (single family and 1-4 family residential)…

For those who really have a life and do not have the time to read building company annual reports, here is a bullet list of tidbits that all will find interesting, particularly in light of today's mortgage environment (pardon if their is info that you are already privy to, this is a comprehensive summary, but I am sure everybody is to find something that is of illuminating):...

_________________________________________________

Reggie's grassroots analysis:

The S&P index severely understates the glut in housing and the downward pressure on pricing. It uses the repeat sales methodology which only includes houses have that have been sold at least twice, which excludes all new construction. So the homebuilder’s product which is being slashed in price with butcher knives and cleavers don’t even show up in the index, and these homes must be slashed enough to sell in a slow market that no longer has cheap credit, has much competition in excess supply, and no longer has the phantom appraisal pricing which helped sustain the bubble in the first place (more on this later).

The index also fails to include anything but single family detached and semi-detached housing, so coops and condos aren’t included in the mix. This means that areas like Manhattan and Brooklyn, South Miami and Las Vegas, DC and Cally are severely under counted. The mere act of excluding condos (the worst victim of boom time speculation) instantaneously makes things look a lot better than they are.

Also excluded are properties who experienced larger than median jumps in pricing, which where considered to be investor properties (benefiting from significant renovation in anticipation of resale). Investor properties constitute a very significant amount of the current prime and sub-prime defaults now.

Mentioned earlier was the push from appraisers eager to win new business. In the residential investment game, you (as in bank, mortgage banker, mortgage broker, real estate broker, investor, seller, and everyone in between) push the appraiser to come in with the highest value possible to allow you to a.) get the biggest loan possible, b.) obtain the most preferential pricing/terms (lower LTV) possible, c.) get as much from the sale as possible, or d.) all of the above. In the comparable valuation game, you pick comparables and adjust them for particulars to come up with a valuation. Once that inflated value is actually recorded in the city register, it's inflated value is used to further hyper-inflate other deals, and the upward spiral continues. The appraiser, in the boom times, picked the highest prices (which were inflated) to get a highest price (which itself was inflated) that is added into the records to make (guess what???) higher prices. Throw the petrochemical fuel of very cheap money and easy credit NINJA loans and it is easy to see how this housing boom was more than a boom, it was a speculative explosion in real asset prices that usually average 1%-3% a year in appreciation doing about 12%-100% in many places.

The caveat is, this works both ways. When the appraisers get busted for being too aggressive (and threatened with litigation and discipline - if you read the articles, they have been passing the buck saying they were pressured into inflating numbers) they start getting overly conservative and do the opposite. The banks also stop looking the other way since they may actually have to use their own money to fund/keep these loans instead of the OPM method of MBS/CDO fame. So now, the guys are looking for the lowest average prices in an attempt to be conservative, and the process reverses itself.

Now, we haven't even gotten to the commercial sector yet, where the real money is thrown around. Speculation and credit underwriting lite is coming home to roost in a sector near you.

October 2007

Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt IThursday, October 11th, 2007

December 2007

Do you remember when I said Commercial Real Estate was sure to fall?Thursday, December 20th, 2007 by Reggie Middleton

My first post on my blog in September warned about the coming drop in real estate prices. I revisited the topic a couple of weeks ago, as I prepared the research of a short position in the sector. Well, we are almost done with the research and the position and I will release a summary of the research and the performance (expected and actual) of the position after Christmas.

Check this out from January 2008

The Commercial Real Estate Crash Cometh, and I know ... - BoomBustBlog

A couple of weeks ago I informed BoomBustBlog.com readers that I was working on a big project concerning commercial real estate short candidates. I stated last year that I was sure CRE was headed down, hard. Well, I am now ready to start releasing the results of my research over the next week or so. Unfortunately, the market has moved against the subject of my research fiercely as I was completing it, but it appears to be far from over. Who is the subject of that research, you ask? General Growth Properties (GGP).  I have actually seen this company pop up in the media and a few discussion groups from time to time, but they have no idea what the management of this company has been up to. First, a little background on how I got here. Those who are not versed in commercial real estate valuation are urged to read my quick and dirty primer on CRE valuation .

I told members of my analytical team to screen the commercial real estate trust, service, and development sector for the usual suspects, starting with the the guys that purchased Sam Zell’s flipped properties from Blackstone. I made some of the companies available via blog post and download:  Commercial Real Estate Cos. (43 kB).  Forest City Enterprise Peer Comparison (198.98 kB),  Vonardo Realty Trust (146.49 kB). After and exhaustive screen and resultant short list, we chose GGP. I then instructed the team to canvass local and national brokers (4), databases (5) and data aggregators (several) to get the most precise localized rental and expenses figures possible. This data, as well as purchase dates, prices, management actions, capital improvements, etc. were used to plug into models such as this 33 page illustrative example,  GGPs Woodlands Village (612.34 kB), to ascertain the true value of GGP’s portfolio. We also measured and valued their development operations, joint ventures, CMBS financing, off balance sheet vehicles and master planned communities. Sum total, I now have roughly 2 gigabytes of “REAL” valuation data on my servers covering 260 properties owned or partly owned by GGP. A this point, I may know more about their operations than they do.

What is more telling is the window of understanding this opens into the commercial real estate space in the US. It is my opinion that most are extremely over-optimistic regarding the prospects for this space.

And here we are Now, in 2011...

The “American Realist” Says: Past as Prologue – Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!! Wednesday, May 18th, 2011

In the post that followed said appearance, Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate, I ran down what I perceived to be the major risks of real estate in the states today, and that is a departure from the fundamentals and bleak macro outlook. During the Q&A at Roubini's crib, where I was actually guilty of accusing Nouriel of being too optimistic (I know, that's probably a first - but if anyone were to do such it would probably end up being me), participants were suggesting in a rather optimistic fashion that if a hard landing or recessionary environment were to come it would presage a time to buy assets at value prices. Of course, that is assuming those assets that you got very cheap didn't then proceed to get much cheaper. Nouriel replied exactly as I would have (and have in the past, particularly during my Keynote at the ING Valuation Conference in Amsterdam), and that was that it simply cannot taken as a given that assets prices will cyclically snap back in a year or even two. Now, I do have an investment strategy that I plan to pursue in regards to real estate, but it is quite different from what I see being bandied about today and over the last 8 years or so. To wit (as excerpted from the link directly above):

... It is the reporting company’s responsibility to report, not to obfuscate. The big problem with this “hide the market marks” thing is that markets tend to revert to mean. Unless said market values fundamentally catch up with said market prices, you will get a snapback. That is what is happening in residential real estate now. That is what happened in Japan over the last 21 years!!! That’s right, it wasn’t a lost decade in Japan, it was a lost 2.1 decades!

This has been the first balance sheet recession that the US has ever had, but there is precedence to follow. Japan had a balance sheet recession following their gigantic real asset bust. They made a slew of fiscal and policy errors, which essentially prolonged their real asset recession (now officially a depression) for T-W-E-N-T-Y  O-N-E long years! For those that may have  a problem reading that, it is 21 long years.What did the Japanese do wrong?

• They refused to mark assets to market
• They attempted to prop up zombie banks
• They failed to promptly clean up NPAs in the banking system
  • They looked the other way in regards to real estate value shenanigans

 

JohnMack_copyOn February 10, 2008, I created an extensive blog post, explicitly labeling Morgan Stanley as "The Riskiest Bank on the Street!" To my knowledge, I was the only one to make such a blatant accusation. Of course, months later Morgan Stanley and all of its brethren started collapsing. Many attributed this to the overall market malaise, I didn't.

In September of 2008, 7 months after the first bearish report, I penned "As I said, the Riskiest Bank on the Street", which essentially compared my opinion, analysis and most importantly accuracy, to that of the Street's sell side, as excerpted...

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Key highlights of my archived research from 2008 (before the crash) on the "Riskiest Investment Bank on the Street":

The Riskiest Bank on Wall Street – Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its equity, which is the highest amongst its peers. Although the Level 3 assets have declined from the previous quarters owing to huge writedowns, the reclassification of assets from from Level 2 to level 3 category continues as the liquidity for the troubled mortgage paper drys up.

Declining ABX index indicates troubled times are not over yet – Morgan Stanley used the performance of the ABX index as one of the benchmarks to writedown US$9.4 billion in 4Q 07. As this index continiues to witness downward trend, we believe that the asset writedown done so far, may not be sufficient.

Forensic Accounting of ABS Assets yields more woes - a security by security accounting of MSs ABS inventory shows at least 30% and probably 56% in additional losses coming down the pike, as well as tests to its excessive exposure to the anemic capital reserves of its counterparties, namely monoline insurers and hedge funds.

Losses from unconsolidated VIEs of $38 billion can wipe out almost half of the company’s total equity –Morgan Stanley has $20 billion of its unconsolidated VIEs assets in credit & real estate portfolio where the company expects a maximum loss ratio of 65%. Considering the worsening real estate markets, we believe that the company will incur huge losses on this portfolio. In addition, the company has $7 billion towards MBS & ABS portfolio and $10 billion of strucutured finance products.

Exposure toward Bond Insurers/private funds raises counterparty risk – The failure of bond insurers, on whose shoulders lie the rating of $2.4 trillion of bonds, raises a serious doubt about a systemic failure in the U.S. financial services industry. Morgan Stanley’s exposure of $3.6 billion toward the bond insurers may result in unforeseen losses for the company. The company has a counterparty credit risk exposure of $13.9 billion toward parties rated BBB and lower.

The riskiest bank on Wall Street – High exposure to Level 3 assets despite significant write-downs

Need to raise additional capital if current crisis worsens – Morgan Stanley raised $5 billion from China Investment Corp to maintain its capital ratios as it reported huge losses in 4Q 07. Going forward, as the credit market environment, the housing and real estate markets continues to crack, the company will likely report huge and may have to raise additional capital.

Worsening macro and market conditions to restrict revenue growth – Financial services industry witnessing its toughest times in recent history faces a tough task of getting things back to normal. The deteriorating macro environment coupled with flagging confidence among investors/customers alike, things are more likely to get worse than better. Furthermore, the decline in structured product revenues, risk averse nature owing to recent turmoil and the less active M&A environment will exert pressure on the company’s revenue growth in the coming quarters.

We value Morgan Stanley at US$20.76 per share, 58% lower than the current market price – We have analyzed Morgan Stanley exposure toward the Level 3 assets and its exposure to unconsolidated VIEs. To value Morgan Stanley, we have used the Discounted Cash Flow (DCF), Price-to- adjusted book (P/BV) and Price-to-Earnings (P/E) multiple methods. Based on our weighted average valuation, we arrive at a fair value of $20.76 which represents a downside of 57% from current levels of $48.25.

Click the read more link below to continue reading or download the richly formatted pdf version:

 Morgan Stanley (287.96 kB 2008-02-11 12:49:56)

bank-run-1931The bank run in Europe appears to be underway again, exactly as I have anticipated. Remember, historically, bank runs were mainly instituted by retail investors pulling deposits. Modern day institutions and mechanisms have successfully been implemented to mitigate and stem the tide of such occurrences to an extent that many potentially devastating bank runs have been avoided. The caveat is, a new instigator of the bank run has emerged. Make no mistake about it, the institutional counterparty is the new purveyor of the modern day bank run. For those who have not been following my European bank run rants, see my many warnings to date regarding the highly contagious European bank run below. For those who have been following, skip past the link list to the news excerpts directly below to see what is going on today and coincidentally what we have been working on for the last week - which is just starting to come out into the mainstream media and the sell side analysts water cooler chatter...

It all started as:

• a keynote speech in Amsterdam,

• then a research note to subscribers, The Inevitability of Another Bank Crisis,
• followed by blog posts on the same, see Is Another Banking Crisis Inevitable?
• then a full fledged, step by step tutorial on exactly how it will happen....
• The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
• What Happens When That Juggler Gets Clumsy?
• Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
• The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
• The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
• Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run 
• France, As Most Susceptble To Contagion, Will See Its Banks Suffer
• Observations Of French Markets From A Trader's Perspective
• On Your Mark, Get Set, (Bank) Run! The D…
• ECB As European Lender Of Last Resort = Institutional Purveryor Of A Pan-European Ponzi Scheme

First CNBC reports US Markets Indicating Sharp Selloff at Open on European Bank Concerns, This is shortly after reporting, by way of the Wall Street Journal reports: European Central Bank Dollar Loan Signals Euro Stress

The European Central Bank has lent dollars to a eurozone bank for the first time since February in the latest sign of escalating tensions in the region’s financial system.

A single bidder borrowed $500 million for a week, the ECB disclosed on Wednesday, after taking advantage of a facility that has largely lain dormant over the past year.

No details were given but the news suggested that at least one bank was having difficulties obtaining the dollar funds it required.

On its own, the use of the facility did not point to dramatic stress levels in funding markets, analysts said.

But it added to other evidence that European banks were struggling to access some forms of financing for the first time in a couple of years.

The so-called Euribor-OIS swap, a gauge of fear in the banking sector, is at its highest since 2009, while short-term euro basis swaps, which show a strong premium for buying dollars over the single currency, are at the most negative since the collapse of Lehman Brothers.

Meanwhile, the ECB continues to see high levels of funds being parked overnight in its “deposit facility”, rather than being lent to other banks.

...

“All the indicators are pointing in the same way: banks are becoming more keen to use official sources of liquidity than one month ago. Is it the crisis levels of 2008? No,” said Laurence Mutkin, rates strategist at Morgan Stanley.

Nick Matthews, European economist at Royal Bank of Scotland, said: “It is probably symptomatic of the kind of stresses and strains there are in the system.”

Acting with the US Federal Reserve, the ECB first offered US dollars to euro zone banks at the end of 2007. The program was reactivated after the collapse of Lehman Brothers in late-2008 – and again in May last year, when the euro zone debt crisis was at its most intense.

Any casual reader of BoomBustBlog has been thoroughly forewarned, and all BoomBustBlog subscribers should have their positions firmly in place, ready to monetize this situation after buying volatility on the cheap and short positions at favorable levels - reference the following documents, all produced while volatility was cheap and the subject banks were trading much higher:

1. SPY option strategies in violent down moves
2. This is the introductory post to a series of trade setups for European Bank at Risk
3. and The Inevitability of Another Bank Crisis!

The Federal Reserve Bank of New York is intensifying its scrutiny of the U.S. units of Europe's biggest banks amid concerns that Europe's debt crisis could spill into the U.S. banking system, the Wall Street Journal reported citing sources familiar with the matter.

This is quite interesting and timely, for several weeks ago we started our own forensic investigation and many would be surprised at what we have found. All BoomBustBlog subscribers are strongly urged to download today's latest actionable note regarding the big American bank (see Actionable Note on US Bank/ French Bank Run Contagion) closely related to the big bank identified in The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely, as excerpted:

Over the next few days I will offer advanced trading techniques to allow BoomBustBlog subscribers to monetize their view via the market, despite the attempts by those who do not see to manipulate free markets. In the mean time I will excerpt portions of the Pro/Institutional report on the French bank most at risk for a run, available for download right now - Bank Run Liquidity Candidate Forensic Opinion.

Here are a few screen shots from the free public abridged version ( French Bank Run Forensic Thoughts - pubic preview for Blog), that easily demonstrates the problem with the French banks cannot be solved by banning short selling. The problem is inherent in the banks themselves. Please click to enlarge to printer quality...

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Tuesday trading update from Eurocalypse...

The SP500 daily chart has the same pattern than CAC.a squeeze could lead us to 1240 but I don't see it really pushing any further out and I see the market being more heavy than Europe because we didn't sell off as hard.

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Contrary to the CAC points (see Eurocalypse Trading Update 8/16/2011 - French Markets and The Inevitable Pan-European Real Estate Collapse), we didnt visit 2010 lows which are my target, so lets not talk about July 2009 lows just yet. The option set up and trading illustration given to subscribers last week still stands as the preferred method for those who trade optionable ETFs to best position themselves. All paying subscribers should download SPY option strategies in violent down moves for retail investors. We will review larger contract futures strategies for professional and institutional investors in the near future.

Fixed Income

While we believed that it's both rational and worthwhile to play the long US notes, Bunds (or Swap rates) as a positive carry trade to leverage the continuing debacle of western economies, these are profit taking levels for those momentum players and flight to quality traders, and perhaps even levels to cautiously try the short side. No, the strategy is not driven by the explosion of the ponzi that US debt or german debt, but simply an over extension of a trend. UST notes monthly charts shows we are in resistance zone.

On bunds, the German debt, there is still this joker that it is suddenly rerated as bad as PIIGS if Merkel gives in to support Italy and Spain (which she has shown she is thus far refusing to do in by refusing Eurobonds)...The short term mo-mo players are not looking at things this way. There is also this matter of the CRE rollovers that will either smash French and German banks, tank pan-European real estate, or the most likely option - both.

Things to watch

I think the stock market can tank in the short term only if the PIIGS crisis resumes abruptly. Is it possible ? Well of course, it is, but I think we'd see serious signs in the debt markets before the stock market reacts, as usual. I read that 22bn of PIIGS debt were bought last week, the fastest pace ever,
and a very significant amount. All the guys who sold, probably bought Bunds instead (they are bond funds, ALMs so if they sell an investment, they should
buy something else with the proceeds...). If ECB activity subsides, Bunds naturally lose some of their bid. and then the bid on PIIGS will be tested as Bunds' yield rise from here. Then the market could well call the ECB bluff and see how big their virtuo-synthetic inkjet powered pockets really are (from a political point of view, of course - they can literally print forever up until inflation scares them back - reference The Bull Argument For Europe Is Credible, Except For The Circular Argument: You Can't Solve Debt Problems With More Debt!!!). If these balls are not as deep as their virtual pockets, then....

Reggie's note:

Of interest, if we're correct in our fixed income outlook, that Pan-European CRE crash may well have ample company stateside. See my rant on over optimism in this space on CNBC: Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate.

As excerpted:

Listen up people, HERE ARE THE NASTY FACTS!!!

Real estate is a highly rate sensitive asset class. Capitalization rates (the popular method of pricing real estate) is explained in Wikipedia as:

Capitalization rate (or "cap rate") is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value.^[1] The rate is calculated in a simple fashion as follows:

Without going into a CRE class, when interest rates go up, cap rates generally go up as well and the value (or cost to purchase) of the property goes down in sympathy unless the rise in interest rates is offset by a commensurate or greater rise in net operating income. Now, either everybody believes that unemployment is going to drop towards zero  in an era of US austerity (reference Are the Effects of Unemployment About To Shoot Through the Roof? then see Budget Austerity: Goldman Sees Danger in US Budget Cuts - CNBC) at the same time that historically low interest rates that actually went negative are going to get lower (see the Pan-European Sovereign Debt Crisis) ---- or cap rates are about to skyrocket. I'll let you decide!

As you can see above, CRE drops in value whenever yields spike more than the + delta in NOI. Looking below, you can see that US CRE actually runs to the inverse of the 30 year Treasury.

That visual relationship is corroborated by running the statistical correlations...

The relationship is obvious and evident! In addition, we have been in a Goldilocks fantasy land for both interest rates and CRE for about 30 years. CRE culminated in the 2007 bubble pop, but was reblown by .gov policies and machinations. The same with rates. Ever hear of NEGATIVE interest rates where YOU have to PAY someone to LEND THEM MONEY!!!

So, BoomBustBloggers, where do YOU think rates are going to go from here? Up of Down??? Let's ask Portugal or any of the other PIIGS group. I have shown, very meticulously, how Portugal can not only afford the path that they are on (record high interest rates) but the losses that will come when they restructure (default) - for all to see. I have done the same with Spain, Ireland and Greece (for subscribers only). See The Truth Behind Portugal’s Inevitable Default – Arithmetic Evidence Available Only Through BoomBustBlog followed by The Anatomy of a Portugal Default: A Graphical Step by Step Guide to the Beginning of the Largest String of Sovereign Defaults in Recent History (December 6th & 7th, 2010). Be sure to carefully and very thoroughly peruse the spreadsheet below to see the many scenarios present that show the NPV of investor losses due to haircuts and restructurings...

I have went through what is inevitable in the US from a fundamental perspective right here in New Amsterdam, just a tad bit before I brought the message across the pond to old Amsterdam.

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Remember, unlike many, I have asserted since 2007: It's a Real Estate Depression!!!

Morning trading update from Eurocalypse...

It has been a hectic time laced with a very violent market. It’s been easy to get burnt both by being bullish or bearish. A very unusual situation wherein unless armed with superior research, deft trading skills, innovative strategies and a lot of luck, your basically damned if you do and damned if you don’t. This is why option strategies are so comfortable. You have a natural stop.  The recent BoomBustBlog subscriber content had some predefined targets and the good thingis to stick to them, even when the market is overshooting the target.Regarding the broad equity indexes, the call was to target the 2010 lows…

For the CAC40, it was around 3250-3300. Well, we’ve been quite wrong because we went more than 10% down from that going thru 3000 at one stage. But I wrote as well, that any significant move under that, would be an overshoot, and by taking profits at our target, we'd be the few ones able to take a short term bet on a squeeze. We are now sitting at 3240. Where from here? Well the market bounced where it should after surpassing the 3300. 3000 was the end of June/beginning of July 2009 lows. Given the speed of the move, and that nothing has changed (were all f*cked, but anyone reading BBB or ZH knew that before the move....), I dont see any fresh reasons, apart from momentum (which is enough in itself) to go much lower. The meaning of that, is that although we are in a bear market, selling without trying to time the market now, can be very painful given how far we are from the break and how the short term bottom COULD look after a bounce like a real bottom and prompt everyone for cover...

Click to enlarge...

20110816_-_CAC_Daily

I see no fundamental reason for a big bounce now, but in this volatile market, even an ephemeral 3450 doesnt seem impossible eventhough we already had a good
bounce. There seems to be a divergence on the daily chart ( on stochastics, MACD, RSI) and the short term pain trade could be higher prices. The ADX is very strong, and indicates as well the possibility of a further technical correction to the move. With implied vol high, fresh buying of options will probably not make money. I advise to keep some remaining gamma options and play with the delta hedge and try to take advantage of high vol and skew to position for FLY or broken flies bearish trades. I even advised buying some OTM vega calls at the lows, because they were too cheap even I had no conviction on a real bounce. Well theyve been repriced nicely thanks to the skew effect + the rally from the lows! Anyone who followed that advice should take profits cause im not sure vol will be bid and market upside is limited from here. Tech levels: if for a ST trade, be neutral at this level (3250) and opportunistic. A move towards 3450 should be faded.

20110816_-_CAC_Weekly

On the downside, last week lows COULD hold, even if it looks ugly when we revisit them... or could very well crash... but I wouldnt give more than 50% to that, so the right thing to do is trying to play the long side below 3000 with call or call spreads to limit the downsidethus for short term trading, I advise playing a volatile new range, 3000-3450, selling implied vols, selling the skew, and waiting a bit before setting up earnestly for the probable next move. Keep your mind open, as usual.

Reggie's Comments:

CNBC reports France, Germany Ruling Out Euro Bonds to Fix Debt Crisis and the S&P 500 resumes is slow downward descent. This is simply momentum trader reaction to what is essentially a foregone conclusion. Anyone who truly condones Eurobonds is essentially asking the more responsible states to willingly accept the risks and costs of funding what could potentially become a black hole with very limited upside in return. As I said in my interview with Property EU, the EU suffers from too many chiefs and not enough Indians! In order to justify a unified, common funding vehicle (or common currency for that matter, here's to you Euro) you will need a unified common, budgetary mechanism, common financial authority, and common government. Unitl then, you will simply have too many bosses telling to few capital Euros what to do. For those who are wondering why I included the article below, stay tuned to the subscription documents coming out over the next two weeks. A stagflationary environment, excess supply and a broken bankings system that not only won't lend but has signficant CRE debt rollovers coming up - and concentrated primarily in the banks of two nations (I'll let you guess who, one of whichi will be the subject of a bank run in 3...2...1...) all add up to a virtual Pan-European real estate collapse.

The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely

Reggie Middleton Featured in Property EU, one of Europes leading real estate publicatios

Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.

The related European commercial real estate video...

BoomBustBlogger "Rogier" posted an interesting counterpoing to my French Bank run thesis. For those who haven't been following, reference SocGen CEO Dismisses Rumors, Says France Is Not US - He's Right, But It May Be Worse And Bank Run Can't Be Ruled Out!!!. Rogier's counterpoing is the Citigroup analysts William Buiter's report on the ECB being capable to bail out all of the indebted Europe, as well as all of indebted Europe's banks as well - simultaneously, by printing money but not prinitng so much as to stoke inflation. Yes, that does sound rather extravagant. As a matter of fact, I was feeling his story a little more until I actually typed that statement down and realized how far fetched difficult it may be. 

One of the failing precepts in the article has been the mindset that is burying the profligate states as we speak, and that is the circular argument. Reference my discussion of this phenomenon as it refers to Greece: Greece Reports: "Circular Reasoning Works Because Circular Reasoning Works" - Or - Here Comes That Default!!!

The gist of the story is that Greece will solve its over-indebtedness issues by acquiring addtionals debt. Hey, we just traveled full circle!

Greece will implement austerity measures that will slow growth and implemenation, thus cut government costs while the country grows the economy out of the hole. But wait a minute here! How do you grow your economy out of a situation by slowing economic growth through austerity. Did we just spin around in a circle again? Below is an excerpt of the Citigroup report that drives the circular reasoning concept home... 

a_circular_argument_more_debt_to_relieve_debt

You see, the problem with the French argument is that the sovereign debt crisis, (which I feelI have credbily predicted and called accurately from the beginning. Reference the Pan-European Sovereign Debt Crisis series, starting with The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one. The primariy problems emanated from oversized banks (Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe) who got into trouble taking undue risks.

Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns

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This is just a sampling of individual banks whose assets dwarf the GDP of the nations in which they're domiciled. To make matters even worse, leverage is rampant in Europe, even after the debacle which we are trying to get through has shown the risks of such an approach. A sudden deleveraging can wreak havoc upon these economies. Keep in mind that on an aggregate basis, these banks are even more of a force to be reckoned with. I have identified Greek banks with adjusted leverage of nearly 90x whose assets are nearly 30% of the Greek GDP, and that is without factoring the inevitable run on the bank that they are probably experiencing. Throw in the hidden NPAs that I cannot discern from my desk in NY, and you have a bank that has problems, levered into a country that has even more problems.

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In the beginning, it was thought that these problems were that of the peripheral EU and CEE states only, but that was (and is) definitely not the case. You see, this is as much a case of humarn behavior as it is macro-economics. If one understands that concentp, the spread was easy to see coming from early last year, reference The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries. The consequent post, also explains what many seem to be overlooking, Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter? 

Now, as a result of sovereing states privatizing profits and socializing losses, they attempt to take multiples of thier GDP on the public balance sheets in terms of economic risks. Yes, it does sound both absurd and unsustainable, and accuracy is endemic on both counts. This particularly so when the health of the sovereign states themselves is callled into question due to the foibles of human nature in terms of honesty - referencing Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!

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The attempt to save insolvent banks that are multiples of the size of the soverign states that try to save them is a recipe for disaster that simply creates insolvencies on both sides of the public/private economic membrane, versus just the side that it originated in. Greece is proof-positive of said posit: How Greece Killed Its Own Banks!  Greece forced its banks to buy Greek debt to stoke the perception of demand. Said debt collapsed in value, and voila!

The natural result of several nation-states attempting the same failed strategy, Contagion - Introducing The BoomBustBlog Sovereign Contagion Model. Contagion is exponential in nature, yet I feel many analysts are still thinking linear. Again, Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?

This point of view started as:

• a keynote speech in Amsterdam,

• then a research note to subscribers,  The Inevitability of Another Bank Crisis,
• followed by blog posts on the same, see Is Another Banking Crisis Inevitable?
• then a full fledged, step by step tutorial on exactly how it will happen....
• The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
• What Happens When That Juggler Gets Clumsy?
• Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
• The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
• The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
• Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run 
• France, As Most Susceptble To Contagion, Will See Its Banks Suffer
• Observations Of French Markets From A Trader's Perspective
• On Your Mark, Get Set, (Bank) Run! The D…
• ECB As European Lender Of Last Resort = Institutional Purveryor Of A Pan-European Ponzi Scheme

CNBC reports Google to Acquire Motorola Mobility for $40 a Share in Cash. This gives Google the hardware chops to release reference quality mobile computing devices without the need for:

1. Carrier subsidies
2. carrier bloatware
3. vendor bloatware
4. slack in technology refreshes, which will lead to..
5. extremely rapid tecnology refresh cycles which have averaged nearly quarter for Google's Andorid OS.

The professional level subscription document detailing the likely causes of a run on our primary bank run candidate is now available for download (Bank Run Liquidity Candidate Forensic Opinion, the retail version containing valuation available here - French Bank Run Forensic Thoughts - Retail Valuation Note). It is presented at a timely fashion for much of the core EU has just implemented short bans on financial companies - exactly as I anticipated several days ago. If history repeats itself (and it usually does), this action will serve as a precursor to the bank run that I have anticipated and warned about over the last few weeks. For those who don't subscribe to the professional BoomBustBlog analysis, yet want an inkling of what is going on in French banking, I have redacted the aforelinked document as a free public preview: French Bank Run Forensic Thoughts - pubic preview for Blog

You know, if it wasn't so damn destructive, it would actually be funny how regulators appear to find it genetically impossible to learn from mistakes - whether it be theirs or somebody elses. In 2008, when the US foolhardedly decided to allow banks to misreport their long term toxic assets bought with excessive, short term leverage, said banks collapsed. It was not as if this was unforeseen. France is anxious to repeat that exercise with its banks and sovereign debt. In 2008, when the US foolhardedly decided to ban shorts on insolvent financial companies, I made a small fortune constructing synthetic short positions with options that skyrocketed in value because regulators dabbled in markets in which they really had no clue. ZeroHedge reminds us that the short ban in the US ended in a 48% drop in financial company share prices.

It should be obvious to anyone who can remember at least 3 years ago that short bans are not good ideas. They spread more panic and uncertainty than they cure - and the banks' business models are based upon faith and full credit. It appears that the French think they can make ths mistake better than the Americans, as CNBC reports SocGen CEO Dismisses Rumors, Says France Is Not US. Of course not, they just act that way when there is an opportunity to efficiently repeat a boneheaded error. Exactly as I warned just TWO days ago in the post "Time To Load Up On Bank Puts? The Futile Attempt To Make The Insolvent Appear Solvent By Interefering With Market Pricing - Short Ban Has Started", I now bring you this afternoon's news - France, Italy, Belgium and Spain Ban Short Sales

Over the next few days I will offer advanced trading techniques to allow BoomBustBlog subscribers to monetize their view via the market, despite the attempts by those who do not see to manipulate free markets. In the mean time I will excerpt portions of the Pro/Institutional report on the French bank most at risk for a run, available for download right now - Bank Run Liquidity Candidate Forensic Opinion.

 Here are a few screen shots from the free public abridged version ( French Bank Run Forensic Thoughts - pubic preview for Blog), that easily demonstrates the problem with the French banks cannot be solved by banning short selling. The problem is inherent in the banks themselves. Please click to enlarge to printer quality...

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