Guest Post: An (important) point regarding the Eurocalypse...
When last week's Italian 10Y surged from 5% to 6%, it marked something irreparable, which was not indicated in the extent of the move, but its violence.
Six percent, as we know, is unsustainable for Italy (more than its GDP nominal growth which is closer to 2-3% today, and getting worse...)
Whats even more important is that VAR has gone crazy everywhere. Not only banks, even insurers and money managers take volatility of an asset as an input. When you lose 7% in capital in one week, which is 7x the 100bp spread you hoped to make in 1 year, something is very wrong. Even stock market indices failed to sell off as much in a week (and rarely do so)...
Thusly, nobody in their right mind is going to buy Italy (or Spain). The only natural buyers now stem from:
- short covering (profit taking) activity,
- passive buying from Italian accounts for ALM purposes (they must be "invited" to do so)
- and public buying trying to prop up the market, but their pockets aren't deep enough.
As a result, we may have the very few next auctions doing ok (especially if yields go up and short covering continues), but then its chaos Portugal-style.. it could take only a few weeks (or even days!) from here.
The only way I envision it not happening is Euro-bonds gaining traction and actually being implemented (but that doesnt seem likely if you believe the press reports) or financial repression.
By financial repression, I mean taking out short sellers,,,, seriously! Not only banking stocks (like was done in 2008:
SEC Extends Ban On Shorting Of Financial Stocks - Forbes.com Oct 1, 2008 – Restrictions will expire Oct. 17, about the time a slew of bank earnings are set to be released.
SEC Halts Short Selling of Financial Stocks to Protect Investors Sep 19, 2008 – SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets. Commission Also Takes Steps to Increase Market Transparency ...
S.E.C. Temporarily Blocks Short Sales of Financial Stocks ... Sep 19, 2008 – The Securities and Exchange Commission issued a temporary ban on short ... Short selling — a bet that a stock price will decline — is the ..
but on govt debt as well, making void all CDS contracts on sovereigns (or saying they will expire or cash settle at a very soon date) and trying to shut out HFs by increasing regulation, disclosure and taxation on them.
Excess volatility is not good for the markets, and it would surely cause huge short covering, but it could buy some time, and if the move is surprisingly large (bringing us to 4% range...!!!) then maybe it's not just buying time, and we are underestimating the extent of the short sellers which currently have the market in hand (and we know all the "good" reasons why).
Reggie here: Of course, the people who conceive of, and implement these grand schemes tend to be quite shortsighted. This was exemplified by:
- the inability of exchange traded option market makers to hedge their positions, thus instantaneously draining liquidity out of those markets
- the removal of natural buyers in a market crash (short seller covering) causing a floorless plunge
- the extreme jump in option, swap and other synthetic short and bearish trade instruments
- and the most obvious issue - most of the companies covered in the ban deserved to be shorted and once the ban was lifted the party was on, its just that the music was blasted all the much louder!
Now, back to our regularly scheduled, guest writer programming...
Higher taxation is quite evident down the road. After all, there have been many tax cuts here and there to support the FIRE industry; including banks, HFs.... that didn't help the deficits, so the logical thing would be to reverse this, but with QE1,2... govts are doing exactly the contrary, handing more and more money disappearing into corporate bonus pools!!
Reggie Here: I clearly delineated a very practical, market-based solution to this dilemma for the Financial Times about a year and a half ago. See The Financial Times' Banker on Bonuses
The problem is undoing quickly what has been done in 20+ years/ It will not be easy and will not be without unintended consequences. In a paper money system where debt = money, it is no wonder banks are holding tons of sovereign debt, it is not bad bank management, it is almost a FEATURE or RULE of the system.
You cant blame only the bankers or the politicians, or the HFs (SPVs) who bought these debts, everybody is involved. SOMEBODY had to buy it, and it could only be the banks, as long as these were the riskless assets you could refinance at the CB in indefinite amount. States issued more because there was demand (as artificially contrived as said demand was, it was demand nonetheless)... The average person, getting benefits from the state and reelecting all our govts in the last 20 years is responsible as well.
Anyway, were all fucked, but now its almost the common view.
The focus is how to try to cope with this in the short and long term, and prepare for the (hopefully good) things which are beyond.