Summary from Barclays Capital inst sales:

1) At this point, it seems Italy is now mathematically beyond point of no return
2) While reforms are necessary, in and of itself not be enough to prevent crisis
3) Reason? Simple math--growth and austerity not enough to offset cost of debt
4) On our ests, yields above 5.5% is inflection point where game is over
5) The danger:high rates reinforce stability concerns, leading to higher rates
6) and deeper conviction of a self sustaining credit event and eventual default
7) We think decisions at eurozone summit is step forward but EFSF not adequate
8) Time has run out--policy reforms not sufficient to break neg mkt dynamics
9) Investors do not have the patience to wait for austerity, growth to work
10) And rate of change in negatives not enuff to offset slow drip of positives
11) Conclusion: We think ECB needs to step up to the plate, print and buy bonds
12) At the moment ECB remains unwilling to be lender last resort on scale needed
13) But frankly will have hand forced by market given massive systemic risk

All seem to be missing the point! I have been warning since early 2010 Pan-European sovereign debt crisis! I warned of BNP in June, with very accurate reseach reports and models available to subscribers - BNP, the Fastest Running Bank In Europe? Banque BNP Exécuter. Despite all this, I fear the greater picture is being missed by most.

At the risk of sounding overbearing, Italy heard the fat lady acapella last year, it's just that no one was listening. BoomBustBlog Subscribers should reference  Italy public finances projection from March of 2010. The killer is that France is inexoriably leveraged into Italy through its banks. If Italy defaults (and it will) it literally breaks the French banking system. All BoomBustBlog followers have read this - Wednesday, 03 August 2011 - France, As Most Susceptble To Contagion, Will See Its Banks Suffer

Now when (and not if, but when) French banks fail, France will both get downgraded and be forced to bail out - once again. They will have to choose between bailing out Greece, Portugal and Ireland - or themselves. I'll leave it up to you which is the most probable path.

Once the inevitable happens, then the Faux Caucus-Franco bailout mechanism that was suppose to support the unsupportable collapses in throught as it had already collapsed in reality. The result? Everybody should then realize that those risk free Bunds are risky as hell because they are backed by a net export nation (Germany) that will have nobody to export to, and spend much of its economic output bailing out the unbailable, or running from said entities.

Things are much, much worse than many are making it out to be.

Saturday, 23 July 2011 The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!: I detail how I see modern bank runs unfolding

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Thursday, 28 July 2011  The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement

I identify specific bank run candidates and offer illustrative trade setups to capture alpha from such an event. The options quoted were unfortunately unavailable to American investors, and enjoyed a literal explosion in gamma and implied volatility. Not to fear, fruits of those juicy premiums were able to be tasted elsewhere as plain vanilla shorts and even single stock futures threw off insane profits.

Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In case the hint was strong enough, I explicitly state that although the sell side and the media are looking at Greece sparking Italy, it is France and french banks in particular that risk bringing the Franco-Italia make-believe capitalism session, aka the French leveraged Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

Published in BoomBustBlog

I am working on an interesting project closely connected to the issue that European (and now American) banks are facing. The firs of several reports should be available to paid subscribers in about a week. In the meantime, let's make a few observations that may or may not have been lost on market participants.

Paid subscribers should reference the quarterly results of the bank that was illustrated in our most recent forensic report - Haircuts, Derivative Risks and Valuation. Yes, BoomBustBlog has hit the skin off the ball once again. I will be available in the private forums to discuss this, as well as provide links for those who have not seen the news yet.

Summary: For years I have warned of the impending European collapse. Now, as it is happening, we still have banks getting away with nonsensical 60% writedowns on essentially worthless debt. Loss Given Default > 100+% - You ain't seen the worst of it, not by a long shot!

From the BNP Paribas earnings press release:

Rather than implementing the agreement reached on 21 July, EU authorities formulated a new Greek assistance package on 27 October. As a result of this plan, whose implementation is still shrouded by uncertainty, BNP Paribas set aside a provision for 60% of the full amount of all Greek sovereign debt it holds, which equates to further provision of 2,094 million euros for the banking book and of 47 million euros for the insurance portfolio. Furthermore, the effect of the additional impairment of Greek bonds on associated companies was negative to the tune of 116 million euros.

The Group's revenues, which totalled 10,032 million euros, were down 7.6% compared to the third quarter 2010. They grew in Retail Banking (+2.2% at constant scope and exchange rates with 100% of the domestic networks' private banking businesses, excluding PEL/CEL effects), and Investment Solutions (+2.5%) but fell 39.8% at Corporate and Investment Banking due to very challenging market conditions and losses on sales of sovereign bond debt (-362 million euros). Corporate Centre revenues were affected by two exceptional items related to the valuing of long-term assets and liabilities at market price (+786 million euros in own debt revaluation and -299 million euros in additional impairment on the equity investment in AXA).

This seems to be glossed over, but the equity impairments and revaluation of liabilities are a big deal, particularly in entities that are bond rich (well, now poor).

... With the additional provision set aside for Greek government bonds, the cost of risk was 3,010 million euros.

Excluding this effect, it continued its downward trend (-28.9%) in all the business units, coming in at 869 million euros, or 50 basis points of outstanding customer loans compared to 72 basis points in the third quarter 2010.

This is nonsense. They are speaking as if the devaluation is a one time event, when in reality it is the beginning of a long string of events. You lose credibility when you play your audience for fools...

The Group reported 541 million euros in net profits (attributable to equity holders) (-71.6% compared to the third quarter 2010). Excluding the Greek debt provision, net profits were 1,952 million euros, up 2.4% compared to the same period a year earlier.

For the first nine months of the year, the Group's revenues totalled 32,698 million euros, a limited decline compared to the first nine months of 2010 (-2.6%). Thanks to CIB's flexible costs, and despite the effect of the bank levies, operating expenses edged down 1.0% (-1.7% excluding the bank levies). Gross operating income was down 4.8% at 13,260 million euros and net income (attributable to equity holders) down 16.0% at 5,285 million euros. Excluding the impact of the provision set aside in connection with the Greek assistance programme, the cost of risk was down 28.5% during the period and net income (attributable to equity holders) totalled 7,034 million euros, up +11.8% compared to the first nine months of 2010.


Click to expand...

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But including losses on Spanish, Italian, Irish and Portuguese capital losses realized upon disposition, and the ongoing losses on Greek debt, what then????

You see, the truly under appreciate problem here is that the private banks rampant selling is driving down the prices of already highly distressed and rapidly devaluing bonds. Reference Bloomberg's European Banks Selling Sovereign Bond Holdings Threatens to Worsen Crisis.

In the news now, exactly as I anticipated European Stocks Drop as Italian Bond Yields Jump as well as:

No surprises here:Wednesday, 03 August 2011 - France, As Most Susceptble To Contagion, Will See Its Banks Suffer

These events are quite relevant for I warned several times over that the true risks are in Italy's funding fragility, its size, and its direct ties into France who, if caught the contagion, would invalidate any Pan-European rescue scheme. That is why "The French Banks Are The First To Accept a Voluntary Greek Restructuring". Well, here we are! Another point that is oft overlooked is that while all of the these private holders are dumping European bonds en mass, who is buying them. Well, I addressed this last year and early this year as well.. Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What! Keep in mind that Italy has already accepted IMF supervision over its finances, which means that it has in essence already given up its sovereign financial independence. We all know what the next step is, don't we? The IMF injects funds under strict austerity and calls the shots, just like it does with (other?) third world nations. There are ramifications here that are simply lost on most, but I will help most find it! Please continue reading...

The ECB as well as many local banks and pension schemes are being forced to buy these bonds to maintain a facade of a bid in a near bidless market (at least bidless from the perspective of avoiding total price collapse), but what does that portend for the entities doing the buying if the sellers are losing so much money and the yields are still flying through the roof? Well I addressed that in early 2010, reference  How Greece Killed Its Own Banks!.

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Yes, it's ugly, and it gets even uglier! Nouriel Roubini Tweets this morning "Italian yields at Ponzi levels: having to borrow more just to finance the interest on debt leading to vicious unsustainable debt dynamics." I respect this man's opinion, but he is just scraping the surface. Look back to last year when I really started bringing up the case of defaults, liquidations and recoveries in the iconic piece How the US Has Perfected the Use of Economic Imperialism. Warning, this is going to piss off many an oligarch! As excerpted...

How many of those Greek, Portuguese, Irish and Spanish bondholders have factored the near guaranteed "additional" haircut (/scalping) they will receive having to stand behind the IMF in the event of a (probably guaranteed) default or restructuring? Do you think the investors of European banks (that includes central banks) that are holding/and currently still buying a boat load of these bonds have factored this into their valuations?

The IMF, like many other international institutions, asserts that it has a "preferred creditor status", and this has been a practiced convention in the past. Thus, IMF has de facto seniority rights over private creditors despite the fact that there is no legal or treaty-based foundation to support this claim and this seniority of rights for IMF will continue under the recent EU rescue plan announced as well as it has not been noted otherwise implicitly nor explicitly. This is the reason why Sarkozy said it is a said day when the EU has to accept a bailout from the IMF (aka, the US). The EU now, and truly, contains a significant parcel of debtor nations.

To add fuel to this global macro tabloidal fire, the Euro members’ loan will be pari passu with existing sovereign debt i.e. it will not be considered senior. Although there is no written, hard evidence to support this claim, it is our view that otherwise there will be no incentive for investors to hold the debt of troubled countries like Greece, which will ultimately defeat the whole purpose of the rescue package. Moreover, there are indications that support this idea. As per Dutch Finance Minister Jan Kees de Jager, “We are not talking about a special preference for the eurogroup loans, that’s not possible because then you would have the situation that already-existing rights of creditors at the moment would be harmed.” (reference http://www.businessweek.com/news/2010-04-16/netherlands-excludes-senior-status-for-greek-aid-update1-.html). Of course, if more investors did their homework and ran the numbers, that same disincentive can be said to exist with the IMF's super senior preference given the event of a default and recoverable collateral after the IMF has fed at the trough.

The above-referenced article is a must read and an eye-opener to all of those who think that those 60% haircuts that BNP et. al. are taking are anything near sufficient. And on that note, what haircut is sufficient to mark Greek debt to market for these big banks and funds? Stay tuned boys and girls, I answered this question last year...

And in the End, What Does It All Mean?

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

Take note that this update will include several American banks and the risks they face from writing nearly all of the richly priced CDS purchased by said European banks. This is an interesting and complicated story because all of those IMF/EU bailouts, besides adding more debt to already debt laden countries, have considerably subordinated the claims of the stakeholders involved. The following was written over a year ago, and has proven to be quite prescient:

The year 2013, with a IMF-proclaimed debt ratio of a tad under 150%, is the time when Greece will have to refinance the debt to pay the IMF. However, since the current debt raised by Greece is at fairly high rates, new debt will only be available at much higher rates (as markets should price-in the risk of high debt rollover) unless there is some saving grace of a drastic plunge in world wide interest rates and a concomitant plunge in the risk profile of Greece. At a 150% debt ratio, historically low artificially suppressed global interest rates that have nowhere to go but higher and prospective junk ratings from the US rating agencies, we don’ t see this happening. Thus, the cost of borrowing for in 2013 is likely to be much higher in the market than the nearly five percent for the existing debt. Greece will either be unable to fund itself in the markets at all, and will have to convince the Euro Members and the IMF to extend the three-year lending facility just announced (reference What We Know About the Pan European Bailout Thus Far) or, it will get the debt refinanced at very high rates. In both cases the total debt as a percentage of GDP will continue to rise, and this is not a sustainable scenario over the longer-term. In addition, if it accept the EU/IMF package and there is an event of default or restructuring, the IMF will force a haircut upon the private and public debtors beyond what would have normally been the case. This essentially devalues the debt upon the involvement of the IMF, a scenario that we believe many sovereign bondholders (particularly Greek, Spanish and Irish) may not have taken into consideration. This also leaves the possibility of a significant need for many banks to revalue their sovereign debt – particularly Greek sovereign debt – holdings.

As illustrated above, there is a higher probability for a Greek sovereign debt restructuring in 2013, which will definitely not hurt IMF (since it has a preferred right) but the Euro Members and other investors who will be holding the Greek debt.

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LGD: Loss Given Default... ~100%???

We're talking damn near complete wipeouts boys and girls. There are practicaly no entities holding this debt at par that are leveraged under 30x. The starting point in case of default for Greece is between roughly 48% to 52% of par. You've seen the math on BoomBustBlog many a time - Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What!

I will have some more goodies along these lines that still HAVE NOT been broached by either the pop media or the sell side for BoomBustBlog subscribers very soon.

Tools for tracking the ever elusive path of contagion for BoomBustBlog subscribers:

 Additional posts on the topic of Bank Runs

  1. The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
  2. What Happens When That Juggler Gets Clumsy?
  3. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  4. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  5. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  6. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
  7. Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run
  8. Observations Of French Markets From A Trader's Perspective
  9. On Your Mark, Get Set, (Bank) Run! The D…

For those who are interested in getting the real nitty gritty, click here to subscribe.

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Published in BoomBustBlog

That guy(s) Tyler Durden over at ZeroHedge (obviously not speaking about yours truly) is pretty sharp. He busted Morgan Stanley with the old hide the sausage game. See Exposing The Latest Eurodebt Exposure Scam Courtesy Of Morgan Stanley: Gratuitous Level 1 To Level 2 Position Transfers:

For the latest gimmick to mask PIIGS sovereign debt exposure (where we already know that the traditional fallback of "gross being irrelevant and only net being important" crashed and burned today after Jefferies offloaded precisely half of its gross exposure, while raising net, thereby confirming that gross exposure is indeed a risk), we turn yet again to Morgan Stanley. As a reminder, despite our note that the company's gross exposure (which is now a major risk factor, thank you Rich Handler for proving our "bilateral netting is flawed" thesis) to French banks alone is $39 billion, Morgan Stanley downplayed this by saying that only $2.1 billion is the actual net funded exposure to Peripherals Eurozone countries. We'll see if Jack Gorman will have to revisit his defense after today's Jefferies action. Well as it turns out, we now have gimmick number two, one which will surely delight the bearish investors out there looking to find a bank doing all it can to mask not only its gross but net exposure (and wondering why it has to resort to such shenanigans). Presenting the Level 1 to Level 2 switcheroo, courtesy of, who else, Morgan Stanley.

From the just released 10-Q:

"Financial instruments owned—Other sovereign government obligations.    During the quarter ended September 30, 2011, the Company reclassified approximately $1.8 billion of other sovereign government obligations assets and approximately $2.1 billion of other sovereign government obligations liabilities from Level 1 to Level 2. These reclassifications primarily related to European peripheral government bonds as transactions in these securities did not occur with sufficient frequency and volume to constitute an active."

Uhm, are you serious? Transactions in all PIIGS securities were sufficiently active in both frequency and volume. We are delighted to present Morgan Stanley with a CUSIP list of all PIIGS bonds together with price and volume data if they so desire to confirm to them that their excuse is about to get tested substantially by the market as one not of prudent accounting (we jest: Level 2 assets are merely a legal way to get par marks for a security that is realistically trading at 35 cents on the dollar in the case of Greece and 87 in the case of Italy), but one of yet another attempt at blatant obfuscation.

I must admit, that this type investigative reporting takes very sharp minds, very witty reporting and a thirst for finding the truth. It probably can only be accomplished by tall handsome brothers with that sharp sense of humor... Know what I mean??? From the Bank Run Liquidity Candidate Forensic Opinion (A full forensic note for professional and institutional subscribers) released in August:

Click to enlarge...

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You see, this game is getting rampant, and it not just french banks and Morgan Stanley, is it Mr. Goldman of Sachs, aka the SQUIDDD!!!

Reggie_Middleton_hunting_the_Squid_Known_As_Goldman_Sachs_GS

Published in BoomBustBlog

As promised in the post from earlier today, I have updated numbers in the BoomBustBlog BNP Paribas "Run On The Bank" Model for professional/institutional subscribers, which can be downloaded here BNP Exposures update - Professional Subscriber Download Version.

Other subscription levels and even non-paying readers should reference The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download for other goodies available to inquiring minds.

Long story short, it doesn't look good.

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Professional/Institiutional subscribers who have downloaded the afore-linked model should realize that this bank's Greco exposure, if realistically marked, can (and most likely will) take a much larger chunk out of TEC. This doesn't even come close to recognizing the risks and writedowns from the other soveriegns. Be sure to take a look at the potential for cash defincies in the bank run scenario tab.

And from The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download:

A very, very well timed call indeed. Now, back to the Bloomberg article...

“It’s nice to see that the risk factors coming out of Europe are abating somewhat,” Michael Mullaney, who helps manage $9.5 billion at Fiduciary Trust in Boston, said in a telephone interview. “That addresses the liquidity issue that would be threatening the European banking system.”

... The cost of insuring European sovereign and corporate debt extended declines after the ECB announcement and as the prospect of default by Greece receded. The Markit iTraxx SovX Western Europe Index of swaps tied to 15 governments dropped 13 basis points to 330 as of 2:45 p.m. in London, the lowest since Sept. 9 and signaling an improvement in perceptions of credit quality. Swaps on France fell 10 basis points to 171, contracts on Italy dropped 29 basis points to 442 and Spain fell 22 basis points to 370, CMA prices show.

Cheap dollar funding is not going to help BNP anymore than it helped Lehman. I have prepared several models to illustrate such, and are designed to go hand in hand with both our illustrative trading supplements and our forensic research on BNP - namely:

The first model (all are cast in Excel 2010 format [.xlsx]), File Icon BNP Exposures - Free Public Download Version, is available to the public free of charge and is designed to spark the discussion of Whether Another Banking Crisis Is Inevitable? I will be discussing this model, and its ramifications on Max Keiser, Russian Television - to be televised Tuesday. It should be interesting. Here are some screen shots.

The Impairment Scenarios: a very important concept that practically the entire European banking systm has somehow forgotten to address.

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Trading and HTM inventory at Level 1,2,3 or fantastical fanstasy?

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For those not familiar with the banking book vs trading book markdown game, I urge you to review this keynote presentation given in Amsterdam which predicted this very scenario, and reference the blog post and research of the same - and then revisit this free model and reapply your assumptions:

The next nugget of knowledge is the File Icon BNP Exposures - Retail Subscriber Download Version. It enables users to simulate an anecdotal bank run - for retail subscribers only of course. In addition to those above, it sports...

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 For those professional investors and institutions, namely hedge funds, asset managers, regulators, high net worth individuals with ties to BNP and family offices, heres to you. This is not a toy, but a tool that can truly communicate why you feel BNP may, or may not be a candidate for a bank run - contingent upon your inputs: File Icon BNP Exposures - Professional Subscriber Download Version. Additional screenshots above and beyond that included above...

Income statement implications of a true bank run...

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Let's recap the BoomBustBlog perspective before I offer my opinion for the upcoming week...

Saturday, 23 July 2011 The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!: I detail how I see modern bank runs unfolding

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Thursday, 28 July 2011  The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement

I identify specific bank run candidates and offer illustrative trade setups to capture alpha from such an event. The options quoted were unfortunately unavailable to American investors, and enjoyed a literal explosion in gamma and implied volatility. Not to fear, fruits of those juicy premiums were able to be tasted elsewhere as plain vanilla shorts and even single stock futures threw off insane profits.

Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In case the hint was strong enough, I explicitly state that although the sell side and the media are looking at Greece sparking Italy, it is France and french banks in particular that risk bringing the Franco-Italia make-believe capitalism session, aka the French leveraged Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

Published in BoomBustBlog

Summary: Since the king of Wall Street traders (not:The Squid That Can't Trade) carries so much risk free (not:Good 'Ole Lehman Collapse Days!) sovereign debt heavily leveraged on their books, if it is proven that a Greek default is not truly a default, hence not a credit event, then isn't Goldman trading extreme risk naked and unhedged? Below, I delve deeply into this question, looking for an answer!

This morning I saw the following from Nouriel Roubini on my twitter feed -Roubini Global Economics Paper: Are CDS Worthless Because Greece's Exchange Won't Trigger a Credit Event? http://bit.ly/ttrgFS followed by this from Chris Whalen - @Nouriel Precisely. Fed, etc encourage CDS to generate income for TBTF banks, then the banks welch on the bets by "investors" Kleptocracy. As anyone who follows me knows, I'm in lock step with that particular opinion espoused by Chris. Still, the bigger and much more pertinent question looms... Aren't the big US investment banks carrying trillions of dollars of unhedged exposure? Quick answer: Hell Yeah!

Reality, Redux

First, a refesher on our European bank run theory expoused 5 months ago...

  1. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  2. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  3. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  4. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!

About a month ago, I posed the question When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't? Condensed, Cliff Notes edition, Goldman has the most shortable share price of all the big banks at around $100 and is quite liquid; it is more susceptible to mo-mo traders than it is to it's own book value, it is highly levered into the European debt/banking mess, and last but not least, Goldman is the derivatives risk concentration leader of the world - bar none! So, if anyone is in need of CDS as a good solid hedge, it should be Goldman, no?

Click any and all graphics in this post to expand to print quality

Reggie_Middleton_hunting_the_Squid_Known_As_Goldman_Sachs_GS

The need for strong hedges are quickly coming upon us, as well as for the Squid. While everyone focuses on Greece, Italy's rates are skyrocketing according to the FT: Greek woes send Italian yields to euro-era high

... Italian 10-year bond yields rose to 6.399 per cent, while the extra premium the country pays over Germany jumped to 459 basis points.

The growing worries over Greece could undermine key government bond auctions later on Thursday, with Spain due to sell a total of €4bn in 2-year and 4-year notes and France planning to raise €6bn-€7bn in 10-year and 15-year paper.

Italian yields and spreads over Germany are around levels at which the markets believe make the country’s debt payments unsustainable and could trigger extra margin payments for the use of Rome’s bonds as collateral.

Markets consider yields of 6.5 per cent unsustainable on 10-year debt, while spreads above 450 basis points over Bunds have in the past prompted clearing houses to charge extra margin payments for Ireland and Portugal. LCH.Clearnet, for example, considers 450bp over a basket of triple A countries a point at which extra fees may have to be charged.

In a further worrying sign, French borrowing costs rose, lifting the premium it pays over Germany to a fresh euro-era record of 135bp. Investors are increasingly worried that France could lose its triple A rating, which in turn would threaten the status of the European financial stability facility, the eurozone’s rescue fund.

... Italian bonds have also been hit by the plan to use the EFSF to cover first losses of new Italian debt which, some investors say, means that there is little point in buying the country’s bonds ahead of such a scheme being implemented.

The fact that the EFSF was forced to delay its own bond issue on Wednesday has also hurt sentiment, as it calls into question not only its ability to fund Ireland and Portugal but also its value as a guarantor.

“The abject failure of the new EFSF deal also confirms the European nightmare is deepening, and should be a wake-up call to Europe’s elites that their current efforts are going in the wrong direction and failing. Failing dismally.”

Remember, these bonds are sitting on Goldman's books as "Risk Free Assets", leveraged to the hilt!

One more time, for the effect...

Italian yields and spreads over Germany are around levels at which the markets believe make the country’s debt payments unsustainable and could trigger extra margin payments for the use of Rome’s bonds as collateral.

Markets consider yields of 6.5 per cent unsustainable on 10-year debt, while spreads above 450 basis points over Bunds have in the past prompted clearing houses to charge extra margin payments for Ireland and Portugal. LCH.Clearnet, for example, considers 450bp over a basket of triple A countries a point at which extra fees may have to be charged.

In a further worrying sign, French borrowing costs rose, lifting the premium it pays over Germany to a fresh euro-era record of 135bp. Investors are increasingly worried that France could lose its triple A rating, which in turn would threaten the status of the European financial stability facility, the eurozone’s rescue fund.

 You see, in the post French Banks Can Set Off Contagion That Will Make Central Bankers Long For The Good 'Ole Lehman Collapse Days! I explained that France's leveraged ties into Italy puts it at extreme risk - much more risk than the market is currently pricing in. So, the ball bounces from Greece, to Italy, to France... Hmmm, who's next? Well, from the post Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

As we sit at the precipice of devastating European banking failure, upon which Goldman is heavily levered into through excessive French exposure (and you've seen how prescient our French banking analysis has been, bordering the prediction of the fall of Bear Stearns and Lehman), I feel many of you should take heed when I say this bank's risk is woefully underappreciated. As in the case of Bear, Lehman, Countrywide, and a slew of other banks, the 10 minutes or so of your time to read this heavy, fact filled piece could be worth a small fortune. While we're at it, I would like to urge all paying BoomBustBlog subscribers  to (admiring the original artwork below, of course) to download and review the latest related documents on this topic:

    1. Goldmans Sachs Derivative Exposure: The Canary in the Coal Mine?
    2. Goldman Sachs Q3 Forensic Review - Retail or Professional levels
    3. Actionable Note on US Bank/ French Bank Run Contagion
  1. As the last few days have demonstrated, a ban run on US soil is still a distinct possibility, if not probability. Reference The Greco-Franco Bank Run Has Skipped the Pond and Landed in NYC.

What's even more interesting is the fact that derivatives concentration and counterparty risk is rampan in the US, while credit risk in Europe is literally blowing up. What if CDS really are a faux hedge as I and other astute (read objective) observers have come to realize? ReferenceThe Banks Have Volunteered (at Gunpoint)…

... let's peruse an email I received from one of my many astute BoomBustBloggers.

I'm a lawyer (and investor). There is no analysis by anyone on the internet about whether the announcement last night would in fact trigger CDS payout. Rather, everyone seems to be accepting the claim by ISDA that the decision would not trigger it. Because I can't find any legal analysis worth reading on the internet I decided to do my own research. In about 5 minutes I found a case in the 2nd Circuit (USA) that explained to me what's going on with those contracts. First of all, they are unregulated private contracts between private parties. In order to know whether a trigger occurred you have to read each individual contract. As a result, what the ISDA says about whether a trigger occurred as to private contracts that are out there is totally meaningless.

There is merit to this assertion since the ISDA contract is simply a non-binding template, often marked up to accommodate financial engineering widgets designed to increase profit margin and decrease transparency to clients and counterparties. By the time all of the widgets are installed on some of these highly customized deals, the original ISDA template is a non-issue.

What seems to be the issue is whether there is considered to be "economic coercion" going on if one of the events to trigger is "restructuring." 

Whaaattt!!! Coercion? What Coercion???!!! robbery_gun_1

 Furthermore, you have to not look at voluntariness in a vacuum but compare the (Greek) bond with the substitute being offered by EU to determine if economic coercion or true voluntariness exists. For example, if the EU will give priority in payment to the substitute it is offering and not the original bond, that is the proper analysis in determining economic coercion/voluntariness etc. My analysis here is based upon a very brief reading of the case and I would need time to analysis fully. Also I'm not a financial professional I don't understand all the implications of what the EU announced. The reason I'm contacting you is because I believe that in the coming days/weeks we will hear of entities that are buyers of the CDS protection giving notice of a credit event to their counterparties to seek to collect on the CDS contract. If payouts aren't made lawsuits will be filed. 

You had better believe it. I really don't know why everybody is glazing over this very obvious fact! Imagine if you bought protection on a bond you acquired at par and you are offered 50% of it back (NPV) to be considered whole while the CDS writer laughs at and says thanks for the premiums... You'd probably break your fingers dialing your lawyer - out of both the swap payments, the CDS payout, and 50% of your investment that you thought (but really should have known better) was protected!

I don't know what a US Court will decide as to whether a trigger has occurred but there is a 2nd circuit case (the one I mentioned above) that is the best I've found to give an inkling about this... I'm telling you all this, because if I am right and there are claims that CDS was triggered and CDS in fact gets triggered... [it should be made] public so people start analyzing whether CDS was in fact triggered instead of blindly accepting the drivel out of Europe that no trigger will occur. That claim is obviously all about perception management not necessarily truth.

So, is Goldman et. al. hedged are is it not? ZeroHedge dutifully reported that Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure- a very interesting refresh of what I called out two years ago through "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

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This concept was further illustrated in An Independent Look into JP Morgan...

Click graph to enlarge (there is a typo in the graphic - billion should trillion)

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and again the following year on CNBC...

Mr. Middleton discusses JP Morgan and concentrated bank risk.

 

Here's the question du jour - Can Goldmans Sachs Derivative Exposure, realistically unhedged, cause the biggest run on the bank in Financial History?

As excerpted from Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

The notional amount of derivatives held by insured U.S. commercial banks have increased at a CAGR of 22% since 2005, which naturally begs the question “Has the value or the economic quantity of the underlying increased at a similar pace, and if not does this indicate that everyone on the street has doubled and tripled up their ‘bets’ on the SAME HORSE?”

Think about what happens if (or more aptly put, "when") that horse loses! Would there be anybody around to pay up?

Sequentially, the derivatives have increased every quarter since Q1-05 except for Q4-07, Q3-08 (Lehman crisis) and Q4-10 while on a YoY basis the growth has been positive throughout recorded history.  In Q2-2011, the notional value of derivative contracts increased 2% sequentially to $249 trillion. The notional value of derivatives was 12% higher than a year ago. The notional amount of a derivative contract is a reference amount from which contractual payments will be derived, but it is generally not an amount at risk. However, the changes in notional volumes can provide insight into potential revenue, and operational issues and potentially the contagion risk that banks and financial institutions poses to the wider economy – particularly in the form of counterparty risk delta. The top four banks with the most derivatives activity hold 94% of all derivatives, while the largest 25 banks account for nearly 100% of all contracts.  Overall, the US banks derivative exposure is $249 trillion and is more than four folds of World’s GDP at $58 trillion.

In absolute terms, JPM leads this list with total notional value of derivative contracts at $78 trillion, or 1.3x times the Wolds GDP. However, in relative terms, Goldman Sachs leads the list with total value of notional derivatives at 537 times is total assets compared with 44x for JPM, 46x for Citi and 23x for US Banks (average).

So, what does this mean? Well, it should be assumed that Goldman is well hedged for its exposure, at least on academic basis. The problem is its academic. AIG has taught as that bilateral netting is tantamount to bullshit at this level without government bailout intervention. If there is any entity at risk of counterparty default or who is at the behest of a government bailout if the proverbial feces hits the fan blades… Ladies and gentlemen, that entity would be known as Goldman Sachs.

As excerpted from Goldmans Sachs Derivative Exposure: The Squid in the Coal Mine?, pages 2 and 3...

GS__Banks_Derivatives_exposure_temp_work_Page_2

Goldman is much more highly leveraged into the derivatives trade than ANY and ALL of its peers as to actually be difficult to chart. That stalk representing Goldman's risk relative to EVERY OTHER banks is damn near phallic in stature!

GS__Banks_Derivatives_exposure_temp_work_Page_3

As opined earlier through the links "The Next Step in the Bank Implosion Cycle???"and As the markets climb on top of one big, incestuous pool of concentrated risk... , this is not a new phenomenon. Quite to the contrary, it has been a constant trend through the bubble, and amazingly enough even through the crash as banks have actually ratcheted up risk and assets in a blind race to become TBTF (to big to fail), under the auspices of the regulatory capture (see Lehman Dies While Getting Away With Murder: Introducing Regulatory Capture). So, what is the logical conclusion? More phallic looking charts of blatant, unbridled, and from a realistic perspective, unhedged RISK starring none other than Goldman Sachs...

 image006

And to think, many thought that JPM exposure vs World GDP chart was provocative. I query thee, exactly how will GS put a real workable hedge, a counterparty risk mitigating prophylactic if you will, over that big green stalk that is representative of Total Credit Exposure to Risk Based Capital? Short answer, Goldman may very well be to big for a counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties out there (and yes, there are a lot of y'all - GS really gets around), expect to get burned at the culmination of that French banking party I've been talking about for the last few quarters. Oh yeah, that perpetually printing clinic also known as the Federal Reserve just might be running a little low on that cheap liquidity antibiotic... Just giving y'all a heads up ahead of time...

image009

Do you remember France? That country that no on is really paying attention to, but whose exposure and risk is so systemic that it can literally and unilaterally blow up the entire European continent? I post again, for effect...

In a further worrying sign, French borrowing costs rose, lifting the premium it pays over Germany to a fresh euro-era record of 135bp. Investors are increasingly worried that France could lose its triple A rating, which in turn would threaten the status of the European financial stability facility, the eurozone’s rescue fund.

And for those who may not be sure of the significance, please review my presentation as the Keynote Speaker at the ING Real Estate Valuation Seminar in Amsterdam.

As you read exactly how precarious the situation is in France (and Belgium, through Dexia, et. al.) keep in mind that although this is definitely not good news for Goldman's numbers, historically since the beginning of this crisis, GS has actually correlated more with coke laced, red bull juice powered mo-mo trader patterns than actual book value - reference The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The Shareholders and Tax Payer??? from just last reporting period...

... I'd like to announce to the release of a blockbuster document describing the true nature of Goldman Sachs, a description that you will find no where else. It's chocked full of many interesting tidbits, and for those who found "The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely" to be an interesting read, you're gonna just love this! Subscribers can access the document here:

As is customary, I have included these free samples for those who don't subscribe, so you can get a taste of the forensic flavor.

Published in BoomBustBlog
Thursday, 03 November 2011 02:40

Reggie Middleton vs the Squid That Can't Trade!

thumb_image001_copyLearning to fly with tentacles instead of wings may prove difficult for the Squid!

Note: Subscribers can download the GS 3rd quarter review with the updated valuation opinion hereicon Goldman Sachs Q3 update Final (482.35 kB 2011-11-03 03:03:51)

In our Goldman Sachs update note, “Show me how to trade” (August 2011), we challenged Goldman Sachs’ ability to create alpha. Besides Goldman’s apparent lack of skill in generating returns in downward markets, we also presented an analysis on how its share price is driven by momentum (equity markets) instead of the commonly accepted metric of book value. Those who would have followed the traditional school of thought (sell side) by bidding the price up instead of down would have seen their capital erode by 9%; the stock is down 9% since our most recent publication. Below are some of the extracts from our previous note alongside updated charts including Q3 results to peruse before we delve further into the quarterly results the BoomBustBlog way.

Unfortunately, despite the entire start syndrome attached to Goldman Sachs, its prop desk is yet to exhibit the ability to create alpha, let alone match the returns of boombustblog.com. The table in the exhibit shows Goldman Sachs’ trading (under) performance vis-à-vis S&P

Given the high correlation of Goldman’s prop trading desk to equity markets and taking into consideration the state of equity markets in Q2-Q3, it would be interesting to see how Goldman Sachs share perform in the coming quarter

‘Goldman Sachs’ share price is driven less by book value per share and is driven more by momentum (multiple)”

image001_copy_copy

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With Goldman Sachs return on equity (ROE) already under considerable pressure to meet even its cost of capital, additional strains on capital could put further pressure on its profitability. In Q3 ROE declined to a negative 2.6% from 6.1% in Q2 and 10.4% in Q3 2010, Goldman Sachs return on equity has declined substantially due to de-leveraging in an adverse market (the absolute wrong time to deleverage, yet the time when most banks seek to do it) and is below its current cost of capital. With ROE down to sub10% from c40% during pre-crisis levels, there is no way a stock with high beta as Goldman Sachs could justify adequate returns to cover the inherent risk. For Goldman Sachs to trade back at 200 it has to resume its ROE of 20% which means it has to increase its leverage back to pre-crisis levels of c25x. With curbs on banks leverage and de-risking this seems highly unlikely. image006_copy

 

Two months or so ago (Monday, 22 August 2011), I penned the public blog post that also relased my most recent research on Goldman Sachs - The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The Shareholders and Tax Payer??? -  as excerpted:

The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!

And for those who haven't been following my Squid Hunting series, there's a lot more to come from those boys at 200 West Street. If you want to know what will happen next, just look at the first few pages of the lastest Goldman subscription docs (click here to subscribe):

After all, eventually someone must query, So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?

 

I'm Hunting Big Game Today: The Squid On A Spear Tip

Summary: This is the first in a series of articles to be released this weekend concerning Goldman Sachs, the Squid! In this introduction (for those who do not regularly follow me) I demonstrate how the market, the sell side, and most investors are missing one of the biggest bastions of risk in the US investment banking industry. I will also...

 

Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

Welcome to part two of my series on Hunting the Squid, the overvaluation and under-appreciation of the risks that is Goldman Sachs. Since this highly analytical, but poignant diatribe covers a lot of material, it's imperative that those who have not done so review part 1 of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part...

Hunting the Squid Part 3: Reggie Middleton Serves Up Fried Calamari From Raw Squid

For those who don't subscribe to BoomBustblog, or haven't read I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction and Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?, not only have you missed out on some unique artwork, you've potentially missed out on 300%...
 

Hunting the Squid, part 4: So, What Else Can Go Wrong With Goldman Sachs? Plenty!

Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3:  I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To...

Hunting the Squid, Part 5: Sometimes Your Local Superhero Doesn't Look Like What They Show You In The Movies

Discuss Finance, Investment, Blogs, Global Macro and Research with Reggie Middleton of BoomBustBlog at Salon de Ning

700 Fifth Avenue  New York, NY 10019

6:45 pm, Friday November 4th

I will bring plenty of research, debate and discussion, so put your smart caps on, be prepared to overpay for drinks and be in the company of beautiful women.

salondenong1 salondenong_copy


Previous BoomBustBlog events have been more than worth it...

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Published in BoomBustBlog

Four months ago, I posted to seminal pieces, namely The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!and The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style! that outlined in explicit detail, the path, methodology and cause and effect of bank runs that will emanate from Europe. Any who have not read these two posts, be aware that I consider them a must. For those of you who feel that my posts are too long, I urge you to take the content embedded within them more seiously (both paid and free content), for although verbose, they are proving to be most prescient. 

As excerpted:

Traditional views on this “bank run model” largely (or more aptly, only) consider individual savers in the form of depositors on the short side (liquid liabilities). It is a run such as this that caused the banking collapse during the US Great Depression. The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!

image006

This phenomena essentially discredits the thinking at large and currently in practice that “since individual expenditure needs are largely uncorrelated, by the law of large numbers” banks should expect few withdrawals on any one day. The fact of the matter is that in times of severe distress, particularly stemming from solvency issues (read directly as the Pan-European Sovereign Debt Crisis, and Greece, et. al. in particular), the exact opposite is the case. Individual depositor and counterparty actions are actually HIGHLY correlated and tend to move in tandem, particularly when that move is out of the target fiat bank. They tend to take heed to the saying “He who panics first, panics best!"

Asset/liability mismatch can, at the margin nearly assure a Lehman-style fiasco in the case of an impetus that sparks herding mentality, whether it be among depositors/savers or institutional counterparties.

So, armed with the cause, effect, and path of bank runs coming from Europe, templated by Lehmand and Bear, guess what happend yesterday? As excerpted from FT.com: MF Global and the repo-to-maturity trade

... So, while most of the media has been commonly referring to MF’s sovereign bond positions as proprietary bets gone wrong, there’s more to it than just that. If anything this was a financing position (or liquidity trade) — not a bet on the future direction of the bonds themselves. What’s more, if executed properly the trade should — at least on paper – have posed little or no risk. The maths was simple enough. You account for the cost of borrowing funds using the bonds in question as collateral (the repo rate) versus the ultimate coupon payments received from the very same bonds.

This is because in dysfunctional markets the repo rate can be out of kilter with the ultimate returns of the bond itself. This is especially the case if there are more counterparties willing to provide short-term liquidity in return for rates that beat the nominal risk-free return.  In other words to act as pawnbrokers to the market. Alternatively, if you have a good credit standing in the market you may be able to achieve a more favourable repo rate than others. If everyone plays their cards right, MF Global receives financing (or liquidity) at a better rate than the market’s –  since they are offsetting the repo charges with the ultimate coupon payments — and the counterparty is rewarded in basis points for holding the bond in the interim.

Gross profit is simply total inflow minus total outflow.

As fixed income guru Moorad Choudhry noted in the “Repo Handbook” such a trade should generally be considered low-risk since the financing profit on the bond position is known with certainty until the bond’s maturity.

...In other words, mark-to-market ought not be a concern. As long as the bond pays out at the price you bought if for (which it will if it is held to maturity), it should not be considered a risky position.

As can be seen from MF Global’s earnings statement, MF was indeed counting on the EFSF guarantee to ensure that this would be the case:

... “Over the course of the past year, we have seen opportunities in short-dated European sovereign credit markets and built a fully financed, laddered maturity portfolio that we actively manage. We remain confident that we have the resources and expertise to continue to successfully manage these exposures to what we believe will be a positive conclusion in December 2012,” Mr. Corzine concluded.

On top of that — just in case an unexpected default risk came its way — MF Global had actually hedged the $6.3bn position with a $1.3bn short French government bond trade.

So what on earth went wrong? Italy and Belgium are, after all, still very unlikely to default before the end of 2012. There is no reason, therefore, why the bonds shouldn’t payout.

Which leaves only the possibility of some skittish repo counterparties suddenly getting cold feet and pulling out (or demanding a greater proportion of over-collateralisation with respect to the loan.

If repo contracts were completely reneged upon, this would not only have left MF with a sudden liquidity issue — especially if they couldn’t find a fresh counterparty — but also with a sudden need to mark-to-market the bonds.

Indeed as Reuters reported on Monday:

Last week, counterparties likely pressed MF Global to post more collateral on derivatives trades and may have started reducing the company’s repo financing lines, market sources said.We’re not sure exactly how easy it is to undo a “repo-to-maturity” trade, but it does leave us wondering who exactly those counterparties might have been.

Update 9.30pm GMT: As Kamekon points out below, in most circumstances — depending on the terms and conditions — repos would be subject to regular margin calls or “loan repayments” which re-establish the original repo ratio. Either way, a fall in the value of the bonds could create a major liquidity drain for MF Global. Though these sorts of liquidity risks should have been accounted for in VaR calculations. Much harder to anticipate would have been a complete disappearance of willing counterparties.

So there you go. The MF Global collapse was fueled (ironically) by ZIRP as clearly predicted here The Ironic, Prophetic Nature of the MF Global Bankruptcy Filing and It's Potential Ramifications, and the straw that broke the camel'sman's back was an old fashioned institutional bank run, as was clearly anticipated many months ago here at BoomBustBlog.

Subscribers, this distrust, collateral calling, back stabbing bank run thing will get much worse before it gets better. I strive to put out quality, not quantity, and I truly believe that those banks and entities outlined in the research reports of the past two months are going to prove to be blockbusters of alpha on the short side. Reference the Commercial & Investment Banks subcategory under "Banks & Financial Services" heading in the subscription content tab. The last three entities covered are again ripe for the picking after the recent bear rally, in the case of a systemic downturn (which I fully anticipate) although I can't guarantee for how long.

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Published in BoomBustBlog

Time Sensitive Note: All paying subscribers are strongly urged to review the "Latest Subscription Documents" section in the right hand margin of the home page. This is strategic time to reinstitute positions while IV has been crushed and underlying prices have increased against the fundamentals and the macro backdrop. New subscription content will be added withing 24 hours.

For those who do not know, I was a real estate investor between 2000 and 2006. By 2006, I came to the realization that there were no longer profitable deals to be had on a sound risk/reward basis, and the entire Ponzi scheme looked to be ready to do the Humpty Dumpty thing. So, I took a year off to raise my brand new baby girl, and came back to pursue plans to start a hedge fund that focused on shorting the FIRE sector and European banks - basically any and everybody who ever did business with me and my colleagues in real estate - the writing was evidently on the wall for anyone who bothered to look at walls.

Those who have followed me for a few years know my mantra, and for those that don't, review my early thoughts and calls on Europe and the global FIRE sector. At a fundraiser that MF Global threw in Rockefeller Center's rolling skating rink, I sat down with the then CEO of MF Global and his wife and informed them of my plans. They sincerely wished me luck and told me to let them know when I got started (I would speak to them on and off annually at the skating rink event or over lunch). I said nothing then, but I was highly suspect of the firms prospects going into what I saw was a risky asset firestorm of a correction. As it turned out, it appears I may have had a point. Even more interesting is the fact that I was the only one that I knew of who proclaimed that Fed ZIRP policy was truly poison laced in Myrrh. Contrary to that espoused by ink stained ivory towers of academia and those who so often correct in the Sell Side, ZIRP is killing the banks while regulatory capture is hiding the metastizing tumors. I also now a few who used to work in the risk departments of MF (yes, they did have one) and they said that Goldman/governer guy was the one that ran MF into the ground. Accordingly, MF was a good brokerage, but he came in and tried to make them bankers and traders, which they were not (at least they weren't good ones, anyway). By forcing the firm to carry inexperienced proprietary risk, he doomed the firm (according to this insider).

Hmmmm... Up is down, and down is up, I bendeth you over if you spilleth my cup! Again, as excerpted from There’s Something Fishy at the House of Morgan":

Again, I have warned of this occurrence as well. See my interview with Max Keiser below where I explained how the Fed's ZIRP policy is literally starving the banks it was designed to save. Listen to what was a highly contrarian perspective last year, but proven fact this year!

 

 

Provisions and charge-offs: I have been warning about the over-exuberant release of provisions to pad accounting earnings since late 2009!

Declines in provision was one of the major contributors to bottom line. JPMorgan reduced its provision for loan losses to $1.2bn (0.7% of loans) in Q1 2011 from $7.0bn (4.2% of loans) in Q1 2010 and from $3.0bn (1.8% of loans) in Q4 2010 while charge-offs declined to $3.7bn (2.2% of loans) in Q1 2011 from $7.9bn (4.4% of loans) in Q1 2010 and from $5.1bn (2.9% of loans) in Q4 2010. Although banks delinquency and charge-off rate has declined, the extent of decline in provisions is unwarranted compared to decline in charge-off rates. As a result of higher decline in provisions compared to charge-offs, total reserve for loan losses have decreased to 4.3% in Q1 from 5.3% in Q1 2010 and 4.7% in Q4 2010. At the end of Q1 the banks allowances to loan losses is lowest since 2009.

Although the reduction in provisions has helped the banks to improve its profitability it has seriously undermined the banks’ ability to absorb losses, if economic conditions worsen. As a result of under provisioning for the past five quarters, the banks Eyles test, a measure of banks’ ability to absorb losses, has turned to a negative 7.7% in Q1 2011 compared with +6.4% in Q1 2010. A negative Eyles test has serious implications to shareholders – the losses from banks could not only drain entire allowances for loan losses which are inadequate but can also wipe off c7.7% of shareholder’s equity capital. The negative value of 7.7% for JPM’s Eyles is the lowest in this downturn.

MF Global Files for Bankruptcy; Shares Remain Halted

MF Global Holdings filed for Chapter 11 bankruptcy protection in New York on Monday morning, after an effort to sell itself to Interactive Brokers Group failed.

MF Global [MF 1.20 --- UNCH ] had a tentative deal to sell assets to Interactive Brokers [IBKR 15.55 0.33 (+2.17%) ] as of late Sunday, but the agreement fell apart as talks continued overnight, said people familiar with the matter. Discussions ended around 5 a.m. ET, one of these people said.

MF Global had been considering filing just its holding company for bankruptcy protection and then executing the sale. That plan is now off the table, one of the people said.

This person said MF Global's parent company would be included in the bankruptcy filing. Voluntary bankruptcy petitions for MF Global Holdings and MF Global Finance USA hit the docket in a U.S. bankruptcy court in Manhattan mid-morning on Monday.

The Chicago Mercantile Exchange said on Monday that customers of broker-dealer MF Global were limited to liquidating their positions. The exchange, which owns the Chicago Board of Trade, said it would no longer recognize MF Global, which has filed for Chapter 11 bankruptcy protection, as a guarantor for floor trading.

... "It was quite difficult to get our money out on Friday, because they had a lot of redemption calls," a trader, whose firm used MF Global as a brokerage said. "The company is not initiating any new position. They are trying to close down positions that they already have with clients that are open."

At MF Global's London office, in Canary Wharf, staff were coming and going from the office as normal at Monday lunchtime.

There was a tense atmosphere and most declined to speak to CNBC.com.

"We're not allowed to speak to you; so you can probably read into that what you will," one MF Global worker told CNBC.com.

The last set of statements are teiling, indeed. MF Global is a mini-Lehman, and while many may not be taking MF Global's demise as seriously, it definitely is. They died from the same disease that afflicts much of Wall Street, and most of European banking. They are smaller, that's the only real difference - and the asset management company that they were spun off is doing just as bad. I said it before, and I'll say it again, Europe is housing Lehman Brothers x 4!


From ZeroHedge: Presenting The Bond That Blew Up MF Global

Reaching for yield (and prospectively capital appreciation) while shortening duration had become the new 'smart money' trade as we saw HY credit curves steepen earlier in the year (only to become the pain trade very quickly). The attraction of those incredible yields on short-dated sovereigns was an obvious place for momentum monkeys to chase and it seems that was the undoing of MF Global. The Dec 2012 Italian bonds (in which MF held 91% of its ITA exposure), as highlighted in today's Bloomberg Chart-of-the-day, appears to be the capital-sucking instrument of doom for the now-stricken MF. As if we need to remind readers, there is a reason why yields are high - there is no free lunch - and while some have already leaped to the defense of the bet-on-black Corzine risk management process with comments such as 'He was simply early and will be proved correct' should remember that only the central banks have bottomless non-mark-to-market pockets to withstand the vol. It also sets up a rather useful lesson for those pushing for EFSF leverage to buy risky sovereign debt - but given today's issue demand, perhaps that is moot.

Hmmmm! I remember over the summer, when MF probably put these trades on, I warned about Italy sparking France while NEARLY EVERYONE ELSE was still focusing on Greece! Reference the following excerpt from Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In case the hint was strong enough, I explicitly state that although the sell side and the media are looking at Greece sparking Italy, it is France and french banks in particular that risk bringing the Franco-Italia make-believe capitalism session, aka the French leveraged Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

So, how accurate was I? Well, we'll see in a few... In this morning's headlines:

So, What's the Next Shoe To Drop? Read on...

For those who claim I may be Euro bashing, rest assured - I am not. Just a week or two later, I released research on a big US bank that will quite possibly catch Franco-Italiano Ponzi Collapse fever, with the pro document containing all types of juicy details. This is the next big thing, for when (not if, but when) European banks blow up, it WILL affect us stateside! Subscribers, be sure to be prepared. Puts are already quite costly, but there are other methods if you haven't taken your positions when the research was first released. For those who wish to subscribe, click here.

Now, let's refresh the output from And The European Bank Run Continues...and more importantly BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional, I strongly urge those who haven't to click upon said link and download your intellectual weapon of choice!) where I modeled Greek losses on BNP.  Below is sample output from the professional level model (BNP Exposures - Professional Subscriber Download Version) that simulates the bank run that the news clippings below appear to be describing in detail...(Click to enlarge to printer quality)This scenario was run BEFORE the Greek bonds dropped even further in price...

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Using more recent market inputs (you know, assuming this stuff was Level 1), we get the following...

bnp_haircut_exposure

Notice here the base case TEC impairment is now approaching the adverse case from just a few weeks ago - and this is using market pricing, not some pie in the sky model!

I have not recalculated the adverse scenario in this example, but you can simply use your imagination, or download the model and run it for yourself.

A Greek default with haircuts somewhat inline with market prices will wipe out 13% of BNP TEC, with a more severe cut (quite likely) taking out nearly 20%. This is not even glancing upon the many problems we discussed in our forensice reports (File Icon French Bank Run Forensic Thoughts - Retail Valuation Note - For retail subscribers,File Icon Bank Run Liquidity Candidate Forensic Opinion - A full forensic note for professional and institutional subscribers).

Now, if the ZH referenced report above is accurate (and I believe it is) the banks are going to try to delever by selling assets in the open markets (all at the same time, selling the same assets to the same pool of potential buyers at the same bad times). This means that the prices used to populate this model are probably still too optmistic. Even if they weren't, look at the capital short fall the Greek default will leave BNP with assuming our institutional bank run thesis holds true and they see a slight withdrawal of liquidity of 10% this year and 15% next (knowing full well the numbers for Lehmand and Bear were much, much higher than that before they collapsed). First, a refesher on our European bank run theory expoused 5 months ago...

    1. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
    2. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  1. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
    1. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!

And the BNP results????

bnp_haircut_exposure_bank_runbnp_haircut_exposure_bank_run

Half trillion euros here, half trillion euros there... Sooner or later, we'll be talking about some real money! Since the problems have not been cured, they're literally guaranteed to come back and bite ass. Guaranteed! So, as suggested earlier on, download your appropriate BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional).

On Derivatives Implosions and Debt Destruction...

Just like the US banks and EU leaders have somehow gamed (or at least tried to game) the CDS market into a sham, they look to do the same in the discorporation of those entities who have been destroyed by the highly deflationary forces taking hold. To wit: MF Global Creditors Led By JPMorgan

The following are MF Global Holdings’ largest unsecured creditors and shareholders, according to the company’s bankruptcy filing and related court papers submitted today in U.S. Bankruptcy Court in Manhattan.

Unsecured creditors rank behind secured lenders in getting repaid in a bankruptcy, and are ahead of preferred and common shareholders.

Unsecured Creditors:

JPMorgan Chase & Co. (JPM)’s JPMorgan Chase Bank, bondholder trustee, $1.2 billion.

Deutsche Bank AG, trustee for $1.02 billion in bonds:

Deutsche Bank Trust Co., bondholder trustee for 6.25% notes, $325 million bondholder trustee for 3.375% notes, $325 million bondholder trustee for 1.875% notes, $287.5 million bondholder trustee for 9% notes, $78.6 million.

From ZeroHedge, we are sourced the ISDA "determinations committee":

Americas Voting Dealers
Bank of America / Merrill Lynch
Barclays
Citibank
Credit Suisse
Deutsche Bank
Goldman Sachs
JPMorgan Chase Bank, N.A.
Morgan Stanley
Société Générale
UBS

EMEA

Voting Dealers
Bank of America / Merrill Lynch
Barclays
BNP Paribas
Credit Suisse
Deutsche Bank
Goldman Sachs
JPMorgan Chase Bank, N.A.
Morgan Stanley
Société Générale
UBS

 

More from Reggie Middleton...

The Street's Most Intellectually Aggressive Analysis: We've Found What Bank of America Hid In Your Bank Account!

This Bank Is Much Worse Than the Rest and the (Guaranteed?) Bust Will Probably Be Funded Right Out Of Your Bank Account!

Published in BoomBustBlog

lauren_icon_twitter__2__reasonably_smallLauren Lyster, the enticing Russian TV/Capital Accounts host gave me the rare opportunity yesterday to sit down and run my mouth for 15 minutes straight. This is a format which is most conducive to true conveyance of knowledge and information, at least in my not very humble opinion. I'm just not the 8 second soundbite type.

In viewing the interviews below, compare and contrast to the other two similar but large channels at large, Fox Business News and CNBC, I am quite curious to get your opinions and feedback.

I also query, why is the bond market so much more fundamentally astute than the equity markets? Is it becuase it is truly too deep and wide to manipulate? In today's headlines (and right after this world saving 5th European bailout):

Let's view the interview before we go any farther...

Interview w/Reggie Middleton: Is Bank of America going Bust? (Part 1)

Interview w/Reggie Middleton: Is Bank of America going Bust? (Part 2)

I addressed the CDS issue in detail in yesterday's blog post, which should be read by any who have not already: The Banks Have Volunteered (at Gunpoint) To Get 50% of Their Money Taken - No Credit Event???. Why is this credit event issue pertinent? Well, if the Europeans succeed in shamming the CDS market, rates skyrocket (duhh, didn't think of that???) and all banks that state they are hedged via CDS truly aren't? I delved into this in detail in 2009, with the blog post And the next AIG is... (Public Edition)... Think about it! If there is a credit event then the fireworks start. If there is no credit event, then what does that say about Goldman, who swears to high hell they are adequately hedged? Hedged with CDS that won't get triggered upon a 50% loss? Let's take a closer look with excerpts from recent BoomBustBlog posts and subscriber research...

Of course, you know I'm going to say "I told you so!" Reference So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't? and then Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored? You see, in said piece, ZeroHedge dutifully reported that Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure- a very interesting refresh of what I called out two years ago through "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

 bank_ficc_derivative_trading.png

This concept was further illustrated in An Independent Look into JP Morgan...

Click graph to enlarge (there is a typo in the graphic - billion should trillion)

image001.png

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

I then posted the following series, which eventually led to me finally breaking down and performing a full forensic analysis of JP Morgan, instead of piece-mealing it with anecdotal analysis.

  1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
  2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
  3. As the markets climb on top of one big, incestuous pool of concentrated risk...
  4. Any objective review shows that the big banks are simply too big for the safety of this country
  5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?

You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish.

JPM Public Excerpt of Forensic Analysis Subscription JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb

 Reggie Middleton on CNBC's Squawk on the Street - 10/19/2010, discusses JP Morgan and concentrated derivative bank risk.

If you think that's scary (and you really should) check out Is Goldmans Sachs Derivative Exposure the Squid in the Coal Mine?

The notional amount of derivatives held by insured U.S. commercial banks have increased at a CAGR of 22% since 2005, which naturally begs the question “Has the value or the economic quantity of the underlying increased at a similar pace, and if not does this indicate that everyone on the street has doubled and tripled up their ‘bets’ on the SAME HORSE?”

Think about what happens if (or more aptly put, "when") that horse loses! Would there be anybody around to pay up?

Sequentially, the derivatives have increased every quarter since Q1-05 except for Q4-07, Q3-08 (Lehman crisis) and Q4-10 while on a YoY basis the growth has been positive throughout recorded history.  In Q2-2011, the notional value of derivative contracts increased 2% sequentially to $249 trillion. The notional value of derivatives was 12% higher than a year ago. The notional amount of a derivative contract is a reference amount from which contractual payments will be derived, but it is generally not an amount at risk. However, the changes in notional volumes can provide insight into potential revenue, and operational issues and potentially the contagion risk that banks and financial institutions poses to the wider economy – particularly in the form of counterparty risk delta. The top four banks with the most derivatives activity hold 94% of all derivatives, while the largest 25 banks account for nearly 100% of all contracts.  Overall, the US banks derivative exposure is $249 trillion and is more than four folds of World’s GDP at $58 trillion.

In absolute terms, JPM leads this list with total notional value of derivative contracts at $78 trillion, or 1.3x times the Wolds GDP. However, in relative terms, Goldman Sachs leads the list with total value of notional derivatives at 537 times is total assets compared with 44x for JPM, 46x for Citi and 23x for US Banks (average).

So, what does this mean? Well, it should be assumed that Goldman is well hedged for its exposure, at least on academic basis. The problem is its academic. AIG has taught as that bilateral netting is tantamount to bullshit at this level without government bailout intervention. If there is any entity at risk of counterparty default or who is at the behest of a government bailout if the proverbial feces hits the fan blades… Ladies and gentlemen, that entity would be known as Goldman Sachs.

As excerpted from Goldmans Sachs Derivative Exposure: The Squid in the Coal Mine?, pages 2 and 3...

GS__Banks_Derivatives_exposure_temp_work_Page_2

Goldman is much more highly leveraged into the derivatives trade than ANY and ALL of its peers as to actually be difficult to chart. That stalk representing Goldman's risk relative to EVERY OTHER banks is damn near phallic in stature!

GS__Banks_Derivatives_exposure_temp_work_Page_3

 As opined earlier through the links "The Next Step in the Bank Implosion Cycle???"and As the markets climb on top of one big, incestuous pool of concentrated risk... , this is not a new phenomenon. Quite to the contrary, it has been a constant trend through the bubble, and amazingly enough even through the crash as banks have actually ratcheted up risk and assets in a blind race to become TBTF (to big to fail), under the auspices of the regulatory capture (see Lehman Dies While Getting Away With Murder: Introducing Regulatory Capture). So, what is the logical conclusion? More phallic looking charts of blatant, unbridled, and from a realistic perspective, unhedged RISK starring none other than Goldman Sachs...

And to think, many thought that JPM exposure vs World GDP chart was provocative. I query thee, exactly how will GS put a real workable hedge, a counterparty risk mitigating prophylactic if you will, over that big green stalk that is representative of Total Credit Exposure to Risk Based Capital? Short answer, Goldman may very well be to big for a counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties out there (and yes, there are a lot of y'all - GS really gets around), expect to get burned at the culmination of that French banking party I've been talking about for the last few quarters. Oh yeah, that perpetually printing clinic also known as the Federal Reserve just might be running a little low on that cheap liquidity antibiotic... Just giving y'all a heads up ahead of time...

image009

And back to Bank of America Lynch(ing this) CountryWide....

The Street's Most Intellectually Aggressive Analysis: We've Found What Bank of America Hid In Your Bank Account!: Yes, BAC is insolvent, and yes CountryWide is (and was) now a real estate company first and foremost - reference "Would you buy Countrywide if all of its bad mortgages were magically wiped off the books?"

I know I wouldn't. I believe there are better investments out there from a risk/reward perspective. Countrywide is in a bit of a jam, and it is not just from bad loans on the books. Looking at the Countrywide Foreclosures Blog (yes, there actually is one), I found this article:14,196 Homes Offered For Sale on Countrywide Financial's Website. I browsed through some of the site, and the small sample of numbers that I looked at seemed accurately reported. It also seems to mesh with Housingtracker.net. Browsing through the comments, someone noticed that the bank and trust offerings were not included. I looked, and at first glance, it seemed like he had a point. Now,it is a lot of work to verify all of this, but if it does pay out (and it looks like it does), Countrywide has nearly 100% of it market capitalization outstanding as REOs - in a market where houses just aren't selling and property values are falling fast. This is totally discounting each and every under performing and underwater mortgage asset they have on their books.

Held by Countrywide Mortgage Co. $ 2,910,876,468
Held by Countrywide Trust and Bank $ 2,969,067,322
Total $ 5,879,943,790
   
CFC Market Capitalization $ 6,180,000,000
% market cap held as REO 95%
 

Subscribers, if the Europeans mess this up (and a gambling man would probably be best served casting his bets in that direction) expect the subject bank of this article, and the most recent forensic download (File Icon Haircuts, Derivative Risks and Valuation) to go "BOOM!" See the blog post This Bank Is Much Worse Than the Rest and the (Guaranteed?) Bust Will Probably Be Funded Right Out Of Your Bank Account!

Lauren asked a very good question regarding why I'm the only pundit making such dire observations...

As for the touchy question as to why I am stating things that no one else does, I tried to be politically correct in espousing my thoughts on the "long only wold of the MSM". I believe I was fair, and I wear my own track record on my sleeve, see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

I can be reached via the following channels, or directly via email:

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I will be releasing the date (probably this week), location and time of the NYC meet and greet within the next 24 hours or so, so we can chat, drink, debate, argue and fraternize with pretty woman together in a trendy spot in the Meat Packing District or the Bowery (I apologize in advance to all of my female readers/subscribers). Those who are interested in attending should email customer support.There has been strong interest in the London meeting, enough to warrant the venue - I simply need to get the travel and venue organized due to a change of plans. For those that are new to the blog, these are pics of previous meet and greets...
BoomBustBlog on the MotherLand in the Hudson, NYC

BoomBustBlog on the MotherLand in the Hudson, NYC

  

BoomBustBlog in the 79th Street Boat Basin, NYC

47b8d631b3127cce98548a67f7f900000047100Abs2TFi2ZsWWg.jpg

BoomBustBlog in the 79th Street Boat Basin, NYC

DSC06310.jpg

 BoomBustBlog at BuddhaKahn, Meatpacking District, NYC

buddhakahn2.jpg

Published in BoomBustBlog

Last week I wrote a scathing expose on Bank of America and its [fraudulent?] transfer of over $50 trillion worth of suspect derivatives into its FDIC insured depository arm - Bank of America Lynch[ing this] CountryWide's Equity Is Likely Worthless and It Will Rape FDIC Insured Accounts Going Bust. It drew quite a bit of attention, but the story doesn't end there. Actually, that was just the beginning. It gets worse, much worse. The next question Du Jour is, "What exactly did Bank of America Lynch[ing this] CountryWide put in Aunt Mabel's retirement savings account? Well, I have already answered that question for subscribers two years ago, but I will explore it further in public now because it leads me to the most recently released BoomBustBlog subscriber research (click here to subscribe) in which we have identified entities that are ripe for a fuse to be lit under their contagion infused ass, and Bank of America Lynch[ing this] CountryWide just so happened to of dumped 5 trailer loads of matches into YOUR bank accounts. Oh, it's so good to be [Bank of] American. Those who don't subscribe, and particularly those who haven't seen the RT/Capital Accounts interview, should spend take the time to view the most "Intellectually Aggressive Analysis on Wall Street" video below, wherein through Reggie Middleton vs Bruce Lee vs BAC, the type and composition of said swap derivatives purportedly dumped into your bank accounts are detailed and explained and illustrated. Be warned, this is not your Daddy's investment analysis, and is not for the feint of heart.

The swaps illustrated and explained in this video are nearly guaranteed to be written with the subject bank of our most recent analysis, compounding the on-balance sheet derivative exposure, which is already the highest in the world once proper TEC adjustements are taken into consideration. This is the same bank, apparently unrecognized by the markets, media and sell side, that will literally go boom when the match is put to the dry gunpowder (subscribers only, click here to subscribe): Haircuts, Derivative Risks and Valuation.

To fully appreciate the risks at stake here, just remember that Bank of America Lynch[ing this] CountryWide bought both CountryWide and Merrill Lynch, the most aggregious mortgage operators in thier respective categories. It's quite possible that CountryWide's litigation liabilities alone could sink the whole bank, while Merrill Lynch was collapsing under its own weight as BAC purchased them at a PREMIUM! Let me attempt to hit this point HARDER! In 2007, I posed the question,"Would you buy Countrywide if all of its bad mortgages were magically wiped off the books?"

I know I wouldn't. I believe there are better investments out there from a risk/reward perspective. Countrywide is in a bit of a jam, and it is not just from bad loans on the books. Looking at the Countrywide Foreclosures Blog (yes, there actually is one), I found this article:14,196 Homes Offered For Sale on Countrywide Financial's Website. I browsed through some of the site, and the small sample of numbers that I looked at seemed accurately reported. It also seems to mesh with Housingtracker.net. Browsing through the comments, someone noticed that the bank and trust offerings were not included. I looked, and at first glance, it seemed like he had a point. Now,it is a lot of work to verify all of this, but if it does pay out (and it looks like it does), Countrywide has nearly 100% of it market capitalization outstanding as REOs - in a market where houses just aren't selling and property values are falling fast. This is totally discounting each and every under performing and underwater mortgage asset they have on their books.

Held by Countrywide Mortgage Co. $ 2,910,876,468
Held by Countrywide Trust and Bank $ 2,969,067,322
Total $ 5,879,943,790
   
CFC Market Capitalization $ 6,180,000,000
% market cap held as REO 95%

You see, CountryWide was insolvent way back in 2007, even if you were able to ignore the biggest problems that they have (had). Throw in the soured, souring, and soon to be soured PrimeX style mortages then add in the massive litigation liabiities and CountryWide is so insolvent that they would have brought down anything that would have dared stand next to them, not to mention acquire them. Which begs the question, "Why in the hell did Bank of America do it?". I posed this in the following month in January of 2008, Quick Opinion on Bank of America Buying Countrywide...

It is a mistake, plain and simple. I normally don't like to tell people who specialize in a business how to run it, since they probably know more about their business than I do - but sometimes the mistakes are just so glaring. I don't care how many analysts are poring over how many books at Countrywide. BAC's error is not misjudging the value of Countrywide now, but misjudging the macro environment in which Countrywide operates.

My experience has been primarily understanding and evaluating companies from the equity perspective, but that definitely doesn't mean that I ignore the fxed income side. I am just not better at it than the other guys. What I have been noticing of late is that credit markets have been screaming murder for some time now, and the equity markets have been humming along new bullish highs and trading runs as if nothing is truly wrong. This is a strong indicator that momentum trading has again taken control of the markets. It is an environment where price trumps value. The last time this came to a head was the dot com bust. It took many institutional and individual investors 5 to 6 years to break even. Some never recouped their losses. Well, my gut has been telling me for about a year and change now that we are back there again. 2008 thus far has done nothing but confirm that we have come to a head. The pic above was an actual shot (one of very many at various locations) of the run on Northern Rock Bank in the U.K. This was real, and it was indicative of a real problem.

Well, we had a very recent run on the bank here in the states as well. There were pictures all over the web when it occurred, and now mysteriously, they are all gone. All I was able to retrieve was this screen capture of a thumbnail from Blownmortgage.com. Just as the pictorial remnants of the run have somehow disappeared, so has the equity markets prudence in the face of such a run. You can guess which bank got ran on.

cwide_bankrun.png

There were companies in the dot com era that made purchases that they thought were risky but potentially profitable, and in more severe cases such as the internet media companies, many have dwindled down to mere pennies per share, ex. Razorfish, et. al. So, historically, companies have had the hubris of BAC to go on and lose most or all of thier investment.

I have been using this chart a lot lately, and it looks like I will be using it a lot more.

If the housing market goes anywhere NEAR its historical trends, we are going to see 30% to 40% drops in real prices. Many people poo-poo this notion, calling it apocalyptic. This is silly to me. Why didn't they poo-poo the notion of 40% to 200% price increases in the same time frame? Isn't that even more dramatic? For some reason, investors - individual and professional alike - have a hard time avoiding following the crowd. They try to catch bottoms (a risky and foolhardy endeavor in my opinion), time tops, and always seem to believe something will bounce back or XYZ asset will never go down in price over the long term (ala Fitch Ratings HPA models or the Japanese real estate market).

But BAC is Value Investing Like Buffet

No they are not. They are gambling like cowboys. The caveat to the Buffet argument is that BAC didn't buy the assets of Countrywide, they bought the whole company, kit and kaboodle - including the liabilities. I can understand if they bought just the servicing arm, but they didn't. Believe me, it is possible to pay less than zero for a company. The last time Buffet bought a financial company steeped in liabilities and risks on the cheap, he regretted it and realized that no matter how cheap he got the assets, he still overpaid. Risk vs. Reward: don't just stare at the reward side of the equation. If you must, simlpy reminisce on Solomon Brothers. In other words, the cost for buying Countrywide could easily be more than what is paid for it.

CFC is dangerous, plain and simple. The residential housing chart clearly shows how far out of whack housing values are in historic real terms. Come on, this makes the remnants of the Gold Rush look mild. If values come anywhere near the mean values of growth, BAC will be paying the CFC bill for a long time, and they will be paying a lot more than $6 billion, the cost of acquisition. Now, I hear there are performance covenants and guarantees in the purchase which may smooth out the pain, but CFC is in a world of hurt, and doesn't have much wiggle room to offer incentives. As I have stried my best to insinuate, it is possible to get CFC for free and still lose money. I know BAC has been in the business longer than I have been short CFC, but I made more money on that short than they did on their $2 billion investment. Sometimes, you are just wrong.

As of last month, CFC had more nominal dollars in REOs than they did market cap. Now, just add all of those garbage loans, the plethora of law suits, a few SEC and state banking authority investigations in a pot with a market where housing value corrects 30% in real terms with inventory building higher and higher, and we have a bitter tasting brew indeed... I hope those BAC shareholders have strong stomachs.

So, was I Right?

Let's let the BoomBustBlog archives tell the tale...

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

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

Do you remember my recent missive "There’s Something Fishy at the House of Morgan"? Well, in it I queried how it was that JP Morgan can continuously pull risk provisions and reserves to pad quarterly accounting earnings at time when I not only made clear that we are in a real estate depression but the facts actually played out the same. As excerpted from the aforementioned article:

I invite all to peruse the mainstream financial media and sell side Wall Street's take on JP Morgan's Q1 earnings before reading through my take. Pray thee tell me, why is there such a distinct difference? Below are excerpts from the our review of JP Morgan's Q1 results, available to paying subscribers (including valuation and scenario analysis): File Icon JPM Q1 2011 Review & Analysis.

Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt I

(1) Land and Debt are four letter words.  One of the golden rules to being a homebuilder is to finance land with equity and use debt for financing your homebuilding operations.  Why?  Because when you are highly levered and the market turns on you, then you will not be able to last during the downturn.  It is a rule that has proved out in every housing recession period.  Why then do builders double up their positions and try to grow faster than the market average?  Greed.  The bigger your company the bigger your compensation package.  If not greed, then stupidity.  This is such a basic concept and it holds true in every downturn.

(2)  There is a dis-connect between the land and housing markets.  When a housing market takes off, the first to know are the builders because they are looking at the sales data.  Eventually, the land market catches on and begins raising prices.  However, when a market is in decline, the builders are the first to know and the land owners hold their pricing until it is too late and they realize the downturn is for real.  Did you hear that banks?

(3) Types of Land Owners.  The most ignorant is the farmer or long time owner.  This person has a basis of practically zero because it has been in the family forever or 30 plus years.  They are not sophisticated and don't really understand the full value of their land.  Next up are the speculators.  These guys bought land 5-20 years ago hoping growth would come there way.  Their basis is higher, but they have no debt and don't have to do a deal if they don't want to.  The next group of land owners is the Investor who put together an LLC...

Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt II

Land is illiquid and for the most part does not generate income but does generate expenses. The exception being leasing land for someone to use for agricultural purposes. If the very nature of land is illiquidity, then what is its liquidity in the biggest real estate crisis since the depression? What is liquidity? Isn't liquidity the ability for a buyer and seller to meet at current market rates? Stocks for the most part are liquid because when I hit sell on my fidelity account someone else is on the buy side. With land, it is difficult to find a buyer at your price in a timely manner. How about now? How much is land really worth if you had to liquidate it today for cash. I believe as do many of the people in private equity, that land is down 50%, thus the land on builders books are down 50%. Bye bye equity.

Why Keep Telling A Joke That's Just Not Funny? Enter The NAR

For those who didn't catch it, I espoused my opinions of JP Morgan's overt optimism on CNBC a couple of months ago, and things are turning out exactly as  have stated with bank reserves being shoved into the accounting profit bucket just as the foreclosure pipeline is being backed up by robo-signing scandals which exacerbates the largely under appreciated shadow inventory problem (The 3rd Quarter in Review, and More Importantly How the Shadow Inventory System in the US is Disguising the Equivalent of a Dozen Ambac Bankruptcies!), MBS investors are demanding significantly increased put backs (see ) and "Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…"

Add all of this up and consider the junk portfolio of the subject bank in question as well as the tight knit incestuous circle of swap writers, and you have a recipe for disaster. Oh yeah, this is just the fallout from the mortgage operations of the Countrywide acquisistion. Keep in mind that although there a lot of CDS on BAC's books, the other swap category (TRS) illustrated in the video above is much more dangerous, particularly as it relates to this housing market.

Subscribers, reference pages 4,5 and 6 of Haircuts, Derivative Risks and Valuation to see how not only the housing and CRE market losses can affect this bank, but the losses on the TRS referenced in the video, or more aptly put, the potential failure of counterparties such as Bank of America Lynch[ing this] CountryWide to pay these "faux" hedges without another massive government bailout. You see this bank is a powder keg sitting atop a tinder box in a match factory with sparks flying all around it!

Let's move on to Merrill Lynch[ing], who was one of the biggest swap writers on the street, credit and total return. What do you think will happen to those swap lines as Europe implodes? Yes, I know many say Greece is not big enough to do damage, but that is said because many can't see the forest due to excessive tree bark in their face...

In French Banks Can Set Off Contagion That Will Make Central Bankers Long For The Good 'Ole Lehman Collapse Days! I made it clear that the French banks were the canaries in the coal mine that nobody hear chirping. At the time of the original analysis, no on was harping on the French banks, besides the BoomBust.

Another BIG Reason Why BNP Paribas Is Still Ripe For Implosion!

As excerpted from our professional series File Icon Bank Run Liquidity Candidate Forensic Opinion:

BNP_Paribus_First_Thoughts_4_Page_01

This is how that document started off. Even if we were to disregard BNP's most serious liquidity and ALM mismatch issues, we still need to address the topic above. Now, if you were to employ the free BNP bank run models that I made available in the post "The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download"" (click the link to download your own copy of the bank run model, whether your a simple BoomBustBlog follower or a paid subscriber) you would know that the odds are that BNP's bond portfolio would probably take a much bigger hit than that conservatively quoted above.  Here I demonstrated what more realistic numbers would look like in said model... image008image008image008

To note page 9 of that very same document addresses how this train of thought can not only be accelerated, but taken much further...

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So, how bad could this faux accounting thing be? You know, there were two American banks that abused this FAS 157 cum Topic 820 loophole as well. There names were Bear Stearns and Lehman Brothers. I warned my readers well ahead of time with them as well - well before anybody else apparently had a clue (Is this the Breaking of the Bear? and Is Lehman really a lemming in disguise?). Well, at least in the case of BNP, it's a potential tangible equity wipe out, or is it? On to page 10 of said subscription document...

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Thursday, 28 July 2011  The Mechanics Behind Setting Up A Potential European Bank Run Trastde and European Bank Run Trading Supplement

I identify specific bank run candidates and offer illustrative trade setups to capture alpha from such an event. The options quoted were unfortunately unavailable to American investors, and enjoyed a literal explosion in gamma and implied volatility. Not to fear, fruits of those juicy premiums were able to be tasted elsewhere as plain vanilla shorts and even single stock futures threw off insane profits.

Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In case the hint was strong enough, I explicitly state that although the sell side and the media are looking at Greece sparking Italy, it is France and french banks in particular that risk bringing the Franco-Italia make-believe capitalism session, aka the French leveraged Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

Subscribers, reference pages 1-4 and 5 of Haircuts, Derivative Risks and Valuation to see how the losses through European contatgion can compound the loan exposure problems of this bank and its likely TRS "faux" hedges (remember, its not really a hedge if it doesn't get paid), not to mention direct PIIGS exposure and holdings. Again, reference the video for potential failure of counterparties such as Bank of America Lynch[ing this] CountryWide to pay these "faux" hedges without another massive government bailout.

So, What's the Next Shoe To Drop? Read on...

For those who claim I may be Euro bashing, rest assured - I am not. Just a week or two later, I released research on a big US bank that will quite possibly catch Franco-Italiano Ponzi Collapse fever, with the pro document containing all types of juicy details. This is the next big thing, for when (not if, but when) European banks blow up, it WILL affect us stateside! Subscribers, be sure to be prepared. Puts are already quite costly, but there are other methods if you haven't taken your positions when the research was first released. For those who wish to subscribe, click here.

Now, let's refresh the output from And The European Bank Run Continues...and more importantly BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional, I strongly urge those who haven't to click upon said link and download your intellectual weapon of choice!) where I modeled Greek losses on BNP.  Below is sample output from the professional level model (BNP Exposures - Professional Subscriber Download Version) that simulates the bank run that the news clippings below appear to be describing in detail...(Click to enlarge to printer quality)This scenario was run BEFORE the Greek bonds dropped even further in price...

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This is the US bank that will SHOCK everybody with a most violent reaction when the excrement hits those cooling machine blades (subscribers only): US Bank Derivative Exposure

This is the European bank that either will set off the global chain reaction or end up being a very significant part of it (subscribers only): 

 

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I will be releasing the date (probably this week), location and time of
the NYC meet and greet within the next 24 hours or so, so we can chat,
drink, debate, argue and fraternize with pretty woman together in a
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BoomBustBlog on the MotherLand in the Hudson, NYC

BoomBustBlog on the MotherLand in the Hudson, NYC

  

BoomBustBlog in the 79th Street Boat Basin, NYC

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BoomBustBlog in the 79th Street Boat Basin, NYC

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