Zero Hedge

This time is different - Peak Facebook?

and notice that MySpace became ubiquitous considerably faster than Facebook.

and AH schizophrenia...

Some look at today's FaceBook IPO flop, the ongoing market rout, and the situation in Europe with disenchantment and disappointment. We, on the other hand, view it with hope: because more than anything, the events of the past few days show that the truth is getting out - the truth that capital markets simply can not exist under the authoritarian rule of central planners, the truth that the stock market is a casino in which the best one can hope for a quick flip, and finally the truth that our entire socio-economic regime, whose existence has been predicated by borrowing from the uncreated wealth of the future, and where accumulated debt could be wiped out at the flip of a switch if things go wrong in the process obliterating the welfare of billions (of less than 1%ers), is one big lie.

We believe that hope is what SocGen's Dylan Grice is what he has in mind when he penned the following conclusion to his most recent piece: La Grande Illusion.

Since the crisis broke in 2008, the Fed and BoE have printed enough money to buy over 60% of the issuance of their respective government securities since. It makes you wonder. What would bond yields in the US and the UK look like without these purchases? Probably like those in the eurozone periphery. Indeed, maybe the euro debacle could have been completely avoided if the ECB had been headed up by a Ben von Bernanke, or a Mervyn Le Roi. Maybe that’s why so many of my friends agree with Atlantic magazine, which praised Ben Bernanke for ‘masterfully navigating’ the financial crisis and avoiding another depression.

Maybe all the Anglo-Saxon central banks have done is create the illusion that our sovereigns are more solvent than they are, and that our budget constraints are really a safe distance away.

But I don’t think they are. And I think the truth gets out eventually. The Enrons, the Allied Capitals, the Bernie Madoffs … they all get their comeuppance. Indeed, it’s what’s happening today in the eurozone. The accounting shenanigans eurozone governments resorted to in order to meet the entry criteria have been found out. Or at least, current CDS prices correlate well with countries’ cumulative deficit manipulations in the run-up to monetary union, as estimated by Paul van den Noord and Vincent Koen at the OECD. You can’t escape your budget constraint with financial gimmickry. You can just make it look like you have for a while.

Because if there is at least one thing the central planners of the status quo do not have control over, it is just that: hope.

Just when we though that nobody would take advantage of the cover provided by the epic flame out of the FaceBomb IPO and the ongoing market crash, here comes Spain. Because there is nothing quite like a little Friday night action following a market drubbing and an "IPO for the people" shock in which to sneak the news that, oops, sorry, we were lying about all that austerity. Because while it came as a surprise to the market back in December when Spain announced it would post a 2011 budget deficit of 8.5% instead of the previously promised 6%, the market will hardly be impressed that Spain actually overspent by another €4.2 billion, to a brand new total of €95.5 billion of 8.9% of GDP. So Monday now has two things to look forward to: the Spanish bond margin hike on one hand courtesy of LCH.Clearnet earlier, and the fact that despite spending even more than expected, GDP growth has disappointed and the country is now officially in a double dip. Hardly what the country with the record wide CDS needs right now.

From Reuters:

Spain was forced to revise its 2011 budget deficit upwards on Friday, after three of the country's regions restated their own figures, exposing the struggle the autonomous communities have had curbing spending even ahead of deeper cuts this year.

Spain said its 2011 public deficit now came in at 8.9 percent of gross domestic product, up from the 8.5 percent initially stated. The country had already widely overshot its deficit target of 6 percent for last year.

The country's treasury department, which disclosed the new figure late on Friday, said Spain was sticking by its 2012 budget deficit target of 5.3 percent of GDP, despite the setback with last year's numbers.

The move came after three of Spain's 17 regions - Madrid, Valencia together with Castilla and Leon - earlier revealed in their budget plans for this year that their own 2011 budget deficits were higher than initially stated.

The central region of Madrid said it finished 2011 with a deficit of 2.2 of gross domestic product, rather than the 1.13 percent it had initially released. Valencia's budget deficit came in at 4.5 percent at the end of 2011, instead of 3.78 percent.

Castilla and Leon's deficit was also slightly higher than previously stated.

The three regions are among the most important in Spain - Madrid is the second largest by GDP, and Valencia the fourth.

Though the autonomous communities have already struggled to rein in spending, deeper cuts now loom, after the central government on Thursday approved their plans to cut spending by 13 billion euros ($16.54 billion) and increase revenue by 5 billion euros.

Of the 17 highly-devolved regions, only Asturias, in the north-west of Spain, had its budget rejected, meaning it will have to present a new one for approval.

The communities' commitment to savings this year will be crucial for Spain to get its overall budget on track.

Fitch said on Friday the government's approval of the regions' budget plans was positive, adding that the willingness of autonomous regions to pass structural reform had increased, but warned there was still a risk they could yet miss 2012 targets.

"We ... expect the central government to put considerable pressure on the regions to cooperate," the rating agency said. "Nevertheless, in the current economic context we consider that there is a risk that potential reforms might have a limited impact on 2012 accounts."

In other words, more rating agencies, downgrades, which as we explained a month ago means that if all rating agencies have Spain at BBB+ or below, the ECB will demand another 5% collateral for bonds posted as repo. Add that to the toxic spiral of LCH bond margin hikes, and things start to look rather bleak.

But saving the best for last:

The change comes as Spain is racing to restore confidence in its banks
and reassure investors spooked by euro zone fears that it can meet
ambitious spending targets.

Mmhmm.

Submitted by Casey Research

In an interview with Louis James, John Hathaway discusses the US's economic outlook and why he's delighted by the current bearish sentiment toward gold.

Louis James: Ladies and gentleman, thanks for tuning in. We're at the Casey Research Recovery Reality Check Summit. We're talking with John Hathaway, one of the more successful fund investors – institutional investors – in our precious metals field near and dear to my heart. John, can you give us a quick version of what you talked about here, for those who didn't make it to the conference?

John Hathaway: Sure, yes. I think we're at the end of a correction that resulted from the peak last summer. It was overcooked, kind of hyperventilated hysteria over the debt-ceiling talks, the rating downgrade of the US sovereign debt, and I think basically the stocks and the metal had been working off that boiled down to what we now have is a simmer. I think we are at a position where there's not a lot of downside, and I would not be surprised by revisiting the previous highs of $1,900 and maybe even new highs over $2,000 this year.

What will do that is basically – so much of the narrative has been quantitative easing. When Bernanke announced on the 29th of February that they were done with quantitative easing (and if you believe that I've got a bridge to sell you, but for the time being let's assume that there won't be any), I was very impressed that gold did not go to a new low. It printed somewhere below $1,600 at the end of the year, made a couple-of-day swoon, but it didn't go to a new low. And then when the Fed minutes came out it also did not go to a new low, it kind of reiterated what Bernanke said. So the narrative may be changing. I'm not ruling out quantitative easing as a possibility, but there are things out there that gold might be looking at that the CNBC mentality hasn't figured out.

Remember that gold rose for many years before we even heard of quantitative easing; it was in a steady uptrend. So what could those things be? What would take gold – what would be the new headlines that might take gold to higher highs? To me, the biggest thing is that the Federal Reserve has purchased something like 61% of all new Treasury debt in the last year; and if they aren't going to continue that, then what's going to happen to rates?

Louis: Right.

John: The Chinese – who had been big supporters because they were rigging their currency – have not been generating foreign exchange to anything like the extent they were, so their participation rate in Treasury auctions has gone way down. If you look up the TIC numbers, foreign buying of Treasuries has dropped precipitously, so you have the two biggest pillars of support for keeping rates low in question here, and let's see what happens on June 30th. If you don't have a political buyer, either the Chinese and foreign buyers who are manipulating currency, and the Fed because they said they aren't going to do it, what are rates going to do?

If you are going to get a risk-free return inflation-adjusted today that's not politically motivated, it's got to be somewhere around 4-5% on the short end of the curve. Every hundred basis points adds a huge amount to the budget deficit, so to me we're in a real trap here, where it's going to be a game of chicken as to whether the Fed can really live up to what Bernanke said on the 29th.

Louis: Isn't that really the bottom line? They can't allow that interest rate to rise with the debt outstanding –

John: It seems very difficult. The recovery, the alleged recovery that we had, is very… I'll grant that things are better than they were a year ago or two years ago, but you'd have to call it feeble at best and maybe not sustainable. That's one thing that I think could affect the gold market.

The second thing, and I think it's very important too, is that inflation is rising. Even though the economy is soft, the number I look at – and I know we're going to have John Williams speak at lunch, and we know he has a very good take on it – is the MIT Inflation Index, because that's real-time pricing of billions of products. You can get to that website just by googling "MIT Inflation Project"; and that does not include services. Most of the services I take are inflating at more than 5%; they are closer to 10%. But goods that could be measured in real time are rising at 5%, so that's also going to be a factor. That means if rates stay where they are, the Feds are just going to be that much more behind the curve.

So those are two things; and the third thing is that there's $1.5 trillion of liquidity in the system that should the recovery – and I'm not a macro forecaster, but let's say the recovery does sustain itself – you've got $1.5 trillion of free reserves that could just turn into money supply. Then you really would have a potentially hyperinflationary scenario, and the Fed would be completely powerless to do anything about it. So I think that's bullish for gold – gold is not backward looking, it basically looks forward. I can go on and on. You've got the European unresolved sovereign debt crisis in Europe.

Louis: Let me jump in with a question about this, then. You've stood out really from the crowd in that most people agree on the general prognosis for gold. Most people are sort of near-term bearish, you know, the ones –

John: It makes me so happy.

Louis: [Laughs] But, you know, once a bear sentiment sets in, it seems to almost have its own momentum.

John: Yes.

Louis: You're the only who's saying "I think we're near the bottom." Most people are saying, "Sell in May and go away" –

John: Yes, I heard a couple of things from this session that just made me want to jump up and buy –

Louis: I understand the contrarian reason for that, but can you tell our audience a couple of reasons why you think we might be near the bottom or why you're ready to buy now and not waiting to see how this summer turns out?

John: Sure. Well, first of all, I'm not a trader. I mean, I'm long, and last summer I thought, "Gee, this is really a little spooky, we're not at a sustainable level," but there wasn't a whole lot I could do about it. And here we are and we have some cash, we have some inflows, so we are able to put money to work. And what is it that makes me think we're there? Sentiment numbers are extremely negative, historically, when they've gotten to these levels. By the way, I put out a quarterly newsletter now that has a lot of this data, which can be found on our website.

Louis: Go ahead and give us the website.

John: It's the Tocqueville Asset Management website, and it should be fairly easy to find. So sentiment is at levels that have been associated with big rallies. Traders' commitments, net longs, net spec longs are way, way down there. I look at that a lot just as a way to see where the market is positioned. The guys who can create some volatility are not there, and so if gold starts moving, they won't want to miss it, and so they'll come in. And then, we've looked at some technical stuff. I'm not a technician but most of what I see from a technical perspective is extremely constructive. So I put those things together.

Sentiment is rock bottom. COMEX traders' commitments are very, very constructive, and technical things that we look at are very constructive. So I would say all of those things, plus hearing these guys say that they are not going to step in – that's more anecdotal, but that to me is just very, very positive. So I – frankly I don't stake my reputation the way that Dennis Gartman does on making trading calls, but just as an experienced observer of this market for some number of years now, I think we're ready to make a move higher.

Louis: Okay, well, thank you very much. Word to the wise.

John: Thank you.

Forget that S&P 500 e-mini futures plunged to four-month lows at 1290; or Treasury yields crashed back to their record lows; or Gold and Silver's surge today; or WTI's plummet to almost a $90 handle; or Citi joining Morgan Stanley in the red year-to-date; or credit markets continuing into the red for the year; or IG9 10Y soaring further to 160bps - widest in 6 months; or VIX closing above 25% for the first time in 5 months (and decompressing to Europe's pain). Today was all about one thing - the disaster that was/is/and will be Facebook - between late openings, overwhelmed systems, a dump to the syndicate bid and almost 600mm shares traded with the syndicate just soaking it all up at $38.00 early and into the close. Is it any wonder that every other social media stock plunged and how do they expect to ever get another internet IPO off again (at anything but a massive discount). No matter what correlation trick was tried to juice markets today - for the tenth day-in-a-row markets saw a BTFD turn into a STFR. Not a pretty end to the ugliest week in six month for the S&P 500 as it nears its 200DMA into the close.

Facebook...

and (h/t Dennis Dick) for the following visual of the HFT tractor beam in FB...

And the massive dominance of the syndicate bid (as who else could it have been) is clear in this chart of the volume profile for today...with Facebook's VWAP perfectly at $40 by the close...

Morgan Stanley = Zuckerpunched

FB needs to be Re-IPOed as the entire float is now held by MS again

— zerohedge (@zerohedge) May 18, 2012

And the S&P 500 e-mini  futures SNAFU continues...

Utilities, Energy, and Materials are all now down YTD with Industrials close...

Gold had quite a week...

and longer-term stocks are catching up to risk-assets (proxied here by CONTEXT)...

And corporate bonds (dark red below) are now starting to get hit by the selling in the indices...

A quick run down of the day's events from Bloomberg TV:

Finally, this is what happens, Larry, when due to lack of real demand, you sell the second largest IPO in history to 25% retail, which has absolutely no idea how to trade a $100+ billion company and preserve the illusion of the ponz.

Charts: Bloomberg and Capital Context

The social bubble may be on the verge of popping, but that doesn't mean that various soon to be extinct offshots can't provide cheap bang for the taxpayer buck. Such as this particular offer which we are fairly certain the Chairman, with Willem Buiter whispering in his ear, is taking a long, hard look at...

h/t Omid Malekan

Unless Greece chooses to leave the Euro area, which JPMorgan doubts will happen, the rest of the region will have to push Greece out. The mechanism for this will be the ECB excluding the Greek central bank from Target2, the regional payments and settlement system. Although this might look like a technical decision about monetary plumbing, the ECB will elevate this to Euro area Heads of State. 

There is understandably a lot of interest in the mechanics of how a possible Greek exit from the Euro would play out in relation to the ECB. Reports of significant deposit withdrawal from Greek banks also direct attention toward the support for Greek banks coming from the Greek Central Bank and the Eurosystem. And yesterday’s announcement by the ECB of restricted access to regular repo Eurosystem financing for a number of Greek banks adds some more complication. Though we would not place a lot of emphasis on what the ECB announced yesterday as a signal of broader attitudes toward Greece, understanding the mechanics matters more broadly.

The view from the asset side…

Let’s start by considering the asset side of the Greek Central Bank’s Balance sheet (This is the less interesting part of the story, in our view).

If the Greek central bank makes loans to Greek banks under standard ECB repo terms, the credit risk on such loans is (under current law) shared across the Eurosystem. Regular repo operations against “extended collateral” see the credit risk transferred to the Greek central bank. And if the Greek central bank makes loans under ELA, the credit risk stays with the Greek central bank.

In the event that Greece were to leave the Euro area, any possible losses on ELA loans to banks and repos against extended collateral accrue to the Greek central bank.  What would happen to any losses on regular repo operations in the context of euro exit is much more hazy. Greece may claim legal  grounds that any losses should be shared. But since EMU exit would be a material breach of existing legal treaties, it is tough to argue that existing legal provisions would necessarily carry much weight. There would probably have to be some negotiation over any losses that accrue down the line.

The ECB’s decision yesterday to limit the access of Greek banks to regular repo financing, forcing more use of ELA, reflects the fact that the banks and the Greek authorities are still haggling over the terms on which they are recapitalised. The ECB’s position is that until the capital goes in, the banks are not fully solvent, hence lending to them goes via ELA, not regular repos. On the one hand, this puts pressure on the Greeks to stop haggling on the recap terms. On the other hand, some may argue that it demonstrates that the ECB is keen to limit the system’s exposure to Greece as a whole, pushing the loans to ELA where necessary, where Greece has no legal comeback at all for losses. We think the first of these is more important.

The view from the liability side….

If we now think about the liability side of the Greek central bank balance sheet: the story gets more interesting. The Greek central bank creates euros when it grants loans to Greek banks via either repos or ELA. In the first instance, these show up as reserve holdings by the Greek banks at the central bank when the euros are credited to their account. But with euros leaving the Greek banking system, Greek banks lose reserves as transactions are settled through the payments system. As Greek bank’s reserves  fall, this is replaced by a liability to the Target2 payments system for the Greek central bank. The Greek central bank’s liability to the rest of the Eurosystem via Target2 is currently near €130bn. As we move toward the Greek election next month, that is likely to climb given deposit flight. But we expect the ECB will do all within its power to keep the Greek banking system afloat until the election, even if some of the loans to Greek banks are redirected via ELA. The terms of ELA can be stretched so that Greek banks do not run out of collateral, while banks can issue bonds to themselves backed by a government guarantee to create more collateral.

How Greece could get cut off from Target2

But a much more challenging question is what happens after the election. Let’s imagine Syriza is able to form a government, declares a debt moratorium, and antagonizes the rest of the region by rejecting the Troika programme in its entirety. Even with no further disbursements of official loans, the region’s loans to Greece via the target 2 system will be continuing to grow. Loans from the Greek central bank to Greek banks would be almost completely forced into ELA.

The ECB can “shut off” the Target2 loans if it exercises its veto over ELA loans (requiring a two-thirds majority on the Governing Council), and if the Greek central bank respects that veto. But the Greek central bank would likely be faced with the need to impose very restrictive controls on Euro deposits to limit outflows if ELA loans to Greek banks cannot be made. If the Greek central bank is faced with the prospect of imposing capital controls, a collapse of the Greek banking system, or defying the ECB’s veto on ELA loans, what route would it take? If it chose the latter, the only way for the ECB to “shut off” the Target2 loans would be to prevent Greek access to the payments system itself, refusing to accept payments of euros to and from Greek banks. At that point, Greek created euros are no longer euros. That decision would not be made by the ECB alone, but would likely be deferred to European Heads of State.

Submitted by Lance Roberts of StreetTalk Advisors

Risk Ratio Indicating More Correction Coming

The current market correction should not come as a surprise to any one. There has been consistent and substantial evidence that the rally that began last October was unsustainable. We discussed the coming correction beginning in March (see here, here, here and here ). The question now is becoming whether the current correction is over or is there more to come?

It always fascinates me to watch the media during market rallies as the bullish sentiment takes hold. There is never a word of caution offered to investors that the risks of investing are rising and some caution should be taken. It is "always" a time to buy and never a time to sell. However, this is absolutely contrary to the basic premise of investing which is to "buy low and sell high." Therefore, as investors, we are left on our own to determine when it is "...a time to reap and a time to sow." Whether you are a trader, or a long term investor, the idea of portfolio management is the same. A portfolio, like a garden, will prosper only when it is cared for by weeding (selling losers), watering (making consistent contributions) and pruning (taking profits). A well-tended garden will produce bountiful harvests while an untended garden will eventually succumb to the weeds.

Bob Farrell's rule #9 is: "When all experts and forecasts agree — something else is going to happen." This statement encapsulates the basic tenant of being a contrarian investor. As Sam Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to buy? If everybody's pessimistic, who's left to sell?"

Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is the darkest. However, being a seller in exuberant markets or a buyer in major rout is very tough, if not impossible, for almost every investor as the emotions of "greed" and "fear" overtake logical buy and sell decision making.

In order to measure the "greed" and "fear" syndrome I have taken the most common measures of investor sentiment including the volatility index, new highs versus new lows, two different polls on bullish versus bearish sentiment and the rate of change of the S&P 500 index and using weekly data combined them into a single "risk ratio."  The reason I used weekly data rather than daily data was to smooth out the day to day volatility of the markets to focus on trend changes in the market.  The risk ratio functions as an oscillator with it rising as investors become more bullish and vice versa.  What is important to notice is that the sentiment ratio generally starts turning down before the market actually peaks.  This ratio has been a key driver of recent commentary warning about the coming correction.

If we lay out the "risk ratio" in bands we can more clearly see what actions need to be taken after various points during the oscillation cycle.  With the oscillator in the upper band and turning down it has clearly been a sign to reduce overall portfolio risk.  While the market is clearly oversold on a short term basis, and very overdue for a bounce, the risk ratio dictates that the bounce should be sold into as the longer term correction is most likely not completed as of yet.  Generally, the best buying opportunities have occurred when the risk ratio has gone from "bullish alert" or "extreme bullish" to the opposite extreme. Most importantly, it is critical to note that the buying opportunity does not come until there is a turn up in the ratio from the previous decline. 

The current down turn in the risk ratio signifies that the current correction is still in progress and will likely continue for at least several more weeks.  However, as I stated above, the market is currently extremely oversold on a short term basis and will likely have a very strong counter trend rally to work off the daily oversold condition.  The current market is acting very similarly to what we saw in 2011 as a potential debt ceiling debate and Eurocrisis loom.  This opens the door to further weakness in the weeks to come.

The one aspect that can not currently be accounted for, which could quickly reverse this analysis, is the introduction of additional stimulative programs by the Fed. While I currently have little doubt that we will see further easing programs - I do not think that they will come about until we see further economic weakness and a more substantial market decline which would give the Fed the "permission" it needs to take action.

Reiteration Of What To Do Now

As we discussed in yesterday's article "Confirmed Sell Signal Approaches" we stated:  "We will want to sell into any reversal that takes us back to previous support levels that have now turned into resistance. Currently, those levels will be 1350, 1360 and 1375ish. Do not get hung up on specific numbers - these are general areas where you want to start raising cash. If the markets are able to rally above those levels we will update our commentary at that time.

The recommended course of actions are:

1. Liquidate weak and underperforming positions as the market approaches the 1350 and 1360 levels.
2. Rebalance winning positions by taking profits and resizing positions back to original weights at the 1350 and 1360 levels respectively.
3. Look for rotation into precious metals as a "safe haven" investment which is currently very oversold.
4. Short duration fixed income is still an alternative as rates will likely remain under pressure from the rotation out of stocks.
5. Be careful with dividend yielding stocks — while they will likely hold up during a correction they are already overbought in many cases.
6. Our call to buy bonds over the past month has played out well. They are currently overbought and extended. Hold current positions but be selective on new additions at this time. Wait for a move in interest rates to 2.2% on the 10-year treasury before aggressively adding more.
7. Hold cash for a buying opportunity when the next "buy" signal becomes apparent."

Remember, it is the psychology of market participants that ultimately drive prices higher and lower as they respond to the external stimuli of the economic, fundamental or political landscape. This is the value of the "risk ratio" indicator in measuring those "fear" and "greed" factors. 

The most important asset destroyed by reversion processes is "time."  It is the one commodity that you have a very limited supply of and no ability to replace.  By using tools to measure, analyze and understand the environment that we face today, and will continue to face in the future, can help us make better decisions in both our planning and investment process.  The management of the many inherent investment risks is critical to long term survival.  For individuals it is important to recognize that the "return of capital" is always far more important that the "return on capital"

Nothing could be more appropriate than topping a week of surreal newsflow than what just happened with the EURUSD, which soared by 80 pips on absolutely non news, in what can be attributed to either some algo going apeshit and lifting every offer, a fat finger, or just the tried and true Bank of International Settlement stop hunt seeking to send correlated risk assets higher courtesy of a spark in upward momentum. Sadly today not even this glaring attempt to jump broad risk into the stratosphere is working. And ahead of a weekend where it is rumored Europe may reopen on Monday, we can't wait for the inevitable snapback.

What we do know for certain is that what is not driving the EUR higher, is news of another semi-bank run in post bank-downgrade Spain, only this time not at nationalized Bankia, but at Banco Santander. From the WSJ:

Banco Santander SA's SAN.MC +2.97% U.K. unit lost about £200 million of deposits on Friday as jittery customers worried about the lender's financial health, according to a senior executive.

The deposit outflows on Friday, amounting to about $316 million, represented roughly 0.2% of Santander UK PLC's total customer deposits, said Steve Pateman, Santander's head of U.K. banking. Those deposits stood at £120.1 billion at the end of last year.

"We had a modestly negative day," Mr. Pateman said.

Santander UK has spent the day scrambling to soothe anxious depositors. Customers apparently are nervous about the British bank's vulnerability to Spain and its fragile banking system, and were further rattled by news coverage of a downgrade of the bank's credit rating late Thursday by Moody's Investors Service.

Customers have been visiting Santander branches and calling customer-service agents to discuss the bank's financial situation, Mr. Pateman said. Branch managers are explaining to them that Santander UK is fully independent of its Spanish parent and that the U.K. bank benefits from strong supervision by the U.K.'s Financial Services Authority, he said.

Mr. Pateman said about 70% of customers who visited Santander UK branches on Friday to discuss their concerns left without withdrawing their funds. The other 30% couldn't be convinced, he said.

"They say, 'I got caught by Northern Rock and I don't want to get caught again'," Mr. Pateman said. Northern Rock is a British bank that collapsed in 2007.

Instead of his usual rant, Charles Biderman of TrimTabs discusses the reality of the macro environment with Madeline Schnapp - though do not worry as the sense of sarcasm and disbelief at the government's actions and hopes is palpable. Noting that our economy is at best growing 'sluggishly' based off her real-time macro data,  Biderman's right hand goes on to explain to him that inflation is running hotter than the government would like us to believe. More importantly, she hits the nail on the head with regard to what Biderman notes is the wasted stimulus money, saying that the economy needs to clear the malinvestments, not sustain them through stimulus transmission mechanisms, in order for growth to once again re-appear. Historically QE2 did manage to create some inventory restocking and pick up in wages/salaries in Q1 2011 but Operation Twist appears to have little to no impact on the real economy (outside of government statistical modelers) - which as we have said before indicates the diminishing returns to government intervention. What is clear is that, as we have noted, that post the 1971 modified gold standard, over a long-period of time it has taken an 'unsustainably' increasing amount of government debt to create economic growth - with the post-2008 insanity that we need $2.50 to create $1 of economic growth. The two end with a discussion of the debt ceiling and deficit potential for a black swan event.

Chart: TrimTabs

Submitted by John Aziz of Azizonomics

The Face of Genocidal Eco-Fascism

I am not exaggerating.

This is Finnish writer Pentti Linkola — a man who demands that the human population reduce its size to around 500 million and abandon modern technology and the pursuit of economic growth — in his own words.

He likens Earth today to an overflowing lifeboat:

What to do, when a ship carrying a hundred passengers suddenly capsizes and there is only one lifeboat? When the lifeboat is full, those who hate life will try to load it with more people and sink the lot. Those who love and respect life will take the ship’s axe and sever the extra hands that cling to the sides.

He sees America as the root of the problem:

The United States symbolises the worst ideologies in the world: growth and freedom.

He unapologetically advocates bloodthirsty dictatorship:

Any dictatorship would be better than modern democracy. There cannot be so incompetent a dictator that he would show more stupidity than a majority of the people. The best dictatorship would be one where lots of heads would roll and where government would prevent any economical growth.

We will have to learn from the history of revolutionary movements — the national socialists, the Finnish Stalinists, from the many stages of the Russian revolution, from the methods of the Red Brigades — and forget our narcissistic selves.

A fundamental, devastating error is to set up a political system based on desire. Society and life have been organized on the basis of what an individual wants, not on what is good for him or her.

As is often the way with extremist central planners Linkola believes he knows what is best for each and every individual, as well as society as a whole:

Just as only one out of 100,000 has the talent to be an engineer or an acrobat, only a few are those truly capable of managing the matters of a nation or mankind as a whole. In this time and this part of the World we are headlessly hanging on democracy and the parliamentary system, even though these are the most mindless and desperate experiments of mankind. In democratic coutries the destruction of nature and sum of ecological disasters has accumulated most. Our only hope lies in strong central government and uncompromising control of the individual citizen.

In that sense, Linkola’s agenda is really nothing new; it is as old as humans. And I am barely scratching the surface; Linkola has called for “some trans-national body like the UN” to reduce the population “via nuclear weapons” or with “bacteriological and chemical attacks”.

But really he is just another freedom-hating authoritarian — like the Nazis and Stalinists he so admires — who desires control over his fellow humans. Ecology, I think, is window-dressing. Certainly, he seems to have no real admiration or even concept of nature as a self-sustaining, self-organising mechanism, or faith that nature will be able to overcome whatever humanity throws at it. Nor does he seem to have any appreciation for the concept that humans are a product of and part of nature; if nature did not want us doing what we do nature would never have produced us. Nature is greater and smarter than we will probably ever be. I trust nature; Linkola seems to think he knows better. As George Carlin noted:

We’re so self-important. Everybody’s gonna save something now. Save the trees. Save the bees. Save the whales. Save those snails. And the greatest arrogance of all, save the planet. What? Are these fucking people kidding me? Save the planet? We don’t even know how to take care of ourselves yet. We haven’t learned how to care for one another and we’re gonna save the fucking planet?

There is nothing wrong with the planet. The planet is fine. The people are fucked. Difference. The planet is fine.

Linkola and similar thinkers seem to have no real interest in meeting the challenges of life on Earth. Their platform seems less about the environment and more about exerting control over the rest of humanity. Linkola glories in brutality, suffering and mass-murder.

Now Linkola is just one fringe voice. But he embodies the key characteristic of the environmental movement today: the belief that human beings are a threat to their environment, and in order for that threat to be neutralised, governments must take away our rights to make our own decisions and implement some form of central planning. Linkola, of course, advocates an extreme and vile form of Malthusianism including genocide, forced abortion and eugenics.

But all forms of central planning are a dead end and lead inexorably toward breakdown; as Hayek demonstrated conclusively in the 1930s central planners have always had a horrible track record in decision making, because their decisions lack the dynamic feedback mechanism present in the market.  This means that capital and labour are misallocated, and anyone who has studied even a cursory history of the USSR or Maoist China knows the kinds of outcomes that this has lead to: at best the rotting ghost cities of China today, and at worst the mass starvation of the Great Leap Forward resulting in millions of deaths and untold misery.

Environmentalists should instead pursue ideas that respect individual liberty and markets. There is more potential in developing technical solutions to environmental challenges than there is in implementing central planning.

If we are emitting excessive quantities of CO2 we don’t have to resort to authoritarian solutions. It’s far easier to develop and market technologies like carbon scrubbing trees (that already exist today) that can literally strip CO2 out of the air than it is to try and develop and enforce top-down controlling rules and regulations on individual carbon output. Or (even more simply), plant lots of trees and other such foliage (e.g. algae).

If the dangers of non-biodegradable plastic threaten our oceans, then develop and market processes (that already exist today) to clean up these plastics.

Worried about resource depletion? Asteroid mining can give us access to thousands of tonnes of metals, water, and even hydrocarbons (methane, etc). For more bountiful energy, synthetic oil technology exists today. And of course, more capturable solar energy hits the Earth in sunlight in a single day than we use in a year.

The real problem with centrally-planned Malthusian population reduction programs is that they greatly underestimate the value of human beings.

More people means more potential output — both in economic terms, as well as in terms of ideas. Simply, the more people on the planet, the more hours and brainpower we have to create technical solutions to these challenges. After all, the expansion of human capacity through technical development was precisely how humanity overcame the short-sighted and foolish apocalypticism of Thomas Malthus who wrongly predicted an imminent population crash in the 19th century.

My suggestion for all such thinkers is that if they want to reduce the global population they should measure up to their words and go first.

FHA insured loans have been a big booster for the current market.  Historically FHA insured loans made up roughly 8 to 12 percent of all mortgage originations but in 2009 they hit 30 percent.  For first time home buyers it was a stunning 50 percent showing that most people can only purchase a home today with a very small down payment.  Yet small down payments create instant negative equity positions if the market moves sideways or pops lower (aka our current market).  For example, the 3.5 percent standard FHA down payment is wiped away by the 5 to 6 percent selling costs.  What is interesting with this is that the FHA insured loan market is fully backed by the government (i.e., you) so any losses will be completely shouldered by the public.  The move to increase premiums recently was no fluke.  One piece of data that stood out to me was of the number of homes in negative equity, how large the FHA numbers grew.

FHA insured loans 1 out of 4 underwater mortgages

A very troubling point showing a morphing of the current market is the number of underwater mortgages backed by FHA insured loans.  As stated before, many of these loans were originated after the bubble popped in 2006 and 1 million originated only in the last two years:

Source:  Federal Reserve, 2012 report to Congress

This data is coming straight from a Federal Reserve report given to Congress this year.  The issues arise from the overall weak economy and the fact that employment growth has been weak across the nation.  Take a look at this example:

“(Business Financial Post) Opalka was refinancing another FHA-backed loan he had obtained in 2008, for $196,000, then at an interest rate of over 6%.

Under the refinancing, he borrowed $192,278 at an interest rate of 4.5%. Opalka, looking at the paperwork, is still surprised at the down payment he had to make in 2010, for a property valued at the time for little more than the loan was worth and in which he had almost no equity.

His down payment was just $3,000 – or about 1.5% of the total loan.

Less than two years later, local real estate estimates now value Opalka’s home at no more than $110,000.”

In this case, this borrower only had to go in with $3,000 to refinance his loan (1.5%).  The home took on a new $192,278 loan but now two years later is valued at $80,000 less.  Just one of the 3,000,000 FHA insured loans underwater.  Do you think this borrower is in good shape?  How motivated will they be to saddle up and keep making payments on a home that is underwater by $80,000?  No wonder why default rates on FHA insured loans are soaring:

An expert that closely follows this market is Edward Pinto and he has a monthly “FHA Watch”:

Some key lending standards are provided:

“1. Step back from markets that can be served by the private sector by taking steps to return to a traditional 10 percent home purchase market share.

2. Stop knowingly lending to people who cannot afford to repay their loans. 9

3. Help homeowners establish meaningful equity in their homes.

4. Concentrate on homebuyers who truly need help purchasing their first home.”

There is so much nonsense with FHA insured loans.  First, most are using these as low down payment entry points.  The median down payment is 4 percent contrary to the deception that was being preached years ago that most people were coming in with large money.  Next, by rolling in the large insurance premiums you are basically financing the debt into the loan making it more expensive to supposedly “lower income” buyers who need more help.  Any doubt why 3,000,000 FHA insured loans now are underwater?  This has a little taste of the Alt-A and option ARM variety.

Finally, the average FHA borrower accumulates 7 percent in equity in their home during their first four years of owning the home.  In other words they barely break even when they sell and this is assuming the market doesn’t shift even slightly lower which it has over the last few years.  Ironically the FHA would be in full bailout mode right now if it weren’t for them squeezing the vice on new borrowers going in with bigger premiums.

The deception is strong in this market.  I love the news that one of the GSEs turned a profit although the bailout costs are still in the hundreds of billions!  Give me $200 billion and I’ll turn you a $2.7 billion profit tomorrow.  With this kind of math, no wonder why we are going to face another bailout with FHA insured loans.

Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.

Well, better late than never.

Note: these are not our trades.

A few days ago we suggested that this action by LCH.Clearnet was only a matter of time. Sure enough, as of minutes ago the bond clearer hiked margins on all Spanish bonds with a duration of more than 1.25 years. Net result: the Spanish Banks which by now are by far the largest single group holder of Spanish bonds, has to post even more collateral beginning May 25. Only problem with that: it very well may not have the collateral.

And as a reminder: Ponzi PatriotismTM

Finally, tying it all together is our post from late April, titled The Next Circle Of Spain's Hell Begins At 5% And Ends At 10%:

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate.

The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity).

The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.

UBS: A 10% Tipping Point

Greater ECB use defers the point at which a sovereign or bank faces a funding challenge, but accelerates the point at which a return to private market financing is unlikely without external support. We continue to see a level of 10% of funded assets financed at the central bank as a tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. Spain’s system just passed this figure, reaching 11% with the most recent announcement of ECB drawings

And a 'bad bank' ahead...

We believe that Spain will need an EU program to raise sufficient funds for what we believe needs to be significant further support for its banks and to provide external verification to regain credibility in the resulting financial system. A ‘bad bank’ to deal with the €323 billion in real estate assets is necessary, but not sufficient, in our view: the €545 billion shortfall in domestic savings compared with loans is likely to demand a “funding bank” in addition. We would view the likely loss content of this large headline to be a significant but smaller €100 billion.

Nomura: De-linking sovereigns and banks is key to stabilising markets

The most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view. Reducing the link between Spanish banks and the sovereign remains one of the key aspects for relieving pressure on Spain, whether this be by removing sovereign debt from balance sheets or ensuring sufficient capitalization to absorb losses. Unemployment out this morning at 24.4% shows the fragile state the economy is in, which is likely to keep pressure on Spanish yields. Against this backdrop the effect on the asset side of balance sheets is concerning, with expected weakness in non-core government bond prices coupled with a weak economy decreasing individuals' and corporates' ability to repay

If all agencies downgrade Spain to BBB+ or below, the ECB could increase haircuts by 5% on SPGBs

The key aspect in terms of the Spanish downgrade(s) is the ECB's LTRO. If all three rating agencies move Spain to BBB+ or below then under the ECB's current framework it moves into the Step 3 collateral bucket which requires an additional 5% haircut across the maturities. In classifying its risk management buckets, the ECB uses the highest of the ratings to determine an asset's position (unlike the sovereign benchmark indices which use the lowest rating, in general). Fitch and Moodys currently rate Spain at A and A3 respectively, with both having a negative outlook in place leaving only a small downgrade margin before Spain migrates to the lower ECB bucket.

Italy's position is marginally more precarious in that it shares Spain's A3 rating from Moody's but is rated lower at A- by Fitch, and is similarly outlook negative from both agencies. One would hope ECB pragmatism would prevail and move to be more accommodative on its collateral haircut rules on sovereign debt.

The weakness of the eurozone's growth outlook is undermining the efforts of many sovereigns to rein in budget deficits, thereby highlighting the self-defeating nature of the fiscal compact as currently defined. Including the political impact, this has potential to lead to further downgrades

LTRO funding is not suitable when collateral values are unstable LTRO, like all repo funding, should only have been implemented with quality assets to avoid excessive margin calls. In 2009-10, when the operations were used to good effect, the majority of European sovereign assets were still perceived to be 'risk free'. 5-year SPGBs rallied from 4.95% in mid-2008 to 2.62% in December 2009 and non-performing loans were at roughly half of their current levels. In 2009, despite economic weakness, risk had generally been contained through continued fiscal programs, and with the ECB providing continued cheap funding it was sufficient to allow some normalization. The key difference between then and now is that sovereigns no longer have the ability to utilize the fiscal side. When the ECB announced the twin LTROs at the end of last year the sovereigns were clearly in a different state from 2009.

If the ECB believes in the mandated reforms it should be comfortable with warehousing sovereign risk

If the ECB believes in the currently prescribed course of reforms and their implementation it should have little issue with holding a major sovereign's collateral on its balance sheet. Taking this a step further, the ECB is generally concerned with moral hazard, which along with subordination, is likely also a reason why we have yet to see the SMP program buying bonds recently. But this is a double-edged sword in that it gives investors little confidence in the sovereigns' recovery prospects if the central bank appears to be in internal turmoil and is showing no action besides utilizing measures that are more suited to a strengthening market. One of our common refrains during the crisis is that moral hazard should not frame the reaction function of central banks. Rather, the over-riding and immediate objective of policymakers during a crisis needs to be avoiding non-linear or dual equilibrium risk. This requires aggressive and bold policies to be enacted. Europe's policymakers have notably failed on this front, and, hence, we have a crisis that has entered its third year.

The ECB’s discomfort is no comfort to investors, eroding confidence

The key question remains in Spain as to who is the marginal buyer of debt beyond the domestic banks and primary dealers. Although the Spanish Treasury has sold a significant amount of its 2012 requirements, as things currently stand the country faces a multi-year funding problem. The extent to which domestic savings filtering through to bond buying is limited given that the general level of savings is likely at its limit. Banks, Santander and BBVA, have also said that they have no more capacity for further sovereign bond purchases given they are at the limit of their risk concentration limits (link), which we think was rather diplomatically put. One risk is that domestic institutions shorten their SPBG holdings and focus more on bills, which would likely be unaffected by any debt restructuring.

We will see a worse situation before any meaningful response is produced by the ECB: QE

Our view is that things will get significantly worse before any meaningful policy response occurs. From the ECB?s perspective this entails pre-announced QE in a size which is commensurate to the problems faced. If the ECB believes in the actions taken by sovereign governments, which it has largely mandated, then its current responsibility is to stabilize sovereign markets in order to facilitate sovereigns' continued financing. The key inhibitor is the deterioration in the political union and the consequent ability to formulate a political response. Absent a proportional policy response, euro breakup remains more probable than possible at this juncture.

Key takeaways for us are:

• the 5% haircut that will force margin calls on the most cash-strapped banks;
• the 10% funding level beyond which the ECB's intervention in the banking system becomes restrictive and self-defeating;
• LTRO funding is not suitable when collateral values are unstable LTRO, like all repo funding, should only have been implemented with quality assets to avoid excessive margin calls;
• greater ECB use defers the point at which a sovereign or bank faces a funding challenge, but accelerates the point at which a return to private market financing is unlikely without external support;
• and finally, the most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view.

While all eyes are focused on Greece (and contagiously Spain), they have forgotten that two far weaker countries still exits - and combined have the power to do as much (if not more) damage than Spain. Portugal and Ireland have moved back into the Red-Zone of risk in Europe's credit markets. Ireland back over 700bps and Portugal back over 1200bps reflects both their idiosyncratic issues (that we have discussed at length) or the systemic issues (which we discussed most recently this morning here). In the case of Portugal, it appears the Dan Loeb trade (we said to fade it) is now being unwound en masse as the reality of the fundamental risks we discussed here seem to be realized. In the case of Ireland, not only is there a rising chance of a 'no' vote at the forthcoming referendum (discussed here) but as Deutsche Bank notes today, via Bloomberg, that Irish banks may face a further $5.1 billion capital call to cover loan losses as "A new, even modest, increase in capital requirements could deter sovereign investor participation and tip the balance in favor of the sovereign requiring a second loan program." Of course the CDS reflect not just the chance of these nations restructuring but also the probability of a EUR devaluation (since the instruments are denominated in USD) but still - we thought Ireland was the template for the success of austerity?

Ireland's risk is breaking out...

and via Citigroup:

"We believe a second program would be forthcoming if requested, probably initially without private sector involvement unless the Irish government itself insisted that PSI is needed, which is unlikely in our view," said Citigroup economists including Juergen Michels and Michael Saunders in a note. "With Ireland’s high government debt level and low potential growth, the risk of eventual government debt restructuring (PSI, Official Sector Involvement or both) also is likely to persist."

and Portugal is critical again...

and this was a disaster in the bond markets...

from our earlier note:

"All-in-all, Portugal remains totally unresolved as a nation mired in unsustainable debt, is likely to need a second bailout very soon and probably a restructuring and while bonds may appear to have rallied, this is entirely due to LTRO and Basis-trade effects and only the long-end (less affected by these technicals) reflects the considerably less sanguine state of this nation's future."

So stepping aside from the biggest aggregator of private data for a few minutes, and focusing on what actually matters, here is Citigroup telling our European readers who have those fancy multi-colored bills in their wallets, that they are in deep trouble.

To summarize from Citi:

• There are many scenarios for a Greek exit;  almost all of them are likely to be EUR negative for an extended period
• Some scenarios could be positive in equilibrium but the run-up to the new equilibrium could be nasty, brutal and long 
• The positive scenarios for the euro involve aggressive reduction of tail risk; none of these seem likely
• It is unlikely that central banks busily substitute EUR for USD in their portfolios during periods of intense political uncertainty.

Full note from Stephen Englander

Many clients are asking us to analyze the currency implications of alternative scenarios with respect to one of more countries exiting the euro. Below we run through some of the main issues that are being discussed. We are uncomfortable with the extent to which the most likely scenarios play out negatively for the EUR, but the euro upside scenarios depend on euro zone policymaker assertiveness that has scarcely been visible recently.

Scenario 1: Managed Greek exit; no contagion or financial market disorder

This is the most benign scenario with respect to a Greek exit, assuming away the major contagion risk. There is likely to be short term euro weakness, but a sharp initial sell-off would be deceptive and the weakness would be relatively brief once the contagion fears wore off. 

Some argue that the euro would rally strongly off this development, arguing that the euro ex-Greece would be much stronger than the euro with Greece. This positive scenario would be a world in which the risk premium on other euro countries has been largely determined by the fear of contagion from a GREXIT, not issues related to other peripherals themselves. Once GREXIT occurred without damage, whether on its own or because of policy commitments, spreads would narrow and the euro would rally.

Absent such an unwinding of knock-on risk on other peripherals, the arithmetic of the euro zone divesting itself of the Greek 2% of the euro zone facing a major depreciation is not very exciting. If the new Greek currency depreciated 50% (a very round number), the implied boost to the surviving EUR with its stronger components would be about 1%, basically it’s overnight move.

The above is a very optimistic reading of what is driving peripheral spreads in other euro zone countries. If the concerns reflect risk associated with national debt in other peripheral countries, not primarily Greek contagion fears, then even if the fears abate, the fiscal concerns on remaining peripherals would prevent a major appreciation. So this benign scenario does not seem the most likely scenario by any means, nor is it likely that the euro’s problems are as Greece-centric as needed to make the euro outcome play out as described. That said, if the benign scenario plays out, EURUSD could rally significantly from current levels, trading closer to 1.45 or higher, but it just doesn’t seem very likely. 

Scenario 2: Greece exits, contagion spreads to other peripherals

Greece repudiates the austerity of bailout #2 and exits the euro zone. Contagion spreads to other peripherals.
This scenario entails months of profound economic and financial confusion during which the euro would be under constant pressure in our view. How the euro evolves depends on how euro zone policymakers deal with contagion risk and that depends on the post-departure policies that are followed.

Substantial euro downside could emerge from investor fears that other peripheral countries in the euro zone would drop out, raising the risk premium on their debt, and making it even less possible to hit fiscal and economic growth targets. A Greek dropout could be viewed as unfortunate but manageable, if the euro zone disintegration was viewed as stopping there at Greece, but the risk is that investors come to expect that other countries will follow. Such countries would experience the worst of all worlds, austerity, a risk premium that now builds in additional currency risk, but no control of exchange rate or monetary policy and no growth. Investors in that case would speculate that the cost of staying in the euro was too high for other countries as well.

The way to avoid this contagion and downward pressure on the euro would be to provide an absolute, non-conditional guarantee that no other country would drop out. This would be a spectacular transformation -- an ECB that is unwilling to act like the Fed morphs into the SNB.

Moreover, some clients have raised the possibility that investors would not believe even such a guarantee – at least not initially. They would argue that the example of Greek depreciation would induce even Mom and Pop in other peripheral countries to shift their deposits to Germany, the UK, the US or Switzerland because the downside from doing so if other peripherals do not drop out is low, and the downside from not doing so if there are further dropouts is tremendous. At a minimum this provides a big hole in peripheral banking systems that would have to be filled by the ECB – probably involving the ECB in far more open-ended risk than they have shown a willingness to take. It is unlikely that all the deposits would go to Frankfurt, so there is probably some direct downward pressure on the euro involved. The final element of the argument is that investors and residents will fear that the ECB can not bring itself to make such a permanent and potentially very expensive contingent commitment.

The EUR could begin to rally if the euro zone manages to ring-fence the other peripherals but so much damage will have been done by then that the EUR would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.

The optimistic view on contagion is that the ECB would not actually have to take on the risk if the commitment was ironclad enough. But if there is any degree of skepticism or if the ECB showed any hesitation, the risk-return would be in favor of capital flight and the euro would fall sharply and the ECB would face additional balance sheet risk. 

This is the problem that the euro faces on any dropout scenario, Even a small country dropout that has limited direct financial and economic implications for the euro zone could raise the stakes enormously with respect to other countries. Whether the euro goes up or down depends on whether the euro zone policymakers can bring themselves to make the needed open-ended commitment and convince the market that they will stick to it thick and thin even if the price tag rises. Given their inability to achieve timely consensus on policies that would have averted the pressures and been much cheaper, investors are likely to sell euros until fully convinced of policymaker resolve.

Scenario 3: Multiple peripheral countries exit, core remains

Our economists do not see this as a high probability scenario, but it is certainly discussed by FX investors. This is the scenario in which the likely dynamics of exit conflict the most with the long-term equilibrium. Define the long term as the point at which economies and exchange rates have moved back to their long-term equilibrium path. The euro of the surviving core will likely be stronger than its predecessor euro was. Consider that the deficit, debt and external balances will be much stronger than with the current euro. So one can make the case that the long term equilibrium value of this ‘core’ euro is much stronger, possibly even at the highs that were seen in 2008.

However, the short and medium term may last for an extremely long time and the dynamics over that period are very negative, not just for the peripherals that drop out but for the core that remains in. Consider that the peripheral countries are likely to drop out one by one, probably accompanied by economic and financial disruption. The impact will be felt on core economies and financial institutions as well, so whatever the long-term equilibrium, the path there will likely be accompanied by economic weakness at least until a stable core is formed and a path to recovery is envisioned – this can take a very long time and is probably well beyond an investible horizon. The high cost to both the dropouts and the remaining core countries is one reason that this is considered such an unlikely scenario. 

Scenarios that boost the euro.

Only the first scenario above has a euro positive component relatively quickly after the Greek exit is realized and the probability is low that investors will look as benignly on the event as the scenario implies. 

The characteristics  that each of the euro-negative scenarios share is that each reflects an augmentation of euro zone risk. Even if the risk is accompanied by a relatively hawkish ECB perspective, the euro falls because investors are focused on the deep risks associated with euro breakup rather than marginal, and probably unsustainable, gains from a hawkish ECB.. The argument we would make is that global investors will cut the euro a lot of slack if extreme tail risk can be eliminated, even if the outcome involves a bigger balance sheet or other unorthodox policies.

Scenario 4: New Greek government embraces austerity plan

We are not so naïve as to think they would actually embrace austerity, but by accepting the plan, they would relieve investors of concern in the short term of a messy default, bank runs and immediate financial crisis. Investors would not necessarily view this as a good outcome objectively, but as a better and much cheaper outcome than the alternative of messy default and Greek euro zone withdrawal. Essentially a continuation of the status quo, the question is how long a period of tranquility such a compromise would buy. If investors are jaded and view it as a very short term patch before renewed strife the bounceback in the euro would be limited.

Scenario 5: ECB bond buying or Eurobond

Both of these take a step towards resolving what is a major failure of monetary policy in the euro zone -- Interest rates are simply too high. A GDP –weighted average 10year yields of non-program euro zone countries is more than 150bps higher than in the US or UK. This effective tightness of monetary policy is hardly justified by upward inflation or growth risks.

Were the ECB to buy bonds aggressively it is unlikely that investors would fight the ECB. Were the fiscal authorities to jointly issue an Eurobond, it is likely that core yields would go up and peripheral yields down – exactly the rate redistribution required to stimulate activity in the periphery and support their asset markets. This is likely to reduce tail risk and support the euro.
Looking at these two scenarios, it seems far more likely that the SMP buying will be renewed than the governments coming together and issuing an euro bond in the near term. It seems far more likely that the trillion EUR balance expansion of the ECB since mid-2011 would have been more effective buying cash bonds than operating through the LTRO.

Having put forward these proposals, we have to admit that they seem less likely than the ECB making an effort at reviving confidence by a bog standard rate cut or an additional LTRO. The political opposition to these measures means that even though they are likely to be the most effective in resolving the crisis, they are unlikely to be the first (or second) applied.

Scenario 6: LTRO or rate cuts

It seems unlikely to us that the euro zone’s underlying problem is that the refi rate is 1% rather than 0.5%, or 1.5% for that matter. A rate cut could be seen by the market as some sort of signal that further aggressive easing was coming, but by itself it seems more likely to stimulate activity in Germany than Spain. Nevertheless, it is possible that the cut could come and that the euro could even rally if the cut was viewed as complementary to other policy actions that euro zone policymakers were planning. If the cut was viewed as a substitute for more effective measures, the euro would probably resume its fall, possibly even accelerating in its decline. To paraphrase Crosby, Stills, Nash and Young – if you can’t use the policy that works, work with the policies you have. But the euro is hardly likely to respond positively.

Similarly, a third LTRO would tread a familiar path. So far, the two earlier LTROs have eased borrowing costs at the short end and led to a shortening of duration by peripheral issuers. An LTRO with a significantly longer maturity might encourage euro zone financial institutions to buy longer dated government bonds and bring down long term interest rates.  The first two helped stabilize and reduce bond yields temporarily but now they are back to where they were in the bad old days of November 2011, although not at the very peak of the crisis.

One reason the first two LTROs did not trigger a sustained drop in peripheral funding costs was the intensifying deposit flight which added to banks’ funding issues. We suspect that a pan-euro zone deposit guarantee, funded by the EFSF or ESM, could enhance the effectiveness of any future bouts of ECB lending as it will limit the outflow of bank resources. That being said, however, so far there is not much appetite for a Europe-wide safety net with the countries of the core reluctant to bankroll bank liabilities in the periphery. Moreover, the potential losses are extremely high if any country were to leave the euro zone and any country left out would almost be guaranteed to experience significant capital flight. If it could be implemented credibly (say with an ECB backstop) then the effectiveness of LTROs would not be undermined by deposit flight and banks might become more aggressive bidders for their sovereign's debt.

Potentially this could ease strains within the euro zone and generate both a global and euro zone risk rally, but to be implemented credibly would require a similar open-ended commitment to those discussed above, and such commitment have been hard to extract from euro zone policymakers.

Concluding remarks

Approaching a second round of Greek elections potential scenarios leave the balance of risks pointing towards a weaker EUR. In the long run, while there may be more favorable equilibriums, the path there we suspect will be very painful. At this stage a mixture between scenarios 2 and 6 seems most likely, with 1 a possibility on the outside – not very promising for the EUR unless policymakers surprise with decisiveness.

Remember there is no short-selling - only long-adds and long-exits. Syndicate fall back...26.7mm shares at $38.00, 9mm shares at $39.00, and 42mm at $40.00 - leaves a VWAP (or average price at which everyone is in Facebook) at $40.36 (green arrow) with over $10.5b billion traded so far as over 60% of the float has 'turned-over' this morning.

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All Hail to the great Moolaram
He`s leading the world`s biggest scam
This demon of money
Makes things appear sunny
By printing when we`re in a jam

The Limerick King

If you just submitted an order to buy FB today, and were confident the order was executed even if at market, you may be out of luck:

• NASDAQ HAS PROBLEM DELIVERING FACEBOOK TRADE EXECUTION MESSAGES

What this means is that the exchange at this point is deciding whether or not to send back late executions to all people who bought, or thought they bought. Needless to say this means that the indicated price is likely not the real price if one factors for all the latent orders, on both the bid and offer side, unless of course all those orders get cancelled, further eroding confident in the market, only this time hitting that one segment most disenchanted with the stock market - mom and pop.

Liberal economists and financial wonks say that we need to learn the lesson from the 1930s and stimulate more to unnecessarily avoid falling back into a very deep economic abyss.

Conservative economists and financial gurus say that we need to tighten our belts and live within our means, or the tsunami of debt will wipe out our prosperity, and that of our children and grandchildren.

We've repeatedly noted that neither stimulus or austerity can ever work ... unless and until the basic problems with the economy are fixed.

But stimulus and austerity are not only insufficient on their own ... they are actually 2 sides of the same coin.

Specifically, the central banks' central bank warned in 2008 that bailouts of the big banks would create sovereign debt crises. That is exactly what has happened.

Remember, it is not the people or Main Street who are getting bailed out ... it is the giant banks.

A study of 124 banking crises by the International Monetary Fund found that propping up banks which are only pretending to be solvent often leads to austerity:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.

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All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

In other words, the "stimulus" to the banks blows up the budget, "squeezing" public services through austerity.

But instead of throwing trillions at the big banks, we could provide stimulus to Main Street. It would work much better at stimulating the economy.

And instead of imposing draconian austerity, we could stop handouts to the big banks, stop getting into imperial military adventures and stop incurring unnecessary interest costs (and see this). This would be better for the economy as well.

Why aren't we doing this?

Because - underneath the false easing-versus-tightening debate - this is not a financial crisis ... it's a bank robbery.

Creditor committees dominated by giant banks like Goldman which helped countries like Greece hide their financial problems are now demanding austerity, and Greece is holding a fire sale of its infrastructure, public utilities, tax base and whole islands to give to the creditors.  First world countries like the U.S. are actually no different.

The big banks went bust, and so did the debtors.  But the government chose to save the big banks instead of the little guy, thus allowing the banks to continue to try to wring every penny of debt out of debtors.  An analogy might be a huge boxer and a smaller boxer who butt heads and are both rendered unconscious ... just lying on the mat.   But the referee gives smelling salts to the big guy and doesn't help the little guy, so the big guy wakes up and pummels the little guy to a pulp.

As we wrote last year:

Economists note:

A substantial portion of the profits of the largest banks is essentially a redistribution from taxpayers to the banks, rather than the outcome of market transactions.

Indeed, all of the monetary and economic policy of the last 3 years has helped the wealthiest and penalized everyone else. See this, this and this.

A “jobless recovery” is basically a redistribution of wealth from the little guy to the big boys.

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Economist Steve Keen says:

“This is the biggest transfer of wealth in history”, as the giant banks have handed their toxic debts from fraudulent activities to the countries and their people.

Nobel economist Joseph Stiglitz said in 2009 that Geithner’s toxic asset plan “amounts to robbery of the American people”.

And economist Dean Baker said in 2009 that the true purpose of the bank rescue plans is “a massive redistribution of wealth to the bank shareholders and their top executives”.

The money of individuals, businesses, cities, states and entire nations are disappearing into the abyss …

… and ending up in the pockets of the [fatcats].

Passionate liberal Keynesians and committed fiscal conservatives may each be seeing only part of the picture. We invite everyone to see the bigger picture.