Wednesday, March 31, 2010

Do Easter Bunnies Lay Eggs?

Commenting on a previous post Debra, a devoted (smile) reader, had this to say:

It would seem that man is a gambling animal that JUST HAS TO HAVE HIS DOSE (fix ?) OF RISK, (like he has to have his dose of arguing about the number of angels on the head of a pin...).

What is obvious to Debra and the millions who work in the gambling industry essentially escapes the academics who create theories and algorithms to explain financial markets.  To wit, they start with the premise that investors want to minimize risk or, to put it more correctly, to maximize their risk-adjusted return.  It sounds reasonable, but show me someone who claims human beings are reasonable and I will show you a fool.  Or a chick barely out of its egg.

When it comes to markets, human beings are in perpetual pendulum motion, swinging from fear to greed and back again.  If anyone thinks this can be expressed in algebraic form, go ahead and  try.  But I should point out that there are already dozens of technical cycle analyses, astrological correlations, chaos theories, chart patterns, etc.  And as far as I know, the only way their creators made any money is by selling books and seminars. 

Indeed, there are only two books on markets everyone should read (many times and with great care, because they can be very dangerous to your financial health if their wisdom is abused).
So, instead, how about using Debra's premise as the starting point to construct market-related academic theories? We could put it thus: investors aim to maximize their profit-adjusted risk appetite.
Now try to put that in mathematical notation to use it in portfolio theory... 
Have a very nice Easter holiday.

Saturday, March 27, 2010

Say Hello To Theo Bawki

Theo Bawki is not a friend from South Africa.  Rather, it's Sudden Debt shorthand for The End Of Banking As We Know It.  And if the Volcker Rule passes Congress without a bunch of customized  loopholes and exceptions, that's exactly what is going to happen. Thankfully.

As preamble, let me take you back 12-13 years. I was visiting the London HQ of Merrill to see a bond trader on behalf of my firm.  During our discussion, I noticed he kept referring to Merrill as a "bank" and, since I was an ex-member of The Thundering Herd myself, I was curious why.  After all, we who had graduated from its rigorous training program never thought of Mother Merrill as anything much more than a big brokerage firm, i.e. a very powerful marketing and sales organization for investment "products".  We most definitely did not think of ourselves as "bankers" - this was a title reserved for the boring folks who worked at Citi, BofA, etc.

But when I innocently asked him if he meant "brokerage firm", he got offended.  He had placed Merrill  (and himself) amongst those who raise funds and invest on behalf of  their institutions as principals, instead of being an honest Mr. In-Between. Apparently, in his mind this carried far less cachet than being a "banker".  The re-transformation of our financial system had started and the walls of  Glass-Steagall were coming down far faster than I imagined.

We all know what happened in the years that followed.  Our financial system became a mishmash of "players" who could and did switch hats at will in order to obtain maximum profit and minimum regulation.  Bank, broker, investor, speculator, private equity and hedge fund, loan originator, packager, servicer, dealer, trader .. all melded into an amorphous mass where Anything Goes.  And, of course, everything went: pop and south.

Patti Lupone In Cole Porter's Anything Goes
In olden days a glimpse of stocking
Was looked on as something shocking,
But now, God knows,
Anything Goes. 

In the aftermath, we urgently need to re-separate and re-define the roles of each member of the financial community.  It is insane to allow institutions that accept government-insured deposits and have access to the Fed to become heavily leveraged speculators, even in their so-called subsidiaries.  Ditto for pension funds: it is insane to allow them to "invest" in highly speculative hedge and private equity firms in the name of yield-enhancement or counter-cyclicality.  It is insane to allow small-time investors to participate and get fleeced in 500-1 margin FX trading or bucket-shop betting on indexes.

Deregulation as practised in the financial industry did not create a simpler, more transparent industry  that operated in the interest of society at large.  Instead, it begat a highly concentrated secretive club of mega-firms run by mega-billionnaire dealmakers who flaunted their riches and power ("I can get a billion at the snap of my fingers", "We do God's work", etc.).  And to add insult to injury, the very same club demanded and got a bailout by the taxpayers when it caught the clap.

So, Mr. and Mrs. Shadow Banker, meet Theo Bawki.  I hope you embrace him warmly and make him your close friend.  But if you don't, don't worry. He's not going away any time soon.

Friday, March 26, 2010

Perception Creates Reality

A reader commenting on the previous post on CDS asked: "... if two people have a bet on a football match, does that affect the result?"

This is a seemingly innocent and deceptively easy question;  but, in fact, it is very difficult.  To answer it we must touch upon the very core of our understanding of the physical world, since it is another way of expressing a fundamental premise of quantum physics/mechanics: Does the mere observation of an event alter its outcome? (see Schrodinger's Cat).

My opinion is that yes, observation certainly affects the result.  I have already dealt with the subject from the financial markets point of view in a series that appeared exactly one year ago (Neo At The Quantum Casino - Part I, Part II, Part III).  In addition, another post dealt with the Quantum Economy (The Economy as Schrodinger's Cat).  I believe that financial markets provide the best empirical validation of this axiom because perception of a fact shapes their action, well before actual fact.  Furthermore, perception very frequently forces a fact into existence -  for example, a run on a bank.

Now, as to CDS being bets.  Yes, of course they are, in the narrow sense.  But, they are much more than a simple up/down wager of the black/red kind at the roullette table.  For one thing, CDS can also act like bonds on steroids: to the seller, a CDS provides an upfront lump sum plus a steady stream of income with little or no principal invested, depending on margin and capital adequacy requirements.  As such, CDS are a particularly pernicious way to inflate systemic leverage and further expand the debt bubble, outside any significant control or oversight from monetary authorities (shadow banking).  I say pernicious, because unlike most straight debt, proceeds from a CDS do not go to fund the "real" economy but stay within the shadow banking system.  They are just more (and more easily toppled) financial domino instruments.

Unlike a straight bond portfolio, a portfolio of CDS is, by definition, much more volatile. Because CDS are so highly leveraged a small movement in price causes large gains or losses.   And therein lies the perception problem, because a volatile CDS market produces - by necessity - increased volatility in the underlying bond market;  CDS and bond markets are interconnected like communicating vessels. A perception of higher or lower default risk is instantly communicated to the bond market via the CDS channel.

The end result is that the CDS "tail" is wagging the bond "dog".  A relatively small, inefficient, opaque and highly leveraged derivatives market controlled by a mere 4 or 5 trading banks, can wreak havoc with the biggest, most important securities market in the world - that for bonds.

Let's put it into casino terms: you are sitting on a ho-hum blackjack table where the action is small and slow.  Suddenly, a bunch of well-known high rollers stops by and starts side-betting heavily on your hand.  Would that affect your judgement and the way you place your own bets?  Of course it would..

Wednesday, March 24, 2010


The discussion about Credit Default Swaps is replete with allusions, examples and (over-)simplifications.  The most frequently used is that CDS is akin to buying fire insurance on a neighbor's house and thus having every incentive to see it burn down.  

But this misses a crucial point: derivatives traders rarely, if ever, want to "take delivery", or execute the futures contract, option, swap, etc.  Instead, they want to make a quick killing on the going market price, i.e. by  trading fire insurance as much as possible instead of seeing the house burn down and collecting on it.  If you want another allusion from Sudden Debt's misty past, they want to trade the "sardine", instead of eating it. 

To wit, it is a fact that the vast majority of futures and many other derivatives contracts are closed out before delivery date, and that most options expire worthless.  Likewise, the vast majority of CDS traders/speculators/hedgers have next to zero desire to deliver (or take delivery of ) the underlying bonds, but , instead, to profit from the market's swings during the time they hold the contract.  

Furthermore, I can tell you from long and relevant experience that the line separating a hedger from a speculator is so thin as to be practically invisible in most cases.  For example, an investor holding a portfolio of bonds comes to the conclusion that credit conditions are worsening and hedges by buying CDS.  Her portfolio now consists of two "legs": bonds and the CDS hedge.  Naturally, the cost of buying and holding a credit hedge reduces her current return close to a risk-free equivalent (say, a U.S. Treasury).  However, this is as near to anathema for active portfolio managers as it gets and that's when trouble starts.  (Why would you pay a manager anything from 0.2% to 2% p.a. just to hold a risk-free asset?)  So, before long, she gets itchy to lift one of the legs, i.e. go net long or net short, no matter what she may preach about prudence and hedging.  It's human nature - and that's what makes markets swing.

Anyway, back to the main story.  The relevant parable for CDS is The Boy Who Cried Wolf (But Didn't Himself Own Any Sheep).  The boy in question is bent upon terrorizing other shepherds because he has shorted mutton meat at the town market and wants to see the shepherds unload their sheep as fast as possible before the "wolf" gets 'em, thus driving down the price.  He has been known to occasionally don a fresh wolf-skin over his body on certain nights and howl to the moon...

Tuesday, March 23, 2010

Die Frau Im Lederhosen

Dear Frau Merkel,

Please stop the hysterics (*) about Greece.  You have nothing to prove, we know who wears the lederhosen in Europe.

The Rest of Europe
(*) From Wikipedia, emphasis mine:  Female hysteria was widely discussed in the medical literature of the Victorian Era.  Women considered to be suffering from it exhibited a wide array of symptoms including faintness, nervousness, insomnia, fluid retention, heaviness in abdomen, muscle spasm, shortness of breath, irritability, loss of appetite for food or sex, and "a tendency to cause trouble"

Monday, March 22, 2010

One of The Dollar's Multiverses: Insufferable Indifference

Love it or hate it, the U.S. dollar is still the world's premier reserve currency. The primary reason is that the United States (5% of the world's population) accounts for 20% of global GDP.  Or, you could turn the argument around and say that, being the issuer of the global reserve currency,  the U.S. can consume much more than it could otherwise.

Whichever came first, the chicken (a huge U.S. GDP) or the egg (the dollar's global  reserve status), we know for certain that a fundamental undrpinning for the "egg" is the fact that crude oil is priced in dollars.  Simple math: the world consumes some 85 million barrels of oil per day.  At current prices that's around 2.5 trillion dollars per year, or ~4% of global GDP.  Add natural gas, LPG, the value added to petroleum and gas products by refining, shipping and marketing and the entire complex easily reaches 10% of GDP.  Hydrocarbons are by far the world's single biggest business.  And that's before finance is added into the pot: trading of energy-related derivatives alone amounts to multiple trillions annually in nominal activity, doubtlessly producing significant amounts of  "real" dollars that are ultimately counted as GDP.

Then, consider the capital sunk into this business: oil and gas wells, drilling rigs and platforms, pipelines, tankers, refineries, storage tanks, service stations, the oil-fueled transportation infrastructure... I don't know if there is a comprehensive global estimate, but I bet that when it is all added up it comes second to only real estate in terms of invested capital.

Global financial supremacy is not a monolith, but a composite.  It is a mosaic of energy and currency cross-relationships that are now supposed to be threatened by the emergence of  the euro as a possible alternative to the established dollar hegemony.  But can the replacement, alone, of one fiat currency for another be the undoing of an Empire?  Of course not - after all they are just book entries.  Just as debt and money cannot create an Empire by themselves, they cannot bring it down, either.  For that to happen a paradigm shift is necessary.  Or, in more classical terms, Rome was not built in one day and didn't come crashing down in one, either.

So, what is the paradigm shift that could bring the dollar hegemony down?  No, it's not the economic parallax error  that goes by the name of China.  As the term parallax implies, that's just a shift of reference points not substance. The Chinese have even adopted the dollar for their currency in all but name, since the yuan is firmly pegged against the dollar.

Oh yes, Chimerica is a very apt name, particularly if you enjoy Graeco-Roman mythology.

The Mythical Chimera

A shift in the energy paradigm, however, will certainly be monumental and could spell the end of the dollar as global reserve currency.  As the world moves away from a highly centralized fossil fuel regime and adopts more distributed solar, wind, geothermal and other renewable sources, then it becomes much more likely that the dollar will lose its global fiat power. It is not Mrs. Merkel's histrionics about the euro that matter, but what goes on in Siemens, Vestas, Gamesa and Desertec.

The threat to the dollar, then, does not lie in the euro, per se, but in its marginalization via the adoption of much more modern, powerful and appropriate energy technologies.  In one quantum multiverse, one that could indeed be our own future,  no one cares about the dollar which is relegated to being the internal exchange medium for a has-been empire.  It will suffer from plain old indifference, just like no one gave a damn who was the emperor of Rome after the 3rd Century AD (does the name Avitus ring a bell? Majorian?).

Saturday, March 20, 2010

A Shameless Plug For Ancient History

Readers may be wondering why I have devoted several posts on the "Greek Crisis".  Apart from newsworthiness - the subject is everywhere, it seems - there is another, less topical reason that goes back thousands of years. Literally.

A couple of weeks ago I had some time on my hands, so I strolled inside a bricks and mortar bookstore to peruse the titles on offer.  I am a big fan of history (not just the facts ma'm, gimme some reasoned interpretation too, that's what I pay you for), particularly financial and economic history.

This time, however, I walked out with a hefty, 670-page tome on ancient history. The Classical World by Robin Lane Fox spans the centuries from Homer to Hadrian in a wonderfully written style, arranged in relatively short chapters that had me turning the pages like a novel.  The book was written very recently (2008) and is fresh both in content and language.  There is none of the ponderously dry academic style here, so common of similar works.  This is a serious book, but it is meant to be read and enjoyed, not sit on a shelf to make you look "well-read".  (I admit to owning  Gibbon's  Decline and Fall of the Roman Empire, all six volumes, five of which have never been cracked open).

And what does the classical world have to do with today's world?  Oh, just Empire, sourcing vital commodities from client states in the Middle East, currency and military domination, an indifferent voting public... you know, nothing important..

Thursday, March 18, 2010

Sideshow Of A Main Show's Sideshow

Note:  Today's post should be read in conjunction with the previous post about Greece.  But if you are too bored to do so, never mind.  It mostly stands alone.

Pardon the mangled syntax of today's title, but  it serves as a hint  to my main point: the Greek "crisis" is just a sideshow - in fact, it's even less than a sideshow.  The whole thing reminds me of those nested babushka dolls from Russia, where one doll serves to obscure the existence of the other.

So, what's the main show? The China - U.S. war for global supremacy, currently being fought on the dollar/yuan battleground. China's cheap currency, administratively pegged at artificially low levels, allows the country to remain the world's ultra-low-cost manufacturing center.  A bottom-rate value for the yuan is completely at odds with China's newfound wealth and power and should, instead, be allowed to move significantly higher, perhaps as much as 50%.  America has finally woken up and is screaming bloody murder..

But America has a problem: its massive budget deficits need to to financed; for this fiscal year alone it comes to $1.6 trillion.  I estimate that at least $1 trillion of that must be provided by foreign investors, since the domestic saving rate is nowhere near what is necessary (it should be over 10% to cover the gap - see chart below).

In the past the U.S. could issue debt almost at will, since it possessed the world's sole reserve currency.  From the inception of the euro, however, this is no longer the case.  The U.S. must  now convince the world  that it should prefer the dollar to price its goods (e.g. crude oil) and to save its excess capital.  It's a battle for hearts, minds and money - and these days this means mostly Chinese politburo hearts, minds and money.

What does this have to do with Greece and the euro? Greece is in the middle of a boxing match between the U.S. and Germany, the EU's heavyweight.  The U.S. financial establishment wants to make clear that the euro is not worthy of reserve currency status and the world should, instead, continue to buy Treasurys.  Germany wants the exact opposite, so it too is being obstinate about bailing out Greece, fearing that such an event would be interpreted as a sign of weakness and lack of monetary resolve.  It's terrible to be caught in the middle, when elephants are trampling about..

Some facts and figures to support my premise:  
  • Greece is a tiny percentage of global GDP.  According to the IMF,  in 2008 it accounted for a mere 0.5% of global output in purchasing parity terms.  Compare this with heavyweights like the U.S. (20%), China (11.5%), Japan (4.3%), India (3.3%) and Germany (3%).  It is ludicrous to attach  overwhelming importance to its, admittedly parlous, finances.
  •  Greek government debt comes to around 300 billion euro.  Let's not compare that amount to other countries but, say, to the assets at PIMCO, the asset management firm specializing on fixed income: $1 trillion.  Or, to the amount the U.S. has already committed to the bailout of AIG alone: around $200 billion. And so on and so forth.  In other words, Greece requires mere peanuts from heaven to put its finances in order.
    • The "Greek Crisis" has been in the headlines for weeks now. A day does not go by without an article in the usual suspects: FT, Bloomberg, WSJ, Reuters - all seem to relish in bashing Greece, or "squashing the Olive" as some less-than-classy commentator put it.  The latest incident came two days ago when Marty Feldstein said: “The idea that Greece can go from a 12 percent deficit now to a 3 percent deficit two years from now seems fantasy. The alternatives are to default in some way or to leave (the euro), or both.”  Yes, that's the same Prof. Feldstein who  over a decade ago said in an infamous essay that the euro's  establishment could lead to war in Europe (EMU and International Conflict, Foreign Affairs Nov./Dec. 1997) Yesterday, even the wily Jim Rogers piped in and said that Greece should be allowed to go bankrupt in order to show the euro means business.
    So what about those babushkas?  The first one we see is a Greek maiden in distress - but when we look inside we find a steely-eyed German frau.  And hidden inside that there is an American cowgirl with a couple of ivory-handled Colts strapped around her waist.  And finally, we find a Chinese lady modelled after the famous laundresses of yore.  She has a thin-lipped smile on her face and says: "No tickee, no shirtee".

      Sunday, March 14, 2010

      The Greek Experiment

      Who wud have thunk it of Greece?

      The country with Europe's most reactionary political tradition (around 15% of voters still go for outright communist and sundry left-wing parties, plus another 10% vote for right-wing/populist ones) is presently implementing a Chicago School economic blueprint in everything but name.  The nominally "socialist" government is lowering wages, freezing pensions, increasing retirement ages, imposing higher consumption taxes, downsizing the bloated public sector, etc.

      All  of this in a  rather chimeric quest to mollify lenders and obstinate rating agencies by transferring peoples' wealth, previously borrowed from mostly foreign lenders, back to those same lenders.  It's yet another bailout plan characterized by money flowing from the "poor" masses to the "rich" financiers, albeit with a well-justified and heavy dose of salt being rubbed onto old, self-inflicted wounds.  Still, I can hear Milton Friedman chuckling in the heavens.

      The Greek government is betting that it will be able to reform the country's astonishingly inefficient  and unproductive economy.  For example, labor productivity per hour worked is the lowest in EU-15, at only 70% of average.  Greece needs to resume growth (4Q2009 GDP was -2.5%), before the rising tide of debt sinks it to the bottom.  It's a fair wager and I would have given them a better than even  chance of success - if it weren't for the aforementioned reactionary nature of Greek society.  As it stands right now, I'd say 40-60 are better odds.

      While most Greeks understand that tough measures are necessary to avert national banruptcy, they are also really pissed-off at the long-standing tradition of widespread tax evasion, corruption and back-door dealings between politicians, businessmen and high-income professionals.  As the Minister of Finance himself recently said there are only 5,000 Greeks who declare annual income over 100,000 euro.  Absurd, of course, given bloated asset prices in Greece (see further down).  

      Greek society is currently precariously balanced between grudging acceptance and outright rejection of the government's course of action.  If people do not see quick results on the economic front their patience will be sorely tested and the balance may well tip into another Greek tradition: revolution and violence.

      So, let's look at the economy.

      Despite recent moves to diversify into the wider Balkan economy through banking, retailing and telecoms, the Greek economy still stands on the same three-legged stool it has used  for many decades: tourism, shipping and agriculture.  It is, thus, very far from being a "modern" global economy.  As I frequently quip, "It is time for Greece to, finally, enter the 20th Century.."

      Let's look at each "leg":
      • Tourism - the largest sector - is geared towards low-income group travellers from Britain and Germany who seek sea, sun and cheap booze.  Yes, there are boutique hotels and classier customers than  400 euro/week all-inclusive types, but they are a small percentage of the lot.  Given the recession and price sensitivity of lower-income travellers, Greece faces stiff competition from destinations  offering the same product at cheper prices (e.g. Turkey and North Africa).
      • Shipping is not exactly a domestic business, but it generates thousands of well-paid jobs and demand for high-value financial, legal and technical services.  Besides, the country had  until recently benefited from the investment of surplus capital from rich Greek shipowners wallowing in the biggest-ever bull market in shipping rates and vessel prices.  They were buying everything that moved, from housing and hotel properties to retail chains and private hospitals - but no more. Shipping has recovered somewhat from the abysmal lows reached at the end of 2008, but it is still very far from "healthy" (see chart below).
                                                                           Time Charter Rates                                Chart: Dryships, Inc.
      • Agriculture accounts for a huge 12.5% of Greek employment  vs. an average of just 3.5% in EU-25 (Eurostat 2006 data).  This is indicative, among other things, of a low value-added economy, particularly in times of global recession and depressed commodity prices.  Furthermore, the EU is about to sharply reduce all agricultural subsidies, a matter of  overarching concern to Greek farmers who are greatly dependent on them.
      The Greeks and their government well understand these dismal fundamental facts, though they may not all agree on who is to blame.  They also know that they carry an onerous debt load, which expanded sharply  in the years after Greece adopted the euro.  The total of government, corporate and household debt is set to reach 220% of GDP in 2010 (120% government, 50% corporate, 50% household).   And this does not include short-dated trade debt that circulates in the form of post-dated checks, a uniquely Greek form of shadow finance.  (No one really knows how much that is, but some estimates range upwards of 250 billion euro, or 100%+ of GDP. I find that number too high to be credible, but what we do know officially is that "bounced" checks reached 3 billion euro in 2009, up from 1.3 billion in 2008 and 630 million in 2002).

      Households, in particular, got into a fast and furious borrowing spree after entry into the euro.  Completely unfamiliar with debt in the past environment of double digit interest rates and tight banking regulation that made consumer borrowing well nigh impossible,  they went from  nearly debt-free  in 2000 (30 billion euro, 22% of GDP)  to now owing 120 billion euro or 50% of GDP.

      The Greek economy fell victim to the South Med strain of the Anglo disease.  Greeks got rid of production and manufacturing (gone to China, where else?) and, instead, borrowed to improve their lifestyle and pump up "assets", mostly real estate.  It may surprise you to know that a simple 100 sq. mt. apartment in a middle-class Athens neighborhood  costs upwards to 350,000 euro, while in a tonier suburb it goes for up to 800,000.   Detached houses? One million euro and up is standard for euphemistically-called "villas" built on postage-stamp plots of 250-300 sq. mts.  Dreaming of a real villa by the sea in Attica?  Be prepared for a shock: eight figures.  

      How do these sky-high prices square with low incomes? Simple:  Debt Bubble.  Mortgage credit expansion was running wild until last year, with amounts outstanding rocketing a torrid eightfold within ten years (see chart below).  By comparison, the U.S. mortgage industry was a popgun.

                                                                The Greek Mortgage Bubble                      Data: Bank of Greece

      There are inefficiencies everywhere you look in the Greek economy, from the way the government collects  revenue  (dozens of tax  and social security offices, one each for every town), to hundreds of  thousands of small and tiny businesses all offering the same products/services at similarly-high prices.  For example, there are some 8,000 gasoline stations in Greece, one for every 1,400 residents.  In Germany there are less than 15,000 - one for every  5,500 residents.  

      Another example: if you need anything done in Greece, you are required to produce a bunch of official certificates, signatures, stamps and permits. (A friend tells me that he needed to suspend his annual membership to a private gym for a few months because he was going out of town.  That way he wouldn't have to pay for the time he missed.  He had to procure an official declaration form, fill it out with everything including his mother's maiden name and to have his signature officially verified.  Don't ask why, the answer is too.. Byzantine.  One can only shudder at what is required to open a business, say something as substantial as a newspaper kiosk...?)

      So, endless hours and days are spent going back and forth to various "offices" collecting a trail of bureaucratic debris.   A few years back another government decided to do something about it.  Great! What do you think they did?  Did they pass a law saying that citizens are considered to be telling the truth prima facie, did they stop the paper-trash war?  Oh, no!  Instead, they established a new official service, with hundreds of bureaus across Greece that will do the paper collecting for you.  Naturally, thousands upon thousands of new bureaucrats were born.  Pricelessly Greek..

      Before the euro, the country coped with its structural problems the "easy", monetary way: high inflation and constant currency depreciation.  Obviously, such an economy had no business adopting the hard-currency euro without a prior major overhaul to make it more efficient and competitive.  But Greece completely punted this opportunity when it chose, instead, to gild its statistics lilly in the mid-to-late 1990's and to enter the eurozone at a politically convenient timeframe.  There were several reasons why the rest of the euro-group allowed this to happen, most importantly because its banks, pension funds and speculators made a huge pile of money during the years-long euro - drachma convergence period.

      It is highly ironic and disingeneous that Germans (and many others) are now pointing their fingers accusingly at "Greek Statistics", claiming to be "shocked".  What utter, undiluted  nonsense.  They knew all along what was going on, but there was lots and lots of profit in looking the other way. At the root of the Greek Crisis olive tree there lays a huge, smelly manure heap of convenient ignorance, if not outright complicity.

      Be the past as it may,  what is important to Greeks, other Europeans and, indeed, the rest of the world is the outcome of the Greek Experiment.  Can fiscal neo-conservative rectitude a la Chicago rapidly solve Greece's deeply ingrained problems, so that pain in its real economy is short-lived and social unrest does not boil over?

      Let me provide just one troubling fact: Greece is home to at least one million economic immigrants (10% of the population), most of them undocumented and working off the books.  This acts to mask the real unemployment situation;  while the official unemployment rate was 10.2% in December 2009 vs. 8.9% in December 2008, the actual number of people out of work is certainly much higher.  What's more, the makeup of illegal immigrants has radically shifted in recent years.  There are now many more Iraqis, Afghans and Pakistanis who are essentially impossible to repatriate, instead of the neighbouring Albanians, Bulgarians and other Balkans of years past.  Crime is  on the rise, with armed bank and shop robberies a daily occurrence.

      Despite all of the above, I still give the whole thing a 40/60 chance of success - higher than most others, including CDS traders who score the five year cumulative probability of Greek default (CPD) at 22% - ninth highest in the world.  The reason for such relative optimism is... fat.  Unlike uber-efficient Germany, Greece can trim away layer upon layer of economic fat and embark on a crash course of reform, finally bringing the country into the core of Western Europe, if not the 21st century just yet.

      Let me put it another way: Greece's cup is, indeed, half empty.  But this is exactly what opportunity is made of, the chance to succeed in filling it to the top.

      Here's, then, to the ultimate success of the Greek Experiment.  Bottoms up! Literally.

      Oh, and P.S. ..

      Look at the Greek government bond maturity profile in the chart below.  Explains a lot, in my humble (but particularly informed) opinion.  If ever a picture was worth a couple hundred basis points to greedy lenders, this is it.
                                                      Greek Government Bond Maturity Profile       Chart: Greek MOF - PDMA


      A Parable As Epilogue 

      Once upon a time there lived in the Kingdom of Hesperia a chubby belle, Olivia was her name.  She was a vivacious lass and enjoyed a good party, as well as a good meal.  Or two. Or three.  All at once.  But she had an infectious smile and a bubbly personality so she was quite popular despite her girth.

      Before long she became favourably known to the Palace and the courtiers decided to invite her to the reception to celebrate the Kingdom's founding.  The gala event was to be held in exactly one year, and the copperplate invitations which went out to Hesperia's citizens of note, Olivia included, specified formal dress and ball gowns.

      Olivia was overjoyed and immediately went shopping for a dress with her best friend Greta.  As women frequently do when vanity rules and time permits, Olivia chose a fabulous, knock-your-socks-off gown three sizes too small for her present Raphaelesque-plus curves.  This is my coming out party, she chirped to Greta, and damned if I won't slim down and look simply gorgeous, darling.  After all, she had a whole year ahead of her.

      But, Olivia loved her food and try as she may she found it nearly impossible to resist her craving for treats.  As happens in parables, time flew oh woe, and found  on the Gala's eve Olivia's curves  two sizes too big for her fabulous gown.

      What can I do? poor Olivia cried to Greta who was thin as a rake and would wear a dinner napkin to the ball.  Well, I told you so, sniffed Greta who had done no such thing a year ago, but no matter.  I know this corset-maker who does wonders with cases such as yours.

      And before you knew it Olivia was fitted with a steel-reinforced truss, squeezed into the fabgown and arrived at the Gala all smiles, if somewhat paler for the effort.  Oh joy, she beamed and sparkled under the crystal candlelight. She flirted with the beaus who feigned amazement at her instant transformation.  Experienced courtiers had seen it all before, of course.  (Waggish tongues hinted they got  kickbacks from the corset-maker.)  The night is young, thought Olivia, and... and... the tables are simply groaning, laden with delicacies untold!

      So, Olivia succumbed once again.  She nibbled at first, then bit and finally gorged on the royal offerings on display.  It would be a shame to let such luxuries go to waste and, after all, she quibbled, am I not three sizes thinner than a year ago? conveniently forgetting the hidden doohickey under the frilly gown that made the mirage possible.

      Alas, royals tend to have a wicked sense of humour and Hesperia's Prince was no exception.  At the stroke of midnight the orchestra struck a fanfare and the young Prince bounded onto a raised stand.  Hesperians!, he cried as a cheshire smile creased his face.  We ate and drank, we danced and romanced.  It's now time to play "follow-your-leader"It's good for our constitution, our national fitness.  And  off he went into the gardens and up the hills surrounding the palace. A gaggle of partiers followed, some laughing and whooping, others wheezing and gasping for breath.

      Olivia was aghast.  I can barely move, never mind follow this..this billy goat of a prince, cursed be his youthful arrogance.  But what could she do? It was one thing to smile deprecatingly, quite another to disobey a direct royal order.  She edged closer to the double doors leading to the manicured gardens which were already full of people and torch-bearers.

      She weighed her options: if she stayed behind she was likely never  to be invited again.  If she attempted to run up the hills in her present state it was sure that her corset would tear apart and her  hitherto artificially hidden curves would burst forth in all their plentitude.
      Thus, we leave Olivia gazing wistfully, once at the ladies' powder room where she can rid herself of the corset and the too-small gown, so to join the revellers-turned athletes;  and again, to the rapidly emptying ballroom.

      What to do? What to do?  And that damned Greta is nowhere to be seen...

      Wednesday, March 10, 2010

      CDS Regulation At The OK Corral

      I have been beating the drum on CDS for a very long time (well, "very long" in terms of the market's attention span, which has more in common with fruit-flies than normal human beings; scroll down to the January 16, 2007 post in the Sudden Debt link provided above). Thus, I am partly bemused and partly satisfied by the current drive to put some order - at long last - in the Far West saloon that is the credit derivatives market.

      Because of what has happened to European PIIGS, and the vested interests of US-based investment banks and hedge funds, said drive has originated and gathered steam in Europe, as this NY Times article points out. The Europeans want outright bans, taxation and heavy regulation, while the Americans want the CDS market to move to an exchange/central clearer in order to impose transparency, capital adequacy and position/trading limit rules.

      In a nuthshell, the Europeans want to kill the cow while the Americans want it moved to a supervised dairy barn where it can be milked in more sanitary conditions, open to periodic inspection by health officials.

      No matter which option you prefer, however, the market has already self-corrected a large part of the excess it created during 2006-08, as the chart below demonstrates. Therefore, calls to corral the CDS market is a bit like closing the barn doors after the cows have gone (see chart below).

                                                                    CDS Outstanding                                                 Data: ISDA

      That is not to say that regulation is not necessary.  It is, and very soon - immediately, even. 

      So, I have a question relating to sovereign-risk CDS (i.e. insurance written on government bonds).  Can a hedge fund - or anyone other than, perhaps, a supranational institution - write insurance on a country??  

      Let's all be serious for a moment, eh?  Because my memory exceeds that of a fruit-fly and I distinctly remember investment banks begging - yes, begging - to be bailed out by national treasuries, just a few quarters ago.

      Monday, March 1, 2010

      What's For Dinner? Gullibility Pie

      The Wall Street Journal reports that a secretive dinner meeting of top hedge fund managers took place recently, at which the subject was the euro going to parity against the US dollar. The gathering is dubbed the euro-dinner and the "short euro - long dollar" trade is characterized as a "career trade".

      Yup... such is the level of financial reporting in the Murdoch Era.


      Let's pause to reflect on these "news":
      1. Truly secretive meetings of market operators never, ever make it to the press. They wouldn't be secretive otherwise, would they now?
      2. A routine, white bread-peanut butter-and-jelly position in the major currency FX market is never a "career trade". This market is simply too huge and efficient to score a major killing.
      3. The euro is already down 11% from 1.52 to 1.35. It took the fear of bankruptcy (of Greece), insolvency (of the rest of the PIGS) and a huge badmouthing campaign in the US-controlled financial press to make it so.
      4. We know that lots of mark-to-market money has already been made on the way down, particularly in sovereign CDS, shorting bonds and shares - plus the plain vanilla FX positions. The first three markets are illiquid and - to my knowledge - short positions are still mostly open.
      So.... what better than a bit of hush-hush, nudge-nudge, wink-wink to push the credulous hoi polloi public into assuming the positions of said hedge fund managers, allowing them to turn open positions into ready cash gains. Trust me, it's not at all easy to get out of big short positions in small, illiquid markets. There is simply too much risk of a short squeeze. Remember the old adage: He who sells what isn't his'n, buys it back or goes to pris'n.

      The Journal also mentions the euro-dinner took place at a townhouse and the menu featured lemon chicken and fillet mignon. Of course.. would you believe them if they said Bob's Greasy Spoon and Beefaroni?

      Well, I say Gullibility Pie is on offer right now and it's being served on a silver platter, with all the trimmings. And it's free!

      Don't bite.

      P.S. I don't really need cred, at least not for readers of long standing, but I should point out that I was talking about the dollar's undervaluation last November, when it went to 1.50. See this post: 2012 - Dollar At The End Of The World.