Tuesday, November 30, 2010

Barbarians At The Gate

As an old hand in the sovereign bond market I can understand - though in no way do I condone - "the market's" attacks on Greece and Ireland, even Portugal.  They are small countries at Europe's economic periphery who borrowed more money from foreign lenders than was good for them and thus left themselves wide open to speculative attack.

 Pygmies And Giants

But now things are getting serious:  "the market" is attacking Spain, the world's eighth largest economy with a GDP of 1.1 trillion euro ($1.4 trillion). And "the virus" is spreading to Italy, Belgium and even to that paragon of financial probity, the most admired country in the world, Denmark.  Yes, Denmark.

Take a look at the Credit Default Swaps (CDS) charts below (all from CMA).
Italian Sovereign CDS
Belgium Sovereign CDS

Denmark Sovereign CDS

(To make things clear: Denmark isn't even a member of the Eurozone! It's a full member of the E.U. but it still uses its own currency, the krona.  It's debt/GDP ratio at 42% is tiny.)

So what is going on?  Not to mince words, a concerted attack on the viability of the euro and thus on the very foundation of the EU itself.  The existence of a common currency for the world's largest economic block is a threat to the US Dollar Hegemony, i.e. anathema for those who wish to prolong the world as we knew it, a modified construct from the Bretton Woods era.

The barbarians are at Europe's gate, threatening to tear down and pillage what took nearly three quarters of a century to construct.  But it's not going to happen.  Like Hannibal's elephants ante Rome's portas, the big financial institutions that are behind this ill-advised campaign are themselves vulnerable.  They need massive amounts of cheap liquidity as fodder (only the Fed is supplying it at the moment) and risk-taking leveraged customers to piggy-back their positions (essentially, hedge funds). 

They also rely on the complete absence  of meaningful oversight and regulation for credit derivatives, an inexcusable condition for which European politicians are entirely to blame.

What is the solution? Starve the beasts.

  1. Immediately withdraw all public pension funds from ALL alternative investment managers.
  2. Prohibit any financial institution that has ANY activity in the EU from having ANY position in EU sovereign CDS.  This includes banks, brokers, insurance companies, hedge funds, etc. that are either domiciled, have rep offices or raise funds in the EU.  And when I say ANY activity in the EU I mean it: not even advertising would be allowed, no articles written by its employees, no interviews, nothing. NO-THING.
Bottom line: you want to play?  OK let's play.  But the rules of the game are  going to be for the benefit of the people, not to attack the people.  Because moral hazard should be, above all, moral.


  1. You are assuming that they are not inside the gate, indeed in bed with (some of) our EU leaders...

  2. There is no attack. Just people desparate to sell to anyone mad enough tobuy or insure.

  3. From my personal experience of European "leaders", they are entirely clueless about how financial markets REALLY work. They themselves have - for the most part - never worked in finance, or anyplace else for that matter.

    They have been taught over a period of three decades that "free" markets are a universal good thing and they are just mouthing the same hot theoretical air over and over again, without understanding an iota of it.

    By comparison, I must admire Hank (Paulson)...

  4. This whole CDS squeeze seems like a bunch of hooligans jumping up and down on a rotten porch, trying to get it to break. Whose fault is it when the porch breaks? The hooligans will run home to Mommy and say the porch was rotten.

    On the other hand, why is there a CDS market anyway? Because the banks simply can't resist collecting premiums for "insurance."

  5. This goes to the heart of one of the problems. Why are we allowing people to "insure" without the reserves to back up their positions?

  6. "Why are we allowing people to "insure" without the reserves to back up their positions?"

    To paraphrase Dire Straits:

    Now look at them yo-yo's
    that's the way you do it.
    You play the credit on the CDS.
    If regs ain't workin', that's the way to do it:
    Money from nothin' and your checks
    are free.

  7. @Crito--It also goes to the heart of another problem: it should be clear that "we" are not allowing people to "insure" without the reserves, the big banks are. Until they decide the game is over nothing will change. There is no "we" about it.

    The problem is clear--and Hell's solutions, while cogent and well-stated, are not particularly difficult to arrive at. But the CDS party continues because the players are all convinced they are making or will make a profit in it--as buyers, sellers, or providers of margin.

  8. Well the "we" in my statement may be reflective of our political representatives and our lack of knowledge about the game.

    It is like the scene from "Casablanca", when the French Captain says, "I'm shocked, shocked to find gambling going on in here." The manager comes in and says, "Here are your winnings Sir."

    We need a half dozen reporters out there with half the knowledge of Hellasious and his writing skills to tell the story.

  9. CDS may have been invented with the best of intentions, but I'm probably giving Blythe Masters too much credit for limiting her thinking to only beneficial hedging.

    How quickly they've turn from a defensive "tool", into an offensive weapon.

    Financial products that can be perverted and made into a destructive WMFD, should be banned.

  10. In simple terms, CDS has gone from a tool to hedge credit risk to a speculative instrument used to bet against ("short") anything from stocks, mortgages, corporate debt and indexes, to entire countries - indeed entire economic blocks.

    I wouldn't have much problem with all of the above - except betting against govt. bonds - if it wasn't for the fact that the self-same bettors turn to govts. and central banks for bailouts, when their bets go sour.

    That's what I call Immoral Hazard.

  11. Hellasious very nice post and great commentary. It does seem quite wrong to be trying to profit from the collapse of the very financial system that the CDSers are turning for bailouts. Am I missing something here?