The wine dark sea

Unbelievably, there is still somebody who does not know what 's happening in Greece... or shall we say who has not heard the news of market turmoil, fiscal crisis, bonds prices collapsing, S&P downgrading them to junk, europe and IMF maybe riding to the rescue, or shall we say talking about it.

In fact we should say none of us knows what's happening in Greece. We know the news, we read the statements of politician and technocrats, we see the protests on the streets, we see the plots of bond yields and CDS spreads. But if we are honest: we do not know what is going to happens. And that matters: because if the bailout works, it will inject a wave of optimism, at least short term, that will drive bond yields down, equity markets up, and makes us all feel like we are in the best of all possible worlds. If instead the bailout is delayed, maybe because of social unrest in Athens, then its bye-bye and thanks for all the fish.

While we wait for that outcome, and it might be a long wait, let's expound platitudes, stereotypes and cliches.
For example: the Mediterranean is a dark wine sea. The people on its shores are more similar than different ("una fazza una razza").

This is why it matters (plot courtesy of IB):
it starts two weeks ago, rescaling so the two lines starts at the same point.
The blue is the bund,  i.e. the future on the 10 years german government bond.
The white is the future on the BTP (the 10 year italian government bond).
This is a way of saying "contagion" with a picture.
Now of course nothing will happen to Italy. The deficit is at 5.2% of GDP, while Greece is >13%.
Nothing will happen, if that 5.2% number is correct, and no serious off-balance sheet exposures, accounting tricks or frauds emerge. We have to hope not. But looking at the plot, somebody in the markets is beginning to get worried.

On regulatory reform

The big banks are making squealing noises about the proposed financial regulation bills in the senate, complaining that it would hurt them seriously and that more time needs to be spent pondering (notwithstanding that 2 years have already elapsed).
The reality is that the bill in the senate, and most of the other proposals being evaluated internationally, hardly address the real issues, and hardly hurt the monopolistic banks.
Check this out, from Reuters:
Wall street gives much to lawmakers in the reform debate

Weaker euro? Cui prodest ?

Let's begin this short blog by thanking the guys at Chicken House Plans (follow link from the picture) for this beautiful photo of candidates for the slaughter.
With that out of the way, let's move onto the idle thought for the day.
The Greek drama is being played in all its reverberating cacophony over the concerned media. "Merkel wants the IMF in" shouts one, "Sarkozy: over my dead body!" bellows another, "Don't mention the war!" urges others, as some vice-mister from Athens reclaims the gold allegedly plundered by the retreating Wehrmacht. The ECB wades in waving its collateral rules, the EC tuts-tuts, the UK keeps a low profile (better not draw too much attentions to fiscal deficits), the Greeks one day want support as they can't possibly afford paying 6% long term on their bonds, next day "we're all fine thank you very much, no help needed". Et-boring-cetera.
Still, at every twist and turns of this comedy of sorts, the markets take note, and react. Especially so the forex market, most egregiously the EUR/USD. Down, up, down, mostly down indeed.
And when it goes down, the chorus joins in, intoning their dirges about the demise of the proud currency... look what you've done now! stop please! help the Greeks! or the EUR will go down... and we can't possibly have that can we?

Well... actually we can. Certainly we can. Maybe maybe we really want it?
I would venture that a weaker EUR is very much welcomed in Germany, though of course you won't get a single politician admitting it. Germany is, as of recently,  the second biggest exporter in the world. A weak euro might help to go back to "numero 1" maybe? It will push up its competitiveness in global markets (ditto for the overall eurozone).
Just another round in the undercover war of devaluation and seeping beggar-thy-neighbour policies that are creeping in.
And, dare I say, there might be a sight of relief within the walls of the ECB. A weak euro will do some of the work for them. The eurozone is still mired in devaluation, and the recovery is limited to a weak pickup in germany and france... so every little help.

This might sound heretic. But by following the good old principle of "cui prodest" one seldom gets it wildly wrong.

Just a quick one

A lot has happened since... pity not to comment on the icelandic vote, or the gyration on greek debt.
Alas time has become very short. Before throwing in the towel though, let's update the trading positions.Maybe post something soon.

Rumblings in the distance. Italy the next target?

Sovereign credit has been very much in the spotlight, be it Greece or the others.
Could Italy be the next to be caught in the crossfire?
The longer term argument for sovereign bonds remains the delicate balance between deflationary and inflationary pressures on the one hand, and the tug of war between large supply coming and possible increase in domestic demand as baby boomers, among other investors disappointed by equity, shift to income and buy government bonds.

We have been bearish on UK gilts for a long time, flattish on US treasuries, and warned not to be short german bunds. At the moment even the bunds could be at risk though, at least for a short while.

The concern we are divining from the rumblings and the gossips comes from the focus on the swaps that were used by Greece to hide its real public debt. From there it is a small step is now to move onto looking at all the swaps that Italy did in the 90's with similar aims.

Up to now Italy has been considered relatively safe from a sovereign point of view: the deficit is not too bad (though the overall debt is). The spread between its bonds and the German ones is comparable, or even lower, than the UK one.
If concerns arise on the veracity of public accounts, including local authorities, it won't be pretty.
Even if there is no substance to those concerns, even if the current numbers are reliable, it won't be pretty.

The chance of the rumours growing and spreading, and acquiring weight, are maybe slim. But it is worthwhile to be careful.

See the FT, Risk magazine, and the Economist for details.

Oil and Patriots

News of a defensive buildup on the southern shores of the Gulf are coming in, together with Obama stating that they can't really stop Iran from making nukes if they really really wanted to.

Not surprisingly oil has been slowly drifting up, though the unexpected inventory buildup in the USA is putting a dampener on that. 

The haruspices closed their spread trade, and are wondering on the next stage for petroleum.

Overall, we suspect the current round of news is not enough to keep oil on the boil. The weakness in the global economy and the news from China are negatives.

But some much more dramatic news could hit the tape any time. So with december oil futures at 80~, it is not enough to take a position (apart from the usual lottery tickets - long calls at very high strike prices).

Let's wait a bit more.

Volcker is back.

So the day after the Mass. debacle, Obama finally gets it. There is only one really popular and populist trend, and it is to bash the banker.
It also happens that as well as being popular and populist, it is also very much the right thing to do.
One just has to hope that they do it right.
Volcker being on board is some consolation.
It also probably means, finally, the end of Geitner and co's. One wonders how long Bernanke can last: though his position is stronger, being less cosy to the banks, and intellectually sounder.
It beggars belief how long it has taken Obama to apprise the situation.
When Rahm said "a crisis is a terrible thing to waste", when Obama reminded the CEO's that he was the only thing between them and the pitchforks... one hoped that he understood that he had a golden opportunity to reform the financial system.
Oh well.
Hopefully he'll get to it now.
Hopefully this won't be just a re-introduction of Glass Steagall, but a strengthening and rationalization, a Glass Steagall squared.

Splitting financial institutions by function is necessary, but not sufficient.
Not just commercial and broker/dealer. Why not hiving off the settlement/payment/clearing functions completely, and treat them as a fully guaranteed utility? they are as important to our economy as electricity generation. Lending could be separated from the advisory function of investment banking. Et cetera: there is more than one way to skin a banker.

Of course, as well as reducing the risk of a full economy blowup caused by the banks as in 2008, this will severely reduce the profit generation ability of the financial sector in the boom times. That is a price worth paying, and additionally it also implies  that the "boom" will be less bubbly as well.

What else needs to be done?
Limits on the size of risk and balance sheets.
Prudential and countercyclical regulation (and maybe a bit of training  for the regulators, so that they have a chance of not getting outsmarted by the bankers).
Clear rules against bailouts of risk-taking institutions, clear guarantees and bailouts mechanisms for deposit-taking banks, and similar.
Making compensation a matter for the company owners, i.e. the shareholders, not just the board.
Forbidding discretionary payments such as dividends and bonuses when increasing debt or some leverage ratio. This should also catch the private equity pirates that sink companies by overleveraging them to pay themselves a dividend. Though it takes some serious work to do it well.

And above all, having some sensible, conservative marking rules for complex, illiquid assets.
Mark-to-market of those is a contradiction in terms (as there is no market), and it has become a ruse to use mark-to-model instead, which allows fake profits to be taken upfront, a' la champagne popping Enron. Then bonuses, and dividends, are paid out of these paper profits... Later on when the losses accrue, the salespeople/structurers/traders move on to another institution, and start the game again.
Without there paper upfront profits, a lot of the crazy derivative structures that fuelled the bubble would have never been traded.
Enough said.

So... will they get it right this time?

Sorry! no nice pictures! will try to find some later

The runes for 2010

This was written before Volcker-Obama rode into town. That deserves a blog of its own

So long since last post. In between, there has been some skiing, but also discussions with friends (who have provided the best of the ideas below, while the dodgy ones are all mine), as well as active trading in the last few days of the year recent weeks. Trading summary for 2009 will be written later in the usual place, as well as the more technical views on trading for the next term.
So the time to examine entrails is upon us again. In short, the executive summary: by end of the year we'll be in trouble. Longer term picture even worse.
Still, this year could be a very profitable one, as January has shown, assuming of course that the right approach is deployed.