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Thursday Technical Update: Systemic Collapse?

  • Written by Syndicated Publisher 356 Comments356 Comments Comments
    November 18, 2011

    I started writing the market recap this morning because the news flow is fast, furious and hard to keep track of. I continue to take my investment direction from the currencies, primarily AUD, EUR and USD (DXY) and the yields and spreads on sovereign debt all of which broke down further today.

    I believe the trade many have waited for a long time is truly upon us. Whether the “powers to be” can keep the game afloat longer only history knows the answer. Ask yourself one simple question though.  What if they can’t?  The simple reality is that with each passing day the problems grow larger and the time to stop the slide in confidence smaller.


    Greece may be out of the news of late but something important still has not happened. Leaders still have not submitted a signed letter of intent to the troika as required to received the next tranche of the bailout. The opposition refuses to sign off on this letter.

    What I find interesting about this is it shows EU leaders just how much power the debtor in fact has. It will strengthen other sovereigns such as Ireland and Portugal to increase their demands and shows how bailing out those in need is far from a panacea.

    Fed Raises Repo Collateral Requirements

    In an interesting move the Fed made a change to MBS transactions with primary dealers by raising collateral requirements something never required in the past. It signals their own concern for counterparty risk and clearly is not a sign of confidence. Clearly they see risk after one of their primary dealers was the first victim of the sovereign debt meltdown.

    US Dollar Demand Grows

    As witnessed by the EUR basis swap the demand for USD is back to fall 2008 levels or in other words liquidity is extremely tight. Below are two charts (1) EUR basis swap from ZeroHedge and (2) five year weekly chart of the USD showing how explosive the move in fact can be when USD liquidity all but disappears.

    TARP Was About Restoring Confidence

    Just like Warren Buffet buying GS in the fall of 2008 was a “stamp of approval” so was TARP. Sure it backstopped the banks but it also was an attempt for the largest investor at the time, the US Government to put their “stamp of approval” on the system. The government was trying to restore investor confidence (among other things).

    Confidence is everything. Banks do not hold all your deposits on hand because of confidence in the system. Businesses invest in inventory because of confidence you’ll come in tomorrow and buy it. Investors buy stocks and options because they are confident they can sell when they want to. I can go on but you get the point. Today we are experiencing a global crisis of confidence. Lending to sovereign nations is no longer considered safe.

    The only way to restore that confidence is to either fix the system or put a “stamp of approval” like TARP. Does the ECB have a large enough stamp? Clearly one country such as Germany is not big enough because we are talking an entire group of countries, the Euro”zone.” Hard to believe we have come to the final stage where the central banks are the last “stamp of approval.” What comes after them? Is their stamp really even big enough? Will investor confidence be fooled again as it was in 2008 with TARP?

    Confidence is hanging by a thread here. A perfect example of such is a letter written today by a broker who has opted to close her shop for concern the system is no longer viable. Client money is no longer safe in her eyes. This is not a blogger speculating or a bear selling “their book.” This is an insider. This is a broker. This is real and very scary stuff indeed.

    The full read can be found here key excerpts are below.

    “I could no longer tell my clients that their monies and positions were safe in the futures and options markets – because they are not.”

    I have learned over the last week that MF Global is almost certainly the mere tip of the iceberg. There is massive industry-wide exposure to European sovereign junk debt. While other firms may not be as heavily leveraged as Corzine had MFG leveraged, and it is now thought that MFG’s leverage may have been in excess of 100:1, they are still suicidally leveraged and will likely stand massive, unmeetable collateral calls in the coming days and weeks as Europe inevitably collapses. I now suspect that the reason the Chicago Mercantile Exchange did not immediately step in to backstop the MFG implosion was because they knew and know that if they backstopped MFG, they would then be expected to backstop all of the other firms in the system when the failures began to cascade – andthere simply isn’t that much money in the entire system. In short, the problem is a SYSTEMIC problem, not merely isolated to one firm.”

    Images: Flickr (licence attribution)

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