FedUpUSA

Archive for November 22nd, 2011

For those unfamiliar, you can read here about Janet.   To say she is the world’s foremost expert on structured finance would be an understatement.

Janet Tavakoli, Tavakoli Structured Finance, Inc.

Damning with nothing faint about it….

• Shortfall estimated at $1.2 billion or more (up from $600 million)
• “Repo-to-Maturity” is a “Total Return Swap-to-Maturity,” a Type of Credit Derivative
• Probable Shortfalls Throughout 2011
• Regulators Waive Required Tests for Jon Corzine
• Jon Corzine to Credit Derivatives Head: Next Time “Double Up
  JT Note: Subsequent to this report Jim Parascandola told me that he was never told to increase the size of any position, albeit his trades were profitable.
• Questions About How MF Global Became a Primary Dealer
• MF Global Wrote Rubber Checks for some Electronic Checks for Others
• Tip-Offs for Some Customers?
• CFTC’s Gary Gensler Didn’t Act
• MF Global Debacle Damages a Key Global Market

Here’s the punchline folks, as I’ve outlined as well:

MF Global’s problematic trades were different from AIG’s, but they were also derivatives, in fact, they were a form of credit derivative. The “repo-to-maturity” transaction was just a form over substance gimmick to disguise this fact. Specifically the transactions are total return swaps, a type of credit derivative, and the chief purpose of these transactions is leverage.

A total return swap-to-maturity includes a type of credit derivative. It allows you to sell a bond you own and get off-balance sheet financing in the form of a total return swap. Alternatively, you can get off-balance sheet financing on a bond with risk you want (but do not currently own so there is no need to sell anything) and take the risk of the default and price risk. (Price risk can be due both to credit risk and/or interest rate risk.) This is an off-balance sheet transaction in which the total return receiver (MF Global) has both the price risk and the default risk of the reference bonds. In this case, MF Global had the price risk and the default risk of $6.3 billion of the sovereign debt of Belgium, Italy, Spain, Portugal, and Ireland. As it happened, the price fluctuations of this debt in 2011 weren’t due to a general rise in interest rates, they were due to a general increase in the perceived credit risk of this debt.

In short the risk doesn’t go away but it’s not on your balance sheet so it is effectively hidden.

Read the entire report folks.  It’s not pretty and, in my opinion, it is required reading from a very credible source.

Financial dictatorship is going to come across the (European) continent. – Bill Still

Some interesting commentary on OWS; if, in fact there is a co-opting in process in this regard, well……

If you remember, my friends, I said originally that this movement could turn into one of two things — one good, the other very bad:

1. A legitimate political movement that ultimately restores the rule of law.

2. A removal of we the people, perhaps through violence and anarchy, ultimately leading to dictatorship.

Which will it be folks?

OWS: The time for choosing has come; you either stand for the right things or you will wind up being used as puppets exactly as was The Tea Party.

Bill Still’s campaign can be found at http://still2012.com/

 

Scaremongering aside, the demise of the euro does not end European integration. It only means that which is unsustainable has been relinquished and a return to stability is finally possible.

So the euro is doomed. Toast. History. This will lead  to:

1. the end of civilization

2. the end of European integration

3. the start of new Dark Ages

4. the return to a sustainable reality

The correct answer is 4.The euro was an unsustainable, self-destructing  extension of the integration that has long simplified trade, travel and work throughout the EU (European Union).

At the risk of over-saturating you with more euro-related material, here are the basics we need to keep in mind as the third act plays out.

A common currency seemed like a good way to simplify trade and lower transaction costs.As I noted yesterday in Some Heretical Thoughts on the U.S. Dollar, such “folk” convictions rest on “sole-source causation”:  in this case, that a single currency would only offer more benefits of integration because it lowered complexity and transaction costs.

The euro supporters forgot or ignored the primary purpose of national currencies:to account for differences in transparency, productivity, trust, money creation and risk between nations’ economies and their Central Banks/States.

If you remove this means of accounting for these fundamental differences, then you have removed a feedback loop from a dynamic system, and thus removed an absolutely  essential flow of information and transparency.

What you’re left with is a system of lies, officially sanctioned opacity,  misinformation, disinformation, cooked books, artifice and propaganda, i.e. exactly what Europe has become.With the euro, there was no way for the system to account for thr vast differences in debt loads, credit risks, transparency, productivity and a dozen other fundamentals that are expressed in foreign exchange rates.

By all accounts, Greece and Italy have painfully dysfunctional national finances and  political Elites resistant to admitting the dysfunction is unsustainable.  Once those nations revert to national currencies, then their currencies will reflect the market’s assessment of their economy and their national/Central Bank policies.

The same will hold true for all the other EU member states: the market will shift through the various metrics and feedback loops and reach an equilibrium around the value of  each nation’s currency.

Profligate, over-indebted nations with dysfunctional Elites and systems plagued by political corruption and gridlock will see their currencies devalued and the interest rates they must pay to borrow money raise to the point that borrowing will no longer be an option to escape the consequences of profligacy, and the devalued currency will preclude buying imports  from strong-currency nations.

These feedback loops are essential to providing the citizenry and their economy with the transparency and information they need to adapt to reality. The euro has erased all that vital information, leaving only interest rates as the sole expression of differences between economies.

Interest rates are simply not a rich enough source of information  and market feedback to express the differences between national economies; the global markets need the information and feedback loop provided by currencies.

As I attempted to describe yesterday, currencies are not explicable with “sole-source causality” or “folk” understandings; they are distillations of numerous information feeds and feedback loops that only a transparent market can generate.

I have little doubt the euro is being held aloft by cloaked Central Bank intervention; the Elites are desperately attempting to cloak the system’s intrinsic dysfunction and stop the market from repricing the euro based on the inevitable return to national currencies.

Rather than fear this return to transparent feedback, we should welcome it and hurry it along.  Systems which cut off feedback and choke transparency with artifice and lies are doomed to implode.  If Europe ditches the failed “folk” experiment called the euro, then the process of recognizing and pricing dysfunction can begin, and the stability  that only transparency and feedback can provide will soon return to the EU.

This may sound counter-intuitive, but it’s the only way forward to a sustainable, stable reality.  The immense hubris of Europe’s dysfunctional Elites precludes their recognition that reality eventually trumps artifice and intervention. Their feeble, addled cries cannot turn back the tide, even if their bloated self-importance is infinite.

Charles Hugh Smith – Of Two Minds

Wow, now we have “more complete” data…. and of course the revisions always go the same way…

The “second” estimate of the third-quarter increase in real GDP is 0.5 percentage point, or $15.0 billion, lower than the advance estimate issued last month, primarily reflecting downward revisions to private inventory investment, to nonresidential fixed investment, and to personal consumption expenditures that were partly offset by a downward revision to imports.

In other words we were entirely too optimistic in pretty much all the things that mattered.

This should not surprise, of course….. just like we see the same pattern with the jobless claims every week that are virtually always “revised up” later on, making the current week report look better.

And here comes Uncle Sam:

• IMF APPROVES CREDIT LINE PROGRAM CHANGES TO PROVIDE LIQUIDITY
• IMF CREDIT LINE CREATES NEW SOURCE OF FUNDS FOR MEMBER NATIONS
• IMF ADDS EMERGENCY FUNDING TOOL TO ASSIST COUNTRIES IN CRISIS
• IMF NEW CREDIT LINE AVAILABLE FOR SIX MONTHS TO TWO YEARS
• IMF CREATES PRECAUTIONARY AND LIQUIDITY LINE
• IMF SAYS ACCESS UNDER 6-MONTH LIQUIDITY LINE COULD BE UP TO 500% OF
  MEMBERS QUOTA

And here is the math: Italy’s quota is 7,882.3SDR; Spain is 4,023.4 SDR. Multiply by 5 and you get 40 Billion and 20 billion SDRs respectively, which  translates to $61 billion and $31 billion. A total of $91 billion in additional capacity? And that’s it: enough to fund Italy and Spain for… two months. This is the best the regime can come up with?

Good thing America can get its own house in order so it can go out and fix the world next, not with one, but two credit lines. Incidentally, absent the US ratifying these two credit lines they are as good as useless because with 17.7% of the total allocation, the US is the defacto lender of only resort (since this is used to bail out Europe, which effectively means Europe will not be lending into these credit lines). And good luck passing a global bail out vehicle through the Frankenstein monster that is the US legislative body.

And the final nail why this move is completely irrelevant:

The IMF board of governors agreed December to roughly double quotas from around $375 billion to around $750 billion. But out of the 187 member countries, only 17 have legally accepted the increase, including Japan, the U.K. and Korea. Most of the countries with the biggest quotas, such as the U.S., China and Germany, haven’t yet gone through the legal process, such as parliamentary or congressional approval, need to hand over their promised dues.

Q.E.Dead

The precautionary Credit Line:

Precautionary Credit Line     The Precautionary Credit Line (PCL) has been established to provide effective crisis prevention to members with sound fundamentals, policies, and institutional policy frameworks that have no actual balance of payments need at the time of approval of the PCL, but moderate vulnerabilities that would not meet the FCL’s qualification standard. Members may request an arrangement with duration of between one and two years. Access under an arrangement with one-year duration shall not exceed 500 percent of quota, with the entire amount being made available upon approval of such arrangement and remaining available throughout the arrangement period subject to an interim six-monthly review. Access under an arrangement with a duration of more than one year shall not exceed 1000 percent of quota, with an initial amount not in excess of 500 percent being made available upon approval of the arrangement and the remaining amount being made available at the beginning of the second year of the arrangement subject to completion of the relevant six-monthly review. Purchases under PCL arrangements are repayable in 8 quarterly installments 3¼ – 5 years after disbursement.

And the Flexible Credit Line:

Flexible Credit Line     The Flexible Credit Line (FCL) has been established to allow members with very strong track records to access IMF resources based on pre-set qualification criteria to deal with all types of balance of payments problems. The FCL could be used both on a precautionary (crisis prevention) and nonprecautionary (crisis resolution) basis. Members may request either a one-year arrangement with no interim reviews, or a two-year arrangement with an interim review of qualification required after twelve months. Upon expiration, the Fund may approve additional FCL arrangements for
the member. Access is determined based on individual country financing needs and is not subject to a pre-set cap. Purchases under FCL arrangements are repayable in 8 quarterly installments 3¼ – 5 years after disbursement.

Source: IMF

ZeroHedge

“…. as a result of a clearing member default at CME Group”

Except….. now it appears that’s not true any more, right?

The “Trends Journal” says it has uncovered critical information that – in light of the MF Global bankruptcy – casts doubt on the fitness of CME Group to serve as a trustworthy derivatives and commodities exchange, and on the credibility of its Executive Chairman, Terence Duffy.

The “Trends Journal” says not only has the scandalous MF Global bankruptcy (the eighth-largest in US history) wreaked financial havoc on thousands of individuals, it has single-handedly destroyed faith in the commodity markets. CME’s reputation as the financial Rock of Gibraltar, upon which the commodity markets are anchored, has now been undermined. By its recent actions, CME’s claim of being committed to guaranteeing the transactions undertaken by its members has been called into question.

As recently as 2010, Terrence Duffy boasted, “No customer has ever lost a penny as a result of a clearing member default.”* Moreover, in the same press conference, Duffy stated unequivocally, “Since we are the guarantor of every transaction that happens in our markets, we have to guarantee the performance of each and every one of these contracts … To do this, we hold more than $100 billion of collateral to support the transactions that are being done on our markets.”

So let’s ask the question: What’s the truth and why should anyone be trading through an allegedly transparent “guarantor” of contracts when segregated customer funds wind up “missing”?

It is at times like this that we find out if the alleged transparency and exchange trading guarantees actually mean something.  I have long been a strong proponent of the regulated futures and options markets on the premise that even during severe events like 1987, 2000 and the 2008 crashes — even when the solvency of clearing members has been called into serious question (or they’ve failed outright!) nobody has gotten rooked as a consequence.

That is the function of a regulated and transparent exchange.  The regulation of margins and supervision of the cash that backs transactions and provides collateral against non-performance is the primary function of such an institution.

It is not clear at this point point exactly what happened with MF Global.  But this much is quite clear — the rapid transfer of open positions to other firms along with the cash margin deposits held on behalf of customers to guarantee trades did not happen in a reasonably-expeditious (like “right now”) basis when MF Global failed.  Some customers were forced to come up with a second margin deposit and if they were unable to do so their positions were forcibly liquidated.  Significant amounts of that margin money appear to have disappeared outright, despite the fact that it is the CME’s job to guarantee performance through the enforcement of margin deposits.  Indeed, they call these margin requirements performance bonds — because they are.

Well, if they were and are performance bonds then perhaps CME would like to explain why they did not demand a full accounting of them on a nightly basis from all clearing firms (including MF Global), how it is that MF Global managed to evade proving up their customer performance bonds, and why their failure to supervise the presence and legitimacy of these performance bonds should not fall on them.

If this alleged supervision and guarantee is in fact worthless then the role of a neutral “referee” that CME Group has asserted has been abdicated and there is no reason to believe that any transparency, any guarantee of fairness in execution is real or any alleged “performance bond” money actually exists.

Indeed, the entire purpose of CME’s existence has been rendered null and void by their own hand.

The entire premise of my endorsement of exchanges — and for forcing derivative contracts onto exchanges as a means of de-fanging the CDS monster — rests on the integrity of this performance bond process.  An exchange, due to the fact that it is paid a relatively small amount of money to handle each contract that passes through it, has a very strong incentive to make sure nobody is cheating and that all margin money is actually there because if they don’t they face losses that are radically outsized when compared to the fee they collect for facilitating the trade itself.

It appears, however, that in the MF Global case this supervisory function failed.  That’s bad.  What’s worse is that it appears CME Group has, at least thus far, successfully dodged taking responsibility for that failure and the apparent non-presence of alleged “performance bond” deposits that in fact disappeared.

There are only two possibilities: Either CME knew the alleged “performance bonds” were not present or they were tricked into believing they were present when they were not.

CME’s thus-far successful dodge of responsibility to make good on these alleged “performance bonds” that were not where they were represented to be makes a mockery of the premise that an underwater position is fully collateralized by the customer who has the losing position and thus the customer with the winning side of that trade will, with certainty, get paid.

That is the entire purpose of requiring margin deposits in the first place!

If we are to have actual regulated markets and a known safe place to trade where customer “performance bonds” actually mean something that must not occur.  If CME was either tricked or worse, allowed MF Global to close a single day’s trading book while the allegedly deposited customer performance bond funds were missing then CME must promptly make good on the missing funds as this is the premise on which a regulated exchange rests!

The literal existence of safe and sound markets is at stake here.  If CME successfully dodges  responsibility for failure to actually guarantee that performance bond funds are real and are where they are represented to be in each and every case then no end user, industry group or other person can reasonably believe that their trades are in fact “money good” anywhere on any United States exchange.

PERIOD.