Next Up: Italy




The Italian 5-year is yielding 6.87% while the 10 year is now 6.77%.

The curve-inversion is very bad and is a stark warning: Get ready.

This has not yet managed to get to the 2yr (6.38%)

Pundits have opined that due to the relatively long duration of the bond portfolio outstanding it’s not a “big deal.”  They’re wrong.

MTM losses will force margin calls and while “risk-weighting” for sovereign debt is typically zero (illusory though that is) it doesn’t matter if your counterparties don’t believe you’re good for the money.  That’s exactly how MF Global blew up, incidentally.

Today, right now, these bonds are not trading as an implied discount in a default.  Tomorrow they might be though and if we don’t cut the crap it is inevitable that it will happen.

Last night it was revealed that Japan had been buying about 10% of the EU’s “support” of the bond market.  If this was supposed to be bullish it didn’t work out very well; between that and the revelation that Olympus has been hiding losses for years the Nikkei dove 111 points.

The world is being dragged kicking and screaming into recognition of two fundamental facts:

  • You cannot borrow your way to prosperity. 
  • You have to pay for what you demand from the government.

People want to talk about this using the term “austerity”, as that’s got a nasty and dirty ring to it.  But austerity is not a dirty word as to be “austere” is to be simple, unadorned, morally strict or somber.

Yeah, I know, it also means having no comforts or luxuries.  To that I say it’s perfectly ok to have luxuries if you can pay for them in the present tense.

We can’t.  They can’t.  And Europe’s governments won’t level with the people.

I can’t sway European governments and neither can you.  But we can, and had better, sway ours.

We’re out of time folks.  When I embarked on writing Leverage as those of you who have followed me know I had predicted that the next part of the ugly saga that began in 2007 was going to come out either Europe or Asia — it would not originate here.

But having squandered the opportunity to ringfence the essential elements of our government and financial system in favor of handing out bailout funds to big banksters and allowing their ripoffs of the public to go unpunished, we also failed to severe the chains — specifically, those linked to derivative risk.  It’s not only still there, it’s been growing since the crisis.

At the time this mess began to unfold I recommended that the government step in and declare the following:

  • All derivative contracts must be exchange traded with nightly margin posted.  That margin must be across the board equal for everyone and it must be in cash or cash-equivalents (e.g. short-term T-bills, say 26 weeks or less.)  The latter requirement essentially takes duration and interest-rate risk off the table for the collateral-holder and ultimate payee if the bet goes bad.
  • The existing contracts have a short period of time (~60 days to six months max) to be moved to an exchange and margin posted.  No fear, no favor, no ifs ands buts or maybes.  Everything from that point forward is double-blinded just as it is for listed options and futures now.
  • If you can’t or don’t do the above, your contracts are torn up as void ab-initio for lack of consideration.  It’s simple: A contract to do an impossible thing is no contract at all.  Either prove that performance is possible or your alleged contract is declared a fraudulent edifice and thus unenforceable.

Yes, I know this tweaks the die-hard libertarians and some others (including all the banksters.)  That’s just too damn bad.  The solution to 30 years of intentional fraud and willful aversion of regulatory oversight sometimes requires that you put back into place the fence that should have existed in the first place.  Libertarians can disagree on the mechanism but not on the essential function of government: To provide effective redress against force or fraud.

Well, a contract that you cannot perform on is a fraudulent edifice.  This is even more true when you cook the terms ex-post-facto (as we just saw with CDS on Greece) so as to redefine what “is” is.  Voluntary my ass; a gun in the face immediately preceding the handover of your wallet is not voluntary when the other option is that your brains become the new room wallpaper.

Never mind the incestuous manner in which the ISDA “determines” a credit event.  The majority of the committee are the writers of these swaps (that is, those who have to pay if they trigger); would you play against the NY Yankees for the World Series if the plate umpire was the Yankee’s coach?

This crap has to stop and stop now.  We cannot have the government spending more than it takes in via taxes.  It’s that simple.  Nor can any other nation.  If you want to call this names (“austerity”) that’s fine; I call it prudence and truth, because it is.

The so-called “supercommittee” isn’t going to do jack and squat in this regard.  They’ll pull some dog and pony show, but this much I assure you: When, not if, Europe comes apart if we have not erected the walls necessary to withstand that financial tsunami first we’re all going to be 500′ below sea level.

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