Wednesday, December 28, 2011

Repo & Euro Financials' Intermediation of Shadow Banking

Despite a less-worse Italian auction this morning, the Euro took a rather ominous swan dive this morning on the wholly unsurprising announcement that the ECB’s balance sheet has swelled to an all-time high of €2.73 trn.    With the market otherwise fairly dull (aside from the odd story about JPMoMo sticking it to some infants and widows with a BBG headline comparing the House of Dimon to the Wehrmacht) I figure I’d take the time to succinctly re-cap my views on Europe, which I briefly touched on in my post last week.

I’m not negative on LTRO per se.  I just think that the necessity of LTRO speaks volumes about the dire funding situation of Euro banks and to the inability of the EU as a federal body to summon the political will to act comprehensively and decisively.  As we lose count of the number of EU interventions lets not forget that this is a slow-rolling, snowballing crisis that has been mounting for more than a year, during the course of which the EU has lost its credibility as a crisis manager.  In LTRO we have yet another stop-gap, backdoor solution that barely responds to the immediate problems while leaving little possibility of further rapid expansion should the situation fail to improve on its own.  A significant improvement in the policy environment notwithstanding, I don’t feel that this is a particularly likely outcome. 

LTRO may look impressive at first glance.  However, with €291.6bn maturing from the ECB’s 7 day main repo operation (MRO) and €169bn of MRO financing rolled on 12/21 against a further €140.6bn of older LTRO maturing (with only €29.7bn rolled), the actual new credit extended is significantly less.  Net this refinancing against a slight increase in fixed-term deposits (€3.5bn) and 45.7 bn moved from October’s 12 mo. LTRO, the new 3-year LTRO adds only €206.5bn in new repo financing extended to financials.  It’s worth noting that this covers only about 60% of the approximately €350bn of sub/unsecured/and otherwise currently un-rollable debt maturing in the coming year.  

Wednesday, December 21, 2011

LTRO, Maasichism, and the Future of Europe in 2012

December has brought another acronym to the rescue kit of European policy makers in the form of the ECB’s Long Term Refinancing Operations (LTRO), the arrival of which has been heralded by at least some market observers with a sense of cautious optimism and hope.  So, with a full allotment of €489.2bn to 523 bidders, clocking in at the upper range of analyst expectations, where do we stand today as we look forward to 2012?    

In sum, it is my view that those looking for LTRO to accomplish what the summit of December 10th did not are likely to be disappointed.  Before reviewing the specifics of LTRO and the extent to which it changes the situation of the European financial infrastructure, let’s briefly discuss the other avenues through which relief may or may not be possible:

While the headline €750bn figure highlighted by the Euristocrats in their presentation of the summit agreement is at first glance impressive the substance of the program is highly problematic.  What was needed was enough money to credibly demonstrate that Europe could buy itself the time necessary to make some very difficult decisions.  Having wasted earlier opportunities, the commitment required has likely grown after countless 'final solutions'.  A a number above €1trn (and probably closer to €2trn by some estimates) would perhaps have signaled that Europe has the intention and the ability to defend its financial system for at least the coming year.  In the end, a sizeable chunk of the committed capital would likely prove to be unnecessary but the important task of halting the reflexive self-fulfilling collapse of confidence would have been accomplished.  Instead, we have for the time being an amount unable to cover even a fraction of the sovereign issuance that is on the table for 2012.  Even had the financial commitment had been credibly adequate, the ultimate success of such a response remains contingent on timely, genuine structural reform of the European system.

Monday, December 19, 2011

No Hard Landing for China, Just an Old Fashioned Crash

About a year ago I began compiling a slide deck on the short case against China in an effort to formalize my thought and form an actionable thesis.  This proved to be fairly all-consuming endeavor and led to a substantial amount of highly enjoyable work that I summarized in a rather long-winded, sometimes polemical (and now slightly out of date) PowerPoint presentation.  My focus is towards the most misunderstood elements of the modern Chinese economy and reflects a perspective sharply at odds with the Western consensus.  Of the ‘soft landing’ camp I am not. 

In my first of what will hopefully be many, if irregularly published, pieces I’d like to briefly touch on my perspective of the Chinese slowdown and its prospects for 2012.

To bring readers up to speed, the situation has recently taken a turn for the worse. The Chinese debt cancer has continued to metastasize. Loathe to loosen in the face of vast demand from local government clients for stimulus, the center has been forced into action by the potential of a looming global slowdown; the Chinese economy, and especially the property markets, however, had already been showing signs of strain.  T
he domestic outlook has been increasingly poor with even the heavily massaged official domestic data looking worse and worse. However, the Chinese policy elite remain trapped between a very real economic (and increasingly pressing social) need to cool inflation driven by unchecked credit growth and the demands of Ponzi growth targets (to be achieved by the aforementioned credit growth).  Absent genuine reform and liberalization, the inherently inflationary tilt of China's managed economy will continue to plague policymakers even as economic activity slows; it is endemic to the model.  Unfortunately, such a fundamental change requires an autocratic oligopoly of the ruling elite to voluntarily relinquish their total control of a massive wealth-generating machine. 

Increasing cognizance of the fact that the $3+ trn of dollars of spoils from mass economic manipulation and top-to-bottom accounting fraud may already be largely spoken for has begun to percolate in the western media. The scale, opacity, and complexity of China's closely held financial system will limit comprehension of the full extent of the problems for most Western observers before it is already well underway.