Alessio Rastani - BBC Trader Interview

Admittedly, I've jumped on the bandwagon a little late with this one, but the ratification this trader employs with his 3 minute rant is quite staggering and potentially exposes an ugly side of an industry with many secrets.

Despite the fact Mr. Rastani may touch on some critical points, I refute the statement 'the stock market, and with it the euro are finished.'  The very definition of efficient markets undermines his point, at least for the time being and suggests there is still a great deal of hope out there.

Tobin Tax - To Bin our Financial Services Sector

On September 28th, The European Commission formally proposed a Financial Transactions Tax (coined 'Tobin Tax' after the Economist James Tobin).  Having accomplished so much in his academic life, I find it somewhat disappointing that his legacy will live on in the form of a levy which may very well strangle the growth and stability he sought to promote.

Moving on from the tax's pseudonym, the paradigm of the EC's proposals would be to impose a toll of 0.1% on every security transaction involving EU based financial institutions.  All OTC derivative deals would also incur a tax of 0.01% on the principal amount of the transaction.  The objective; to raise an indicative €55 billion for European Union nations.  The implications on the other hand will be far less black and white.

Turning attention first to those who are in favour of implementing such proposals, we witness three key arguments.  The first is obvious (and appears in my view to be the only one the EC have considered), the tax will raise money for a debt ridden area in times of austerity and economic hardship.  The second, is more personal.  People want banks and financial institutions to foot the bill for a problem they created (which is understandable and in a just world may be a little more persuasive).  Finally, supporters realise this could be the end of high-frequency traders and with it, the bad money that follows.  HFTs aim (in the most part) to capitalise off of arbitrage; trading many times a second, taking advantage of pricing indifferences.  As a result, computers account for c.90% of market transactions and have therefore 'taken over' in a terminator style saga (to put it melodramatically).

The problem is though, supporters will likely receive a fraction of the returns expected from the intrinsic benefit of the toll.  Financial institutions' whose cages have already been rattled by Basel III and (within the micro arena), proposals such as the Vickers report (see earlier post), will likely use this as an opportunity to move to other parts of the world where they can retain their competitive edge.  HSBC have already threatened to move to Hong Kong and ICAP, a FTSE100 inter-dealer broker have threatened they may move off-shore if the Tobin tax were to be instated.

The EC claim (at this stage) to implement the toll only if political agreement throughout the EU is unanimous. Speculators believe however that they may go ahead regardless, which could have a positive impact on the UK market share of the global financial services industry if Britain were to veto the proposal.  Given Britain's status as one of the world's dominant financial centres, I don't see the Coalition Government signing up (thankfully.)

On a final note, I dare say I'm in agreement with a Tobin tax, if acceptance was world-wide.  I very much doubt this is possible however, considering each nation has their own incentives to promote business.

European Investment Bank's 'Special Purpose Vehicle'

Although I take no credit for this post, the underlying synopsis of this article by zerohedge.com provides some indication as to why equity markets have rebounded so decisively off of support over the past 48 hours:

(To trim the article around the edges, below is the underlying paradigm.  For those who'd like to read the full (brilliant) analysis, I've included the link):

"Nothing has been officially announced, but according to a news article published by CNBC here is what this new structure could look like (there are lots of moving parts):

1. It would involve money from the European Financial Stability Facility (EFSF), a bailout vehicle created in 2010 to alleviate the sovereign debt crisis in Europe, to capitalize a special purpose vehicle that would be created by the EIB, a bank owned by the member states of the European Union.
2. The special purpose vehicle would issue bonds to investors and use the proceeds to purchase sovereign debt of distressed European states.
3. This could potentially alleviate the pressure on the distressed states and on the European banks that hold a lot of the distressed sovereign debt. The bonds issued by the special purpose vehicle could then be used as collateral for borrowing from the European Central Bank (ECB), allowing the central bank to make loans to banks faced with liquidity shortages.
4. They would buy bonds of the special purpose vehicle, and those bonds could be used to access liquidity facilities from the ECB.

Although the structure is complex, the underlying result is relatively simple. Banks would essentially be allowed to exchange their sovereign debt for debt issued by a special purpose vehicle created by the EIB capitalized with funds from the EFSF."

http://www.zerohedge.com/news/rosenberg-explains-what-if-anything-has-changed?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29

As far as equity markets (and no doubt European banks) are concerned, implementation of such a strategy would take a mountain of pressure off of balance sheets and although somewhat far fetched, could be a feasible short term solution to the volatility we're currently seeing. 

I agree with the author of this post (Tyler Durden reconstructing the views of David Rosenberg), this is most likely another deterrent from the real problem.  I further believe implementation, if (legislatively possible) will be a timely process and thus the superfluous strength this 'rumour' has spurred will most likely be sold into at the 5,400 level on the FTSE100.  I also remain pessimistic on Merkel's ability to retain any form of control over her unruly parliament and thus I envisage it will be some time until the EFSF's fund holds the necessary fire power to sooth markets.  Volatility until Christmas, here we come. 

The Implications of a Greek Default - How Will Markets React?

Despite speculation that yesterday would mark a catastrophic Greek default, news yesterday morning indicated the insolvent nation did in fact come up with the €769 million required in coupon payments on 2040 and 2037 bonds.  The questions therefore remain; will Greece default and if so when.  To address the first, we take note of the fact Credit Default Swap spread for Greek sovereign debt prices in a near 100% chance of default.  Assuming therefore this event is more than likely to happen, the only question remaining is when.  Personally, I subscribe to the view that it will happen early 2012 regardless of actions taken by the rest of Europe to prevent it.  In terms of other debt-ridden European nations, this illustration by CNN provides some indication of the likelihood of the default of other nations (indicative again of CDS spreads).

This article aims to address therefore the likely outcome of a Greek default on financial markets.  Without the resources at my disposal to look at micro effects, I shall offer my opinion only on macro repercussions.

Looking first at the bond market, the most obvious consequence would be elevated pressure on the nations highlighted above.  It's logical to assume bond yields on sovereign debt would rise as a Greek default would likely set a precedent that other indebted nations could follow.  This is the nature of Eurozone contagion.  The key 'security' (to use the term loosely) in this scenario would be the yield activity on Italian and Spanish 10-year debt.  History tell us the tipping point has been 7%, after which borrowing on money market ceases to be economically viable.  It would also prove exceptionally difficult to bring the yield back down below this level and hence the downward spiral Greece found itself in all too recently could begin.  In terms of AAA rated sovereign debt, I'd imagine these yields to lower as a 'risk off' mode comes into play and investors flock to safe haven assets.

The next major blow would likely be struck upon the banking industry, mainly in Europe but also throughout the world.  The link below graphically illustrates relative exposure each nation's banks have to other European nations:

http://www.ft.com/cms/s/0/9686c004-fca4-11df-bfdd-00144feab49a.html#axzz1YavOr400

At a glance it would appear French banks (whose stock prices are currently being dealt hell) would fare the worst from a Greek default.  French exposure to Greek debt currently stands at $52.9bn, followed by Germany; $35.7bn and then the United Kingdom, $13.7bn.  French and German banks are also the greatest owners of Italian debt, holding $404.9bn and $164.9bn respectively.  We can therefore assume both France and Germany would be the hardest hit by a Greek default (which in my view, surely steps up the argument for their parent governments to adopt some sort of Eurobond asap.)  Perhaps a more significant outcome, rather than just monetary loss from this situation is the second credit crunch that could follow.  A quote from Gary Jenkins, head of fixed income research at Evolution Securities states "you would get the loss on the Greek debt of course, but I think much more important is the funding situation.  Who is going to be lending the banks money if you have got Euro Zone sovereigns defaulting and you are unsure about what is going to happen next?"  (Source: Reuters)


In accordance with the Capital Allocation Pricing Model, equity markets would also take a drastic hit as bank shares tank, dragging everything else lower.  The ability of banks to lend would also be pulled into question and funding for future operations could come to a standstill.  By all accounts, this would be more than likely to result in a double dip recession.

Looking on the bright side, some of the biggest gains in stock market history were recorded last year and when the dust finally does settle, there will be many companies out there with no where to go but up.  More importantly though it could give countries, banks, the Euro and people the chance at a fresh, debt free start.  At present, I for one fail to see the end to the current crisis.  Perhaps in time this will come to be known as the perfect solution to an imperfect problem.

Market Reaction to a Hint of Political Direction

In a previous post I offered my view on market pressure influencing the actions of subordinate politicians. It would appear, however, that during the course of this week, leaders have stepped up their game (ever so slightly) and may even be regaining control of the situation. Germany and France have reiterated their support for Greece and talk of the Euro Bond is becoming ever more potent. Don't get me wrong, this positive progress could be reversed in a second but for the time being the markets are seeing a modest recovery. With regards to authoritarian sentiment weighing towards Euro Bond implementation, this article by Reuters is extremely useful.


http://uk.reuters.com/article/2011/09/15/uk-eurozone-eurobonds-idUKTRE78E1CE20110915


In this post, I'd like to take the chance to reiterate the importance I place behind a top-down approach to tackling this crisis. Let's take a look at what has sparked positive movements in the FTSE100 this week:

On Tuesday, fresh concern arose around an imminent Greek default (an economy which is due to run out of cash in October if the latest tranche (8bn euros) of the EFSF bailout package isn't forthcoming. As per usual, the market tanked as investors faced the uncertainty of the resulting impact of the inevitable (the yield of 146% on Greece's 1 yr bond says it all). Since however, it has rallied mainly due to two signs of political strength (or should I say hope?):

• Merkel & Sarkozy reassured markets they simply wouldn't let Greece tumble out of the Euro Zone.
• Whispers of a Euro Bond arose around the corridors of parliaments around Europe.

Although seemingly insignificant 'actions,' this is raw demonstration of the importance of political leadership in today's market. Negative news continues to tumble in (UBS's $2bn hit, World Bank chief stresses the danger the economy faces etc.) but political union has trumped to deliver a rise.

Merkel now needs to swallow her pride, stop hiding behind her prized AAA gov. bond and take control of the situation. Unfortunately, as I write, this just in;

http://uk.reuters.com/article/2011/09/15/uk-eurozone-idUKTRE78E1XW20110915

Sir John Vickers Report - An Analysis on Ring Fencing the UK

Yesterday marked the release of the anxiously awaited Sir John Vickers' government backed Independent Commission on Banking report. The headline statement called to implement regulations across Britian's major banks referred to as 'ring fencing,' a paradigm which would separate Investment Banking division from Retail Banking. In theory, this division would remove the need for tax payers to foot the bill for British banks in the event of another credit crunch in the future, while in practice the outcome may be fickle at best. Before examining this in detail, I first think's important to examine two representations from well informed sources which caught my eye.

For privacy reasons, I shall omit the name of the first speculator and refer to him as a top analyst employed at Investec in London who follows the financial sector. When I asked his view on ring fencing, his response followed; "ring fencing is a solution in search of a problem. Ring fencing wouldn't have prevented the fall of Northern Rock, Lehman brothers or exempted the need for the government to bailout RBS or HBOS." He developed to state "what happened in 2008 was natural selection; those who were weak got taken out and now, 3 years down the line, we're going to over regulate those who were strong enough to survive in a period of futile recovery." I must say, at the time I shared his view. The ICB would call to close the door after the horse had bolted.

A paragraph in the 'Comment' section of Tuesday's Evening Standard offered up an opposing view from another city insider (again, anonymous): "A glance at the banks' record over the past 30 years shows how parasitic the current arrangements are. He says that over that time frame bank shareholders have lost much of their money, retail savers have done very badly, taxpayers have thrown in billions to keep the banks afloat, and the people who work in financial services have made a bomb." Another hard hitting statement.

Having watched the Q&A session with Vickers yesterday morning it occurred to me despite the disastrous impact this will have on Britain's banks, this is the right action. The ICB is not calling so much for banks to implement ring fencing, it is calling for the government to ring fence the banks from the tax payer.

Having said this, the report painted a disastrously bleak tone for the future of UK banks and indeed therefore the future of the UK's economy. First lets take a look at the indicative headline figures:

• Cost per year: £4-7bn - to be absorbed by banks' shareholders, employees and balance sheets 
• Equity capital increase to 10% of assets (Basel III: 7%) 
• Banks should have loss absorbing capital of between 17%-20% 
• Due date: 2019 

In their rawest form, the numbers spell an end to an era of extreme leverage within the UK. Where as before banks could use money deposited by individuals for their speculative, investment based activities, post 2019, they may only use capital proprietary to their investment banking divisions. This means risk will be reduced on the front of the consumer (those with money held in retail bank accounts), but also on the part of the investment bank. If you subscribe to an efficient market hypothesis theory (which regrettably, I do) you'll agree that lower risk will result in lower reward which shall effectively equate to the end of the colossal profits witnessed by Britain's banks up until now. Unfortunately for the rest of us, this shall also have an impact on our economy as financial services are estimated to make up 10% of our annual output with some citing this change to result in a 0.3% decline in economic growth.

Therefore, I take a negative outlook in terms of the future of this country. Although in this instance I believe the benefit of this regulation marginally outweighs the cost, I do not see where growth will come from in the near future. Our service sector is suggested to account for 77% of our economy and by imposing tighter regulations we render ourselves less competitive with other more cavalier nations throughout the world. I do not think the banks will relocate their London HQs but I do think the government needs to keep a close watch on the resultant outcome and review regularly whether the benefits to the people of Britain are being outweighed by the possible slump in our future performance as a nation.

Euro Bonds - The Get Out of Bail Free Card

The phrase 'contagion' or 'contamination,' has driven market sentiment over the course of the year, with those in the driving seat keeping a very close eye on what some speculators believe has already occurred. The theory logically states, when crisis breaks out in one country's bond or equity markets, the trouble is likely to spread to others. Such is the nature of global economic integration in the 21st Century, markets are no longer solely exposed to their own domestic economies but also others around the world. Of course, when a string of debt-ridden countries share a unanimous currency, the threat becomes considerably leveraged.

Apprehension starts with Greece, Ireland and Portugal, three nations which have required monetary assistance from the ECB over the past 2 years. At this stage the banks come into the picture and could arguably be described as the core vehicle through which the 'disease' spreads. This is due to unfavourable positions taken in sovereign debt across euro zone nations, thus, when countries start to struggle with their payments, its the banks who lose out.

I jump now, to today. I believe August priced in a great deal of what is no longer contagion threat, rather reality. The debt crisis has quickly spread, as feared, from the source to Italy and Spain (the Eurozone's third and fourth largest economies respectively). While it was possible to calm markets with the promise of throwing more money at peripheral EU countries in order to 'solve the problem,' the same cannot be said for Italy and Spain. Therefore, we're faced with a situation where the clock is ticking - the debt crisis across Europe worsens by the hour and the up-until now solution to this problem, lacks fire power against a debt mountain.

Like other speculators, I believe the Euro Bond is the only effective solution. A Euro Bond would serve as a 'joint and several liability bond,' effectively resulting in financially more robust nations (such as Germany and France), vouching for their penny-less counter-parts; Greece and the other trouble makers.

Sarkozy remains typically impartial, so the resistance lies with Merkel. It's obvious as to why this is; Germany, the Euro Zone power house, would have to sacrifice her prized AAA rated sovereign debt, which at present yields c.1.9% on 10yr bunds. This maybe understandable, but it seems to me that the Germans are forking out anyway in this scenario. Either they are forced into offering direct, monetary aid to peripheral nations or their cost of borrowing grows. Unfortunately, I'm not in a position to comment on which one would likely cost the country more. S&P have indicated a Euro Bond would take the rating of the lowest participant, which wouldn't bode too well for the likely yield, but I still believe this is likely to be less than the estimated €2tn required to bail out Italy.

Looking further beyond merely Germany and France, a decision to implement such a security would also do wonders for global financial sentiment and give struggling nations such as Greece (who must currently offer c.20% on their 10 year yield - a figure impossible to finance) an outside chance at sustainable recovery.

In my view, this will have to happen to advert catastrophe. European politicians must be aware of this, and the risks associated with non-action.

Heads of State - Crisis Calls for Action

For my maiden post, I'd like to cover what is most likely a fairly basic view on a widely discussed topic.

I believe at this moment in time, financial markets are firmly dictating the next move for politicians worldwide which quite frankly is a disgrace.  There's rarely a good word to be said about either Dominique Strauss-Kahn (in my view, he's guilty as sin) or Gordon Brown, but in 2008 their coordinated efforts at least placed politicians in control of the fear and greed of the rich and resultant welfare of everyone else while the markets came crashing down.

To develop on this view, let's take a look at the key figures of power.  Obama & Cameron appear to be taking a back seat on this issue producing little, but competent input where necessary.  Obama for example with his $300bn job stimulation package as of today and Cameron steering a thankful Britain away from a costly, and most likely nugatory Greek bailout.  In my opinion, they are probably taking the right approach.

Let's jump to another key link;  Sarkozy & Merkel.  In my view, this is where the problem lies.  Two heads of state, left in charge of an unfavourable situation.  Merkel's rebellion within her own lower parliament is quickly shunning her ability to act on a growing Euro zone debt crisis and drowning the market in negative sentiment, whilst Sarkozy is yet to do, well, anything.  Their frequent encounters are indicative of this entire, political predicament.  They meet for 'emergency talks' and nothing comes of it.

I will discuss Euro bonds and my views on what should be done in a later article, but for now, lets look at another unfavourable.  Berlusconi, the man in charge of cutting Italy's $1.9 trillion debt mountain, whilst being charged himself for tax evasion, sleeping with an under-age and attempting to bribe a judge.  Unfortunately for the rest of the world, the strength of the Italian economy could be the tipping point between a continuation of the current futile recovery and a double-dip recession scenario, which is why having Berlusconi in power at this point in time is a threat to financial markets globally, rather than just an embarrassment to the Italian people.  While a Greek, Irish and Portuguese bailout is little more than a nuisance for the EFSF's 440 bn euro safety net, this wouldn't be enough to save Italy in the case of default.  I'd argue, that even increasing this amount to the proposed 2tn Euros, the Euro would still collapse, resulting in vast bank exposure to European government debt to trigger another global economic meltdown.  In my view, the best thing Berlusconi can do is listen to the pleas of his country and step down from what he described himself as "this bloody country [Italy]."

In my view, change will occur.  As will be discussed in the next article, MerKozy at some point will have to respond to the growing pressure on politicians to take control, and as far as I can see, a Euro Bond looks like the best option.

Mission Statement

It's easy to follow current affairs.  I believe formulating an opinion is much more difficult.  This blog aims to serve as an articulation of my own thoughts, predictions and views on varying financial circumstances.  I by no means claim to be an expert.  Therefore, advice, contrary opinions and constructive feedback would be most welcome.