Thursday, October 13, 2011

City of London to Leverage the BRICs

Last week, when we learned of the first set of cash-settled foreign currencies that would be cleared by LCH.Clearnet, it seemed an odd assortment. From FXWeek.com:
London-based CCP is set to launch clearing for NDFs in six currencies in mid-November, having shelved plans for options clearing while banks discuss settlement-related issues with regulators
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LCH.Clearnet plans to launch its widely anticipated foreign exchange clearing platform for non-deliverable forwards (NDFs) in mid-November, sources close to the offering's development tell FX Week.
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The new clearing service, dubbed ForexClear, has been in development since late 2010. LCH.Clearnet declined to comment for this article, but it is understood the platform will launch with NDFs covering six currencies against the US dollar: Chinese yuan, Brazilian real, Indian rupee, Russian ruble, Korean won and Chilean peso.
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While it had initially been expected to cover FX options and NDFs, the clearing house is understood to have temporarily shelved options pending discussions that were initiated in June between the US Federal Reserve and the major banks about the management of settlement risk for options.
Only yesterday, we learn that the local exchanges in many of these countries are joining forces to cross list their markets. From the FT:
Six of the world’s largest emerging markets exchanges have unveiled an alliance, in an unprecedented arrangement that aims to capture increasing investor interest in key “Brics” markets at a time when exchanges globally have been consolidating.
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Under the alliance Hong Kong Exchanges and Clearing, BM&FBovespa of Brazil, the National Stock Exchange of India, Bombay Stock Exchange, Johannesburg Stock Exchange and the two Russian exchanges that are in the process of merging – Micex and RTS – will cross-list each others’ stock index futures contracts. They will be listed in the local currency of each exchange, it was announced at the annual meeting of the World Federation of Exchanges in South Africa.
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The bourses will also work towards devising a Brics index that traders could use to gain broad exposure to emerging market indices.
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The development is a sign that exchanges in the Brics countries see an opportunity to expand globally at a time when their rivals in developed markets in the US and Europe are battling pressure on their margins from competition in cash equities trading from rivals and “dark pools”.
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The idea for the alliance was devised by HKEx, which first approached the other exchanges in June. Romnesh Lamba, head of the market development division at HKEx, told FT Trading Room: “From a revenue and investor perspective, we don’t expect there will be cannibalisation of each others’ markets.”
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The first stage of the project will see the exchanges begin cross-listing of financial derivatives on their benchmark equity indices by June 2012. The members will look to develop new products for cross-listing on their exchanges, which would be traded in local currencies.
As a reminder, LCH.Clearnet provides clearing services for the Hong Kong Mercantile Exchange (HKMex), the commodities wing of HKEx, and some have theorized the HK Merc was DOA until LCH was brought on board. As another reminder, foreign exchange is Geithner's loophole to Dodd-Frank. So, it looks like CLS Bank will leverage the developed world while LCH leverages the developing.

More here, at the now-free (and defunct) FT Tilt:

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Wednesday, October 5, 2011

France & Belgium Front-Run Germany; More Evidence for the Malmgren Hypothesis

The markets went vertical yesterday, after the Financial Times printed an article in the final hour of US trading that suggested Europe was close to a bailout solution for its larger banks. A careful read, however, suggests it confirms more the Malmgren Hypothesis (namely, a German withdrawal from the EU and EMU) than an imminent agreement on the EFSF. From the euphoria-inducing FT (emphasis ours):
EU examines bank rescue plan
By Peter Spiegel and Alex Barker in Luxembourg
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European Union finance ministers are examining ways of co-ordinating recapitalisations of financial institutions after they agreed that additional measures were urgently needed to shore up the region’s banks.
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Although the details of the plan are still under discussion, officials said EU ministers meeting in Luxembourg had concluded that they had not done enough to convince financial markets that Europe’s banks could withstand the current debt crisis.
“There is an increasingly shared view that we need a concerted, co-ordinated approach in Europe while many of the elements are done in the member states,” Olli Rehn, European commissioner for economic affairs, told the Financial Times. “There is a sense of urgency among ministers and we need to move on.”
“Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty,” Mr Rehn said. “This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis.”
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In a sign that European governments were preparing to act, Wolfgang Schäuble, the German finance minister, said Berlin could, if necessary, reactivate support mechanisms it put in place in 2008 to recapitalise the banks. The mechanisms had expired and the German government had until now insisted they were not needed.
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Markets have been unsettled again this week by troubles at Dexia, the Franco-Belgian lender, which holds €3.5bn in Greek bonds and €15bn in Italian bonds and has been struggling to raise enough short-term cash to run its day-to-day operations.
The French and Belgian governments said they would take “all necessary measures” to prop up Dexia.
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Some European officials had hoped to avoid a large-scale effort to shore up eurozone banks until the bloc’s €440bn bail-out fund is formally given powers to recapitalise financial institutions in countries not covered by bail-out programmes.
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But the process of getting the fund new powers has proved slower than expected, with three countries – including Slovakia – yet to approve the EFSF’s overhaul. Because the EU risked being overtaken by events, Mr Rehn said finance ministers meeting in Luxembourg agreed on the need to act through national capitals while co-ordinating their approach.
A first step would likely be to ensure all countries have mechanisms in place to prop up their banks.
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Mr Rehn cautioned that while there was “no formal decision” to begin a Europe-wide effort, co-ordination among EU’s institutions – including the European Central Bank, European Banking Authority and the European Commission – on necessary measures had intensified.
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The last quoted paragraph's mention of the ECB notwithstanding, we read these developments as a fiscal bailout of the troubled Euro banks, not a monetary one. Meaning, no money printing, more good money being sent after bad, and no bailout of the periphery.

Here are the details of the Dexia bailout by France and Belgium from WSJ Marketbeat blog (via ZeroHedge):
  • Franco-Belgian lender Dexia is set to park assets worth in excess of EUR180 billion into a so-called bad bank, a vehicle backed by guarantees from the French and Belgian governments, in an effort to disentangle itself from gripping liquidity strains, people familiar with the matter said Tuesday.
  • The bad-bank plan is part of a deeper makeover under which Dexia is considering selling all its core units and which may effectively lead to a dismantling of the lender.
  • Under a plan submitted to Dexia’s board on Monday, the bank would ring fence into a special vehicle all the assets it inherited from an aggressive expansion push early in the past decade as well as units that can’t be sold under current market conditions, the people familiar with the matter said.
  • These assets would include a portfolio of bonds worth EUR95 billion and about EUR30 billion in loans deemed non-strategic, they said. Dexia Crediop and Dexia Sabadell, the bank’s municipal lending units in Italy and Spain, respectively, would also be folded into the bad bank, the people familiar with the matter said. The European sovereign debt crisis has cast a cloud on most financial assets in Southern European countries, making it virtually impossible for Dexia to find buyers for the two units.
  • Over the past year, Dexia had succeeded in reducing short-term financing needs stemming from its large portfolio of long-term bonds. Yet, in recent weeks, the bank was increasingly struggling to raise funding at affordable costs. With little hope that liquidity strains would ease in the short term, management came to conclusion that Dexia could no longer carry the oversized bond portfolio alone, one person familiar with the matter said.
  • In a first step, Dexia may continue to carry the bad-bank vehicle on its books, but France and Belgium will give its guarantee to securities the bank must issue to meet refinancing needs, the people familiar with the matter said. Longer term, Dexia may transfer bad bank ownership to France and Belgium, these people said
As a reminder, here are some excerpts from the Malmgren Hypothesis, wherein the EU member states support their own banks to the exclusion of the broader institutional Euro framework:
The Germans have already concluded that if they are going to write any further checks then they are going to write them to their domestic institutions and protect their domestic investors. Necessarily, this means that many Eurozone countries will default on their debt. It now seems this will happen within a matter of days. Germany has, therefore, already announced its intention to ring-fence and support their own banks and only their own. This may ultimately involve the nationalization of some or even all the German banks. This is necessary because a falling Euro will further weaken the ability of the other Eurozone members to meet their commitments and thus increases the risk of multiple sovereign defaults. Eurozone countries that are going to default will do so virtually simultaneously rather than sequentially.
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The nationalization of the German banks, or the creation of a purely German Bailout mechanism, will immediately cause the markets to blow out the spreads on all debt instruments around the world with the possible exception of certain G7 countries like the US and the UK. Note that even the UK has massive bank exposures to the continent especially in Ireland. Ireland may get a bailout from the UK (again) but it is hard to imagine the UK writing a check to anybody else. This would force other Eurozone members to consider how to deal with their own bank debt problems: France, Italy, Belgium all leap to mind but the market will be bound to pressure others from Cypress and Eastern European countries to Bank of America. In fact, the entire banking and payments systems will be subject to entirely unknown shocks and logistical problems should this announcement be made.
Greece defaults and Germany will shore up the German banks. Other countries will either have to do the same or the market’s will discern which countries cannot bailout their banks due to lack of funds. The UK will be asked whether it is going to support the Irish banks. I suspect the UK will say yes but they may not be ready to answer the question when it comes. Any delay will force the UK government to reveal that the UK banks are cash rich. This will raise questions about their lack of lending. Bank failures will probably occur. Small institutions may bring significant consequences. We will see if the French have the resources to manage their banks. Christian Noyer insists that they do, but he would.
Accordingly, it appears France and Belgium have front-run the Germans to ring-fence Dexia ahead of a similar announcement (regarding Deutsche Bank or Commerzbank, for instance). Who will be next: Italy (Unicredit, Intesa Sanpaolo), Spain (Sabadell, Banco Popular, Bankinter), Austria (Raiffeisen), Norway (DnB NOR), Switzerland (UBS), or France again (Soc Gen, BNP)?
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Attack on Bank of New York Mellon Continues; US & Schneiderman File Suit Over Forex Fees

From the New York Times (emphasis ours):
U.S. and New York Sue Bank of New York Mellon Over Foreign Exchange Fees

By ERIC DASH and PETER LATTMAN
Published: October 4, 2011
The New York attorney general and the United States attorney in Manhattan filed separate lawsuits on Tuesday against the Bank of New York Mellon, accusing it of cheating state and other pension funds nationwide out of foreign exchange fees over the last decade.

In a civil lawsuit filed in state court, the attorney general, Eric T. Schneiderman, said that the Bank of New York Mellon had consistently overcharged customers for processing foreign currency transactions. He is seeking about $2 billion, which is the ostensible ill-gotten profits that the bank generated over the last decade.

Preet S. Bharara, the United States attorney in Manhattan, filed a civil complaint in Federal District Court in Manhattan that also charges the Bank of New York Mellon with defrauding its customers in the foreign exchange markets. Whereas Mr. Schneiderman is seeking redress on behalf of state pension funds, Mr. Bharara is seeking hundreds of millions of dollars in penalties on behalf of the United States.

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Mr. Schneiderman’s lawsuit charges that the bank guaranteed that customers would receive the most competitive or attractive rates available on any given trading day. In reality, the lawsuit says, the Bank of New York Mellon provided the opposite: the worst or nearly the worst of the rates available to the bank. Then it earned nearly $2 billion — or as much as 75 percent of its foreign exchange revenue — by pocketing the difference, the suit contends.

The New York attorney general’s action comes after similar moves by authorities in California, Florida, Massachusetts and three other states that are looking into the foreign exchange practices of the Bank of New York Mellon and one of its main competitors, the State Street Corporation. The Securities and Exchange Commission and Justice Department are also in the middle of investigations, according to corporate filings from the banks.

The inquiries began almost two years ago when a group of whistle-blowers made up of plaintiffs’ lawyers and Harry M. Markopolos, the financial investigator who first sounded the alarm about Bernard L. Madoff’s Ponzi scheme, sought out the New York state attorney general’s office to bring lawsuits against the bank.

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It is not the first time Mr. Schneiderman has squared off against the Bank of New York Mellon. He recently moved to block a proposed $8.5 million settlement involving the bank and the Bank of America over troubled loan pools issued by Countrywide Financial. The suit accuses the Bank of New York Mellon of fraud in its role as trustee overseeing the investment pools, a claim the bank has denied.
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Saturday, October 1, 2011

Solvency Crises Coming to a Head; Brace Yourselves for BAC Restructuring and Possible German Exit from the Euro

History tends to makes fools of those that speak of "imminent" institutional collapse. It's much safer to use the time-unconstrained term "inevitable" and wait for the eventuality. The inertial resistance to structural change is difficult for most to fathom. Yet, there are those fleeting and few-between periods when resistance snaps on multiple fronts, and a new global reality emerges. Here are two shoes waiting to drop:

1) Europe (to be, or not to be a union):


Were she not a major insider, we would tend to dismiss the leading bullet points from her article of September 13, 2011 as a bit hyperbolic.
News to expect in the coming days and weeks:
  • Greece defaults
  • Germany protects German banks but other countries cannot do the same thus quickly provoking multiple sovereign defaults and or bank failures, all of which may easily lead to a payments crisis in the global banking system. Derivatives are particularly at risk in terms of operation and execution.
  • The Euro falls in value especially against the US dollar
  • The Germans announce they are re-introducing the Deutschmark. They have already ordered the new currency and asked that the printers hurry up.
  • The Euro falls even more on any news that Germany is withdrawing from the Euro.
  • Legal wrangling begins as to the legality of Germany’s decision. Resolution takes years.
  • Germany insists that the Euro continues to exist even they do not use it any longer. They emphasize that European unification will continue and suggest new legal instruments to strengthen European Unification including new EU Treaties.
Read on, though (and you should read every word), and the supporting information and logic is robust (brackets and emphasis ours):
The Germans have already concluded that if they are going to write any further checks then they are going to write them to their domestic institutions and protect their domestic investors. Necessarily, this means that many Eurozone countries will default on their debt. It now seems this will happen within a matter of days. Germany has, therefore, already announced its intention to ring-fence and support their own banks and only their own. This may ultimately involve the nationalization of some or even all the German banks. This is necessary because a falling Euro will further weaken the ability of the other Eurozone members to meet their commitments and thus increases the risk of multiple sovereign defaults. Eurozone countries that are going to default will do so virtually simultaneously rather than sequentially.
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Eurozone countries may or may not have the resources to nationalize their banks. Therefore, we have to expect that bank failures are a real possibility. Apparently, the Europeans are warning the US to come up with a plan to nationalize Bank of America given that it is already in a precarious position, despite the injection of capital from Warren Buffet. The multiple lawsuits against Bofa and other banks alone will render the US banking system vulnerable to any dramatic announcement out of Europe. But, no doubt US banks have immense exposures to European institutions and some may even have sovereign credit risk directly on their balance sheets.
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It is hard to overestimate the shock that this will bring to the financial markets. Risk aversion will set in quickly as people start to consider the multiple possible consequences, some unintended, of such a decision. Huge fortunes will be made and lost in this moment in history.
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It is worth providing a review of the evidence that led me to this conclusion.
Next, she enlightens with several facts and dispels many myths. First, no check is coming:
Christine Lagarde’s speech at Jackson Hole revealed the recognition that there was a risk that Germany might not “write a check” to bailout the Eurozone members. She said, to paraphrase, “somebody needs to write a check or we are going to have historic multiple bank failures.” Everyone in the audience understood that no check is coming. The ESFS is not yet funded and a number of the contributors will not hand over cash if there is no collateral.
The German court decision was not a bailout approval:
The Federal Constitutional Court Press Release[viii] has also been misinterpreted by those who want to believe that bailouts will occur. The FT reported that the court ruled in favor of Chancellor Merkel. But, the reality is that the court took the authority to decide away from the Chancellor and gave it to the Budget Committee in the Bundestag. This committee has 48 members and each is certainly driven by the polls and cares about re-election. The Budget Committee is deeply likely to oppose any bailouts that will cost German taxpayers, just as Dr. Issing says.
The real reason the Swiss pegged to the Euro:
If any doubts remain about the German inclination to return to the DMark then consider these announcements. Switzerland announces a peg to the Euro. It was crystal clear at Jackson that the Swiss leadership expected an historic event to occur which would culminate in a rush into Swiss Francs. They tested the water by announcing a “fee” which would be applied to all non-Swiss purchasers of their currency. Within a few days they announce the peg. In short, Switzerland knows what is coming and has just barred the door to anyone who might try to escape the demise of the Euro by leaping into Swiss Francs.
Oh Canada (and Japan):
The statement by the central bank in Canada is similar. I happened to be in Canada when the statement was made. Canadians were deeply confused. After all, to paraphrase, the central bank said, “all the bad things we thought might happen, are now happening, so we are going to maintain a highly defensive position”. In other words, Canada is also gently warning the markets that it will do what it has to do to prevent the currency from suddenly accelerating in the event of a European currency implosion. The Japanese are hinting at this as well. According to Reuters the Finance Minister, “Azumi also said he was ready to step into the currency market to counter speculative moves, although Japan would likely struggle to gain G7 support for intervention.”[xi]
Who will benefit?
It therefore seems likely the US Dollar and US Treasuries will be a major net beneficiary of any failure to bailout Europe. As an aside, this means the market would undertake QE3 as it were. The Fed won’t have to do “operation twist” or consider QE3. [This was written before the September 21, 2011 FOMC meeting, in which OT was announced, but no balance sheet expansion (QE3).] They will be able to focus their attention on the inflation “target” and finding ways to justify letting it rise.
People read the Stark resignation wrong:
It is fascinating that Jurgen Stark’s resignation[xii] has caused people to think the chances of a bailout are increased when in fact his resignation signals that the risk is increased that no bailout will occur AND Germany will withdraw from the Euro. Stark has been a board member at the ECB until his resignation.
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But, that was not enough to stop Stark’s resignation. When we look back in history we will see that all the important German policymakers resigned from the ECB before Germany formally returned to Deutschemarks, just as one would expect. It also seems too much of a coincidence to my mind that former Head of the Deutcshe Bundesbank and ECB board member Axel Weber leaves the ECB just before all the proverbial starts hitting the fan, goes to UBS as Chairman, and the next thing you know that describes the ways in which countries could leave the Euro including the potential costs if Germany left.
Bernanke's dream come true:
The Federal Reserve will have no choice but to make unlimited liquidity available to the market. They won’t need to announce QE3. The market will do it for them. But, the Chairman really wants to announce QE3 and may use these events as a reason to do so. [Oh, does he ever.]
Other market predictions:
Gold, diamonds, agricultural assets, energy prices and mined asset prices will rise. Default reduces the debt burden and allows growth and inflation to return. If central banks (other than the ECB) throw huge liquidity out into the market because of this event then the liquidity is going to lean away from paper financial assets other than the most trusted and liquid (US Treasuries), and lean toward hard assets.
She concludes that stagflation will accelerate:
The world is about to experience deeper stagflation. The cost of living will now rise even more but growth remains stunted. Policymakers will start to veer back and forth between dealing with unemployment and dealing with inflation. The years ahead will be referred to as “stop go” years because policy will at times try to stop price hikes and at other times policy will try to push growth. Luckily, the world has seen this movie before in the 1970’s. Hopefully, we have learned something from the past and it ends rather more quickly this time around.
Here is the official ECB legal counsel's policy paper on withdrawal and expulsion from the EU and EMU:


Bottom line: an exit from the monetary union, whether unilateral, coordinated, or forced, requires withdrawal from the European Union itself. Thus, if Malmgren is correct about Germany's return to the DMark, it is a de facto withdrawal from the EU under current agreements, despite what the politicians and pundits might say. [Interestingly, the paper notes that this would not preclude continued use of the Euro as a currency, secondary or otherwise.]

2) North America (Bank of America):


Some excerpts (brackets ours) from another must-read by RC Whalen (emphasis and brackets ours):

...The reference to DeMarco is regards his willingness to support the object of the [Soros-]Boyce-Hubbard-Mayer paper on widespad home refinance. We seem to recall a jazz band with a similar name. Actually it is streamlined home refinance. Read the BHM paper and you will understand why the economy is foundering and why the Obama/Geithner binary consciousness won't ever get it.

While the Fed can make a great fuss about intervening in the long end of the government bond market, the central bank cannot get liquidity into the consumer sector unless and until we restructure BAC and other large lenders. Our view is that "twist" by the FOMC is a response to the unwillingness of the Obama White House to embrace mass refinancing of performing mortgages a la BHM. Remember, psident Obama is the puppet and Wall Street as personified by Robert Rubin is pulling the strings.

BAC, Wells Fargo ("WFC"/Q2 2011 Stress Rating: "A") and other large servicers are not going to allow loans in portfolio or owned by investors ppay if they can at all avoid it. Fannie Mae and Freddie Mac, both big owners of high SATO paper, likewise are dragging their feet on refinancing. But the impending insolvency of BAC provides a catalyst to begin the restructuring of the US housing sector and the economic recovery. And yes it is very doable.

On the restructuring:

The answer is that consumer payments, swaps, taxes, interest and principal, FX and all of the other financial operations of BAC will continue uninterrupted. The banks, broker dealers and other operating affiliates of BAC do not file bankruptcy, but the debtor parent does ask for the court to protect the operations of the entire group. We've got some of our cash sitting in the El Segundo branch of Bank of America, N.A., BTW. We aren't moving.

So long as the subsidiary banks of BAC are book solvent and stable, these businesses can continue to operate and, most important, contribute income to the parent. Regulators led by the FDIC and Fed are going to support the restructuring because a commercial reorganization is clearly pferable to a Dodd-Frank resolution, for reasons we have discussed pviously.

...

Taking an aggressive approach to cleaning-up the subsidiaries of BAC could yield enormous operational savings and leave the restructured bank vastly more liquid and profitable. Let’s assume for this discussion that we write-down the bank level TCE and intangibles, and an additional $100 billion in parent equity downstreamed to banks, for $250 billion total bank level asset reductions/cleanup. We then recap the banks with new debt and equity raised by the parent.

Once these tasks are done, we can move to Pro-forma 2, which is BAC on exit from bankruptcy. In the table we show $1.4 trillion in total consolidated assets on exit, including some $1 trillion in bank assets, $200 billion in parent level TCE, no intangibles and $100 billion in new debt. This works with or without Merrill, which is said to be worth in the $30 billion range and could be sold during the restructuring.

BAC management then does the biggest IPO in US history for the most profitable and liquid large bank in the world. BAC's peers would be forced to restructure more rapidly just to remain competitive, but probably via debt conversion and without a bankruptcy. Credit creation in the US economy again becomes positive. Mission accomplished.

So, perhaps the White House and the Fed are not sleeping together after all, which we had agreed with here. If the mortgage refi plan mentioned by BHO is the new Freddie Mac Standard Mod, which rolls out today, October 1, then we could hardly characterize it as "massive" or "streamlined". It's the Classic Modification with lipstick. In particular, these requirements will prove major obstacles to widespread use:
  • Borrowers must document an eligible hardship that is causing or expected to cause a permanent or long-term increase in expenses or decrease in income. (Unemployment and other temporary hardships are not eligible hardships.)
  • Borrowers must have verified income available to make the modified mortgage payment. (Unemployment benefits are not an acceptable source of income.)
To get a bit wonkish again, see also the new servicing proposals by the FHFA here. The more "radical" of the two proposals would separate (bifurcate) the representations and warranties of the seller and servicer, and would allow for a fixed fee for servicing rights with a separate interest only (IO) security that is not tied to the mortgage servicing rights (MSRs). The former is a step in the right direction, but the latter simply seems to be a workaround to avoid Basel III capital requirements on MSRs for the big banks that are also mortgage servicers. Again, nothing revolutionary.

Bottom line: the current and future contemplated policies in the US are insufficient to deal with the fundamental insolvency of the large banks and with the pent-up dysfunction in the mortgage industry. With the big bank state attorneys general settlement now facing resistance from California, and New York Attorney General Eric Schneiderman continuing to turn the screws on Bank of America and Bank of New York Mellon, a major market-clearing event could be around the corner in the US, even if the EU survives.

As we write, the fingers of instability are mounting and, while the world might just manage to kick the can once more, there is a growing likelihood that the next phase of crisis is upon us. Brace yourselves, as when it comes, it will be necessarily worse than 2008.

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