Cliff Wachtel's  Instablog

Or, Grand Illusion Instead of Grand Solution

Or, Putting the Moron Back in Oxymoron: A great stupid contradiction in terms

Or, EU Summit: An Exercise In Tragicomic Irony    

Cliff to EU: You Have GOT to be kidding me. I know there was talk of a final solution for the EU, but I didn’t think you meant, well, that kind of final solution.

Ok, expectations weren’t high, but I was really hoping for at least something of value in this chamber pot. Nope, just the usual reeking contents. Let’s just get through this quickly. Fortunately market reaction has been subdued, so there’s still time to plan for when this farce turns to tragedy.   See below for some good basic ideas. Hint: unlike with stocks, they can’t ban shorting risk assets in forex markets, so it’s a great time to be ready with some kind of forex account.

1. “Voluntary” 50% Haircuts (!?) For Holders Of Greek Bonds: Someone please explain to me how this can’t be considered default. Even the relatively flexible IIF was already quoted this week as saying 60% would be default – and 50% is supposed to be better? We must assume this will be seen as a default and thus this item alone risks starting a wave of defaults as credit markets shun the GIIPS and more sovereign states and banks fall like dominos. I’m far from alone in this fear. For example, see this from Nomura bank via wsj.com.

Please. This can’t work. No, no, wait, it gets better, look what’s next on the list

2. Increase EFSF Bailout Fund 4-5 Times With…Leverage (Borrowed Funds).Ah ha. Create more debt to pay off the old debt, much of this new debt backed by such rocks of fiscal probity as….Spain and Italy, on the assumption that THEY will be able to pay off the new debt in case of default. How can one sell default insurance on oneself? If I default, how will I be able to pay off the insurance on that default? This is pure obfuscation that may fool the masses but not one who matters – like credit markets being asked to trust and lend funds to the EU. See here for the gory details.

3. China & IMF (US largest contributor) To Contribute Major Funds To Bailout: Two problems here- the US and China.

1. The US: Isn’t even able to get a political deal to reduce its own debt. How will Republicans and US voters react to more spending….for Europe? Yes, the fate of Europe influences the US, but direct aid to US banks and businesses hit with losses from the eventual EU defaults will be much easier to sell to voters. Even if they do, how long will it take? Will Obama really give the Republicans this kind of ammo with an election coming?

1. China: Facing its own (relative) slowdown and debt troubles, will it really be willing to double down on its EU bet. It hasn’t done so yet despite prior attempts to lure it into a deeper commitment to the EU. Also, whatever cash comes with, ahem, a few quid pro quos. China wants the EU to label it a market economy, which in essence makes it harder to take steps against China when it does the very opposite

4. Greece To Get ~€130 Billion In Fresh Aid: From where, given its dubious track record? Maybe if all the above go smoothly, there might be some leaders willing to risk their careers and reputations throwing more cash down the Greek rat hole even as Greece continues to contract and become less able to meet its obligations. FYI many believe the 50% haircut still won’t be enough, even if the creditors go along with it and it somehow isn’t considered a default (which would raise borrowing costs for the other GIIPS and endanger them).

5. EU Leaders Assume Italian Reforms Will Work: Italy has done little so far (other than some fist fights in the Italian parliament over relatively minor pension reforms) but the working assumption is that Italian debt/GDP drops as the nation somehow grows while cutting state spending. Hmmm.

6. EU Banking Authority Estimates only €106 billion needed to recapitalize European banks so that they meet the new 9% requirements. Two problems here:

1. Unclear if that 9% refers to real Tier 1 capital and excludes riskier bonds. EU Council President van Rompuy only used the phrase “highest quality capital,” offering vagueness when what markets want are specifics.

1. Unfortunately, this estimate is not based on any stress tests accounting for adverse scenarios like multiple defaults, which a distinct possibility to say the least.

7. Estimated deadline for a final plan on EU Treaty changes is now March 2012. Will credit markets give Europe that much time? At least one IMF senior economist as mentioned March 2012 as the outer limit of time the EU has before credit markets abandon the EU and bring a banking crisis.

Judging from market reactions thus far, no one seems that worried. Given the stakes, it appears reasonable that they should find a solution. I’ll believe it when I see it. There are no good solutions, and so far we haven’t gotten details on who will take the pain and how.   As a reminder of where this all STILL appears to be headed – an abyss – a global banking crisis as sovereign states and banks fall like dominos. I re-post this graphic from strafor.com, one of the best summaries there is, word for word.         Via stratfor.com (hat tip to seekingalpha.com for pointing it out)  01 oct 27 1048

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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?