Paul Krug­man reminds us of another set of lessons not learned:
http://krugman.blogs.nytimes.com/2011/10/24/the-worst-institution-in-the-world/

“
Octo­ber 24, 2011, 12:53 pm
The Worst Insti­tu­tion In The World

Ryan Avent sends us to the Bank for Inter­na­tional Set­tle­ments, which has decided to throw every­thing we’ve learned from 80 years of hard thought about macro­eco­nom­ics out the win­dow, and to embrace full-frontal liq­ui­da­tion­ism. The BIS is now advo­cat­ing a posi­tion indis­tin­guish­able from that of Schum­peter in the 1930s, oppos­ing any mon­e­tary expan­sion because that would leave “the work of depres­sions undone”.

And these are the sup­posed guardians of the world mon­e­tary sys­tem.
”

In light of the sur­prise Greek vote on whether to approve the pro­posed bailout pack­age, it’s worth not­ing that big US banks have once again bet the farm on a gov­ern­ment pol­icy. In the lead up to the 2008 finan­cial cri­sis, that bet was sim­ply that the US gov­ern­ment would bailout out all the banks in the event of a full sys­temic cri­sis brought on by a hous­ing bust (a cor­rect and very prof­itable wager). This time, the big banks are bet­ting that the EU pub­lic will bail out the euro­zone sov­er­eign debts.

Here’s one his­tory les­son the big boys have learned well:
“too big to fail” never fails.

Default Risk in Europe Rises for U.S. Banks as Swaps Soar to $518 Bil­lion
Q
By Yal­man Onaran — Nov 1, 2011 9:37 AM CT

U.S. banks increased sales of insur­ance against credit losses to hold­ers of Greek, Por­tuguese, Irish, Span­ish and Ital­ian debt in the first half of 2011, boost­ing the risk of pay­outs in the event of defaults.

Guar­an­tees pro­vided by U.S. lenders on gov­ern­ment, bank and cor­po­rate debt in those coun­tries rose by $80.7 bil­lion to $518 bil­lion, accord­ing to the Bank for Inter­na­tional Set­tle­ments. Almost all of those are credit-default swaps, said two peo­ple famil­iar with the num­bers, account­ing for two-thirds of the total related to the five nations, BIS data show.

The pay­out risks are higher than what JPMor­gan Chase & Co. (JPM), Mor­gan Stan­ley and Gold­man Sachs Group Inc. (GS), the lead­ing CDS under­writ­ers in the U.S., report. The banks say their net posi­tions are smaller because they pur­chase swaps to off­set ones they’re sell­ing to other com­pa­nies. With banks on both sides of the Atlantic using deriv­a­tives to hedge, poten­tial losses aren’t being reduced, said Fred­er­ick Can­non, direc­tor of research at New York-based invest­ment bank Keefe, Bruyette & Woods Inc.

...

Hedg­ing Strategies

Sim­i­lar hedg­ing strate­gies almost failed in 2008 when Amer­i­can Inter­na­tional Group Inc. couldn’t pay insur­ance on mort­gage debt. While banks that sold pro­tec­tion on Euro­pean sov­er­eign debt have so far bet the right way, a plan announced yes­ter­day by Greek Prime Min­is­ter George Papan­dreou to hold a ref­er­en­dum on the lat­est bailout pack­age sent mar­kets reel­ing and cast doubt on the abil­ity of his coun­try to avert default.

...

Five Banks

Five banks — JPMor­gan, Mor­gan Stan­ley, Gold­man Sachs, Bank of Amer­ica Corp. (BAC) and Cit­i­group Inc. © — write 97 per­cent of all credit-default swaps in the U.S., accord­ing to the Office of the Comp­trol­ler of the Cur­rency. The five firms had total net expo­sure of $45 bil­lion to the debt of Greece, Por­tu­gal, Ire­land, Spain and Italy, accord­ing to dis­clo­sures the com­pa­nies made at the end of the third quar­ter. Spokes­men for the five banks declined to com­ment for this story.

...

In the­ory, if a bank owns $50 bil­lion of Greek bonds and has sold $50 bil­lion of credit pro­tec­tion on that debt to clients while buy­ing $90 bil­lion of CDS from oth­ers, its net expo­sure would be $10 bil­lion. This is how some banks tried to pro­tect them­selves from sub­prime mort­gages before the 2008 cri­sis. Gold­man Sachs and other firms had pur­chased pro­tec­tion from New York-based insurer AIG, allow­ing them to sub­tract the CDS on their books from their reported sub­prime holdings.

‘AIG Moment’

When prices of mort­gage secu­ri­ties started falling in 2008, AIG was required to post more col­lat­eral to its CDS coun­ter­par­ties. It ran out of cash doing so, and the U.S. gov­ern­ment took over the com­pany. If AIG had col­lapsed, what the banks saw as a hedge of their mort­gage port­fo­lios would have dis­ap­peared, lead­ing to tens of bil­lions of dol­lars in losses.

“We could have an AIG moment in Europe,” said Peter Tchir, founder of TF Mar­ket Advi­sors, a New York-based research firm that focuses on Euro­pean credit mar­kets. “Let’s say Greece defaults, caus­ing runs on other periph­ery debt that would trig­ger col­lat­eral require­ments from the sell­ers of CDS, and one or more can­not meet the mar­gin calls. There might be AIGs hid­ing out there.”
...

Coun­ter­party CDS

Banks also buy CDS on their coun­ter­par­ties to hedge against the risk of trad­ing part­ners going bust, Duffie said. To ensure those claims are paid, the banks may be turn­ing to insti­tu­tions deemed sys­tem­i­cally impor­tant, such as JPMor­gan, accord­ing to Duffie. The bank, the largest in the U.S. by assets, accounts for a quar­ter of all credit deriv­a­tives out­stand­ing in the U.S. bank­ing sys­tem, accord­ing to OCC data.

Gold­man Sachs said it had hedged itself against the col­lapse of AIG by buy­ing CDS on the firm. Com­pany doc­u­ments later released by Con­gress showed that some of that pro­tec­tion was pur­chased from Lehman Broth­ers Hold­ings Inc. and Cit­i­group, firms that col­lapsed or were bailed out dur­ing the cri­sis.

U.S. banks are prob­a­bly bet­ting that the Euro­pean Union will also res­cue its lenders, said Daniel Alpert, man­ag­ing part­ner at West­wood Cap­i­tal LLC, a New York invest­ment bank.

“There’s a fire­wall for the U.S. banks when it comes to this CDS risk,” Alpert said. “That’s the EU banks being bailed out by their gov­ern­ments.”
...

@Pterrafractyl: Glad to see you’re on our side. =)

In related news...something tells me this MF Global implo­sion is going actu­ally be inves­ti­gated:
http://money.cnn.com/2011/11/01/news/companies/mf_global_jpmorgan/

JPMor­gan cries foul on MF Global
By Aaron Smith @CNNMoney Novem­ber 1, 2011: 2:31 PM ET

NEW YORK (CNN­Money) — JPMor­gan Chase, MF Global’s largest cred­i­tor, cried foul Tues­day about the bro­ker­age firm’s bank­ruptcy filing.

In an objec­tion filed in fed­eral bank­ruptcy court in New York, JPMor­gan said it wants “to limit the relief” that MF Global is seek­ing from the court to pro­tect the value of its cash collateral.

MF Global filed for Chap­ter 11 pro­tec­tion Mon­day. The com­pany, led by for­mer New Jer­sey gov­er­nor Jon Corzine, said it has more than $2.2 bil­lion in debt.

Most of the debt is held by unse­cured cred­i­tors JPMor­gan, which is owed more than $1.2 bil­lion, and Deutsche Bank (DB), which is owed more than $1 bil­lion. An addi­tional $10 mil­lion is divided among 45 other cred­i­tors, includ­ing Amer­i­can Express (AXP, For­tune 500), KPMG and PricewaterhouseCoopers.

“JPMor­gan is will­ing to the work with the debtors, but, in these cir­cum­stances, the debtors have to rec­og­nize their bur­den of giv­ing JPMor­gan as much ade­quate pro­tec­tion as they can pro­vide,” said JPMor­gan, in the court filing.

JPMor­gan requested lim­its on MF Global’s use of cash col­lat­eral dur­ing the bank­ruptcy process and asked for pri­or­ity over other cred­i­tors in going after the brokerage’s assets.

....
”

An instant clas­sic: “...in these cir­cum­stances, the debtors have to rec­og­nize their bur­den of giv­ing JPMor­gan as much ade­quate pro­tec­tion as they can provide...”

in light of the above com­ments regard­ing the big bets US banks made on a Euro­zone bailout and the bank­ruptcy by MF Global, it’s worth not­ing that it sounds like MF Global went under by going long on Euro­zone sov­er­eign debt: http://blogs.wsj.com/deals/2011/11/01/mf-globals-downfall-raises-question-on-feds-primary-dealer-pick/

Novem­ber 1, 2011, 12:26 PM ET

MF Global’s Down­fall Raises Ques­tion on Fed’s Pri­mary Dealer Pick

By Min Zeng

The Fed­eral Reserve is among those feel­ing the pinch from the col­lapse of MF Global, which only eight months ago was added to the Fed’s list of 22 pri­mary dealer banks.

MF Global’s down­fall seems unlikely to pose a sys­temic finan­cial risk to either the U.S. econ­omy or the Fed. But it’s pos­si­ble it will make the selec­tion pro­ce­dure tougher for pri­mary deal­ers, an elite group of insti­tu­tions with which the New York Fed con­ducts mon­e­tary pol­icy and which are oblig­ated to par­tic­i­pate in U.S. Trea­sury debt auctions.

MF Global’s for­tunes quickly went down­hill over the past week amid con­cerns over its expo­sure to the euro zone’s sov­er­eign debt. In this way, its tra­vails under­score the poten­tial con­ta­gion risks to the U.S. finan­cial sys­tem via the pri­mary dealer network.

“At the very least these appli­ca­tions will undergo a much more strin­gent vet­ting pro­ce­dure,” Chris Rup­key, senior finan­cial econ­o­mist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “The les­son of his­tory after these sud­den finan­cial bank­rupt­cies is that reg­u­la­tors come down harder than ever.”

The Fed had tight­ened con­di­tions for select­ing deal­ers in Jan­u­ary 2010, increas­ing cap­i­tal require­ments from $50 mil­lion to $150 million.

“No one can hold the Fed respon­si­ble for the risk of the firm,” said Michael Franzese, head of Trea­sury trad­ing at Wun­der­lich Secu­ri­ties in New York. “You try and put ade­quate pro­ce­dures in place so it doesn’t hap­pen but you have to trust peo­ple to do the right thing.”
...
”

I’m link­ing this story about the $500+ bil­lion Japan just spent devalu­ing its cur­rency because, in many respect, the Euro­pean Mon­e­tary Union should be viewed as a kind of per­ma­nent cur­rency inter­ven­tion scheme divided between the mem­ber states. The eco­nom­i­cally weaker coun­tries (i.e. the P.I.I.G.S.) basi­cally had arti­fi­cially enhanced cur­ren­cies and credit line while the stronger nations (Ger­many, France) saw their cur­ren­cies arti­fi­cially sup­pressed as a con­se­quence of join­ing the Euro-zone.

Sup­pressed cur­ren­cies are eco­nomic manna for exporters, espe­cially if the cur­rency is nor­mally rel­a­tively expen­sive. For the weaker Euro-zone nations, how­ever, they are put into a seri­ous bind. The coun­tries shift to an arti­fi­cially enhanced cur­rency, cou­pled with an enhanced abil­ity to bor­row (pub­lic and pri­vate) AND restric­tions on net gov­ern­ment bor­row­ing (via euro­zone treaties). So they’re pretty much guar­an­teed to expe­ri­ence a domes­tic asset bub­ble (which is what hap­pened, con­trary to the “prof­li­gate P.I.I.G.S. gov­ern­ment spend­ing” meme. But if infla­tion kicks in and inter­est rates rise, or the bub­bles burst and deficits tem­porar­ily surge, the gov­ern­ment is forced slash pub­lic spend­ing in order to clamp down on inter­est rates to stay within the guide­lines of the treaty. So the coun­try can­not fall into a finan­cial sit­u­a­tion neces­si­tat­ing a sig­nif­i­cant cur­rency deval­u­a­tion (rel­a­tive to the other mem­ber states) and/or higher gov­ern­ment deficits. Ever.

So we should really be view­ing any sort of “bailout” of P.I.I.G.S as, par­tially, just an argu­ment over which mem­bers of the Euro-zone are going to make the indi­rect pay­ments required to some­how smooth over the eco­nomic stresses imposed on the P.I.I.G.S (as opposed to the eco­nomic relief valve that the Euro-zone cre­ates for the stronger mem­bers). If the bailouts end up being min­i­mal, with the bulk of the costs falling on the P.I.I.G.S cit­i­zens via aus­ter­ity pro­grams, then it will be the P.I.I.G.S.‘s pub­lic that pays the piper. Or it could be the pri­vate cred­i­tors (via a harsh “hair­cut” on deval­ued P.I.I.G.S. bonds) or the wealth­ier nations (Germany/France directly bail­ing out Greece with­out the “aus­ter­ity” death sen­tence) that end up pay­ing the costs. Or, the ECB could just print up free money and paper over the whole thing (but how are the “mar­kets” sup­posed to have “con­fi­dence” with­out the proper real world pain and suffering?)

So, with all that in mind, also keep in mind that cur­rency manip­u­la­tions can get really expen­sive: http://www.bloomberg.com/news/2011–11-02/japan-faces-510-billion-losses-from-yen-sales-jpmorgan-says.html

Japan Faces $510 Bil­lion Losses From Yen Sales, JPMor­gan Chase & Co. Says
Q
By Shigeki Nozawa — Nov 1, 2011 10:13 PM CT

Japan’s gov­ern­ment faces almost 40 tril­lion yen ($512 bil­lion) in losses from inter­ven­ing in the foreign-exchange mar­kets to stem the yen’s advance, accord­ing to esti­mates by JPMor­gan Chase & Co.

Val­u­a­tion losses on Japan’s foreign-exchange reserves minus yen lia­bil­i­ties totaled 35.3 tril­lion yen at the end of 2010, accord­ing to Finance Min­istry data. The losses may swell fur­ther as the yen is pro­jected to climb to 72 ver­sus the dol­lar by Sep­tem­ber 2012, said Tohru Sasaki, head of Japan rates and foreign-exchange research at JPMor­gan Chase in Tokyo.
...

Weaker Dol­lar

If investors’ risk aver­sion sub­sides, it wouldn’t be sur­pris­ing if the dol­lar were to weaken another 10 per­cent on a trade-weighted basis, Sasaki said. The U.S., which holds the world’s largest current-account deficit, is in an “unprece­dented” sit­u­a­tion, where it keeps inter­est rates near zero even though it needs to attract funds from over­seas by offer­ing higher yields, he said.
...
”

Some­thing tells me we may see more “Why Not Give The [fill in the blank]s Their Say?” pieces like this going for­ward: http://www.nytimes.com/2011/11/04/business/why-not-give-the-greeks-their-say.html?_r=2&ref=business

Why Not Give Greeks Their Say?
By FLOYD NORRIS
Pub­lished: Novem­ber 3, 2011

The fun­da­men­tal nature of Euro­pean gov­er­nance is about to change.

Either a large part of the Con­ti­nent will move much closer to a fed­eral gov­ern­ment, with com­mon fis­cal poli­cies and a sub­stan­tial loss of sov­er­eignty for many nations, or it will spin apart, with pos­si­bly severe eco­nomic and finan­cial consequences.

That has been clear for months, and mar­kets have alter­nately soared and plunged as it appeared Europe was closer to or far­ther from reach­ing the first alternative.

This week, it appeared that the prospect that scared Euro­pean lead­ers the most was the specter of democ­racy. When the Greek prime min­is­ter, George A. Papan­dreou, pro­posed a ref­er­en­dum on whether Greece would go along with the agree­ment reached at the Euro­pean sum­mit meet­ing last week — one that calls for more aus­ter­ity and that polls say is unpop­u­lar with most Greeks — much of Europe reacted with shock and alarm. How dare he do that?

In the end, he could not per­suade his own gov­ern­ment, and there will be no vote. That should be a cause for sor­row in the rest of Europe, not joy. There is lit­tle rea­son to think that Greek cit­i­zens will be more coop­er­a­tive now that it has been made clear their opin­ions are irrel­e­vant to the peo­ple who run Europe.

It is not only the Greek peo­ple who should be con­sulted about the major changes now under way in how they are gov­erned. So should the peo­ple of other countries.

Hereto­fore, the coun­tries that joined the euro zone did so with the under­stand­ing that they could have the best of all worlds — the con­ve­nience of a com­mon cur­rency with­out the eco­nomic and polit­i­cal inte­gra­tion that would inevitably be needed if the coun­tries did not pur­sue sim­i­lar eco­nomic poli­cies. That under­stand­ing was wrong.
...
”

There’s a NY Times piece on the MF Global implo­sion (fol­low­ing its bad bets on the Euro­zone debts) that high­lights a crit­i­cal aspect of the mod­ern finan­cial par­a­digm: Part of the global deriv­a­tives mar­ket includes pri­vately cre­ated deriv­a­tive con­tracts made in secret that are basi­cally bets on any sort of real-world event one can con­ceive of. In other words, we’ve cre­ate a “mar­ket” for bet­ting on things like war, dis­as­ters, finan­cial col­lapse and any kind of calamity one can imag­ine. And because this mar­ket is all secret, we’ve lit­er­ally added an extra finan­cial incen­tive for engag­ing in the kinds of con­spir­a­cies that might result in, say, war, dis­as­ters, finan­cial col­lapse, etc. It’s like turn­ing the planet into a mafia bankster’s play­ground:
http://www.nytimes.com/2011/11/06/business/in-mf-global-sad-proof-of-europes-fallout.html

“
...
In any case, the fig­ures com­piled by the D.T.C. don’t show the entire amount of credit insur­ance that has been writ­ten on Greece and other nations. D.T.C. says it believes its fig­ures cap­ture 98 per­cent of the mar­ket, but credit default swaps are often struck pri­vately; not all of them are reported to reg­u­la­tors.

Con­sider an invest­ment vehi­cle known as a credit-linked note. In these deals, investors buy a note issued by a special-purpose vehi­cle that con­tains a credit default swap ref­er­enc­ing a debt issuer, like a gov­ern­ment. That swap pro­vides credit insur­ance to the party buy­ing the pro­tec­tion, mean­ing that the holder of the note is respon­si­ble for losses in a so-called credit event, like a default.

Credit-linked notes are very pop­u­lar and have been issued exten­sively by Euro­pean banks. Many are gov­erned by I.S.D.A. con­tracts, which define the terms of a credit event and require a rul­ing by the asso­ci­a­tion on whether such an event has occurred.

But some deals have dif­fer­ent def­i­n­i­tions or con­trac­tual lan­guage over­rid­ing the I.S.D.A. agree­ment. “The peo­ple writ­ing these con­tracts may say, ‘I would like to be paid if there is a vol­un­tary restruc­tur­ing of debt, or if Greece goes back to the drachma, or if Greece goes to war with Cyprus,’ ” Ms. Tavakoli said. “I can declare a credit event where I am enti­tled to get paid if any of those events hap­pen.”

The other party has to agree to these terms up front. But, given the nature of these so-called bespoke deals, we don’t know the full extent of the insur­ance that investors have writ­ten on trou­bled nations or the cir­cum­stances under which the insur­ance must be paid. Nei­ther do we know who may be fac­ing severe col­lat­eral calls or demands for ter­mi­na­tion pay­ments on the con­tracts.
...
”

Of course, con­spir­ing to tank the econ­omy and then secretly bet­ting to profit from it on a grand scale would never actu­ally hap­pen...

Two inter­est­ing state­ments on the euro­zone, the first a pre­dic­tion and the sec­ond a proclamation:

1. http://www.reuters.com/article/2011/11/06/us-britain-euro-goldman-idUSTRE7A51P020111106

Euro zone coun­tries could split, says Gold­man Sachs exec

LONDON | Sun Nov 6, 2011 12:45pm EST

(Reuters) — Coun­tries in the euro zone will find it increas­ingly unat­trac­tive to stay in the sin­gle cur­rency, if there is a German-led fis­cal inte­gra­tion, the chair­man of Gold­man Sachs Asset Man­age­ment said in a Sun­day Tele­graph interview.

Por­tu­gal, Ire­land, Fin­land and Greece could all pull out of the euro zone rather than oper­ate under a sin­gle trea­sury, Jim O’Neill, whose divi­sion man­ages more than $800 bil­lion (500 bil­lion pounds) of assets, was cited as saying.

He also called on the Euro­pean Cen­tral Bank (ECB) to show more lead­er­ship to reas­sure “wor­ried investors.”

“The Ger­mans want more fis­cal unity and much tougher cen­tral obser­va­tion — with the idea of a finance min­istry,” O’Neill said.

“With that caveat, it is tough to see all coun­tries that joined want­ing to live with that — includ­ing the one that is so trou­bled here (Greece).”

He added that only coun­tries such as Ger­many, France and Benelux, were suited for a mon­e­tary union because their exchange rates were closely linked. But for oth­ers, it was questionable.

O’Neill said coun­tries such as Fin­land and Ire­land that are neigh­bors of non-euro zone coun­tries — the UK and Swe­den — might pre­fer to quit the euro, which would bol­ster the strength of the sin­gle cur­rency.

...
”

Keep in mind that a strength­ened Euro defeats half of its entire point for exist­ing from the wealth­ier mem­bers’ per­spec­tives. It will be inter­est­ing to see how appe­tiz­ing a stronger, smaller euro­zone would be the remain­ing mem­ber nations (would there be a new P.I.I.G., rel­a­tively speaking?).

And when sig­nals like the fol­low­ing are sent out by sig­nif­i­cant play­ers in the euro­zone debt mar­kets, you have to won­der if we might see a whole new form of bank run emerge...banks run­ning out of the mem­ber states and back home under a ban­ner of nation­al­is­tic rhetoric:
2. http://www.reuters.com/article/2011/11/04/commerzbank-idUSL6E7M406E20111104

UPDATE 5-Commerzbank turns off money tap after Q3 Greece hit

By Edward Taylor

FRANKFURT, Nov 4 (Reuters) — Germany’s second-largest lender Com­merzbank will refuse loans which don’t help Ger­many or Poland, as the euro zone cri­sis makes Euro­pean banks more pro­tec­tion­ist in choos­ing between writ­ing new busi­ness and meet­ing strin­gent cap­i­tal requirements.

“We are not doing busi­ness which is not to the ben­e­fit of Ger­many or Poland,” Chief Finan­cial Offi­cer Eric Strutz told ana­lysts on a con­fer­ence call dis­cussing third-quarter earn­ings on Fri­day. “We have to focus on sup­port­ing the Ger­man econ­omy as other banks pull out.”

...
”

...from a great Krug­man post today: http://krugman.blogs.nytimes.com/2011/11/07/wishful-thinking-and-the-road-to-eurogeddon/

Wish­ful Think­ing And The Road To Eurogeddon

Gavyn Davies has a very good piece today offer­ing another way to think about the euromess. I say “another way to think” advis­edly — his analy­sis of the basics is, as far as I can tell, iden­ti­cal to mine, but he offers a dif­fer­ent angle of approach that may be bet­ter than the route the rest of us have been tak­ing. Here’s Davies:

It is nor­mal to dis­cuss the sov­er­eign debt prob­lem by focus­ing on the sus­tain­abil­ity of pub­lic debt in the periph­eral economies. But it can be more infor­ma­tive to view it as a bal­ance of pay­ments prob­lem. Taken together, the four most trou­bled nations (Italy, Spain, Por­tu­gal and Greece) have a com­bined cur­rent account deficit of $183 bil­lion. Most of this deficit is accounted for by the pub­lic sec­tor deficits of these coun­tries, since their pri­vate sec­tors are now roughly in finan­cial bal­ance. Off­set­ting these deficits, Ger­many has a cur­rent account sur­plus of $182 bil­lion, or about 5 per cent of its GDP.

The euro prob­lem can then be defined a find­ing a way (1) to finance these imbal­ances in the short run (2) end the imbal­ances over the medium run.

It’s also worth not­ing that we’re not talk­ing about imbal­ances that have been going on for­ever. The inter­nal imbal­ances of Europe are a recent devel­op­ment, coin­cid­ing with and almost surely caused in large part by the cre­ation of the euro itself (GIPS is Greece, Italy, Por­tu­gal, Spain):

...
”

Well, it looks like a euro­zone split is unof­fi­cially get­ting dis­cussed between France and Ger­many. The for­ma­tion of new “core” euro­zone area of eco­nom­i­cally stronger mem­bers would also include dra­mat­i­cally increase “inte­gra­tion” of areas like per­sonal and cor­po­rate taxes, and the rest of the EU would be a “con­fed­er­a­tion”. No short­age of twists and turns on this roller coaster:

French and Ger­mans explore idea of smaller euro zone

By Julien Toyer and Annika Breidthardt

BRUSSELS | Wed Nov 9, 2011 4:27pm EST

(Reuters) — Ger­man and French offi­cials have dis­cussed plans for a rad­i­cal over­haul of the Euro­pean Union that would involve set­ting up a more inte­grated and poten­tially smaller euro zone, EU sources say.

“France and Ger­many have had intense con­sul­ta­tions on this issue over the last months, at all lev­els,” a senior EU offi­cial in Brus­sels told Reuters, speak­ing on con­di­tion of anonymity because of the sen­si­tiv­ity of the discussions.

“We need to move very cau­tiously, but the truth is that we need to estab­lish exactly the list of those who don’t want to be part of the club and those who sim­ply can­not be part,” the offi­cial said.

French Pres­i­dent Nico­las Sarkozy gave some fla­vor of his think­ing dur­ing an address to stu­dents in the east­ern French city of Stras­bourg on Tues­day, when he said a two-speed Europe — the euro zone mov­ing ahead more rapidly than all 27 coun­tries in the EU — was the only model for the future.

The dis­cus­sions among senior pol­i­cy­mak­ers in Paris, Berlin and Brus­sels raised the pos­si­bil­ity of one or more coun­tries leav­ing the euro zone while the remain­ing core pushes on toward deeper eco­nomic inte­gra­tion, includ­ing on tax and fis­cal pol­icy.
...

“In doing this exer­cise, we will be very seri­ous on the cri­te­ria that will be used as a bench­mark to inte­grate and share our eco­nomic poli­cies,” the senior EU offi­cial said.

One senior Ger­man gov­ern­ment offi­cial said it was a case of prun­ing the euro zone to make it stronger.

“You’ll still call it the euro, but it will be fewer coun­tries,” he said, with­out iden­ti­fy­ing those that would have to drop out.

“We won’t be able to speak with one voice and make the tough deci­sions in the euro zone as it is today. You can’t have one coun­try, one vote,” he said, refer­ring to rules that have made decision-making com­plex and slow, exac­er­bat­ing the crisis.

Speak­ing in Berlin, Merkel reit­er­ated a call for changes to be made to the EU treaty — the laws which gov­ern the Euro­pean Union — say­ing the sit­u­a­tion was now so unpleas­ant that a rapid break­through was needed.

From Germany’s point of view, alter­ing the EU treaty would be an oppor­tu­nity to rein­force euro zone inte­gra­tion and could poten­tially open a win­dow to make the mooted changes to its make-up.

...

“This is some­thing that has been in the air for some time, at least in high-level talks,” said one EU diplo­mat. “The dif­fer­ence now is that some coun­tries are mov­ing for­ward very quickly ... The risk of a split, of a two-speed Europe, has never been so real.”

In Sarkozy’s vision, the euro zone would rapidly deepen its inte­gra­tion, includ­ing in sen­si­tive areas such as cor­po­rate and per­sonal tax­a­tion, while the remain­der of the EU would be left as a “con­fed­er­a­tion”, pos­si­bly expand­ing from 27 to 35 in the com­ing decade, with enlarge­ment to the Balkans and beyond.

Within the euro zone, the crit­i­cal need would be for core coun­tries to coor­di­nate their eco­nomic poli­cies quickly so that defenses could be erected against the sov­er­eign debt crisis.

“Intel­lec­tu­ally speak­ing, I can see it hap­pen­ing in two move­ments: some tech­ni­cal arrange­ments in the next weeks to strengthen the euro zone gov­er­nance, and some more fun­da­men­tal changes in the com­ing months,” the senior EU offi­cial said.
...

[...] the Euro­pean Union. They were sug­gested by a lis­tener of Dave Emory’s For The Record show, Pter­rafractyl. The major­ity of them are rel­e­vant for the under­stand­ing of this cri­sis and they com­plete very well [...]

Hooray!

Novem­ber 10, 2011, 1:26 pmLegal/Regulatory
In MF Global’s Wake, Reg­u­la­tors to Audit All Futures Firms
By BEN PROTESS

Fed­eral reg­u­la­tors have ordered an audit of every Amer­i­can futures trad­ing firm to ver­ify that cus­tomer money is pro­tected, a move that comes after roughly $600 mil­lion in client funds were dis­cov­ered to be miss­ing from MF Global, the bank­rupt bro­ker­age firm once run by Jon S. Corzine.

The Com­mod­ity Futures Trad­ing Com­mis­sion, the fed­eral reg­u­la­tor search­ing for the miss­ing money at MF Global, will audit many of the nation’s largest futures com­mis­sion mer­chants, accord­ing to a per­son briefed on the deci­sion. Exchanges like the CME Group will exam­ine smaller firms to ensure they are keep­ing cus­tomer money sep­a­rate from com­pany money, a fun­da­men­tal rule on Wall Street.
...

It looks like some tough action is on the way fol­low­ing the MF Global implosion....

Gary Gensler, the commission’s chair­man, abstained from vot­ing after recus­ing him­self from the inves­ti­ga­tion because of ques­tions about his past asso­ci­a­tion with Mr. Corzine. While the two were not close in recent years, Mr. Gensler worked for Mr. Corzine at Gold­man Sachs in the 1990s. And Mr. Gensler sup­ported Mr. Corzine’s cam­paign as a Demo­c­ra­tic can­di­date for gov­er­nor of New Jer­sey, with a $10,000 check.

With Mr. Gensler out, a Repub­li­can mem­ber of the agency, Jill E. Som­mers, will serve as the senior com­mis­sioner on the case, the agency said in the state­ment.
...

Well it sounds seri­ous since they’re recus­ing the folks with con­flicts of inter­est. Jill Som­mers may be a Repub­li­can appointee to the CFTC, but at least she doesn’t have any con­flicts of inter­est:

Remarks of Jill Som­mers, Com­mis­sioner of the Com­mod­ity Futures Trad­ing Commission

Before the Futures Indus­try Asso­ci­a­tion, Chicago

Octo­ber 16, 2007

Thank you Ray. I am delighted to be back in Chicago today with my fel­low newly appointed Com­mis­sioner, Bart Chilton. Hav­ing worked closely with the FIA over the years dur­ing my tenures with the Chicago Mer­can­tile Exchange and ISDA, I see a lot of famil­iar faces in the room. This is a great oppor­tu­nity for me to meet those of you I haven’t got­ten a chance to know yet, and I look for­ward to work­ing with all of you from my new per­spec­tive as a Com­mis­sioner of the CFTC.

...

After grad­u­at­ing from the Uni­ver­sity of Kansas with a degree in Polit­i­cal Sci­ence, my career plan con­sisted of intern­ing for a few months with Sen­a­tor Bob Dole in Wash­ing­ton, D.C. I did not dream of stay­ing in Wash­ing­ton, but life had a dif­fer­ent path for me. I ended up work­ing for Sen­a­tor Dole, both in Wash­ing­ton and in Kansas, for almost five years. I left the Capi­tol to work for an agri­cul­tural con­sult­ing firm and became involved with futures issues. In 1998,I began work­ing for the Chicago Mer­can­tile Exchange in its Wash­ing­ton, D.C. office, where I was respon­si­ble for reg­u­la­tory and leg­isla­tive affairs. This gave me the unique oppor­tu­nity to work closely with con­gres­sional staff on the Com­mod­ity Futures Mod­ern­iza­tion Act from the very begin­ning to the long awaited end. I left the CME in 2004, and most recently worked as Pol­icy Direc­tor and Head of U.S. Gov­ern­ment Affairs for ISDA.

While work­ing for the CME on the CFMA, I met my hus­band Mike, who is a con­gres­sional staffer for Repub­li­can Leader John Boehner. We live in Alexan­dria, VA and have three chil­dren, ages five, four and three.
...

Umm...hooray??

Heh, I had totally missed this doozy:

Ger­many “Raises” €55.5 Bil­lion, or 1% Of Its Debt/GDP Ratio, Thanks To Deriv­a­tive “Account­ing Error“
Sub­mit­ted by Tyler Dur­den on 10/28/2011 21:11 –0500

As usual, the most sur­real news of the day, per­haps week, is saved for Fri­day night, when we learn that Ger­many has mag­i­cally raised over a quar­ter of its total EFSF oblig­a­tion of €211 bil­lion by way of what is essen­tially magic. The Tele­graph reports that “Ger­many is €55bn richer than it pre­vi­ously thought because of an account­ing error at state-owned bank Hypo Real Estate Hold­ing. The mis­take at “bad bank” FMS Wert­man­age­ment, hap­pened because col­lat­eral for deriv­a­tives wasn’t net­ted between the asset and lia­bil­ity side, an FMS spokesman said. As a result, FMS will only con­tribute about €161bn to Germany’s debt this year, down from €216.5bn in 2010.” Another way of rep­re­sent­ing the error is that it is equal to a ridicu­lous 1% of the country’s debt to GDP ratio. “Germany’s 2010 debt-to-GDP ratio also drops, to 83.2% from the pre­vi­ous 84.2%, a finance min­istry spokesman said.” In other words, the mod­ern world, best char­ac­ter­ized by the implod­ing fiat ponzi, has dis­cov­ered a way to raise cap­i­tal (elec­tronic, nat­u­rally) cour­tesy of CDS book­mark­ing errors. And now, we have seen it all.

Since money is fun­gi­ble, espe­cially at the sov­er­eign level, the “unlocked” cap­i­tal which for­tu­itously was in a favor­able net­ting direc­tion (and we can’t wait to get our hands on the detailed expla­na­tion of just what the error was that resulted in €31 in 2011 and €24.5 bil­lion in 2010 of addi­tional “debt” issuance going to fund FMSW, also known as Germany’s bad bank, and now effec­tively being unwound) can and will used to plug bad Greek debt short­falls at any other wards of the state which has mate­r­ial expo­sure to bad debt. Such as par­tially nation­al­ized Com­merzbank, which as we noted yes­ter­day by way of Ger­man FAZ, is dump­ing all of its PIIGS (and poten­tially US) bond expo­sure into a bid­less mar­ket with the same urgency as US banks offload­ing sub­r­pime paper in the sum­mer of 2007, in order to pre­serve liq­uid­ity and raise cap­i­tal. Most impor­tantly, this is also money that amounts to over 25% of the Ger­man oblig­a­tion toward the EFSF of €211. So while one can dream up ridicu­lous sto­ries of €55 bil­lion account­ing errors, the real­ity is that the source does not really mat­ter: after all these are merely elec­tronic ones and zeros. And the next time Ger­many needs to “raise some elec­tronic cash” to fund even greater PIIGS related short­fall, it will sim­ply find even greater “account­ing errors” which mag­i­cally give jus­ti­fi­ca­tion to shift a lia­bil­ity to an asset, and thus val­i­date what is effec­tively non-sterilized print­ing of euros at the national level! Is this merely an appe­tizer of things to come, and an expla­na­tion of how Europe will “fund” the hun­dreds of bil­lions in cap­i­tal short­fall once the PIIGS start falling left and right like domi­noes, tipped over by what is now the Greek default of Octo­ber 27, 2011? Of course not: cer­tainly this is noth­ing more than an inno­cent acci­dent (for €55 bil­lion) and any­one claim­ing oth­er­wise is a con­spir­a­to­r­ial anarchist.

...

And the truly good news is that with roughly one quadrillion in deriv­a­tives float­ing out there, the bulk of which nobody has any clue what they are, where they are, and what they are col­lat­er­al­ized by, it means that the world is free to find derivative-based “errors” which can mag­i­cally fund well over two times the global debt which at last check was about $500 tril­lion. At the end of the day, no one is the wiser: after all this is merely the cre­ation and destruc­tion of elec­tronic ones and zeros in the span of nanosec­onds in one computer’s ran­dom access memory.

Another les­son to be learned from this is that it’s all good as long as the account­ing error makes money:

Ger­many admits account­ing blun­der but no scapegoats

By Erik Kirschbaum

BERLIN | Thu Nov 3, 2011 3:53pm EDT

(Reuters) — The Ger­man gov­ern­ment has no plans to sack the bankers or accoun­tants who made a 55-billion euro ($75 bil­lion) book­keep­ing blun­der that exposed it to ridicule across Europe, the finance min­is­ter said Wednesday.

Wolf­gang Schaeu­ble said it was “an extremely annoy­ing mis­take” for the nation­alised mort­gage bank Hypo Real Estate (HRE) and the PwC accoun­tancy firm to have let such an error slip through undetected.

The Berlin gov­ern­ment has been scathing about Greece’s book­keep­ing prac­tices dur­ing the euro zone crisis.

“I don’t believe in look­ing for scape­goats,” Schaeu­ble told a news con­fer­ence after sum­mon­ing exec­u­tives from HRE and the accoun­tancy firm to his office.

“Every­one promised improvements.”
....

Read­ing sto­ries like this from last year almost makes it seem like our busi­ness and polit­i­cal lead­ers have become the guy from Memento, suf­fer­ing from some sort of brain trauma by the 2008 melt­down that has left them unable to cre­ate new mem­o­ries or learn new lessons:

Does fis­cal aus­ter­ity boost short-term growth? A new IMF paper thinks not

Sep 30th 2010 | from the print edition

MOST peo­ple, among them the tens of thou­sands of work­ers who ral­lied in Brus­sels on Sep­tem­ber 29th, believe that fis­cal aus­ter­ity leads to a shrink­ing econ­omy, at least in the short run. Jean-Claude Trichet, pres­i­dent of the Euro­pean Cen­tral Bank, dis­agrees. In June he said that “the idea that aus­ter­ity mea­sures could trig­ger stag­na­tion is incor­rect.” Argu­ing that a cred­i­ble fiscal-consolidation plan would restore con­fi­dence, he said: “I firmly believe that in the cur­rent cir­cum­stances, confidence-inspiring poli­cies will fos­ter and not ham­per eco­nomic recovery.”

With rich-world bud­get deficits aver­ag­ing about 9% of GDP in 2009—up from only 1% in 2007—and their aver­age public-debt-to-GDP ratio expected to hit 100% by the end of this year, aus­ter­ity is a bul­let that few rich coun­tries will be able to dodge. But is it right to claim, as Mr Trichet and other devo­tees of “expan­sion­ary fis­cal con­sol­i­da­tions” do, that belt-tightening can actu­ally aid growth in the short term? The intel­lec­tual back­ing for these claims comes from a study by two Har­vard econ­o­mists, Alberto Alesina and Sil­via Ardagna, which stud­ied past fis­cal adjust­ments in rich coun­tries*. They found that, more often than not, fis­cal adjust­ments that relied on spend­ing cuts boosted growth, even in the very short run. But a new study by econ­o­mists at the IMF reck­ons that the Har­vard study was seri­ously flawed**.

Aus­ter­ity can have some short-term ben­e­fits. Imag­ine, for exam­ple, that con­sumer demand is depressed in part because peo­ple fear the prospect of a wrench­ing fis­cal adjust­ment. Devis­ing a cred­i­ble aus­ter­ity pack­age could lead peo­ple to regard their eco­nomic future with less trep­i­da­tion. This increased opti­mism may encour­age peo­ple to spend more freely even in the short run. But are such ben­e­fits large enough to ensure that the net effect of fis­cal con­sol­i­da­tion is to boost growth? The IMF’s con­clu­sion is that they are not.
...

But then I recall that this pat­tern of behav­ior has been going on for a quite a while. So they’re not suf­fer­ing from short-term mem­ory loss. They’re just delu­sional lunatics.

With the P.I.I.G.S. prob­a­bly out of the pic­ture going for­ward and Bel­gium and France now pos­si­bly fac­ing expul­sion from the euro­zone ‘in’ group (they are so no longer cool), it’s worth not­ing that the goals set out by Merkel on the big EU treaty changes (like tak­ing gov­ern­ments to court for too much bor­row­ing), will poten­tially involve a much smaller eurozone:

The Irish Times — Thurs­day, Novem­ber 10, 2011
Merkel calls for treaty change to sta­bilise currency

DEREK SCALLY in Berlin

GERMANY: CHANCELLOR ANGELA Merkel has ramped up her euro zone res­cue rhetoric, say­ing treaty change to allow “bind­ing” EU over­sight of national bud­gets is an imper­a­tive step to sta­bilise the sin­gle currency.

Hours later Dr Merkel described the debt cri­sis as a “turn­ing point” in EU his­tory, Euro­pean Com­mis­sion pres­i­dent José Manuel Bar­roso – also in Berlin – warned euro zone mem­bers against the “logic of inter­gov­ern­men­tal­ism” and said a “split EU” would result if euro zone mem­bers rushed through reforms and left euro acces­sion mem­bers behind.

Dr Merkel said she could no longer see a euro zone cri­sis solu­tion that pre­served the EU sta­tus quo, where national bud­gets had the poten­tial to imperil the whole EU, with no means of inter­ven­tion by Euro­pean institutions.

“I’m of the view that we need a treaty change,” she said. “If [sta­bil­ity pact] agree­ments are not observed, a Euro­pean insti­tu­tion must have the right to inter­vene in a bud­get being queried.

“With these mea­sures in the back­ground, national par­lia­ments would, as a rule, present bud­gets that meet the goals of the sta­bil­ity and growth pact,” she said.

“Oth­er­wise I sup­port giv­ing the com­mis­sion or another mem­ber state the right to take the coun­try in ques­tion to the Euro­pean Court.” Dr Merkel’s remarks come amid a grow­ing debate in Ger­many about whether the EU can pro­duce mean­ing­ful reforms among its 27 mem­bers, or whether a euro zone avant-garde should pro­ceed faster.

...

The notion of a 17-member euro zone avant-garde forg­ing closer fis­cal and eco­nomic ties via an inter­gov­ern­men­tal deal has alarmed the Euro­pean Commission.

Mr Bar­roso said yes­ter­day that his com­mis­sion saw its respon­si­bil­ity to “stead­fastly uphold its role as the guar­an­tor of all mem­ber states”.

“The EU as a whole and the euro area belong together,” he said in Berlin, and reminded his audi­ence that, except for two euro zone opt-out coun­tries, the EU treaties fore­see all other mem­bers join­ing the sin­gle currency.

He described it as an “absurd” idea for the 17 euro zone coun­tries to agree deeper fis­cal and mon­e­tary inte­gra­tion with­out bring­ing along non-euro mem­bers. This would in effect, he said, rep­re­sent an “opt-out” of the mon­e­tary core of the union from the Euro­pean Union as a whole.

“Let me be clear – a split union will not work. That is true for a union with dif­fer­ent parts engaged in dif­fer­ent objec­tives; a union with an inte­grated core but a dis­en­gaged periph­ery; a union dom­i­nated by an unhealthy bal­ance of power or indeed any kind of direc­to­rium,” he said. “All these are unsus­tain­able and will not work in the long term.”

...

You can’t say these aren’t inter­est­ing times.

It looks like Merkel is dou­bling down on the “either we form a ‘polit­i­cal union’ or the whole thing is kaput” rhetoric:

Merkel Urges Over­haul of Euro­pean Union
Q
By Tony Czuczka and Brian Parkin — Nov 14, 2011 6:14 AM CT

Ger­man Chan­cel­lor Angela Merkel called for an over­haul of the Euro­pean Union, advo­cat­ing closer polit­i­cal ties and tighter bud­get rules, in her most explicit pre­scrip­tion for end­ing the debt crisis.

Speak­ing to her Chris­t­ian Demo­c­ra­tic Union party’s annual con­gress in the east­ern Ger­man city of Leipzig today, Merkel said lead­ers must cre­ate a “new Europe” by deep­en­ing ties in the 27-nation EU. At the same time, she repeated Germany’s rejec­tion of jointly sold euro bonds.

“The task of our gen­er­a­tion now is to com­plete the eco­nomic and cur­rency union in Europe and, step by step, cre­ate a polit­i­cal union,” Merkel said. “It’s time for a break­through to a new Europe.”

Merkel’s address marks an esca­la­tion in her rhetoric as the debt cri­sis that began in Greece in Octo­ber 2009 sent Ital­ian and Span­ish bor­row­ing costs to euro-era records last week and roiled French mar­kets. After lead­er­ship changes in Italy and Greece, the chan­cel­lor is turn­ing her atten­tion to shap­ing the euro and the EU’s future.

“What she means is that either we get more Europe now or the project will die,” Ralph Brinkhaus, a CDU mem­ber of parliament’s finance com­mit­tee, said in an inter­view. “This means that Ger­many must give up some sov­er­eign rights and some party col­leagues and vot­ers may find this hard to swal­low. But there’s no alter­na­tive.”

Save the EU

Merkel renewed her warn­ing that “if the euro fails, Europe fails” and said her mis­sion was to save the “his­toric” EU project.

“Big polit­i­cal changes are now sweep­ing through the euro zone, putting — at least for now — the many skep­ti­cal polit­i­cal observers to shame,” said Erik Nielsen, chief global econ­o­mist at Uni­Credit SpA (UCG) in Lon­don. In Italy, Greece and Spain, which holds elec­tions on Nov. 20, “peo­ple want ‘more Europe,’ not less.”
...

New Europe, it’s what the pub­lic wants!

Here’s an arti­cle that cap­tures an impor­tant par­al­lel between the US and Ger­man economies dur­ing their most recent eco­nomic booms. It also helps explain the Ger­man domes­tic polit­i­cal pres­sures that come into play when­ever more euro­zone bailouts are discussed.

Back in the early 2000’s, when the P.I.I.G.S. were handed still test­ing out their new euro­zone plat­inum cards, Ger­many was under­go­ing “labor mar­ket reforms” (aus­ter­ity mea­sures for the work­ers) to keep down export costs (wages). So, while Ger­many has become the continent’s chief exporter and its com­pa­nies are sit­ting on large piles of cash, the Ger­man worker has seen few of those gain over the last decade, with most of those gains going to the top:

Is a Ger­man ‘Fourth Reich’ emerging?

Euro­peans accuse Berlin of using the euro cri­sis to boost Ger­man power

Siob­han Dowl­ing­No­vem­ber 15, 2011 06:07

idea to send a Ger­man. And his name cer­tainly didn’t help matters.

When Horst Reichen­bach arrived in Athens recently to head a new Euro­pean Union task force to help the coun­try deal with its debt, the Greek media instantly dubbed him “Third Reichenbach.”

Car­toons appeared of him in Nazi uni­form. A Greek tabloid showed a photo of his office with the head­line: “The new Gestapo head­quar­ters.”
...

The view from Germany

Only a few years ago, as economies else­where on the con­ti­nent boomed, Ger­many was regarded as the sick man of Europe. It was still bear­ing the huge costs of reuni­fi­ca­tion with East Ger­many. Unem­ploy­ment was stub­bornly high. A decade ago, it endured a tough restruc­tur­ing of its econ­omy, includ­ing unpop­u­lar labor and wel­fare reforms.

“Ger­many did what Greece and Italy and France will now need to do,” said Ulrike Guerot, head of the Berlin office of the Euro­pean Coun­cil on For­eign Rela­tions. “We did this 10 years ago and we are now see­ing the fruits of what we did.”

...
Another key fact is that while other coun­tries regard Ger­many as an eco­nomic colos­sus with the means (if not the will) to help, the real­ity for its work­ers is at odds with this image. While wages increased sig­nif­i­cantly in many other coun­tries over the past decade, in Ger­many they have remained stag­nant for years. A report released by the Berlin-based Ger­man Insti­tute for Eco­nomic Research last week showed that when adjusted for infla­tion, wages actu­ally declined by 4.2 per­cent over the past decade.

In part, this is due to the mush­room­ing of low-paid, pre­car­i­ous jobs, a result of the labor law lib­er­al­iza­tion that helped boost growth. Yet even in highly union­ized jobs, wages have not risen significantly.

“There has been a large shift of income from labor to cap­i­tal,” said Whyte, at the Cen­tre for Euro­pean Reform. “In other words, Ger­man firms are now sit­ting on large piles of cash, but Ger­man work­ers have not been get­ting pay rises.”

Sell­ing the bailout to Germans

The plight of the Ger­man worker makes the bailouts a harder sell. The advan­tages of a strong euro zone aren’t clear to the many peo­ple who have not gained finan­cially from the country’s increas­ing wealth.

“Many Ger­mans basi­cally have not seen the fruits of the euro and ben­e­fits of the sin­gle mar­ket in the first place, and now they feel like they are going to pay for the all oth­ers,” said Guerot, from the Euro­pean Coun­cil on For­eign Rela­tions. “It’s very hard to make the argu­ment among Ger­mans that they should put bil­lions on the table for Italy or Greece to save the sin­gle mar­ket.”
...

I’d snark­ily rec­om­mend an “Occupy Berlin” sis­ter move­ment at this point if it was nec­es­sary. It’s not.

It begins?

Novem­ber 15, 2011 7:28 pm
Euro­zone bonds hit by mass sell-off

By Richard Milne and David Oak­ley in London

Euro­zone bond mar­kets suf­fered a mass sell-off on Tues­day as investor fears spread beyond Italy and Spain to triple A-rated France, Aus­tria, Fin­land and the Netherlands.

The pre­mium that France and Aus­tria pay over Ger­many to bor­row rose to euro-era records of 192 basis points and 184bp respec­tively, lev­els investors say are no longer con­sis­tent with top credit ratings.

“Mar­kets are los­ing patience so they are going for the jugu­lar, which is the core coun­tries and not the periph­ery,” said Neil Williams, chief econ­o­mist at Her­mes, the UK fund man­ager. “There is con­ver­gence but it is con­ver­gence on the weakest.”

...

The rise in bond yields affected all main euro­zone coun­tries apart from Ger­many, and sug­gests that the two-year-old sov­er­eign debt saga could be enter­ing a dan­ger­ous phase.

...

It’s worth not­ing that a cur­rency union con­sist­ing of a large num­ber of mem­bers sort of lends itself to a weird musical-chairs/kill-of-the-hill sit­u­a­tion when inter­lock­ing finan­cial sys­tems work out the toxic debt or what­ever eco­nomic imbal­ances that build up. Then again, if you swapped out Ger­many for just about any other major eco­nomic power, things might look dif­fer­ent and the whole euro­zone may have imploded months ago because the Ger­many econ­omy is sort of in a league of its own right now (assum­ing an intact euro­zone going for­ward). But a musical-chairs/king-of-the-hill dynamic seems like some­thing we’re going to see more of as cur­rency unions catch on. That should be fun.

@Pterrafractyl: The mate­r­ial that you post on these pages is pretty good. I think you def­i­nitely have enough tal­ent to start your own blog/site. Then we could pull our forces together, exchange links, com­ment on each other sites, etc. Don’t you find it would be a good idea? I love to read you on Dave’s site but I think you def­i­nitely make the cut to go the next level. What we need now is to cre­ate a net­work of peo­ple who share our ideas and val­ues. And you will always have the oppor­tu­nity and plea­sure to com­ment on Dave’s site at your will and discretion.

Counter-party risk? What’s that? They never cov­ered that in my con­tem­po­rary eco­nomic his­tory class:

JPMor­gan, Gold­man Keep Italy Debt Risk in Dark
Q
By Chris­tine Harper and Michael J. Moore — Nov 15, 2011 6:01 PM CT

JPMor­gan Chase & Co. (JPM) and Gold­man Sachs Group Inc. (GS), among the world’s biggest traders of credit deriv­a­tives, dis­closed to share­hold­ers that they have sold pro­tec­tion on more than $5 tril­lion of debt globally.

Just don’t ask them how much of that was issued by Greece, Italy, Ire­land, Por­tu­gal and Spain, known as the GIIPS.

As con­cerns mount that those coun­tries may not be cred­it­wor­thy, investors are being kept in the dark about how much risk U.S. banks face from a default. Firms includ­ing Gold­man Sachs and JPMor­gan don’t pro­vide a full pic­ture of poten­tial losses and gains in such a sce­nario, giv­ing only net num­bers or exclud­ing some deriv­a­tives altogether.

...

JPMor­gan said in its third-quarter SEC fil­ing that more than 98 per­cent of the credit-default swaps the New York-based bank has writ­ten on GIIPS debt is bal­anced by CDS con­tracts pur­chased on the same bonds. The bank said its net expo­sure was no more than $1.5 bil­lion, with a por­tion com­ing from debt and equity secu­ri­ties. The com­pany didn’t dis­close gross num­bers or how much of the $1.5 bil­lion came from swaps, leav­ing investors won­der­ing whether the notional value of CDS sold could be as high as $150 bil­lion or as low as zero.

...

Coun­ter­party Clarity

“Their posi­tion is you don’t need to know the risks, which is why they’re giv­ing you net num­bers,” said Nomi Prins, a man­ag­ing direc­tor at New York-based Gold­man Sachs until she left in 2002 to become a writer. “Net is only as good as the coun­ter­par­ties on each side of the net — that’s why it’s mis­lead­ing in a fluid, dynamic market.”

...

JPMor­gan sought to allay con­cerns that its coun­ter­par­ties are unre­li­able by say­ing in the fil­ing that it buys pro­tec­tion only from firms out­side the five coun­tries that are “either investment-grade or well-supported by col­lat­eral arrange­ments.” The bank doesn’t iden­tify the counterparties.

...

Bungee Cords

If the value of Ital­ian bonds drops, as it did last week, a U.S. firm that sold a credit-default swap on that debt to a French bank would have to pro­vide more col­lat­eral. The same U.S. com­pany might be col­lect­ing col­lat­eral from a British bank because it bought a swap from that firm.

As long as all three banks can make good on their promises, the trade doesn’t have much risk. It could all unravel if the British firm runs into trou­ble because it’s wait­ing for a pay­ment from an Ital­ian com­pany that defaults. The col­lapse of Lehman Broth­ers Hold­ings Inc. in 2008 demon­strated some of the rip­ple effects that one fail­ure can have in the mar­ket.
...

FASB Rule

The Finan­cial Account­ing Stan­dards Board in 2008 started requir­ing com­pa­nies to dis­close the world­wide gross notional credit pro­tec­tion they’ve writ­ten and bought. As of Sept. 30, JPMor­gan said it had sold $3.13 tril­lion of credit-derivative pro­tec­tion and pur­chased $3.07 tril­lion, up from $2.75 tril­lion sold and $2.72 tril­lion bought at the end of 2010, fil­ings show. Gold­man Sachs dis­closed it had writ­ten $2.07 tril­lion and bought $2.20 tril­lion, about the same amount it reported at year-end.

At the end of the sec­ond quar­ter, those two firms accounted for 43 per­cent of the $24 tril­lion of credit deriv­a­tives sold and bought by the 25 largest banks in the U.S., accord­ing to the Office of the Comp­trol­ler of the Cur­rency. The top five account for 97 per­cent of the total, the data show.

Guar­an­tees pro­vided by U.S. lenders on gov­ern­ment, bank and cor­po­rate debt in Greece, Italy, Ire­land, Por­tu­gal and Spain rose by $80.7 bil­lion to $518 bil­lion in the first half of 2011, accord­ing to the Bank for Inter­na­tional Settlements.

...

@Claude: thanks for a the kind words and sug­ges­tions. Putting together a new site is an inter­est­ing idea. I have too much on my plate at the moment but it’s some­thing to pon­der for the future. Thanks for your efforts too!

It looks like the kid gloves are finally com­ing off:

NY Fed to Raise Mar­gin Require­ments on Mort­gage Secu­ri­ties

Pub­lished: Wednes­day, 16 Nov 2011 | 5:18 AM ET

By: Reuters

The New York Fed said it will be increas­ing the col­lat­eral require­ments on 21 primary-dealer banks in trans­ac­tions deal­ing with mortgage-backed secu­ri­ties, in an effort to lower the set­tle­ment risks with its counterparties.

...

“The Fed­eral Reserve Bank of New York informed its pri­mary deal­ers today that it will require deal­ers to mar­gin against their out­stand­ing agency MBS for­ward trans­ac­tion­swith the NY Fed. Deal­ers are required to post col­lat­eral in a num­ber of other types of oper­a­tions with the NY Fed,” a New York Fed spokesman told Reuters.
...

Sep­a­rately, the Jour­nal said the Fed­eral Reserve may impose a 2.5 per­cent ini­tial mar­gin on the dol­lar amount of the mortgage-backed secu­ri­ties trans­ac­tions from the deal­ers.

A dealer may need to put up $25 mil­lion in cash col­lat­eral for an MBS trans­ac­tion of $1 bil­lion, accord­ing to the paper.
...

Oooo, ouch, that’s going to hurt the big boys unused to hav­ing to play it so safe. Have fun with your measly 40-to-1 bets, Suckers!

More his­tory lessons left unlearned:

Novem­ber 18, 2011, 12:57 pm
The Brün­ing Thing

Joe Weisen­thal tells us about an ana­lyst will­ing to risk a Godwin’s Law cita­tion; Dylan Grice of Soc­Gen points out that it was the defla­tion­ary poli­cies of 1930–32, not the infla­tion of 1923, that brought you-know-who to power.

Indeed. When we hear asser­tions that Ger­mans are deeply hos­tile to loose money because of their his­tor­i­cal mem­o­ries, I always won­der why those mem­o­ries are so selec­tive. Why is 1923 seared into col­lec­tive mem­ory, while the Brün­ing dis­as­ter has appar­ently gone down the mem­ory hole?

This is impor­tant — and there’s not much time to get the record straight.

http://www.telegraph.co.uk/news/worldnews/europe/eu/8898213/German-memo-shows-secret-slide-towards-a-super-state.html

Ger­man memo shows secret slide towards a super-state

An intru­sive Euro­pean body with the power to take over the economies of strug­gling nations should be set up to tackle the euro­zone cri­sis, accord­ing to a leaked Ger­man gov­ern­ment document.

By Bruno Water­field, in Brus­sels
17 Novem­ber 2011

The six-page memo, by the Ger­man for­eign office, argues that Europe’s eco­nomic pow­er­houses should be able to inter­vene in how belea­guered euro­zone coun­tries are run.

The con­fi­den­tial blue­print sets out Germany’s plan to tackle the euro­zone debt cri­sis by cre­at­ing a “sta­bil­ity union” that will be “imme­di­ately fol­lowed by moves “on the way towards a polit­i­cal union”.

It will prompt fears that Germany’s euro cri­sis plans could result in a Euro­pean super-state with spend­ing and tax plans set in Brussels.

The pro­pos­als urge that the Euro­pean Sta­bil­ity Mech­a­nism (ESM), a euro­zone bailout fund that will be estab­lished by the end of next year, should be trans­formed into a ver­sion of the Inter­na­tional Mon­e­tary Fund for the EU.

The Euro­pean Mon­e­tary Fund (EMF) would be able to take full fis­cal con­trol of a fail­ing coun­try, includ­ing tak­ing coun­tries into receivership.

The leaked doc­u­ment, The Future of the EU: Required Inte­gra­tion Pol­icy Improve­ments for the Cre­ation of a Sta­bil­ity Union, comes as David Cameron meets Angela Merkel, the Ger­man chan­cel­lor, in Berlin today to talk about treaty changes and the euro­zone crisis.

The Ger­man plan begins with a pro­posal to cre­ate “auto­matic sanc­tions” that could be imposed on euro mem­bers spend­ing beyond tar­gets set by the Euro­pean Com­mis­sion. Ger­many is demand­ing that if euro rules are “con­sis­tently vio­lated”, it should be able to demand action from the Euro­pean Court of Justice.

Ger­many, Fin­land, Aus­tria and the Nether­lands would be able to ask EU courts to impose sanc­tions, from fines to the loss of bud­getary sov­er­eignty, to pro­tect the euro.

The memo states the EMF would be given “real inter­ven­tion rights” in the bud­gets of euro mem­bers who have received EU-IMF bailouts.

Open Europe, a think tank, has called for Mr Cameron to demand con­ces­sions from Mrs Merkel in exchange for the plans, which need the con­sent of all 27 EU coun­tries, giv­ing Britain a veto.

http://www.telegraph.co.uk/news/worldnews/europe/eu/8898044/Germanys-secret-plans-to-derail-a-British-referendum-on-the-EU.html

Germany’s secret plans to derail a British ref­er­en­dum on the EU

Ger­many has drawn up secret plans to pre­vent a British ref­er­en­dum on the over­haul of the Euro­pean Union amid con­cerns it could derail the euro­zone res­cue pack­age, leaked doc­u­ments obtained by The Daily Tele­graph disclose.

By Bruno Water­field, in Brus­sels
18 Nov 2011

Angela Merkel, the Ger­man chan­cel­lor, is today expected to tell David Cameron that Britain does not need a ref­er­en­dum on EU treaty changes, despite demands from senior Con­ser­v­a­tives for more pow­ers to be repa­tri­ated to Britain.

The leaked memo, writ­ten by the Ger­man for­eign office, dis­closes rad­i­cal plans for an intru­sive new Euro­pean body that will be able to take over the economies of belea­guered euro­zone countries.

It dis­closes that the EU’s largest econ­omy is also prepar­ing for other Euro­pean coun­tries, which are too large to be bailed out, to default on their debts — effec­tively going bank­rupt. It will prompt fears that Ger­man plans to deal with the euro­zone cri­sis involve an ero­sion of national sov­er­eignty that could pave the way for a Euro­pean “super state” with its own tax and spend­ing plans set in Brussels.

Britain would be rel­e­gated to a new outer group of EU mem­bers who are not in the sin­gle cur­rency. Mr Cameron will today travel to Brus­sels and Berlin for tense nego­ti­a­tions with Mrs Merkel amid grow­ing dis­agree­ment between the lead­ers over how to deal with the eurozone.

The Prime Min­is­ter is increas­ingly exas­per­ated that Ger­many refuses to pro­vide more finan­cial help for Italy and other strug­gling coun­tries amid con­cerns that the cri­sis is hav­ing a “chill­ing effect” on the British econ­omy. Mrs Merkel yes­ter­day said she expected Mr Cameron to “exam­ine a stronger involve­ment with other coun­tries” once the euro­zone cri­sis had been resolved.

She said: “We’ve seen a sov­er­eign debt cri­sis evolve in some states and par­tic­u­larly those in the euro­zone find them­selves in the inter­na­tional focus.

“It was right of David Cameron to con­cern him­self with the UK’s debt issues when he became Prime Min­is­ter — that’s my firm con­vic­tion, and once the neg­a­tive focus has moved away from Europe, he will exam­ine a stronger involve­ment with other countries.”

The euro­zone con­ta­gion is threat­en­ing to spread to Spain and France. Yes­ter­day, the price of Span­ish gov­ern­ment bor­row­ing reached the “brink” of cri­sis point.

The Span­ish gov­ern­ment sold 10-year bonds at a 6.975 per cent yield — just below the seven per cent level which has trig­gered inter­na­tional assis­tance elsewhere.

Amid protests in Milan and Turin, Mario Monti, Italy’s unelected “tech­no­crat” prime min­is­ter unveiled sweep­ing aus­ter­ity reforms. Mr Monti warned that a break-up of the sin­gle cur­rency would take euro­zone economies “back to the 1950s” in terms of wealth.

The six-page Ger­man for­eign min­istry paper sets out plans for the cre­ation of a Euro­pean Mon­e­tary Fund with a trans­fer of sov­er­eignty away from mem­ber states.

The fund will have the power to take ail­ing coun­tries into receiver­ship and run their economies. Even more con­tro­ver­sially, the doc­u­ment, enti­tled The future of the EU: required inte­gra­tion pol­icy improve­ments for the cre­ation of a Sta­bil­ity Union, declares that the treaty changes are a first stage “in which the EU will develop into a polit­i­cal union”. “The debate on the way towards a polit­i­cal union must begin as soon as the course toward sta­bil­ity union is charted,” it concludes.

The nego­ti­at­ing doc­u­ment also explic­itly exam­ines ways to limit treaty changes to speed up the reforms. It indi­cates that Mrs Merkel will tell Mr Cameron to rule out a pop­u­lar EU vote in Britain.

“Lim­it­ing the effect of the treaty changes to the euro­zone states would make rat­i­fi­ca­tion eas­ier, which would nev­er­the­less be required by all EU mem­ber states (thereby less ref­er­enda could be nec­es­sary, which could also affect the UK),” read the paper.

Senior gov­ern­ment offi­cials con­firmed that they had dropped a pre­vi­ous demand that EU pow­ers should be “repa­tri­ated” to Britain in return for the treaty changes requested by Ger­many, a move that will anger Con­ser­v­a­tive MPs.

“I don’t think that any­one is seri­ously propos­ing going down that route,” a senior gov­ern­ment source said.

Open Europe, a think tank, last night called for Mr Cameron to demand some­thing in return from Mrs Merkel for her “far-reaching plan”, which requires the unan­i­mous con­sent of all 27 EU coun­tries, giv­ing Britain a veto.

“It would be the first step towards a vision of ‘polit­i­cal union’ that would have major con­se­quences for the future of the entire EU, and there­fore the UK’s place within it,” said Stephen Booth, the think tank’s research director.

“Merkel is dar­ing Cameron to call her bluff, but if the UK is seri­ous about tak­ing a lead­er­ship role in shap­ing the EU, Cameron will have to take a stand sooner rather than later.”

Bill Cash, chair­man of the Com­mons Euro­pean scrutiny com­mit­tee, accused the Coali­tion of stand­ing by in “no–man’s land” while Ger­many shaped the EU to suit its own interests.

“We are going to get noth­ing sig­nif­i­cant in return for agree­ing to this,” he said.

Mr Cameron is today also expected to pres­surise Mrs Merkel into lift­ing Ger­man oppo­si­tion to the use of the Euro­pean Cen­tral Bank to res­cue the euro.

How­ever, last night, Mrs Merkel said: “If politi­cians think the ECB can resolve the prob­lem of the euro’s weak­nesses, then I think they are per­suad­ing them­selves of some­thing that won’t happen.

@R. Wil­son: Here’s another secret (well, ex-secret):

Merkel tight­ens grip on euro­zone: Why did Irish bud­get plans end up in Berlin?
Doc­u­ment cir­cu­lates reveal­ing next year’s bud­get not yet approved by Irish PM
Enda Kenny forced into embar­rass­ing denial that his plans were being inspected by Berlin

By Rob Davies and Hugo Duncan

Last updated at 11:03 AM on 18th Novem­ber 2011

Fears that Germany’s grip on the euro­zone is tight­en­ing increased last night after it emerged that details of Ireland’s bud­get plans were leaked to Ger­man politicians.

A doc­u­ment cir­cu­lated in the Ger­man Bun­destag revealed Dublin’s pro­pos­als to save the debt-ridden coun­try £3.25billion.

The details were for next year’s bud­get, which have not yet been approved by the Irish Taoiseach Enda Kenny.

He was forced into an embar­rass­ing denial that his plans were being inspected in Berlin.

...

Mr Kenny met Ger­man Chan­cel­lor Angela Merkel in Berlin ear­lier this week.

Asked how such sen­si­tive infor­ma­tion ended up in the hands of a for­eign power – just a day after their meet­ing – Mr Kenny said he had ‘no idea’.

...

Ireland’s Depart­ment of Finance said it had no expla­na­tion for why the doc­u­ment – which was not signed by finance min­is­ter Michael Noo­nan – had ended up in Ger­man hands.

...

Dublin is aim­ing to slash around £10billion from spend­ing plans over the next four years in an aus­ter­ity drive aimed at forg­ing a last­ing eco­nomic recov­ery.

Ear­lier this week, Berlin declared that Europe is ‘speak­ing Ger­man and Britain must be less self­ish’ towards the EU.

The UK has a duty to help the euro­zone despite being out­side the sin­gle cur­rency, accord­ing to one of Mrs Merkel’s clos­est allies.

Even more provoca­tively, Volker Kauder, leader of Germany’s CDU par­lia­men­tary party, warned Britain could not block a finan­cial tax that would cost the City billions.

Putting aside the creepi­ness of see­ing Ire­land secretly seek out approval from their new bosses, I have to admit that, of all the major changes hit­ting the euro­zone and EU, the one thing I wouldn’t mind see­ing the finan­cial activ­i­ties in City of Lon­don come under some sort of Tobin Tax (Along with the rest of the planet’s finan­cial cen­ters). It would def­i­nitely help with the scam of high-frequency trad­ing, although I don’t know if it would really solve the City of London’s rather large sys­temic money-laun­der­ing issues (and that’s just part of the prob­lem).

A moment of “Fun with His­tory”:
Then:

Inside Wall Street’s Black Hole</b

by Michael Lewis Feb 19 2008

For years, investors have relied on a com­plex for­mula to man­age risk. But what hap­pens if the Black-Scholes model is wrong—and we’re in big­ger trou­ble than ever?

The strik­ing thing about the seem­ingly end­less col­lapse of the subprime-mortgage mar­ket is how egal­i­tar­ian it has been. It’s nearly impos­si­ble to draw a demo­graphic line between the vic­tims and the perps. Mil­lions of ordi­nary peo­ple igno­rant of high finance have lost bil­lions of dol­lars, but so have the biggest names on Wall Street, and both groups made exactly the same bet: that real estate val­ues would never fall. Stan O’Neal, the for­mer C.E.O. of Mer­rill Lynch, was fired for the same rea­son the lower-middle-class fam­ily in the sub­ur­ban waste­land between Los Ange­les and San Diego may have lost its sur­pris­ingly nice home. Both under­es­ti­mated the like­li­hood of an unlikely event: a finan­cial panic. In ret­ro­spect, the small army of Wall Street traders who lost tens of bil­lions of dol­lars in subprime-mortgage invest­ments looks as naive and fool­ish as the man on the street. But there’s another way of view­ing this cri­sis. The man on the street, for the first time, acted on the same fool­ish prin­ci­ples that have guided the behav­ior of sophis­ti­cated Wall Street traders for the past few decades.

If you had to pick a moment when those prin­ci­ples first appeared a bit shaky, you could do worse than the 1987 stock mar­ket crash. Black Mon­day was the first of a breed: a panic that sug­gested dis­as­trous eco­nomic and social con­se­quences but in the end had no seri­ous effects at all. The burst­ing of the inter­net bub­ble, the Asian cur­rency cri­sis, the Russ­ian gov­ern­ment bond default that trig­gered the fail­ure of the hedge fund Long-Term Cap­i­tal Management—all of these extreme events seemed, in the heat of the moment, to have the power to change the world as we know it. None of them, it turned out, was that big of a deal for the U.S. econ­omy or for ordi­nary cit­i­zens. But the 1987 crash marked the begin­ning of some­thing else too—a col­lapse brought about not by real or even per­ceived eco­nomic prob­lems but by the new com­plex­ity of finan­cial markets.

A new strat­egy known as port­fo­lio insur­ance, invented by a pair of finance pro­fes­sors at the Uni­ver­sity of Cal­i­for­nia at Berke­ley, had been taken up in a big way by sup­pos­edly savvy investors. Port­fo­lio insur­ance evolved from the most influ­en­tial idea on Wall Street, an options-pricing model called Black-Scholes. The model is based on the assump­tion that a trader can suck all the risk out of the mar­ket by tak­ing a short posi­tion and increas­ing that posi­tion as the mar­ket falls, thus pro­tect­ing against losses, no mat­ter how steep. Nearly every employee stock-ownership plan uses Black-Scholes as its guid­ing prin­ci­ple. A pension-fund man­ager sit­ting on bil­lions of U.S. equi­ties and fear­ful of a crash needn’t call a Wall Street bro­ker and buy a put option—an option to sell at a set price, lim­it­ing poten­tial losses—on the S&P 500. Man­agers can cre­ate put options for them­selves, cheaply, by short­ing the S&P as it falls, and thus, in the­ory, be free of all mar­ket risk.

Good the­ory. The glitch was dis­cov­ered only after the fact: When a mar­ket is crash­ing and no one is will­ing to buy, it’s impos­si­ble to sell short. If too many investors are try­ing to unload stocks as a mar­ket falls, they cre­ate the very dis­as­ter they are seek­ing to avoid. Their desire to sell dri­ves the mar­ket lower, trig­ger­ing an even greater desire to sell and, ulti­mately, send­ing the mar­ket into a bot­tom­less free fall. That’s what hap­pened on Octo­ber 19, 1987, when the sweet logic of Black-Scholes was shown to be irrel­e­vant in the real world of crashes and pan­ics. Even the biggest port­fo­lio insur­ance firm, Leland O’Brien Rubin­stein Asso­ciates (co-founded and run by the same finance pro­fes­sors who invented port­fo­lio insur­ance), tried to sell as the mar­ket crashed and couldn’t.

Oddly, this fail­ure of finan­cial the­ory didn’t lead Wall Street to ques­tion Black-Scholes in gen­eral. “If you try to attack it,” says one long­time trader of abstruse finan­cial options, “you’re mak­ing a case for your own unin­tel­li­gence.” The math was too advanced, the the­o­rists too smart; the debate, for any­one with­out a degree in math­e­mat­ics, was bound to end badly. But after the crash of 1987, indi­vid­ual traders at big Wall Street firms who sold financial-disaster insur­ance must have smelled a rat. Across markets—in stocks, cur­ren­cies, and bonds—the price of insur­ing your­self against finan­cial dis­as­ter rose. This rise in prices and the break with Black-Scholes reflected two new beliefs: one, that huge price jumps were more prob­a­ble and likely to be more extreme than the Black-Scholes model assumed; and two, that you can’t man­u­fac­ture an option on the stock mar­ket by sell­ing and buy­ing the mar­ket itself, because that mar­ket will never allow it. When you most need to sell—or to buy—is exactly when every­one else is sell­ing or buy­ing, in effect can­cel­ing out any advan­tage you once might have had.

...

Then again:

...
Black-Scholes didn’t work; tril­lions of dol­lars’ worth of secu­ri­ties may have been priced with­out regard to the pos­si­bil­ity of crashes and pan­ics. But until very recently, no one has bitched and moaned about this prob­lem too loudly. Lay folk might har­bor pri­vate mis­giv­ings about the clergy, but as lay folk, they are reluc­tant to express them. Now, how­ever, as the sub­prime mar­ket unrav­els, the begin­nings of a revolt against the church seem to be tak­ing shape.

One of the revolt’s lead­ers is Nas­sim Nicholas Taleb, the best­selling author of The Black Swan and Fooled by Ran­dom­ness and a for­mer trader of cur­rency options for a big French bank. Taleb can pre­cisely date the ori­gin of his own per­sonal gripe with Black-Scholes: Sep­tem­ber 22, 1985. On that day, cen­tral bankers from Japan, France, Ger­many, Britain, and the United States announced their inten­tion to tor­pedo the U.S. dollar—to reduce its value in rela­tion to the other coun­tries’ cur­ren­cies. Every day, Taleb received a list of his trad­ing posi­tions from his firm and a matrix describ­ing his risks. The matrix told him how much money he stood to make or lose, given var­i­ous cur­rency fluc­tu­a­tions. That Sep­tem­ber 22, when the cen­tral bankers announced their plan to lower the dollar’s value, he made money but didn’t know it. “I didn’t know what my posi­tion was,” he says, “because the move­ment was out­side the matrix they’d given me.” The French bank’s risk-analysis pro­gram assumed that a cur­rency crash of this mag­ni­tude would occur once in sev­eral mil­lion years and there­fore wasn’t worth considering.

...

In the past two years, Taleb has co-authored a pair of papers that have appeared in the sort of aca­d­e­mic jour­nals that orig­i­nally pub­lished the Black-Scholes model. He and his co-author attack the model head-on in its own lan­guage (math), and as much as call for a retrac­tion of the Nobel Prize awarded to Myron Scholes and Robert Mer­ton for their work in cre­at­ing the model. “This is what I’m say­ing to Mer­ton and Scholes,” Taleb says. “You guys are just par­a­sites. You’re not bring­ing any­thing use­ful to the mar­ket. You are lec­tur­ing birds on how to fly. You’re watch­ing them fly. And then you’re tak­ing credit for it.”

...

Now:

The Money Cri­sis’ First Blush

By: Adrian Ash, BullionVault
Posted Wednes­day, 23 Novem­ber 2011

This SUMMER’S FIRST U.S. debt down­grade came after Wash­ing­ton failed to fix the debt ceil­ing one way or the other. Three months later, and Wash­ing­ton just failed again.

Yet that first down­grade also saw 10-year Trea­sury yields fall to 3.0% as US debt prices rose. And today, with a sec­ond down­grade nailed on, that yield is already down below 2.0%.

What gives? Why is the finan­cial world pil­ing into US debt – dri­ving its price higher – even as the secu­rity of that very debt risks being de-rated fur­ther below the magic risk-free AAA mark?

“Most risk and return mod­els in finance start off with an asset that is defined as risk free,” explains an NYU pro­fes­sor. “The expected returns on risky invest­ments are then mea­sured rel­a­tive to the risk-free rate.” The loss of “risk free” as a con­cept thus plays hell with Wall Street’s invest­ment con­fi­dence, let alone its models.

Pric­ing stock-market options using the Black Scholes equa­tion, for instance, starts by assum­ing that “it is pos­si­ble to bor­row and lend cash at a known con­stant risk-free inter­est rate.” Remove the “risk free rate”, and things fall apart faster than Long Term Cap­i­tal Man­age­ment, the hedge fund built on Black-Scholes’ model, which col­lapsed when the world changed but the equa­tion didn’t.

...

So no risk-free rate, no base­line for banks or insur­ers, those multi-trillion-dollar indus­tries per­vad­ing pretty much every deal, order and pur­chase you can think of today out­side the black econ­omy. But even cash-only gang­sters aren’t free of the cri­sis hit­ting the finan­cial world’s only other com­peti­tor for the role of “risk-free” ref­er­ence point. Because in Euro­zone bonds, the very denom­i­na­tion itself is now in question.

...

Now again:

MF Global and the repo-to-maturity trade
Posted by Izabella Kamin­ska on Oct 31 19:26.

If ever there was an exam­ple of an “overnight repo Black Swan” event, MF Global’s “repo-to-maturity” lad­dered trades seem to be it. Though, in this case, they’re prob­a­bly bet­ter described as the real­i­sa­tion of the “short-term repo Black Swan”.

A.k.a insti­tu­tions’ grow­ing ten­dency to risk it in the short-term repo uni­verse, to beat the crappy returns being offered in the “risk-free” market.

So, while most of the media has been com­monly refer­ring to MF’s sov­er­eign bond posi­tions as pro­pri­etary bets gone wrong, there’s more to it than just that.

If any­thing this was a financ­ing posi­tion (or liq­uid­ity trade) — not a bet on the future direc­tion of the bonds themselves.

What’s more, if exe­cuted prop­erly the trade should — at least on paper – have posed lit­tle or no risk.

...

Then and Now:

Salomon Broth­ers Alums: Where Are They Now?
Lisa Du | Nov. 17, 2011, 11:05 AM

Although the Salomon name no longer adorns any finan­cial giant, its legacy is com­mon knowl­edge even for the finan­cial neophyte.

Its sta­tus in finan­cial lore is thanks to its numer­ous inno­va­tions in the bond mar­ket, Michael Lewis’ semi-memoir Liar’s Poker (a manda­tory read for any­one con­sid­er­ing a foray into finance) and the firm’s very pub­lic Trea­sury bond scan­dal in 1991.

But the invest­ment bank and trad­ing house was also chock full of employ­ees — some reck­less, some arro­gant and some tal­ented. Those for­mer bankers have gone to both suc­cess sto­ries or dis­as­trous down­falls. (There are two MF Global exec­u­tives in there too!)

So from Mayor Bloomberg to John Gut­fre­und, we rounded them up.

Michael Lewis

THEN: Michael Lewis worked as a bond sales­man in Lon­don for Salomon Broth­ers in the late 1980s.

NOW: Writ­ing best-sellers year-by-year. In the finan­cial sphere, he’s received praise for The Big Short and Boomerang about the after­ef­fects of the finan­cial cri­sis. In the cin­e­matic world, two of his books — The Blind Side and Mon­ey­ball — have been made into crit­i­cally acclaimed films.

HOW HE GOT HERE: Lewis quit his job at Salomon to write Liar’s Poker. From there, the rest is history.

Michael Stock­man

THEN: Got his career start as a mort­gage trader at Salomon.

NOW:Serv­ing as Chief Risk Offi­cer at MF Global, which filed for bank­ruptcy Oct. 31 and is now embroiled in legal troubles.

HOW HE GOT HERE: Trade mort­gages at Mor­gan Stan­ley and Gold­man after Salomon, then went on to a long career in risk man­age­ment — most recently as UBS America’s chief risk offi­cer. Also did a stint as a vis­it­ing scholar at Dartmouth’s Tuck School of Business.

John Meri­wether

THEN: John Meri­wether was the head of fixed-income trad­ing at Salomon and rose to vice-chairman in 1988. He resigned from the firm when it became embroiled in a scan­dal involv­ing false bids for trea­sury bonds.

NOW: His most recent hedge fund busi­ness, JM Advi­sors, only raised $28.85 million.Ouch.

HOW HE GOT HERE: Meri­wether seems prone to bad luck when it comes to invest­ments. He started his own hedge fund Long Term Cap­i­tal Man­age­ment, which had a spec­tac­u­lar fall in 1998 after a bad bet on the Russ­ian ruble and los­ing 90% of their assets. After that, Meri­wether started JWM Part­ners, which also closed fol­low­ing the 2008 finan­cial crisis.

...

Jon Bass

THEN: Spent 14 years as a man­ag­ing direc­tor over­see­ing fixed-income sales at Salomon, and later Cit­i­group when it was acquired.

NOW: Global head of insti­tu­tional sales at MF Global, the bro­ker­age that recently filed for bank­ruptcy and now fac­ing legal troubles.

HOW HE GOT HERE: Held lead­er­ship posi­tions in sales at UBS and BTIG.

...

Myron Scholes

THEN: Joined Salomon in 1990 as a spe­cial con­sul­tant, then rose to man­ag­ing direc­tor of fixed-income derivatives.

NOW: Chair­man of Plat­inum Grove Asset Man­age­ment, and sits on the board of sev­eral companies.

HOW HE GOT HERE: Scholes part­nered with Meri­wether to start Long Term Cap­i­tal Man­age­ment. Before the fund col­lapsed, Scholes won a Nobel prize in eco­nom­ics with Robert Mer­ton for his pio­neer­ing work in deriv­a­tives val­u­a­tion, the Black-Scholes model. He’s also seen his share of trou­bles in the LTCM fall­out and when his fund suf­fered fol­low­ing the finan­cial crisis.

Today’s “Fun with His­tory” moment was brought to you by His­to­ri­ans for Fred­die Mac.

It’s not a cri­sis. It’s a fea­ture:

In Debt Cri­sis, a Sil­ver Lin­ing for Ger­many
By STEPHEN CASTLE
Pub­lished: Novem­ber 24, 2011

BRUSSELS — Some­one, some­where, usu­ally makes money from bad news. With Europe’s debt cri­sis, that — at least until this week — was Germany.

The failed Ger­man bond auc­tion on Wednes­day might have brought to an end one tur­bu­lent chap­ter in the his­tory of the Continent’s debt cri­sis, dur­ing which Berlin remained insu­lated from much of the fallout.

Since 2009, Ger­many and a hand­ful of other coun­tries, like the Nether­lands, have ben­e­fited sig­nif­i­cantly from cheaper bor­row­ing costs as investors diverted cash from riskier assets and the bonds of south­ern Euro­pean coun­tries to debt issued by the Continent’s fis­cal hawks.

Accord­ing to an esti­mate by Re-Define, an eco­nomic research insti­tute in Brus­sels, Ger­many saved around 20 bil­lion euros ($26.7 bil­lion) in bor­row­ing costs from 2009 to 2011, with an addi­tional 20 bil­lion euros in esti­mated sav­ings locked in for the future. A sep­a­rate analy­sis, by the De Volk­srant news­pa­per in the Nether­lands, put Dutch sav­ings at around 7.5 bil­lion euros for 2009-11.

The drop in Ger­man bor­row­ing costs, which accord­ing to Re-Define have fallen by more than half since the cri­sis hit, is more than a sta­tis­ti­cal quirk because it has helped shape the way the cri­sis has been han­dled within a two-tier euro zone.

It helps explain why Ger­many has taken a tough line against “bud­get sin­ners” in the south like Greece, which have been vir­tu­ally locked out of bond mar­kets by high bor­row­ing costs, and why Ger­many has been reluc­tant to cre­ate a “big bazooka” or huge bailout fund to stem the cri­sis. The bond mar­kets deliv­ered cheap money to Ger­many, and resulted in some­thing Berlin badly wanted: eco­nomic over­hauls in South­ern Europe. “So in fact, in the Ger­man sys­tem, they think, ‘It’s not bad that those guys under­stand that they are really close to the abyss,’ ” said one Euro­pean offi­cial, who did not want to be iden­ti­fied because of the sen­si­tiv­ity of the issue.

The idea that those coun­tries are learn­ing some­thing from the cri­sis, the offi­cial said, is “deep in the men­tal­ity” of Germany.

...

Another thing “those coun­tries” might want to learn soon is that treaty changes that allow for joint eurobond issuance at the cost of EU over­sight over mem­ber state bud­gets just might cre­ate the great­est eco­nomic Frankstein’s Beast the world has ever seen: A cen­trally run eco­nomic gov­ern­ing coun­cil with a man­date to impose “aus­ter­ity” (i.e. cut deficit spend­ing on pesky social pro­grams) when­ever there’s a drop in rev­enue. It’s like the US set­ting up a per­ma­nent “Super Com­mit­tee” for the expressed pur­pose of killing state-level social spend­ing at the start of every recession.

Hooray, state-enforced Guilded Ages for­ever!:

EU Seeks Tougher Bud­get Over­sight, Floats Euro-Bond Options
Novem­ber 24, 2011, 2:36 AM EST

By Jonathan Stearns

(Updates with com­ments by Bar­roso in fourth para­graph. For more on Europe’s sovereign-debt cri­sis, see EXT4.)

Nov. 23 (Bloomberg) — Euro­pean Union reg­u­la­tors pushed for more bud­get con­trol over euro-area nations to ease the debt cri­sis, heed­ing Ger­man demands in return for offer­ing less cred­it­wor­thy gov­ern­ments the prospect of joint bond sales.

Weeks after win­ning a year-long bat­tle for stronger pow­ers to sanc­tion spend­thrift euro coun­tries, the Euro­pean Com­mis­sion pro­posed adding the right to screen national bud­gets ear­lier and mon­i­tor more closely nations such as Italy where ris­ing bor­row­ing costs threaten finan­cial sta­bil­ity. The com­mis­sion, the EU’s reg­u­la­tory arm, also asked for tighter fis­cal sur­veil­lance of nations such as Greece, Ire­land and Por­tu­gal after they exit res­cue pro­grams.

In exchange, the com­mis­sion advanced the idea that the Ger­man gov­ern­ment opposes of bonds sold jointly by the euro area’s 17 nations by out­lin­ing three options for such debt issuance. It said two of the three options would prob­a­bly involve the lengthy process of chang­ing the EU treaty and all of them would require rein­forced fis­cal over­sight.

The goal is “stronger bud­getary dis­ci­pline in the euro area,” com­mis­sion Pres­i­dent Jose Bar­roso said at a press con­fer­ence today in Brus­sels. “With­out stronger gov­er­nance in the euro area, it will be dif­fi­cult if not impos­si­ble to sus­tain a com­mon currency.”

Finan­cial Downturn

Fac­ing Group of 20 calls to end the two-year-old debt cri­sis, pre­vent another finan­cial down­turn and pre­serve its mon­e­tary union, the euro area is fash­ion­ing a German-designed reg­u­la­tory strait­jacket for high-debt mem­bers. Ger­man Chan­cel­lor Angela Merkel wants the tighter frame­work as a con­di­tion for fur­ther finan­cial sup­port of weaker euro economies, which have received taxpayer-funded aid pack­ages total­ing 386 bil­lion euros ($519 bil­lion) and ben­e­fited from con­tro­ver­sial Euro­pean Cen­tral Bank bond purchases.

....

Even if the joint eurobonds get issues, some­thing tells me the P.I.I.G.S. are still head­ing to the slaugh­ter­house.

Self-reinforcing Metaprob­lems:

Igno­rance is bliss when it comes to chal­leng­ing social issues
Mon, 11/21/2011 — 15:28

The less peo­ple know about impor­tant com­plex issues such as the econ­omy, energy con­sump­tion and the envi­ron­ment, the more they want to avoid becom­ing well-informed, accord­ing to new research pub­lished by the Amer­i­can Psy­cho­log­i­cal Association.

And the more urgent the issue, the more peo­ple want to remain unaware, accord­ing to a paper pub­lished online in APA’s Jour­nal of Per­son­al­ity and Social Psychology.

“These stud­ies were designed to help under­stand the so-called ‘igno­rance is bliss’ approach to social issues,” said author Steven Shep­herd, a grad­u­ate stu­dent with the Uni­ver­sity of Water­loo in Ontario. “The find­ings can assist edu­ca­tors in address­ing sig­nif­i­cant bar­ri­ers to get­ting peo­ple involved and engaged in social issues.”

...

“Beyond just down­play­ing the cat­a­strophic, dooms­day aspects to their mes­sages, edu­ca­tors may want to con­sider explain­ing issues in ways that make them eas­ily digestible and under­stand­able, with a clear empha­sis on local, individual-level causes,” the authors said.

...

Let’s see, ok, so we have a com­plex prob­lem (per­va­sive igno­rance brought about, in part, by our species’s self-inflicted stu­pid­ity in response to stress-inducing news), and part of the solu­tion is to com­mu­ni­cate it in a sim­ple man­ner to the audi­ence (every­one), empha­siz­ing local, individual-level causes. And if you fail they’ll reflex­ively avoid think­ing about it.

How’s this one: Your soci­ety is being taken over by fas­cist thugs because you and every­one you know know noth­ing about almost everything.

Too com­plex? Ok, how about just swap­ping out “brain” for “soci­ety” and “drugs” for “per­va­sive igno­rance about com­plex issues”. It worked so well before.

It’s just a tweak

Plan by Merkel, Sarkozy to tweak EU pact seen as long shot
By Sumi Somaskanda, Spe­cial for USA TODAY
12/04/2011

BERLIN – Count­ing down to a key Euro­pean Union sum­mit this week on the spi­ral­ing debt cri­sis, French and Ger­man lead­ers say they will push for treaty changes to allow for a closer fis­cal union — a solu­tion some say is likely to fail.

“It’s all very nice and inter­est­ing, but it still has to be rat­i­fied by all 27 EU coun­tries, and nobody knows if that’s real­is­tic,” said Bert Van Roose­beke, an econ­o­mist for the Cen­ter for Euro­pean Pol­icy in Germany.

Closer inte­gra­tion of the cur­rency union would mean mem­ber states ced­ing fis­cal sov­er­eignty to a cen­tral author­ity and would require the rules defin­ing power of the Euro­pean Union to be rewrit­ten. The­o­ret­i­cally, vot­ers in one EU nation can stop the pro­posal from becom­ing law.

...

Also, those were tears of joy:

UPDATE 2–Italy PM unveils sweep­ing aus­ter­ity package

Sun Dec 4, 2011 5:04pm EST

* 30 bil­lion euros in tax hikes, spend­ing cuts

* Monti renounces own salaries

* Pen­sion age to rise to 66 by 2018

By Giuseppe Fonte

ROME, Dec 4 (Reuters) — Prime Min­is­ter Mario Monti unveiled a 30 bil­lion euro pack­age of aus­ter­ity mea­sures on Sun­day, rais­ing taxes and increas­ing the pen­sion age in a drive to shore up Italy’s strained finances and stave off a cri­sis that threat­ens to over­whelm the euro zone.

Packed into a sin­gle emer­gency decree which comes into effect before for­mal par­lia­men­tary approval, the mea­sures fol­lowed grow­ing pres­sure for sweep­ing mea­sures to restore con­fi­dence in the euro zone’s third-largest econ­omy.

Monti said the pack­age, divided between 20 bil­lion euros of bud­get mea­sures over 2012–14 and a fur­ther 10 bil­lion euros in mea­sures to boost growth, was painful but necessary.

“We have had to share the sac­ri­fices, but we have made great efforts to share them fairly,” he told a news con­fer­ence, in which he said he had renounced his own salary as prime min­is­ter and econ­omy minister.

In a mark of the emo­tional impact of the cuts, Wel­fare Min­is­ter Elsa Fornero broke down in tears as she announced an end to infla­tion index­ing on all but the low­est pen­sion bands, a move that will mean an effec­tive income cut for many pen­sion­ers.

...

As part of a crack­down on tax eva­sion, cash trans­ac­tions of more than 1,000 euros will be banned, and there were also mea­sures to lib­er­alise busi­ness open­ing hours and open up phar­ma­cies and the trans­port sec­tor to more competition.

...

That pro­posed ban on cash trans­ac­tions over 1000 euros was kind of sur­pris­ing to see given the immense scope of the mafia’s influ­ence there and its money-laundering needs and the inter­twined nature of money-laundering with the econ­omy from small front-business, to high finance and pol­i­tics. It will have a fas­ci­nat­ing impact on the Ital­ian econ­omy if it’s actu­ally imposed. Will more laun­der­ing take place via small busi­ness (which might actu­ally have a stim­u­la­tive effect on the econ­omy) or will more laundering-related finan­cial trans­ac­tion just go unre­ported and deeper under­ground? Who, oh who, will answer the god­fa­thers’ money-laundering prayers?