The T Report: Skeptics Galore and the Big Picture

Posted by on Jun 11, 2012 in The T-Report | No Comments

It seems like it would be easier to find an adult who believes in Santa Claus than one who believe the events in Spain over the weekend accomplish anything. It is actually very hard to find a positive article, yet most seem to take worst case scenarios and take that as the likely outcome. Some seem to even rely on combining worst case scenarios that are actually mutually exclusive.

One and Done or More to Come

Before focusing on the issues directly surrounding this weekend’s announcements, it is important to put this event in the proper context. Even if the Spanish situation was resolved by this action the markets were be at serious risk of fading hard. There are too many problems in the world – Grexit, recession in Europe, declining economies in the U.S. and China, etc. If nothing is done that helps those situations, then the rally will be fairly short lived. Fixing Spanish banks is a bit like drowning one lawyer – a good start. Signs that this is another haphazard deal to delay the inevitable will cause the market to sell-off. Signs that the EU is truly working hard to make this deal have the least impact on Spain and signs that other policy shifts and money printing programs are in the pipeline will add to the rally.

Given how much doubt there is that anything else is about to be done, the element of positive surprises seems high, and quite possibly the central bankers and policy makers took note of the Economist’s cover this weekend, because it is a pretty accurate portrayal. With either get large intervention, largely in the form of money printing, to help the economies, or we don’t and the economies drag down. Longer term would we be better off dealing with short term pain to reduce the complexity of the situation and weed out bad companies and industries? Probably, but time and again we have seen the aversion to that, and the only time they let it happen with Lehman made them even more convinced to avoid doing it again (in spite of belief of many that more Lehmans would have been better).

Headline Volatility

Expect headline volatility. There will be headline after headline. There will be rumor after rumor. Some of the headlines and rumors will be important, and some might even be true, but most won’t.

The amount of money coming into the market is a game changer if done well, and the market is overbought if real new money isn’t coming in, so the volatility is justified. Ignoring useful headlines will hurt. Reacting to useless ones will hurt.

This morning we have already seen the market sell-off on the headlines that the TROIKA will indeed be involved in Spain. Schaeuble has tried to clarify that the involvement is with how the FROB distributes the money, in line with official press release. I believe that the IMF involvement, call it Troika if you prefer, at the disbursement and monitoring of banks is a good thing. Mistaking this as a sign the Troika is going to drive Spain down the same path as Greece and Portugal seems wrong, especially when Schaeuble himself, not usually the most helpful person in bailouts, has taken the time to point out the error.


Of all the headlines we will see, the most fanciful, far-fetched, and reacted to will be ones involving CDS. CDS has such a special place in the hearts of investors that the noise and drama surrounding it tends to be blown out of all proportion, and is often wrong – providing great trading opportunities.

Rumors that the ESM lending will trigger a Credit Event helping spook the rally. Maybe there will be a Credit Event due to the ESM lending, but

  1. ESM is not yet up and running so for now any lending would have to come from EFSF
  2. How ESM lends to Spain is yet to be determined but from the press releases it looks like the loan would be to FROB, providing lots of leeway around and “subordination” issues
  3. To be a Credit Event, a bond would need a negative pledge, and with €523 billion of local bonds that can be bent at will, the focus will be on the €5 billion of direct foreign law bonds. So even if workaround is difficult (which it probably isn’t), the group that needs to be negotiated with is small
  4. Technical defaults tend to have far less of an impact. Fannie Mae and Freddie Mac both had Credit Events but the bonds themselves were never restructured and never failed a payment. If market believes that the bonds are enough to give Spain a fighting chance, it may not be a big deal.

Of all the things to focus on, and there are a lot, CDS should be on the backburner. The hype and amount of incorrect information about CDS and what it would mean is far worse than anything else.

Focus on the actual details of the plan and what it does for banks and the sovereigns and whether it works or not. The jury is still out on that, but that is more important than some CDS hype (which yes, should be on an exchange).

Should be a long week, but letting market direction dictate views which in turn dictate positions is likely to be dangerous, especially since lately the market seems worse than ever at pricing anything correctly in the short term.