Arthur Rothstein Blatz on Tap Summer 1939. Butte, Montana "Men lounging in front of the Arcade"

Friday's NFP number brought us some altogether unprecedented BS from the BLS. Much has already been said about the filthy stench emanating from these "data points", so I will just review the most important points here. First thing to note is that squeezing a record 1.2 million people out of the "labor force"(people who don't waste time looking for jobs that don't exist) is apparently a sure fire way to get the headline unemployment rate down to only 8.3%

ZeroHedge, as usual, does an excellent job deconstructing the self-contradictory nonsense that is known as the NFP jobs report.

Record 1.2 Million People Fall Out Of Labor Force In One Month, Labor Force Participation Rate Tumbles To Fresh 30 Year Low

"A month ago, we joked when we said that for Obama to get the unemployment rate to negative by election time, all he has to do is to crush the labor force participation rate to about 55%. Looks like the good folks at the BLS heard us: it appears that the people not in the labor force exploded by an unprecedented record 1.2 million.

 

No, that's not a typo: 1.2 million people dropped out of the labor force in one month! So as the labor force increased from 153.9 million to 154.4 million, the non institutional population increased by 242.3 million meaning, those not in the labor force surged from 86.7 million to 87.9 million. Which means that the civilian labor force tumbled to a fresh 30 year low of 63.7% as the BLS is seriously planning on eliminating nearly half of the available labor pool from the unemployment calculation.

 

As for the quality of jobs, as withholding taxes roll over Year over year, it can only mean that the US is replacing high paying FIRE jobs with low paying construction and manufacturing."

 

 

   

To make matters much worse, the number of long-term unemployed (27 weeks or longer) remains at a very high level of ~5.5 million and youth unemployment remains at 23%. And only 10% of the headline increase in jobs was due to additions for full-time employment, while a record 700,000 part-time workers were hired in January. ZeroHedge also follows up with a great analysis of the seasonal adjustment mechanism used by the BLS to turn manufacture millions of jobs out of thin air and turn a miss of expectations into a massive beat.

 

Explaining Yesterday's Seasonally Adjusted Nonfarm Payroll "Beat"

 

"What is very notable is that in January, absent BLS smoothing calculation, which are nowhere in the labor force, but solely in the mind of a few BLS employees, the real economy lost 2,689,000 jobs, while net of the adjustment, it actually gained 243,000 jobs: a delta of 2,932,000 jobs based solely on statistical assumptions in an excel spreadsheet!

 

So how does this data fit in specifically in the context of the just passed NFP whopper of a number? Simple. The chart below shows the January seasonal adjustment for the past 4 years, since 2009. The number of jobs added for "seasonal" purposes to the NFP number were as follows: 2009 - 2,006,000; 2010 - 1,970,000; 2011 - 2,129,000, and the all important 2012: 2,146,000.  

 

Once again, this is the number added to the NFP unrevised baseline to get a "final" number which is then blasted to the media. The chart below shows the historical January adjustment, to the NFP data, as well as the 2012 reported adjustment, and also what the statistical adjustment would be for the NFP number to have the NFP number come in line with expectations of a 140,000 beat.

 

Here is the kicker: the market mood yesterday would have been far more somber if instead of a seasonal fudge-factored statistical addition of 2,146,000 jobs, the BLS had decided on a number that is merely the simple average of the statistical adjustment of the past 3 years, which comes down to 2,035,000. In fact, had the BLS used this seasonal adjustment, the final NFP headline number (SA) would have been +132,000, or a miss of expectations of 8,000 (the Seasonal Adjustment number to get to consensus January expectations would have to be +2,043,000 to the NFP number).

 

In other words, the difference between a + and - 2% move in the stock market is based on less than a 5% variation to the entire January seasonal adjustment, as had the BLS add just the simple average, the BLS report would have been a disappointing miss, and the market would have likely dropped (although with 5 momos in charge of the entire market, the thesis would have likely promptly shifted to "more QE coming" so who really knows)."

 

 

   

The combiniation of a horrendously exclusive "labor force" definition, extremely weak internals and a goal-seeked seasonal adjustment (significantly higher than recent average) make the NFP report the most highly manipulated and misleading piece of work to come oozing out of Obama's Administration yet. And Karl Denninger does a few more calculations to determine that, not only was this not a very good employment report as claimed, but it was actually the worst since January of 2009!

 

Employment Report: Blatant And Outrageous Lies 

 

"Indeed, the total number of employed persons fell. A lot. To put a number on it, the total number of employed persons fell by 737,000 by actual count.

 

Now the cheerleaders will state that this is a common thing in January, and indeed it is. But the correct adjustment is to look at the population increase and subtract that back off as well. In other words, we take the loss of employment and add the population growth. When we do this we get a whopping 2.422 million in the wrong direction which was bested only by the -2.618 million in January of 2009 through the process of this downturn!

 

In fact other than January 2009 there has never been a single month in my table, which dates back to 1999, that put up a worse combined number. This "performance" rates a literal "second from utter despair and disaster", and the employment rate shows it:"

 

 

   

This sort of aggravated manipulation/miscontruction will become commonplace in the months ahead of November’s elections and it does carry real consequences, beyond simply buying a few points with the market. Sports radio pundits are reporting that some 5 million (!) Americans are going to buy new televisions to watch The Superbowl, and jobs reports such as this one will give them unjustified comfort when making such horrible decisions.

Why put off a several hundred dollar purchase on credit when you are confident that there are plenty of jobs waiting for you or that your current job is safe? Why not take out a few loans from Sallie Mae and enroll in that graduate program when the economy is in full recovery mode? The people lured into consumer-friendly complacency by these faux reports and the media lackeys who shill for the status quo will have a very rude awakening when all their bills come due, and it turns out the jobs were never there to begin with.

Yet, there is also a growing section of disenfranchised Americans who will be forced to trust their own lying eyes and [lack of] paychecks over the juked statistics from federal agencies or Jim Cramer's insufferable blather. Perhaps the biggest consequence of these manipulations will be to completely undermine confidence in the crony corporatist establishment. Still, it may take some more time for the harsh realities of Depression to set in across the all-consuming middle-class of America, which starkly contrasts with the situation in Europe.

Say what you will about the Eurocrats – they are power-hungry shysters who work through endless circuits of Summits and acronymous funds, turning their citizens into full-blown debt slaves just so they can keep the current crop of banksters and politicians in power, while the latter bumble, tumble and stumble towards any temporary “solution” to be had, no matter how useless, unjust or counter-productive it is – BUT they do produce much more legitimate economic and financial data than their American counterparts.

They still offer a hint of transparency to their citizens; something that has been utterly stripped away from the American populace over these increasingly painful years. There is no doubt that the peoples' plight is much more acute in Europe right now, where many of those living in the periphery are struggling to make ends meet every hour of every waking day. Eurostat gives us the latest unemployment data for the EU-27 and the Eurozone (17), and it’s grim.

Unemployment Statistics

"Eurostat estimates that 23.816 million men and women in the EU-27, of whom 16.469 million were in the euro area (EA-17), were unemployed in December 2011. Compared with November 2011, the number of persons unemployed increased by 24 000 in the EU-27 and by 20 000 in the euro area. Compared with December 2010, unemployment increased by 923 000 in the EU-27 and by 751 000 in the euro area.

 

The euro area seasonally-adjusted unemployment rate was 10.4 % in December 2011, unchanged compared with November 2011; it was 10.0 % in December 2010. The EU-27 unemployment rate was 9.9 % in December 2011, also unchanged compared with November 2011; it was 9.5 % in December 2010.

 

Among the Member States, the lowest unemployment rates were recorded in Austria (4.1 %), the Netherlands (4.9 %)and Luxembourg (5.2 %), and the highest rates in Spain (22.9 %), Greece (19.2 % in October) and Lithuania (15.3 % in the third quarter of 2011).

 

________

 

In December 2011, 5.493 million young people (under 25) were unemployed in the EU-27, of which 3.290 in the euro area. Compared with December 2010, youth unemployment increased by 241 000 in the EU-27 and by 113 000 in the euro area. In December 2011, the youth unemployment rate was 22.1 % in the EU-27 and 21.3 % in the euro area. In December 2010 it was 21.0 % and 20.6 % respectively. The lowest rates were observed in Germany (7.8 %), Austria (8.2 %) and the Netherlands (8.6 %) and the highest in Spain (48.7 %), Greece (47.2 % in October) and Slovakia (35.6 %)."

 

 

 

   

These levels of youth unemployment are obviously a recipe for disaster, economically and socially. EU peripheral nations are tasked with growing themselves out of severe, structural deficits, but the figures above, among many others, tell us just how unrealistic that has been all along. Spain wants to cut its budget deficit nearly in half over two years when close to a quarter of its population, and almost half of those under 25, are not earning a regular income.

If the Troika and Mariano Rajoy get their way and spending on healthcare, education, etc. is gutted across Spanish regions, it will be even harder for any of these people to find employment, pay off various debts and consume at anything close to levels that sustain growth. The numbers put out by the EU may be more accurate than those pubished in America, but that’s little consolation to the men, women and children across the Continent who those numbers represent.

I’d like to get back to the BLS’ latest propaganda, though, and point out one other very important consequence of the report. It appears the rabid momentum chasers are once again picking up pennies in front of a gigantic steamroller, since everything in Europe is still as uncertain and unstable as it ever was and, on top of that, the bogus U.S. data may have just killed the one thing that investors have been taking to the bank for many months now – large asset purchases by the Fed.

I wouldn’t go so far as to say that some scale of QE3 has been “priced in”, but it is clear that the markets are now thoroughly addicted to credible promises of cheap, never-ending liquidity; or, as they would tell you in AA meetings, one sip is too much and one trillion sips are never enough. The problem for them now is that there is very little credibility left underlying the Fed’s “promises”, thanks to the complete joke of a jobs report produced by the incumbent politicians guiding the BLS.

With unemployment data suddenly showing massive improvement above expectations last month (and the non-manufacturing ISM reporting price increases across several commodities), the U.S. government has placed itself back in a position where there is simply no justification for any monetary easing. The Administration will continue to goose any and all economic data it can get its hands on going into elections, which will make it that much more difficult for the Fed to act, which, in turn, will make it very difficult for the market to keep up its appearances.

I believe it would be a mistake to assume that this fact has been lost on large money managers, as the following snippet from The Guardian Blog suggests.

 

Guardian Live Blog  

 

"The drop in the unemployment rate to 8.3% means it is at the lower end of the Federal Reserve's forecast range - which could provide fuel to those in the Fed who want to hold back from further measures to boost the economy. Joshua Raymond, chief market strategist at City Index, said:

 

'This is a really stellar set of numbers and has surprised many who had expected a slowing of jobs growth after the December holiday period.

 

The jobs figures paint quite a different picture to the tone of voice used by the Federal Reserve last week, which applied a somewhat dovish tone towards US growth expectations. This naturally poses the question what are the Fed seeing further down the path that the market isn't right now?

 

And what's more, a stronger than expected labour market goes directly against the rational to increase asset purchases through quantitative easing, and this may pose a somewhat negative impact in the medium term for those investors that had factored this into their trading.'

 

Within the figures private sector jobs rose 257,000 while government jobs fell by 14,000, compared to expectations of a 20,000 drop. The increase in non-farm payrolls is the biggest since April 2011."

 

We could call it the mirror image of 2009-10, when all that mattered to the American political and financial elites was goosing the markets to manage perceptions of economic health and churn trading profits. As housing, jobs and manufacturing data naturally worsened (with exactly zero jobs created in August 2011, later revised slightly upwards) and the electioneering switch was flipped, the politicians have taken precedence over the bankers and are manipulating the source data with the belief that the markets will naturally play along.

What the politicians fail to understand is that the feedback between the real economy and the markets, to the extent it existed, has been irreversibly corrupted over the last few years through centralized intervention. You can goose all the data you want, but the increasingly fewer traders [or robots] that make up "the market" these days only want one thing – more monetization of debt. And, until now, most of them have been too clueless to figure out that unrestricted printing of money is not a guaranteed outcome in 2012.

This is something that TAE has consistently pointed out for quite some time now, while others have declared that money printing is the end all and be all of the system. Ultra-loose monetary policy and some form of printing will be a staple feature of our world for some time to come, but let’s remember that the financial system is not isolated from the sociopolitical system or vice versa. Both the probability and effectiveness of money printing will hinge on numerous variables, three of the most important being systemic deleveraging, social confidence/mood and political manuevering, and all three of those are coming to a head this year.

Unknown Dreaming of great fortunes 1858California gold miner joining the British Columbia goldrush

After the Fed’s latest announcement on January 25, in which the central bank said very little more than the obvious ("exceptionally low" fed funds rate at least through late 2014), we have returned to typical speculations about how much “money printing” (or quantitative easing) by central banks we will see in upcoming months to accompany these low rates. Perhaps the Chief Speculator is Tyler Durden at ZeroHedge, who never backs down from an opportunity to re-assert (or manufacture) the near-term bullish arguments for gold. This article will review some of the more notable and ridiculous opportunities seized over the course of only a few day following the FOMC release. Each one was a relatively short and sweet post that showcased a nifty-looking correlation chart. I do realize that Durden wasn't claiming any of these posts as an extensive and irreproachable analysis, but the fact is that he decided to put them up for a reason. Soon after the Fed’s announcement, ZH ran the following headline and analysis [emphasis mine]:

Market Now Pricing In $770 Billion Increase In Fed Balance Sheet As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29. Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio). So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!"

Essentially, he is saying that the reaction in the EUR/USD pair after Bernanke’s statement had implied that the movers and shakers in the currency markets expected the dollar to be devalued by the Fed in the near future through quantitative asset purchases. Since the pair moved to levels that "imply" a ratio between the size of the Fed and ECB's balance sheets higher than currently established (based on loosely-correlated movements over the course of 2 years), and the ECB is expected to unleash at least another €500bn next month, we can project that the Fed will unleash a response of $767bn (or thereabouts). To Durden’s credit, he provides a partial explanation of why we should probably dismiss this entire train of thought in the very next sentence that he writes.

Naturally, that's a simple heuristic based on only what the EURUSD pair is implying. Of course, this is not a scientific way of predicting where Bernanke will go, but that is at least what the market seems to be telling us.

To only say that this mode of prediction is non-scientific is to do all forms of non-scientific economic analysis a huge disservice. It is patently ridiculous to think there is any connection whatsoever between the immediate reaction of a currency pair to a Fed announcement and either the expectations OR the actual value of future asset purchases by the Fed (even ignoring the fact that Bernanke's comments were not much more "uber-dovish" than they have ever been over the past year). It is much more likely that the EUR/USD has simply been moving with the perception of financial risk in the Eurozone this whole time, and perhaps with the expectation of ECB “money printing” since mid-2011. The markets' perception of risk is most certainly tied into the Fed’s QE asset purchases (or the lack of them in 2H 2011) during waves of greed/fear, but all of that is a very far cry from the currency pair acting as a predictive indicator of money printing. Durden almost admits as much above before reverting back to his goal-seeked analysis in pursuit of a predictable conclusion.

So at the end of the day, the balance sheets of the world's two biggest central banks will increase by about €500 billion for the ECB and ~$770 for the Fed and $655 billion for the ECB. Incidentally, this analysis assumes all else equal which, with Greece on the verge of default and Portugal potentially in its footsteps, isn't... Thus our question is: gold is not on its way to $2000 yet why again?

It is really unfortunate that such an informative and clever site occasionally feels forced to produce such weak arguments in favor of, what else, gold. The truth is that no one can be certain when Bernanke will decide to pull the trigger on QE3 or how much the Fed’s balance sheet will actually be expanded in nominal terms or relative to the ECB’s balance sheet, and analyses such as the one above provide us with no clearer picture of those possibilities than we had before. It only serves to confuse the issues at hand and provide us with a sense of predictive confidence that we simply can’t have. What we do know is that the Fed’s perpetually low interest rates and the potential for another few hundred billion in QE are very unlikely to make a dent in the ongoing global deleveraging tsunami, and therefore the natural flight to safety away from currencies such as the Euro for U.S. Treasuries and the U.S. Dollar. That is even truer if the ECB floods the European banks with another €500b to €1tn of LTRO funds in February, since very little of that money will actually make it to the distressed consumers, businesses and sovereigns that need it the most. The next day, ZeroHedge asked semi-rhetorically whether Bernanke has become a “gold bug’s best friend”. The logic contained within this brief analysis is similar to the one presented above, as it tries to connect the Fed’s statement and Bernanke’s comments on Wednesday to the subsequent positive returns of gold (and “implicitly silver”) over the 24 hours that came after [emphasis mine].

Has Bernanke Become A Gold Bug's Best Friend? Below we present the indexed return of ES (or stocks) and of gold over the past 24 hours since the Bernanke announcement of virtually infinite ZIRP, and the latent threat of QE3 any time the Russell 2000 has a downtick. It is unnecessary to point out just when Bernanke made it all too clear that the Fed has nothing left up its sleeve, expect to directly compete with the ECB over "whose (balance sheet) is bigger," as it is quite obvious. What is not so obvious, is that for all intents and purposes, Bernanke may have unwillingly, become a gold bug's best friend, as gold (and implicitly silver) has benefited substantially more than general risk. Much more. So for the sake of all gold bugs out there, could the Fed perhaps add a few more FOMC statements and press conferences? At this rate gold should be at well over $2000 by the June 20 FOMC meeting.

Granted, the first bolded statement above is quasi-hyperbole, but, then again, it’s not. ZeroHedge and others have been identifying the “latent threat of QE3” in the Fed’s various statements since the early days of 2011, well before QE2 even ended, which may as well be "any time the Russell 2000 has a downtick". The reality is that the Fed has no other choice but to leave open the possibility of further monetary easing in the near future, because otherwise it would be responsible for an uncontrollable downward cascade of markets around the world. And if one is looking hard enough to be vindicated for consistently repeated predictions of money printing to, as Buzz Lightyear would declare, “infinity and beyond”, then one will certainly find latent threats of such printing contained within almost all of the statements released by almost every central banker in the world. What’s much more disturbing is the notion that knee-jerk market reactions to these statements by precious metals (which is fittingly compared to “general risk” in the graph) are somehow indicative of a sustainable price trend. In the next paragraph, we get the caveat that it is not all “smooth sailing” for gold, because rumors of CME margin hikes or actual hikes could surface at any moment and destroy the otherwise developing moonshoot in gold and silver. That’s actually not really a caveat as much as a re-assertion of the flawed premise that market demand for PMs is indestructible outside of centrally-coordinated “takedowns”. What they don’t mention is that debt deleveraging (something quite prevalent these days) is the equivalent of demand destruction, and that’s all a margin hike really is. To top off a series of highly flawed and misleading analyses, Durden follows up the next day with a posting in which he states that Tim Geithner has been added to ZeroHedge’s list of “best Goldbug friends”. Why, you ask? Because there appears to be at least some correlation between increases in the U.S. debt ceiling and increases in the price of gold over the last 10 years. Therefore, the latest increase of $1.2tn in the debt ceiling means Geithner can spend more money for at least a few more months, which means gold can keep going up!

Tim Geithner Added To List Of Gold Bugs' Best Friend

Today we note that it is not only the Fed, but the US Treasury, and specifically the ravenous Mr. Geithner, who just got a green light to issue another $1.2 trillion in debt, and bring total debt to $16.4 trillion, which would still be 107% of today's GDP (which we don't see growing much if at all over the next year), that can be added to the list of best Goldbug friends. As the chart below demonstrates quite vividly, in addition to global and local monetary expansion, the price of gold tends to correlate quite well with the US debt ceiling. Which means that per yesterday's Senate 52-44 vote authorizing Timmy to go hog wild (which in turn means that Bernanke will have to step in and monetize much of this new debt issuance), the price of gold just got a green light for at least $250 in upside - the implied price just got raised to $1960. Of course, anyone who thinks the US will stop issuing debt there needs a brain MRI stat. Thank you Senate. And thank you Timmy. And, of course, thank you Ben.

Frankly, I don’t see much of a correlation until at least 2005, besides both the debt ceiling and price of gold steadily increasing over the last decade, which should be no surprise for either of them (excluding the sharp declines in gold price during risk-off phases of 2008 and late last year). To the extent a meaningful correlation does exist, there is really no reason to infer any sort of causation when a whole slew of variables independent of the debt ceiling can explain why gold has generally been on the rise since 2009, including all of the policies that have suppressed the dollar (such as low interest rates and monetization of MBS/Treasuries). Of course there is a connection between the government spending/borrowing and the Fed monetizing debt in unprecedented amounts. The USG already made clear it would be spending/borrowing this money last year (and more), and of course it will end up becoming a huge problem for the U.S. and its currency down the line. How exactly any of that, or this specific instance of Congress raising the debt ceiling, translates into a “green light” for gold to reach $1960/oz. soon is a very different story. It is a story that really has no credible basis in reality and serves only to support a pre-determined objective. Among the plethora of very useful reports/analyses produced by ZeroHedge on a daily basis, these brief postings may not seem like such a big deal. However, they represent a goal-seeked mentality and modus operandi that is frequently on display within the HI/gold crowd and can lead to very misleading conclusions. I can’t be certain, but I’m pretty sure we will see many, many more postings like the ones above over the course of this year, and they will appear almost exclusively when it comes time to discuss gold. None of the above is meant to suggest that the price of gold will plunge into the abyss in the near future, but it is meant to suggest that there are significant risks of gold failing to hold its current valuations around $1700/oz, let alone reach $2000/oz and beyond. These risks are especially formidable when we stop pretending like the Fed, ECB, Bernanke, Geithner or anyone else is in a good financial or sociopolitical position to halt the upcoming waves of debt deflation. We here at The Automatic Earth only ask that you keep these risks in mind as you continue to read and contemplate your future allocations of cash.

Tyne & Wear Archives and Museums Just watch me June 9 1902 Fron album of prisoners brought before the North Shields Police Court in England between 1902 and 1916.

 

"Time has stopped before us The sky cannot ignore us No one can separate us For we are all that is left The echo bounces off me The shadow lost beside me There's no more need to pretend Cause now I can begin again." Smashing Pumpkins, The Beginning is the End is the Beginning

 

Ashvin: The latest revolution of the Euro Crisis Cycle has brought us back to talks of restructuring Greek sovereign debt through "Private Sector Involvement" (PSI), which are somehow taking place in a Universe where debt restructuring is not allowed to be confused with "debt default" or "bankruptcy". On Friday January 20, the IIF (representing some of Greece’s creditors) and the Greek government announced that they had finally reached an "agreement" on the basic structure of the restructuring (or the basic restructuring of the structure?).  Here’s the live blog update from The Guardian on Friday, which really stood out to me:  

A framework of the deal -- the basic structure of the bond swap that the Greek finance minister Evangelos Venizelos wants to present at Monday's eurogroup meeting -- has been accepted by both sides, "put in place" and I understand committed to paper. But it would also seem that other aspects of the agreement - be them legal, technical or matters of substance -- remain unresolved and will be discussed at negotiations that resume at 7:30pm local time [6.30 GMT] and look set to continue over the weekend. If Greece's massive €360 bn debt load is to be made manageable much will depend "on the inter-related role of all the interests at stake" insiders say. Even if a decisive agreement is reached, the proposal will have to be put to technocrats -- given the complexity of the deal -- and they could very likely change it again. "The outline won't be the end of the beginning but the beginning of the end," said another source again requesting blanket anonymity because of the delicacy of the talks.

That’s how these anonymous blankets, with their linear mindsets and scripts, really think about the process and justify the charade to everyone else who looks on in anticipation. We have not reached the end of the beginning, but the beginning of the end! Or is it really the beginning of the end of the beginning? Let’s just go ahead and say that the end is the beginning, which is also the end. It’s a circle, a cycle, a never-ending series of revolving points; an optical and psychological illusion of mass proportions.

 

 

Of course, not more than two hours after the live update from above, I stumbled across another live update from The Guardian that, in combination with all the reports over the course of just one week, was starting to make the Escher Stairs look like a straight, non-stop, round trip flight from Athens to Brussels and then back to Athens… and then back to Brussels.  

"At the risk of just adding to the confusion over what is or is not happening with the discussions between Greece and the private bondholders, CNBC is reporting no deal has been reached on the terms of a debt swap. Nor is there apparently a press conference planned for tonight. However that does not rule out the idea that a framework has been agreed, and further details will be hammered out over the weekend, as we reported earlier."

 

So now we should just be glad that we can’t "rule out" the possibility that a framework has been established to "hammer out" further details in upcoming days. What all of this really means is that there are way too many vested interests fighting over the pieces of the same wealth pie which is continuously dwindling in size, and it will take way too long for them to actually sign their names to an agreement that is suitable to all interested parties, as opposed to continuously cycling rumors of "progress" being made. But, alas, even the framework of a deal didn’t last past Saturday, as the parties involved kept making right turns until they came full circle to the point of "stalled talks". Here’s a report from Dow Jones on Saturday January 21, via ZeroHedge:

 

Greek Bondholder Talks Stalled, Agreement Unlikely By Monday Deadline Talks between Greece and its private sector creditors over a debt writedown plan appeared to stall Saturday as the banks' top negotiator left Athens amid signs of fresh disagreements over how much Greece would pay its bondholders in the future. Officials close to the talks said they may not conclude before a meeting Monday of euro-zone finance ministers where a second bailout which will keep Greece from defaulting is supposed to be discussed. Without a deal on the write-down of the debt held in private hands, the loan can't be released. Institute of International Finance chief Charles Dallara, who has been negotiating with Greek officials on the bond swap plan for the last two days, left Athens Saturday as hurdles remained over the interest rate the new bonds would pay private sector creditors. "Right now there are no talks. There will be consultations with the EU and the IMF to determine where we stand and then we'll see. It (negotiations) has again become complicated with the new demands over the coupon," said a person with direct knowledge of the talks.

And here’s Paul Anastasi and Farry White from The Telegraph with a similar report, except with a slightly more optimistic spin, courtesy of official "spokespersons" from the IIF and Greek government.

 

Greek debt deal hits setback as talks suspended Charles Dallara, managing director of the Institute of International Finance (IIF), a lobby group representing private creditors who have lent €47bn (£39bn) to the Greek government, has so-far failed to reach agreement on the key interest rate of the new bonds Greece will issue. Athens was anxious to strike a deal ahead of a meeting of eurozone finance ministers on Monday, which could have set in motion the paperwork and approvals necessary to give Greece its next tranche of aid, worth about €130bn. This will prevent a disorderly debt default when €14.5bn of Greek bonds mature in March. However, Greek government officials said on Saturday that the crisis talks had now been postponed for a few days. A spokesman for the IIF said that Mr Dallara had travelled to Paris for a long-standing social arrangement and his departure was "in no way a reflection on the talks". The talks have made "substantial" progress, the spokesman said, noting that Mr Dallara was in phone contact with the Greek prime minister and could return to Athens at any point. International private creditors have already accepted a 50pc "haircut" or loss of their investments in Greek bonds, a move that would cut €100bn from Greece's €360bn debt pile. However, the sticking points appear to be the term to maturity of the new replacement bonds and the rate of interest, or coupon, that they will pay. "We are now expecting a solution in a few days," the Greek government official said. "Nobody expects a failure, as that could raise the spectre of a default. But it would have been convenient to have wrapped things up this weekend, because of the simultaneous presence in Athens of the Troika.

 

Not much commentary necessary, right? "Back to the drawing board" would imply that they had actually managed to upgrade from the drawing board to some more concrete stages of action, so that doesn’t work. The talks allegedly continue, but the questions of about what, between whom and to what end are all blowing in the wind. These PSI talks, and the Eurozone in general, are still stuck in the depths of an Escher diagram, where every ounce of "progress" is simply a function of some Eurocrat and mainstream media outlet declaring it to exist.

No one wants to accept the fact that, until the entire system is fundamentally transformed (through disorderly collapse or otherwise), this vicious crisis cycle will never end. The Greek PSI negotiations are a perfect example of the hamster wheel that is Europe. In theory, it is both necessary and just for private creditors (mainly banks) to take large haircuts on the net present value of their Greek bond holdings. But as long as the "restructuring" is treated as a means to avoid outright default/bankruptcy, stabilize the structurally imbalanced Eurozone and continue business as usual in the future, it will fail to produce any meaningful results. You simply can’t satisfy all of the vested parties in a fundamentally broken and collapsing system. After a prolonged period of running around in circles, someone is bound to crash into someone else. The revolutions of the Euro Crisis Wheel are bound to spark an actual revolution that forces the system to do that which is unspeakable - change. It is now starting to look like the disorderly Greek default in March (there is no "orderly" version), which was always inevitable but never until now capable of being marked on a calendar, will be the event that sets that particular ball rolling. Let’s face it – even after a credit market "rally", the Greek government is paying close to 400% for a year’s worth of money. The hold outs in the PSI right now are the hedge funds who have loaded up on Greek bonds and CDS insurance, as they figure it is better for them to try and get paid out in full on one or the other than agree to "voluntarily" participate in the swap deal and relinquish their rights as bondholders. Indeed, this literal leverage has given them a degree of negotiating leverage that was certainly under-estimated by the mainstream until now. If they do not take place in the debt swaps, then they can avoid taking a haircut on their bonds, and if they are "coerced" into a restructuring by retro-actively inserted "collective action clauses" (allows a majority of creditors to override the minority), then the CDS most likely get triggered. On top of that, ZeroHedge just produced a lengthy and complex report that describes, among many other things, the various other implications of a retro-active change of local law.

 

Subordination 101: A Walk Thru For Sovereign Bond Markets In A Post-Greek Default World Before we, like Reuters and like JP Morgan, accept that even the local-law debt can be crammed down, we point readers to a seminal paper by none other than Lee Buchheit, the same one who is currently advising Greece on its bankruptcy negotiations (to call a spade a spade), called How To Restructure Greek Debt from May 2010, in which he says the following: [Buchheit] 'No country in Greece’s position would lightly consider a change of local law as an easy method of dealing with a sovereign debt crisis. The following factors, among others, counsel extreme caution before embarking on such a remedy. • If done once, future investors will fear that it could be done again. The debtor country may therefore be compelled in future borrowings (in which international investor participation is sought) to specify a foreign law as the governing law of its debt instruments. • A dramatic change in local law by one country might allow a worm of doubt to slip into the heads of capital market investors in other similarly-situated countries, driving up borrowing costs around the board. • The official sector supporters of the debtor country will presumably balk at any action of this kind that could unleash the forces of contagion and instability upon other countries whose debt stocks also contain predominantly local law-governed instruments. • The more dramatic or confiscatory the effect of the change of law, the higher the likelihood that it would be subject to a successful legal challenge.

The report also describes how a stripping of the creditor protections offered by Greek bonds issued under U.K. law, which contain CACs and have been accumulated by these holdout hedge funds, will probably have even more severe implications for sovereign bond markets around the world. We should also remember that no one really knows what the knock-on effects of CDS triggers would be throughout the global financial system, since it is entirely unclear how many billions worth of derivatives have been written on Greek debt. It’s really the space between a huge, jagged rock and a very hard place for just about everyone involved, as it has always been. Besides the two direct parties involved (Greece and its creditors), we also have the European Commission, ECB and IMF, who obviously don't want the Greek government to compromise to the point where no meaningful debt reduction is made and they are simply writing checks (endorsed by Western taxpayers) to both the Greek government and its bondholders for nothing in return. English language Katimerini reports a bit on this angle:  

Dallara suddenly leaves Athens Talks between Athens and the steering committee of private creditors concerning the Private Sector Involvement plan (PSI+) will resume by telephone on Sunday as the committee’s head, Charles Dallara, left Greece unexpectedly on Saturday. According to reports on Skai radio the International Monetary Fund, the European Commission and the European Central Bank are not happy with the provisional agreement between the Greek government and its private creditors, as they believe it does not secure the sustainability of the Greek debt. As a result Dallara, who is also the head of the Institute of International Finance flew to Paris on Saturday to discuss developments with lenders and funds which hold the bulk of the privately-held Greek bonds worth 206 billion euros. Finance Minister Evangelos Venizelos told reporters on Saturday that negotiations would continue on Sunday by phone. Both the IIF and the government have leaked that there is progress in the talks but any agreement would require the approval of Brussels, Berlin and the IMF. Sources suggest that the Greek side proposed to private creditors a 3.5 percent interest rate for bonds maturing by 2014, 3.9 percent for those maturing by 2020 and 4.6 percent for those expiring after 2021. There will be a 10-year grace period and the new bonds will be under British law. Reuters cited an unnamed source saying that "things are complicated, we are getting closer on the numbers but there is still quite some work ahead. An agreement is unlikely before next week, if there is an agreement at all.

For argument’s sake, though, let’s say the Troika, the Greek government and the holdout creditors manage to come back full circle (via telephone conference) to "progress" being made and a deal "nearly within reach" in the next night or two, and then put an actual deal to paper. What will that mean for the Euro Crisis Cycle? Simple – it will continue rolling on in a broader and more devastating fashion. First of all, Greek debt will still not be sustainable in any meaningful sense of that word, as this comprehensive report from Barclays makes clear (via ZeroHedge).  

Greek Debt Likely Unsustainable Even With Haircuts, Barclays Complete Q&A On PSI 6) Does the PSI in its current form make the Greek debt sustainable? The October Troika debt sustainability report highlights that the current PSI with nearly universal participation gets debt/GDP close to 120% by 2020. First, this number is still on the high side to conclude that Greek debt is sustainable. Second, the underlying macroeconomic assumptions by the October Troika report in terms of GDP growth and primary balance post-2015 are still optimistic (c.3.8% average nominal growth and average 4% primary balance). If these macroeconomic assumptions are reduced to a more realistic 2.5-3%, then the debt sustainability picture would look much worse. As seen in Figure 1, a 50% national haircut with 50% participation does not get Greece close to 120% debt/GDP by 2020, as envisaged even with the relatively optimistic macro economic assumptions of the Troika. Only if 100% participation is achieved would close to a 120% debt/GDP target be reached. For this reason, the Troika does not want to sacrifice universal participation and is determined to do whatever is necessary to maintain it. When worse macroeconomic assumptions are used, the notional haircut needed for a reasonably sustainable debt path is about 80%. Therefore, if Greece and the Troika go ahead with October summit broad parameters for the PSI, even with 100% participation Greek debt is not likely to be sustainable in the absence of substantial fiscal and structural adjustment by Greece in the years ahead.  

 

That's right - even if 100% of private creditors participated in the proposed debt swap arrangement for a 80% haircut to notional value (not going to happen!), Greece's debt would still remain at entirely unsustainable levels for many years to come (and that's assuming a 100-120% debt/GDP ratio is the threshold for sustainability). Secondly, the Greek situation is obviously only one piece of a much larger puzzle in Europe. Peter Tchir remarks on those other debt-swamped Eurozone countries who sure would love to have some "voluntary debt swaps" of their own.

Greek PSI Here We Come? Be Careful What You Wish For "So it looks like we should get an announcement sometime today about the proposed Greek PSI deal.  Yes, proposed, not finalized.  Asides from the obvious fact that there will be limited or no documentation for the deal, we still have no clue who has agreed to what. As far as I can tell, no one has given the IIF negotiators any binding power.  Obviously some of the institutions that the IIF negotiators are associated would have trouble not approving the "deal", but how many bonds do they really represent? I think this will be a relatively small portion of bondholders and then the real game begins.  The carrot and stick that the EU and ECB can use with other holders and the desire to maximize profits (or minimize losses) on the other side.  So far, this news seems to be acting inversely to the "downgrades" price action, as early front-running is meeting sell the news. If the terms of the deal being leaked are true, it will be extremely interesting to see what other countries do.  Not only will Greece receive a 50% notional reduction (except from the ECB and other "public" holders), but they will get very long dated money at very low rates.  Who wouldn't want that?  Why should Spain be going through semi-legitimate auctions when Greece can get longer dated money at lower rates?  Why should Portugal or Hungary bother with painful steps to reduce debt when the alternative is spend more, reduce debt via restructuring, and get lower rates on that reduced debt?"

 

There is absolutely no way that European private banks can afford to take another 50-100% haircut on the bonds of Portugal or Ireland on top of Greece, let alone Spain or Italy. Any attempts towards such an outcome would be even less "voluntary" than the Greek swaps, and that’s really saying something.  And who would even want to buy the bonds of these countries after the most coercive restructuring in history just took place? This time it was a few hedge funds that have brought us to the brink of potentially catastrophic debt deflation, next time (if there is one) it will be a much broader force of resistance.

 

 

The economic, financial and political divides within Europe will simply deepen to the point where the internal hemorrhaging overwhelms any and all top-down "solutions". So IF this Greek PSI deal is finalized soon, the IMF bailout money is disbursed and Greece gets through the next few months, the focus will simply shift back to those equally troubled and much bigger debt issuers across Europe (and perhaps the world). We’ll be right back at the end of the beginning or the beginning of the end, depending on which way the crisis propaganda decides to spin on any given day.

Unknown Bass August 17, 1900 A world's record 384-pound black sea bass caught by Franklin Schenck of Brooklyn with rod and reel off Catalina Island, California "You cannot survive without that intangible quality we call heart. The mark of a top player is not how much he wins when he is winning but how he handles his losses. If you win for thirty days in a row, that makes no difference if on the thirty-first you have a bad night, go crazy, and throw it all away." -Bobby Baldwin

There still remains a large population of stubborn "fish" in the developed world, who are clinging on to hopes of an economic recovery like incredulous poker players cling on to hopes of winning all their money back by playing three cards to a straight or a flush.  These are the people who continuously get their clocks cleaned and then reload their chips in a vicious cycle of defeat; the people who keep the game alive and profitable for the "sharks". At the same time, the bankrolls of fish have been diminished so severely and their egos bruised so badly that an increasing number are simply being forced out of the game for good. They can no longer ignore the fact that their lofty expectations have been flattened into silver dollar pancakes, and that they may find themselves lacking food to eat the next day if they continue gambling with what little wealth they have left.On February 9, I wrote the following:

A Glimpse Into the Stubborn Psychology of Fish "It's only when the school of fish stream towards the exits in unison that the "game" becomes wholly unprofitable for solid players. Until that tipping point arrives, our bets will continue to scream "I have a monster!" at the top of their lungs, and the fish will continue to make crying calls in stubborn disbelief. The psychology of fish always leads them from a state of comfortable wealth to one of utter destitution over time, as they incessantly chase their losses, throwing bad money after even worse money.As the total amount of money sunk into the pot exponentially increases along with net losses, the fish find it that much more difficult to simply walk away from the game. In the long-run, however, every fish goes for broke and is simply unable to purchase any more chips to play with. The solid players are then left with a minimal or non-existent edge at their tables, as the game begins to consume itself, and that's when you know it's time to get up, leave the casino and begin the long journey back home."

In the financial investment world, anyone still speculating on rising share prices through "buy and hold" strategies, for example, would be labeled a huge "fish". A fish could also be a country such as Croatia, who recently decided to become a member of the EU in 2013. That was a classic move of "chasing" losses, or throwing good money after bad. After being downgraded to nearly junk status by Standards & Poor a year earlier, and struggling to achieve any economic growth whatsoever, Croatia panicked and stubbornly decided that its best play would be to shove the remainder of its chips into the middle of an imploding European Union, scurrying for the last deck chair on the Titanic.The most striking example of fish remains the rabid consumers of the developed world, who still feel the need to trample each other during the Holiday season for some sense of short-term gratification. They draw down their savings and run up their credit cards at a time when their jobs could evaporate at any moment along with the value of their assets and retirement accounts. So while there are still quite a few individuals, corporations and countries harboring the stubborn psychology of fish, it’s also clear that fewer and fewer people and entities can afford to remain in this category – i.e. we have most likely reached the "tipping point". The point where there are no longer enough naive fish for the cut-throat "sharks" to feed on.

A shark is a solid, patient player who immediately assesses the playing styles of his opponents when sitting down at the game, and uses that information to pounce on every single situation in which the shark has a mathematical advantage. The shark is out to maximize value and profits like everyone else, but typically realizes many of his/her own limitations and does not hesitate to sit on the sidelines, patiently waiting for opportunities to strike.The sharks also have a variety of tools at their disposal, including multi-layered deception and misinformation (something Bill Gross, the notorious financial shark, is familiar with) and an ability to make accurate probability assessments rather quickly with any given hand. Despite all of these advantages, even the most cunning sharks still share one fatal flaw – they are addicted to the game and refuse to quit even as the game collapses in on itself. The #1 reason the sharks lose money in the medium to long-term is not because of bad luck or better opponents, but rather they beat themselves. They lose patience with bad players, they let their ego get the best of them against good players and they start to take unnecessary risks with their bankroll. It could start off with small mistakes, such as getting into large pots with other players for the sole purpose of "out playing" them with weak hands, i.e. bluffing them off of the pot. These mistakes simply snowball on top of each other, as the inevitable losses pile up and the players begin to doubt their ability to remain patient and win. Eventually, the losses and frustration build up to such a level that the good player feels compelled to move up in stakes and win some money back. So the player goes from, let’s say, a $500 max buy-in game to a game where one cannot play comfortably without a stack of at least $2000-$3000 in front. At this point, the formerly disciplined players have entered a self-destructive spiral of throwing bad money after good which they are very unlikely to escape from.In a game of poker, the sharks can either put all of their available capital at risk on one game, or maybe leverage that capital up a few times by borrowing from a - pardon the pun - loan shark or the local bank, but that’s really about it. The desperate sharks in the world of international finance, though, can take their self-destructive attitude to a whole different level of extreme. The highest stakes game in this world is obviously found within the shadow credit markets, where hundreds of trillions of dollars worth of derivative debt instruments are bought and sold between large institutional players. These games are established by the very largest players in smoke-filled rooms at the back of the speculative casino, and cannot be observed or regulated by any official exchanges. ZeroHedge has been gradually piecing together what little we know about these "dark pools" to arrive at a more complete picture of how big this shark-infested game really is. It turns out that the total notional value of outstanding "over the counter" derivatives rose to a record $707 trillion in the first half of 2011, which was a $107 trillion increase in six short months. [1], [2]

$707,568,901,000,000: How (And Why) Banks Increased Total Outstanding Derivatives By A Record $107 Trillion In 6 Months "So why did the notional increase by such an incomprehensible amount? Simple: based on some widely accepted (and very much wrong) definitions of gross market value (not to be confused with gross notional), the value of outstanding derivatives actually declined in the first half of the year from $21.3 trillion to $19.5 trillion (a number still 33% greater than US GDP). Which means that in order to satisfy what likely threatened to become a self-feeding margin call as the (previously) $600 trillion derivatives market collapsed on itself, banks had to sell more, more, more derivatives in order to collect recurring and/or upfront premia and to pad their books with GAAP-endorsed delusions of future derivative based cash flows. Because derivatives in addition to a core source of trading desk P&L courtesy of wide bid/ask spreads (there is a reason banks want to keep them OTC and thus off standardization and margin-destroying exchanges) are also terrific annuities for the status quo. Just ask Buffett why he sold a multi-billion index put on the US stock market. The answer is simple - if he ever has to make good on it, it is too late.

The description above almost perfectly captures the self-destructive psychology of sharks in action, as the game enters an entirely new phase of ridiculously high stakes and almost no margin for error. As the value of the shadow debt-derivative system implodes, the financial sharks are forced to throw ever-more leveraged money onto the table until they have nothing left, because the alternative is to simply quit the game and accept their current losses.Peter Tchir provides some clues into what kind of derivative bets are being placed when he describes "The Ultimate Trade". It was recently revealed that many European banks have been selling large amounts of CDS insurance on the bonds of their home countries, while also buying large amounts of the sovereign bonds themselves. In essence, they are going "all in" on the bet that those countries will remain solvent.

The Ultimate "All-In" Trade "But why would BSC be so willing to sell protection [on itself]? Well, the markets were very wide because of the fear that they would default. You sell as much protection as possible. If you default what do you possibly care? Your stock is wiped out, your job is gone, and your strategy is totally explainable to future employees. If you don't default all this massive amounts of protection screams tighter and you have your best year ever. No brainer for the firm, an issue for the market.So, why are French banks selling protection on France like it is going out of style? Why are Italian banks doubling down on Italy? Because if the bailouts work, it is free money. Huge tightening on top of the spread income until the bailout finally wins. If the sovereign defaults, is the bank really going to be around anyways?It is the ultimate trade. If you make money, you get paid. If you lose money you were screwed anyways."

For the sharks swimming in the high seas of finance, current losses are so devastating to their balance sheets and their expectations that they cannot even conceive of a worse situation than leaving the game, so they double, triple and quadruple down using whatever capital and whatever leverage they can get their hands on through synthetic financial products. That’s the hallmark of a shark’s psychology right before he/she blows sky high:

"I’m such a clever player, yet so deep in the hole, that there’s no other choice but to let it all ride. Just give me one more game; one more hand to prove myself. If I win, I’m back even or maybe even booking a healthy profit. If I lose, then I simply end up in the dark and frightening place where I would have ended up anyway."

The reality, though, is that this dark place ends up being much more frightening that anyone could have ever expected. After it’s all said and done, we can be sure the bruised and battered sharks will be begging the Lord Almighty to return them to the place where they were before they decided to make their final stand. But life simply doesn’t work that way, and that’s why we find our economies and societies held hostage to a self-destructive global banking system.Reuters and Zero Hedge have recently cast some more light on the shadowy games played by the sharks of finance, as they examine the role of the "re-hypothecation" of collateral assets through a never-ending chain of large broker-dealers and banks. Boiled down to its most basic form (which is really all that matters), this process allows a single asset to be pledged as collateral for short-term loans an infinite number of times. In the shadow banking system, many of these loans take the form of "repo" transactions, where the collateral security is "sold" for cash with the condition that it will be bought back at a specified date and rate of interest. These Escher stairs of OTC transactions, in turn, allow the financial sharks to potentially create an infinite amount of leverage behind their speculative derivative bets.In this particular game, all of the big-name sharks gather in the City of London, where virtually no restrictions exist on how many times the same collateral can be "re-hypothecated". The following are excerpts and graphs from an IMF report prepared by Manmohan Singh and James Aitken, courtesy of Zero Hedge.

The (sizable) Role of Rehypothecation in the Shadow Banking System " The United Kingdom provides a platform for higher leveraging stemming from the use (and re-use) of customer collateral. Furthermore, there are no policy initiatives to remove or reduce the asymmetry between United Kingdom and the United States on the use of customer collateral. We show that such U.K. funding to large U.S. banks is sizable and augments the measure of the shadow banking system.… Rehypothecation occurs when the collateral posted by a prime brokerage client (e.g., hedge fund) to its prime broker is used as collateral also by the prime broker for its own purposes. Every Customer Account Agreement or Prime Brokerage Agreement with a prime brokerage client will include blanket consent to this practice unless stated otherwise.… On-balance sheet data do not "churn," where churning means the re-use of an asset. If an item is listed as an asset or liability at one bank, then it cannot be listed as an asset or liability of another bank by definition; this is not true for pledged collateral... However, off-balance sheet item(s) like ‘pledged-collateral that is permitted to be re-used’, are shown in footnotes simultaneously by several entities, i.e., the pledged collateral is not owned by these firms, but due to rehypothecation rights, these firms are legally allowed to use the collateral in their own name."

"Following the collapse of Lehman, hedge funds have become more cognizant of the way the client money and asset regime operates in the United Kingdom. For some, the United Kingdom provides a platform for higher leveraging (and deleveraging) that is not available in the United States. In general, post Lehman, one would expect an increasing tendency for those providing collateral to counterparties to ask for their collateral to be segregated from the counterparty’s assets and to place limits on its further use.Our understanding is that the U.K. FSA has not yet made any changes on the use (and re-use)of collateral since their LBIE experience that would remove or reduce the asymmetry in the U.K. and the U.S."

So, there you have it. The financial sharks are sitting down with each other in London to play one last game of incredibly high-stakes poker with infinitely leveraged capital, where absolutely none of them can afford to lose! Some of them will lose, though, and, when one or several major institutions do go down, it will become apparent that none of them really have the actual capital to back up their electronic chips. In a sense, that is what has already happened with MF Global, and the liquidity crunch was only temporarily stalled by the coordinated action of the Fed and other central banks. To see why, we can return to the original article by Christopher Elias on rehypothecation for Thomson Reuters.

MF Global and the great Wall St re-hypothecation scandal "MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation.A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently. To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up. Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic."

As the institutional clients of brokers become increasingly fearful of having their funds effectively stolen through rehypothecation after the MF Global debacle, they will do everything in their power to make sure their cash cannot be further subjected to this process, which will only exacerbate asset sales to meet margin requirements, leading to lower valuations of toxic assets and more funding shortages at banks.  The most toxic assets right now are the sovereign bonds of peripheral Eurozone countries, up to and including Italy. If the banks turn to their governments (taxpayers) to re-capitalize them,  then the countries’ own funding needs will worsen as their debt yields go up, which also exacerbates the funding needs of the banks. Yalman Onaran describes this "death spiral" in his article on Bloomberg:

European Banks Taking Cash From Governments Seen Sparking 'Vicious Cycle' "The size of potential losses at European banks has scared away short-term creditors, squeezing the region’s lenders. The European Central Bank has stepped in to replace funds being withdrawn, providing unlimited cash and lowering requirements on the quality of collateral it will accept. "We’re in a death spiral," said Andy Brough, a fund manager at Schroders Plc in London. "As the yields on the peripheral bonds increase, value of the bonds decreases and the amount of capital the bank has to raise increases."

Basically, the amount of actual capital available for the pot continues to rapidly shrink, while the sizes of the outstanding bets and raises remain the same – a theme well-known to readers of The Automatic Earth. The central banks are trying to hold back a tsunami of margin calls that will produce waves of potentially infinite height, and therefore there is no way they can hold them back for very much longer. As llargi at The Automatic Earth outlined in his post, Cash for Christmas, the funding situation for European banks remains dire despite the coordinated CB swap lines designed to lower the short-term cost of borrowing dollars, perhaps because there is a massive shortage of euro funding as well, and there is very little chance it will improve.What is truly frightening about these financial sharks is that their predictable psychology ends up being much more destructive to the rest of society than to themselves. In a poker game, the sharks playing recklessly outside of their bankrolls will self-destruct, go home in tatters and perhaps drink themselves into a coma. In the game of high finance, though, the sharks will be bailed out and/or go home with much their personal wealth intact, after the institution’s shareholders, creditors, employees, customers and just about everyone else associated with it is wiped out.The sad fact is that we are all currently a part of their reckless poker game, whether we like it or not.  There is only one way around that - the people must force their governments to hold the bankers criminally, civilly and financially liable for their actions and losses. If that doesn’t happen very soon, through whatever means necessary, then the only other option is to insulate yourself from the fallout through whatever means you are able and willing to undertake. The long journey from the casino back home is well underway, and now we must simply make it to that home, safe and sound.