The Limerick of Finance for 07/12/15

Eurozone and Greece haggling for deal
Delaying has lost its appeal
France and Germany cross
Let's see who's the real boss
This stuff is about to get real

The Haiku of Finance for 04/18/15

Message to the Greeks
Pay debts or exit euro
No more stalling game

The Haiku of Finance for 03/04/15

Euro is so low
Await the easing to come
Greek bonds waiting first

The Haiku of Finance for 02/16/15

Greece left the meeting
No deal at all for Europe
Almost no time left

The Limerick of Finance for 02/15/15

Greek exit contingency plan
It pays to have one in the can
Athens won't agree
They want money free
Europe should have eased like Japan

Body Language Hints Greece Is Not For Turning After G-20 Meeting

Tonight's NPR Marketplace broadcast repeated a Margaret Thatcher quote relevant to Greece's negotiating position:  "The lady's not for turning."  It is a very pithy assessment of the Greek approach to the eurogroup.  The two sides met today and all public reports indicate that they have not agreed to resolve Greece's pending debt crisis.  Body language can tell the story.

I have not located any real-time photos or videos of Jeroen Dijsselbloem, the Dutch finance minister who chaired the talks, after he held the post-meeting press conference.  The talks achieved little of substance.  I am certain that hedge funds on both sides of the Atlantic are frantically analyzing the facial expressions and body language of the eurogroup participants as they emerged from the meeting.  Confident posture would indicate a strong negotiating position, while slouching and slinking away from the cameras indicates the euro folks fear Greek demands.  Greek finance minister Yanis Varoufakis appears remarkably confident in his most recent public appearances, perhaps even flippant.

The NPR broadcast I referenced above offered comments from  economist James Galbraith, a former colleague of Mr. Varoufakis and the son of famed economist John Kenneth Galbraith.  His comments emphasized Mr. Varoufakis' rationality and knowledge of game theory.  I described the two parties' likely game theory boundaries in a previous article.  The Greeks are playing a weak hand the only way they can . . . with an immovable negotiating position that will force Europe's hand.

Europe thus has two choices if Greece will not tolerate any form of debt restructuring that requires another political upheaval in Athens.  I now consider an ECB-driven quantitative easing bailout to be slightly more likely than a Greek exit from the eurozone.  The reason for my shift is the changing atmosphere among the developed world's finance leaders.  A consensus emerged at the latest G-20 finance ministerial meeting favoring concurrent monetary stimulus and tolerating multiple currency devaluations.  Group photos of that meeting speak volumes.  The expressions on the faces of Christine Lagarde and Janet Yellen were priceless.  Mme. Lagarde of the IMF looked she was having the time of her life, entertaining several finance ministers as if she were fending off romantic suitors.  Ms. Yellen, on the other hand, looked like someone had just handed her a multi-trillion dollar bill for a party she knows the Federal Reserve cannot afford.

Portfolio managers should study financial statements, but when data is unavailable they must seek anecdotal indicators of human intentions.  They need financial analysts who can detect anomalies in human psychology.  Anomalies manifest in speech, facial expression, posture, and gait.  The US intelligence community produces trained human intelligence (HUMINT) analysts who notice these details.  These highly motivated people need something to do when they leave the military.  They might as well move to Wall Street and work in business intelligence.  Figuring out how hard the Greeks are riding Europe is right up their alley.

Greece Projects False Bravado

Greece continues to build a kindling pile for the euro's immolation.  The Greeks claim to have no problem funding their short-term needs.  The entire world knows that is false.  A few weeks of cash until bankruptcy counts as a major short-term problem.  The ECB already called the Greek bluff by refusing the country's bonds as collateral.

We already know the outline of Greece's comprehensive proposal for a debt swap.  The growth-linked bonds they want to issue will constitute a selective default in the eyes of credit rating agencies. Private sector portfolio managers will then be reluctant to add Greek credit risk to their European debt holdings.  Hedge fund managers who have already loaded up on Greek bonds will watch their valuations crater.  The ECB would ordinarily be buyer of last resort, if the troika cares more about systemic stability than it does about saving face.

The hushed conversations in recent days between Greek ministers and their European counterparts made for fascinating lip-reading.  European leaders admitted in unguarded public moments that they knew Greece was destroying the euro.  The Greeks just smirked.  Every statement coming out of Athens is the equivalent of a big smirk at the world.

Full disclosure:  Long put position against FXE.

The Haiku of Finance for 01/27/15

Greek debt in standoff
Europe knows cost of outcomes
All will harm euro

Greek Debt Game Theory

Greece's new leaders run a nation whose sovereign debt is about 175% of its GDP.  Most of the Syriza party's cabinet are untested in senior leadership roles.  Entering negotiations with ambit claims is probably beyond their ability.  The European troika should take them at their word when they say that Greece cannot afford to pay its debts in full.  This understanding sketches out the boundaries of a high-stakes Prisoner's Dilemma.  Game theory can help us understand the dilemma's probable outcomes.

The probable end state of most Prisoner's Dilemmas is the defection of the party who first realizes the advantage of abandoning a compromise solution.  The first to defect maximizes their own self-interest.  The classic formulation of this dilemma presumes that the two primary parties do not know each others' intentions.  The European troika and Greece's Syriza know each other's intentions exactly, so an immediate defection from a negotiated solution is not likely.  The problem is that Syriza's absolutist campaign rhetoric leaves little room for a negotiated solution.  Electing amateurs who have never strategized or negotiated beyond a marketing campaign places a crisis-riddled nation at a distinct negotiating disadvantage.

The troika's bankers and economists have obviously considered several scenarios, including a Greek debt default and exit from the euro.  Their negotiating position includes consideration of the cost to Europe of Greece's untenable positions.  Greek Prime Minister Alexis Tsipras has until the Feb. 12 EU summit in Brussels to telegraph any softening of his demands for lifting austerity.  He has stated a willingness to "negotiate" but has not budged on his commitment to reinvigorate the Greek welfare state.

Game theory indicates several possible outcomes if we assume the Greek position is fixed.  One set of scenarios should include some form of renewed European generosity that is insufficient to meet Greek demands.  Another should include hard European demands that Greece adhere to its debt covenants if it wants a loan lifeline after Feb. 28.  The least likely scenario is Greek capitulation to any demand, even a temporary one, to secure said lifeline.  A turnabout acceptance of austerity would shatter Syriza's governing coalition and prompt snap elections again.

The likely range of outcomes under game theory is thus some sort of Greek default that prompts the country's withdrawal from the euro.  Europe's leaders have calculated this cost and believe it to be manageable, but they are tempting fate by inviting Greece to negotiate.  The public statements of both EU and Greek leaders indicate that this is the full range of policy outcomes, yet one outcome is also a possibility.  Systemic stability has emerged as an overriding policy consideration on both sides of the Atlantic since the 2008 financial crisis.  Printing euros to maintain a unified eurozone is the most powerful option available to Continental leaders committed to a unified currency.

The negotiations may be mere political theater if the troika is sufficiently confident that ECB monetary stimulus can paper over Greece's problems long enough for a renewed bailout to push the country into growth.  The math gets complicated depending on how enthusiastic economists are for the effects of debt on growth, but the philosophy is not complicated at all.  The ECB quantitative easing timetable can immediately shift to accommodate bond purchases that support further Greek bailouts,  The cost of that option is the decimation of the euro's buying power against the US dollar.  Brussels has yet to indicate whether the cost of the euro's dismemberment or the cost of its devaluation is more tolerable.  Mr. Tsipras' conduct in Brussels will trigger Europe's choice.  Alfidi Capital judges a Grexit to be just as likely as a quantitative easing bailout.

Full disclosure:  Bearish on the euro; long put position against FXE.  

The Limerick of Finance for 01/25/15

Greek leftists have won their big prize
Euro watchers cannot feign surprise
Throw doubt onto debts
Bond shorts will place bets
Pricing yield for some time won't be wise

The Limerick of Finance for 01/18/15

One half trillion euros for bonds

We'll see how the market responds

Swiss bankers checked out

Avoiding a rout

Sinking reserves into swampy ponds

The Haiku of Finance for 01/07/15

Euro drop alarm
Bankers speed up Greece end game
All crossing fingers

Euro Drop Brings Woe to Europe

The euro's precipitous decline reflects more than financial market nervousness over Greece's political stability.  Persistent structural weaknesses in much of Europe's constituents feed the euro's fragility.

The European Central Bank (ECB) watches the euro's unfolding crisis with alarm.  Its most recent reforms allow it to act more decisively in setting monetary policy, much like the US's Federal Reserve.  It can now move swiftly to unleash quantitative easing that can flood the Continent with new credit that supports the euro's nominal value.  The deluge remains a simple-minded central banking solution to a complex problem that only the liquidation of bankrupt debtors has ever solved.

The national economies of Spain, Greece, Italy, and even France continue to suffer from severe competitive deficiencies.  All are saddled with high taxes and complex regulations that make their economies less competitive.  Their exports would suffer without Germany's willingness to allow its creditworthiness to support their profligate borrowing.  That profligacy partly drives the ECB's plan to buy European sovereign debt.  It also leads to a vicious feedback cycle of debt-driven sovereign spending, credit-enhanced consumer spending, and currency inflation that will demand still more quantitative easing.

European banks have unfortunately started down the road of paying negative interest rates on deposits.  Charging depositors for the privilege of holding savings in cash accounts feeds the euro's deflationary trend by slowly taking the most liquid form of money out of circulation.  Deflation gets a bad rap from central bankers, but the eurozone's high level of indebtedness means a deflationary spiral makes it harder for private-sector debtors to pay their bondholders.  The ECB knows that European corporations can't afford to be sanguine about deflation, hence the increasingly loud financial sector chatter for a more inflationary monetary policy.

The European unity experiment is under more stress now than at any time in its history.  Lithuania's entry into the currency union is in no way a counterbalance to Greece's potential exit; the difference is measured in hundreds of billions of euro-denominated debt that could instantly evaporate.  The ECB would be well advised to delay its planned QE past this month's Greek elections.  It would otherwise swallow worthless Greek bonds whole.

Full disclosure:  Long put against FXE.

The Limerick of Finance for 12/28/14

The euro is hitting the rails
Greek observers are biting their nails
New political mess
Brings currency stress
Expect chaos if next bailout fails

The Limerick of Finance for 11/09/14

The euro is taking big hits
Its value has gone down the pits
Draghi's stimulus pledge
Pushed it over the edge
Investors deserve to have fits

Eurozone Bank Closure Proposal as Stalking Horse for Integration

This is a very interesting proposal out of the eurozone to share the costs of closing down failed banks.  I think it's unrealistic to expect a closure to take as long as ten years.  Compare it to a track record of forced closures in recent history.  The US's Resolution Trust Corporation took about six years to wind up the vast bulk of failed savings and loan associations it had to address.

I think the staggered time horizon for triggering European countries' participation is a good selling point for getting buy-in among the more stable northern countries.  I believe the plan is a decent stalking horse for full Europe-wide integration of bank regulation.  I am not clear on whether the regime will include penalties for countries that opt-in but then refuse to comply with requests to help out a failed bank in another country.  Let's say Greece opts in, thinking that making a tiny contribution to a pooled resolution fund is a small price to pay for obtaining further sovereign debt bailouts.  If some Spanish banks fail and Spain reaches the limit of its own portion of the Single Resolution Fund, what would happen to Greece if it refuses a request from Brussels to contribute more of its own money?  Would the Board of the Single Resolution Authority assess some penalty for Greece?  Would it ask Brussels to expel Greece from the eurozone?  Or would it turn to Germany and the Netherlands for more than their fair share of bailout cash?

The parties to this proposed treaty have a lot to talk about in the next few weeks.  Details of the mechanisms for pooling and risk management are far less important than the willingness of Germany to backstop everything if those mechanisms fall apart.  Germany's appetite for such risk will in turn depend on the credibility of the dollar swap lines the Fed has extended, and whether the world's currency traders will still support the dollar if the ECB triggers those swaps.  

The Haiku of Finance for 03/28/13

Escape repression
Banking with no impairment
Outside eurozone

Alpha-D Update for 03/18/13

This is definitely one of the simplest portfolio updates I've ever published.  My covered calls and cash-covered puts on GDX expired unexercised.  I did not renew them.  I did not make any changes to my GDX holdings.  They remain useful as a hard asset hedge against high inflation.

I did not make any changes to my positions in FXA, FXC, or FXF.  They are currency hedges against the potential devaluation of the U.S. dollar.  I have no open options positions on those ETFs.

The only change I did make was to buy a long put against FXE, the CurrencyShares Euro Trust.  I did this because I believe the euro in its present form is doomed.  Read my articles yesterday on the EU/ECB/IMF extortion of bank deposit account holders in Cyprus.  No bank customer in any of the heavily indebted euro countries will feel safe holding cash in a European bank now that their confidence has been shattered.  My bet on a very long-dated FXE put is a bet that the euro will be much less valuable or even nonexistent in a few years.

Watch Cyprus this week.  Their government has two options.  Option one:  They can accept the European bailout and harm their depositors, accelerating a run on European banks.  Option two:  They can reject the bailout and force Cyprus' banks into bankruptcy, which will require Cyprus to immediately leave the eurozone.  Once one country leaves, other PIIGS will be tempted to follow.

Game theory predicts that the first defector from a sub-optimal regime is the winner.  All other subsequent defectors pay progressively larger penalties the longer they wait to defect.  I am sitting in cash that I will deploy at some appropriate point once the chaos is in full swing.

EU Forces Cyprus to Destroy Its Depositors

Europe is testing the limits of its citizens' patience.  The government of Cyprus has announced a levy of between 6.75% and 9.9% on depositors accounts in Cypriot banks.  This stunning move comes at the behest of the ECB as a requirement for Cyprus to remain in the eurozone.

Early reaction from ordinary citizens is entirely predictable.  One guy parked a bulldozer in front of his Cyprus bank.  The outrage expressed on social media channels is palpable.  Calling it a "bail-in" with exchanges of shares in the banks as compensation means nothing if those bank shares ultimately prove worthless.

The tone of mainstream media coverage is as outrageous as this decision.  Talking heads are congratulating Europe's leaders and trying to confine the debate to choices between some confiscation or total confiscation.    The IMF's advocacy of a total "bail-in" for every account larger than 100K euros means that option is still on the table if this measure doesn't stabilize the Cypriot banking system.  That may now become a self-fulfilling prophecy as depositors start making panicked withdrawals.

I am not surprised that Europe's leaders think the savings of common citizens are collective assets to be appropriated as they see fit.  I am not surprised that sovereign governments are bailing out criminally incompetent bankers with the savings of people who have done the right things during their working lives.

I will be very surprised if there are no bank runs in the PIIGS countries on Monday and Tuesday.  Account holders in Europe have a very limited window of opportunity to protect their life savings before more onerous financial repression comes their way.  This confiscatory grey swan is about to lay a big fat goose egg all over European financial markets.

The Haiku of Finance for 03/12/13

Europe has no fix
Debtors will default and leave
Rump euro coming