“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” – Rudiger Dornbusch

Ben Bernanke made some surprisingly frank confessions in his House testimony about Fed portfolio risk. When asked what the effects of a mortgage refi program would be on his trillion mortgage portfolio, Ben responded that the Fed would suffer losses. He then said he couldn’t really quantify how much. In another sly legend in his own mind statement Ben warned that if “investors lost confidence” in US fiscal policy (but certainly not his policy), there would be nothing the Fed could do about arresting higher rates. He should have added that marked to market and given the duration of its holdings, that the Fed will lose $2 billion on every basis point increase in rates.  That’s $200 billion for a modest one percent uptick in rates.

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In November, Gretchen Morgenson of the New York Times wrote a story describing the “voluntary” debt restructuring process that may give clues as to why the latest Greek “deal” can’t seem to be concluded. Once again, a rumor surfaced Wednesday (apparently out of France) that a deal was “hours away.” Sure enough, back when the Morgenson piece came out, the counterattack to it began and the point she put forth faded. Felix Salmon wrote a rebuttal to her tract with the nifty title “CDS conspircy theory de jour.” I found Salmon’s logic circular and painful to read, but decide for yourself. He even claimed Greek CDS issuance is “minuscule” and writes, “I can’t think of any bank who has ever amassed a big position on Greek CDS,” as if he were privy.

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When you hear talk about expanding the European LTRO funding, is is important to go straight to the mechanics of the exercise, and then ask what does the new round of exposure mean to the ECB. The LTRO is a repo transaction where the ECB takes in collateral in order to back any loans. The ECB will swap cash in exchange for questionable assets so that insolvent banks can replace funding caused by defacto bank runs. If they choose they can then double down on sovereign bets, or pay off creditors. Italian banks in particular are so exposed to their own sovereign debt that they may have decided to gamble away, figuring they are dead anyway. Might as well take the ECB with them. But we need to constantly ask ourselves what is the risk to the ECB itself, and by extension Germany, France, Italy and Spain, who are the principal sponsors of the ECB. What happens when the banks evaporate in the next debt hiccup and the ECB needs to seize the collateral.

This article at FT Alphaville by Joseph Cotterill provides the gory details. It appears the LTRO has mostly been about a cozy arrangement with French banks, and to a lesser extent Italian banks. The ECB quietly expanded the list of collateral it would accept by more than a third at the start of the year. Almost all the 10,599 debt instruments it added were from banks – and more than 8,000 of them from French banks. The ECB is going about accepting unlisted bank bonds — i.e., bonds that the banks could have issued purely to themselves solely in order to pledge them as collateral for central bank funding. They carry no prospectus, etc. If the ECB we-take-no-losses-in-defaults model holds true, then other bank bondholders will be further subordinated down the capital structure.

Wonderful, the ECB can secure its lending to these already hyper-leveraged exposed banks, with flaky bonds issued by the same cast of characters. How is that going to work in a pinch?  Oh we already are in a pinch. It is obvious that Europe is now “all in” and fully prepared to go down with their bankster cronies.

I follow up at Actionable with a discussion on the impact of the approaching French elections. Click here to subscribe.

In 2008 the markets got very worked up with what at the time I was relentlessly calling a China commodity bubble.  A search under the term “China Bubble” from Winter Watch turns up 75 articles mostly in 2007-2008 and also in 2011. A bubble can be defined as speculative activity not well related to the real economy,  in short a maladjustment. One of the consequences of this was the ramp up of shipping construction to feed the China boom.   When commodities came back in late 2009-2011, shipping construction surged forward unchecked. Now with China rolling over, the shipping that was produced during this period is increasingly lined up and stacked in Asian harbors around the world.  22.7% of the existing fleet, is due for delivery this year.  Shipping rates have collapsed, another event which the markets continue to largely ignore.

I have been feeling for some time that this would bite the players involved. Although the shipping company stocks have become very depressed of late, the story as it relates to shipping lenders  has been relatively overlooked. Now the IHT is out quoting industry observers stating that European banks may be facing writedowns on these loans on the order of $100 billion, which is even more than their Greek losses.

At my Actionable site I am now recommending a bearish strategy using a big poorly capitalized European bank that is not only exposed to European sovereign debt, but also to the double impact of inflated commodity lending in general. The market thinks LTRO, I think multiple lending blowups in tandem.  In addition to shipping, I am  including shale nat gas, which is also maladjusted. Natural Gas was discussed separately on Jan. 23 in the “Natural Gas in Maladjusted Feast and Famine Mode” report.

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For additional analysis on this topic and  related trades, subscribers go to Russ Winter’s Actionable. The subscription fee is $69 per quarter and helps support Russ’s work on your behalf. Click here for more information or to subscribe. 

China’s imports from Japan fell 16.2pc in December. Imports from Taiwan fell 6.2pc.  The strong yen strikes again: Honda decides to build a high-performance hybrid Acura in Ohio – instead of its home nation of Japan. The firm’s continued shift in production to North American capacity signals a wider trend of Japan’s automakers to battle currency-related losses by moving operations.

Japan is on life support.  The largest buyers of their debt are now sellers.  Japan Post Holdings holds almost 3 trillion dollars of JGB’s and GPIF, the retirement fund, holds over $1 Trillion of JGB’s.  Japan Post is the largest financial institution in the world and has 75% of assets in JGB’s and now wants to diversify.  The retirement fund is liquidating $80+ billion per year to pay out benefits.  Just read that the banks across Japan have 25% of assets in JGB’s and the IMF is coming over this summer to do an interest rate risk analysis if rates were to move 1% (double) what would be the impact to the capital of the banks?  Are the banks going to move to 30%, no.

The insurance companies are big holders and the people are getting old and dying.  The savings rate is at 2% and headed negative (also demographics).  The trade surplus has turned to deficit.  The budget for this year was to have more JGB issuance than government revenue (about 50% of spending to be borrowed), then the earthquake hit.  There are projections that the end total may approach two thirds of total spending will be borrowed for the current fiscal year.   There are no new large buyers to replace the above and to sell bonds outside of Japan would require much higher rates. The Japanese people have trusted their financial institutions to the government and the trust has been violated.  The money is gone and the government is not fiscally responsible.  This party is about to end.  John Mauldin called Japan, “A bug looking for a windshield” and Kyle Bass, “A giant ponzi scheme that is running out of time”.

This chart is actually dated, these CB own these markets, use thin capital bases, and are going to be handed the losses on  the fictitious capital they hold.  Tattoo this on your forehead, CBs hold well over 15 trillion in securities and loans to banks of various and often dubious quality, an immense gamble. These are all ultimately the responsibility of the sponsoring country, and represents a monster contingent liability. That will be the end game.

Barry Ritholz has each CB chart.

I spotted some interesting commentary on the maturing March 2012 Greek bonds. After buying at 40-45 cents, it seems the hedge funds are trying to unload in a bidless 35-cent market. The ECB has the largest stake, bought at 70 cents. This official holder’s dominance of this market, and refusal so far to  participate in haircuts, is making the whole exercise futile and severely subordinates any potential non-official holder or future buyer of  European sovereign debt. Reuters reports that the ECB is split and confused on this issue. The IMF’s LaGarde says, “If the level of Greece’s privately held debt is not sufficiently renegotiated, then public creditors will also have to participate.” Apparently, the IMF was also confused as this was retracted or denied. As I wrote in ”Stick it to the Local Issued Bondholder,” this is one of two serious subordination fiascos, the second being a slew of UK-law non-local  issues that restrict collective restructuring actions (see chart at the “Stick it” link).

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