June 18?–There was pre-weekend jockeying on Friday given the fluid situation in Greece.

June 18?–There was pre-weekend jockeying on Friday given the fluid situation in Greece.  Pressures seen on Thursday abated to a small degree…near euro$ contracts were up 2.5-3.5 bps as was the ten year yield. Once again open interest fell in each of the first four eurodollar contracts, with EDU and EDZ both down about 38k, EDH2 down nearly 5k, and EDM2 -29k.  One might think that open interest would be RISING here; that near euro$ contracts would be freshly shorted as a bonafide hedge against funding pressures.  The conclusion I draw is that most hedge funds/banks simply have used the contract as a (speculative?) trading vehicle to roll up the curve. The exit of positions reflects a re-evaluation of whether that strategy remains valid.

–FOMC result on Wednesday (two day meeting begins Tues).  There is also housing data, but a lack of fresh US economic figures this week.

–WSJ: Russia to continue paring back holdings of US debt.  The answer to the question “Who will actually buy US debt?” appears to have an ever shorter list of candidates given that China, Japan, the Federal Reserve, and now Russia are now simply whistling past the treasury storefront, averting their gaze, with hands deeply shoved in pockets. For now, the demand for safety against a backdrop of an increasingly unstable world financial architecture keeps US rates low.  And the Fed will step back in when those buyers are sated.



I was starting write a long rant, instead of the short clip above.  So I am including some of those thoughts here, if only because it helps me organize my own viewpoint.  The financial crisis has never really ended, seems to me it’s like a chimp that swings through the jungle catching one vine after another, gaining speed on the downswing, losing a bit of velocity on the upward arc before spying another vine to grab.  The problems remain, and are inter-related.  There is too much debt/overhead relative to productive income/assets.  When Bernanke implores Congress to handle long term structural problems, it is an overt admission that central banks can’t “fix” everything.  From Prudent Bear: Aggressive “activist” policymaking has been at the heart of this unprecedented Credit inflation, and the markets today fully expect policymakers to ensure this Bubble’s perpetuation.

But policy makers are inevitably losing the confidence of the markets.  The ultimate timing is the main question.

I worked at Refco and was there for the implosion shortly after the IPO.  Refco closed in late 2005, because there was an asset on the balance sheet that had no value.   Supposedly a group of bad debts related to customer blow-ups were re-labeled as an asset.  According to Wikipedia and word of mouth from ex-employees, part of this asset was from trading losses of hedge fund manager Victor Niederhoffer in Oct 1997. http://en.wikipedia.org/wiki/Refco That’s a long time…eight years.  During which time the company went public.  The underwriters neglected to catch this fraudulent inconsistency.  Ultimately the company ceased to exist. The head guys went to jail.  Just a couple of weeks ago settlement checks from court proceedings were sent out to investors.  Case closed… thirteen years after the fact.

It seems that the entire world banking system is riddled with holes in the collective balance sheet.  But these days no one seems to go to jail.  The valueless assets are simply bounced around.  They are still called assets.  You know and I know that someone’s holding a lot of worthless crap.  Right now the crap du jour is Greek debt and CDS.  I don’t understand the size of the problem.  I’ve seen a couple of articles saying it’s all manageable.  A friend of mine sent me an email from a knowledgeable investor saying that much of the debt and CDS is ‘hedged’  and that US CDS exposure is irrelevant.  Ok, so maybe a particular institution is short Greek CDS and long Ireland.  Hedged?  Maybe.  But what I think I learned from subprime is that someone has a leveraged position on dubious assets. As George Bailey said to Mr Potter, “It means bankruptcy and scandal and prison! That’s what it means!”  And when these stories come out, it spills into the real economy and erodes the confidence in economic agents that actually transact business in goods.

The solution has been to keep relaxing rules….mark to market, capital requirements, mortgage down payments through the FHA.  It’s going to end.  When Long Term Capital Mgmt failed in 1998, the bailout was less than $4 billion and total losses were $5-10 billion.  Quaint.  But it wasn’t that long ago…and at the time it brought the financial system to the edge of the abyss.

Where Obama completely blew it was in not trying to limit size of the financial sector.  He wrongly kept Geithner and Summers, who I am sure, convinced him that financial mkts and bondholders are the key to the economy…if you don’t ‘save’ them the whole thing goes.  But they needed to wipe out some shareholders, not allow bonuses, perhaps temporarily nationalize some financial firms.  Then what would happen?  The smart guys leave and start PRIVATE funds…and THEN you see if there’s truly capital out there or not.  The public financial firms would operate with a lot less risk.  Like Meredith Whitney says, there are going to be adjustments everywhere.  Contracts between local govt’s and their employees are going to be broken.  Same thing with bondholders and debtors.  And the ordinary Joe that never quite had a handle on it gets mad.  At someone.

Finally, coming back to the eurodollar futures market, I can’t seem to grasp the importance of the three month LIBOR setting.  It reminds me of the little Johnny joke where Johnny is sent home early from school.  His father asks him why.  Johnny says it was because of a math problem.  The father asks what the question was.  Johnny says “the teacher asked ‘what’s two times five?’ ”  Johnny says ”ten”.  Then she asked “what’s five times two?”  And the father says to Johnny, “What the f*ck’s the difference?”  Johnny exclaims, “That’s what I said!”   Does it really make any difference whether the LIBOR setting is 0.19% or 0.25% or 0.75% and that maybe JPM and DB transact at that rate?  It makes a LOT of difference to the people with 1.2 million open interest in EDU1.  But maybe the recent loss in open interest of the near contracts represents concern about the meaning of the contract itself.

Posted on June 18, 2011 at 12:07 pm by alexmanzara · Permalink
In: Eurodollar Options

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