Hedgie John Paulson, 21st Century Robber Baron?

What could be less likely to produce useful generalizations than a debate over vaguely defined moral issues based on unexamined ideological assumptions and presuppositions? - John Chandler, author of The Visible Hand

Outrageous fortunes tend to elicit suspicions of how they were amassed. In American history, this phenomenon is crystallized by the so-called "robber barons" prominent at the turn of the 20th century. Their names should be familiar to people the world over: John D. Rockefeller, Andre Carnegie, J.P. Morgan, Leland Stanford, and so on. Something these folks and their kin have done to take the sting from public scrutiny of how they amassed their wealth is to create foundations and sometimes institutions of higher education. Even today we have the Rockefeller Foundation, the Carnegie Foundation, and the JP Morgan Foundation, Meanwhile, Rockefeller also founded the University of Chicago, while Stanford did the same with his eponymous education institution.

The intersection of money and academia is of great interest to me personally for obvious reasons. Contrary to popular beliefs that academics are more interested in prestige or knowledge than wealth, I am often surprised how those in academia are among the worst money grubbers you'll find. There are certainly odd examples to be found. For instance, so many years after Enron became the very symbol of American corporate malfeasance, the University of Houston still awards--get this--the Enron Teaching Excellence award. Instructors also very much welcome chaired professorships. If you thought winning an Enron prize for excellence in anything was bad enough, the University of Missouri has a Kenneth Lay Chair in Economics. Malodorous dead company or malodorous dead guy--pick your poison, but it's still money either way. (A former American colleague tells me of someone offered the Playboy Enterprises Chair [!] who turned the offer down since he was a family man, but I sometimes doubt the veracity of this story even if it does make for great dinnertime conversation for academics,)

Anyway, just as episodes of corporate malfeasance symbolized by Enron were symptomatic of the excesses of the dot-com bust, so do we have our superstar hedge fund managers of today who are in serious need of...image rehabilitation. Like the robber barons of yore, John Paulson has made an outrageous fortune--in his case by taking out credit default swaps against issuers of subprime mortgages. The $15 billion he netted has been called The Greatest Trade Ever. The lustre of this move has dimmed somewhat with the revelation that Goldman Sachs offered a package of securities that Paulson shorted unknowingly to its buyers, but hey, read John Chandler's caveat above. Certainly, Paulson has his share of defenders in much the same way vultures have their defenders in the fauna food pyramid:

It’s widely accepted that while short sellers of stock are despised by corporate America, they serve a useful purpose. They enable people who don’t believe CEOs’ happy talk to put their money where their scepticism is. You may not believe the stock (or house prices) are a bubble, but those who think they are serve to restrain valuations by betting against them. In the process, they actually mitigate bubbles. One of the structural shortcomings of the housing market is that it is quite hard to short; houses are illiquid and heterogenous. This, all else equal, makes housing more inefficient and prone to bubbles. Arguably, devices that addressed this market flaw made the market more efficient. (Like Mr Sorkin, I am ignoring for the moment the legal question of whether Goldman made the right disclosures in marketing its synthetic CDO.)

Moralizing aside, I was reading my copy of the LSE employee newsletter when, lo and behold, I discovered that John Paulson was trying to cover his name in glory (or so he may think) by associating himself with our school. To remove the possible tarnish of dirty trading tactics, his pre-emptive strike is to fund a unit investigating Europe's role in combating financial crisis. It's interesting timing, of course, given that other hedge fund managers are using lower key tactics in taking advantage of EU turmoil. Maybe it's his way of washing his hands of the matter. Having had run-ins with US authorities already during the subprime fiasco, what better way to wash his hands of the matter as troubles head to Europe and its even more busybody lawmakers and civil servants...for the paltry sum of £2.5 million?

Paulson & Co. founder, John A. Paulson has donated more than £2.5 million to fund new research and teaching on Europe's unique role in the post-crisis financial world at the London School of Economics and Political Science. The gift will establish the John Paulson Chair in European Political Economy, a position which will be occupied by a leading scholar who combines expertise in finance, policy and the European Union with the reputation to speak to a global audience.

The chair will be located in LSE's European Institute which applies a broad range of academic disciplines to understand Europe's complex and developing role in the world. This comes at a time when the euro crisis has focused attention not only on the currency's future but also on how EU governments can restructure their politics, economies and social affairs in response. It is hoped the holder of the chair will be able to take up the appointment in September. The donation also includes funding for an associated five-year research programme.

Question their methods but robber barons of a century ago left behind buildings, railroads, universities, and so forth. What will the current generation of budding industrialists (de-industrialists?) leave behind? I'll bet John Paulson is giving it some thought as evidenced by his donation to the LSE. Fair enough. And I certainly wouldn't mind being the John Paulson Chair in International Political Economy one day [just kidding--but only just ;-)].

Hedge Fund Attack Hits France, Germany [Shh]

No one knows what it's like to be the bad man
To be the sad man
Behind blue eyes...

It's pretty safe to say that those working in the financial services industry are the usual suspects when things go awry in the world economy: Erratic market movements? Betting on commodities driving up the cost of living? Casino capitalists playing god with the lives of those in the developing world? Blame it on "the speculators." Two years ago, former Brazilian President Lula (himself a former labour activist) memorably told then-UK Prime Minister Gordon Brown that "blue-eyed" individuals were at fault for the global financial crisis:

This crisis was caused by no black man or woman or by no indigenous person or by no poor person," Lula said after talks with the prime minister in Brasilia to discuss next week's G20 summit in London. "This crisis was fostered and boosted by irrational behaviour of some people that are white, blue-eyed. Before the crisis they looked like they knew everything about economics, and they have demonstrated they know nothing about economics."

Challenged about his claims, Lula responded: "I only record what I see in the press. I am not acquainted with a single black banker." The remarks by Lula, a former trade union leader who had an impoverished upbringing in the poor north-east of Brazil, enlivened Brown's five-day trip to North and South America.

Now, hedge funds tend to attract a lot of attention for obvious reasons. Not really being obligated to disclose their holdings or trading strategies, they are suspected of any number of things--from fomenting the Asian financial crisis to worsening the subprime crisis. Short selling, hoarding, and similar trading strategies are not usually pleasant matters for dinner table discussion.

With the spotlight still on hedge funds, they are now more circumspect when it comes to shorting troubled European economies' sovereign debt. The battleground of the Asian financial crisis was primarily Southeast Asia and the subprime crisis North America. Now, though, the theatre of operation is Western Europe. Let's say that scrutiny is forcing many hedge funds not to be so obvious--by purchasing naked credit default swaps on PIGS debt, for instance. Instead, they are waiting for blowback to the very centre of the European Union:

Hedge funds are steering clear of hotly debated credit derivatives and reverting to more orthodox bond plays so as not to invite more regulation from the many politicians who blame them for the global financial crash.

Fearing being seen as "bringing down a country", funds are instead trading sovereign and corporate bonds as they hunt for less controversial ways of making money from market volatility. "The larger funds have been really cautious in trading CDS. They don't want to find themselves in the newspaper, and let it become an issue with their client base," said Jeff Holland, co-founder of fund of hedge funds firm Liongate.

Scouring through the track records and portfolios of hundreds of fund managers, firms such as Liongate select other funds to invest client money in, giving them a wide overview of trading strategies used by hedge funds. At the height of Greece's debt problems in February last year, Europe's second-biggest hedge fund firm Brevan Howard, which now runs $32 billion in assets, told its investors it had sold out of "meaningful" positions in CDS and bonds in Spain, Portugal or Italy. The firm declined to give further details.

"Hedge funds have been playing the bond spreads, which is less visible," said Philippe Gougenheim, head of hedge funds at Unigestion, which invests in hedge funds. "In the macro space they're definitely active on the bonds." While data on hedge funds' trades can be scarce, at the time of the Greek crisis last year hedge funds accounted for 12-20 percent of CDS activity, according to one hedge fund industry source, citing estimates from banks...

Leading European politicians have blamed CDS -- a bet on the creditworthiness of a borrower -- for aggravating the debt crisis, allowing investors to speculate on a default rather than protect against it, their original goal. Europe is approving a law giving the European Securities and Markets Authority powers to intervene in markets to ban practices, including naked selling of CDS, where the buyer does not own the underlying bond. That comes after an EU report -- which was not published, despite protests from the hedge fund industry -- on sovereign CDS last year largely exonerated CDS markets for putting pressure on bond prices.

To avoid the risk of tighter regulation, many hedge funds are buying or short-selling sovereign bonds -- even of countries as seemingly stable as France and Germany. "CDS is proving to be a more challenging market for traders, considering that governments are indicating that they could well change how the market is regulated," said Scott MacDonald, at U.S.-based credit specialist Aladdin Capital...

"We're still seeing some funds using CDS but a lot have diversified because of politics and uncertainty in the regulation of CDS," said Ben Funk, head of research at fund of funds firm Liongate, adding that cash bonds and currency also offer better liquidity. He added: "The general consensus is that there's more pain to go (for indebted European countries)... A lot of managers have taken off short Portugal or Spain positions, where it's almost a given there's going to be problems, and have moved to France or Germany...[i]n those countries the spreads are so tight, but should there be instability in the periphery they'll move."

I still remember then-Malaysian Prime Minister Mahathir "Death to Speculators" Mohamad calling out George Soros for destabilizing regional currencies. (They eventually kissed and made up.) Every generation creates its bogeymen, and the next one to raise the EU's ire just may be--you guessed it--a blue-eyed hedgie.

But my dreams
They aren't as empty
As my conscience seems to be...

Funding Carry Trade w/ $, Currency of the Doomed

It is common knowledge by now that next to nothing is going right in the US economy. America's various debt orgies have brought it little but additional misery. Deficit lovers thought they could revive this wasteland by borrowing even more humongous amounts to cure ills caused by borrowing too much in the first place. In the end, nobody feels sorry for America--except perhaps Martin Wolf, who's become something of an apologist for Anglo-Saxon orthodoxy as of late. It's justice served: if you act foolishly, you fully deserve what's coming to you.

As if we needed even more proof of the descent of this economic wasteland comes even more news of its pointless existence. Briefly, the "carry trade" is one of the most basic plays in foreign exchange. One borrows in a currency charging lower interest--the "funding currency"--and lends in a currency yielding higher. In the past, nearly zero-yield Swiss francs and Japanese yen were the favourite funding currencies of foreign exchange traders. However, a comatose US economy has meant policymakers keeping similarly low interest rates Stateside.

Voila! The dollar is now becoming a funding currency of choice. Not only is it yielding next to nothing, but limited expectations of the US escaping the ambit of its self-inflicted and wholly deserved financial ruin mean many are willing to use the dollar as a cheap and stably moribund funding currency. That is, a funding currency is best provided by an economy with few growth prospects that may require interest rate rises to cool down. Reuters explains this latest piece in the puzzle of American decline:

While the dollar is still far from surpassing the Japanese yen and the Swiss franc as the world's funding currency of choice, investors are no longer rushing to buy the greenback as a safe haven any time trouble erupts worldwide. While not inherently bad for the dollar, being a funding currency is a sign of investors' disenchantment in U.S. economic growth and return potential. In time, countries with funding units face difficulty attracting foreign investment, further eroding economic prospects and the attractiveness of their currency.

On Thursday for example, the dollar sold off against both yen and Swiss franc after a report showed factory activity in the U.S. Mid-Atlantic region unexpectedly contracted. Both currencies are lower yielding than the dollar, making them better funding options. Until recently investors would have sold them and bought back dollars after the headlines.

The move on Thursday "was not a flight into U.S. dollars, but a flight out of the dollar," said Douglas Borthwick, a managing director for trading at Faros Trading LLC, a forex execution firm in Stamford, Connecticut. "If the dollar is no longer seen as the destination for the 'flight to safety' then the market will use it as the currency to be short against high-yield trades given it will shield them the most from adverse moves," he added. "Thus it would become the funding currency of choice."

In the forex markets, a funding currency is used to finance so-called carry trades. A carry trade involves borrowing in a low yielding currency to buy higher yielding assets elsewhere. High liquidity, low yields and low volatility are all desired traits in a funding currency. The Japanese yen fit all of those attributes for years, making it popular for trades involving the Brazilian real, the Mexican peso and the Australian dollar.

"There's a possibility the dollar will be just like the yen a couple of years ago," said Dean Malone, a currency director at Compass FX in Dallas, Texas, which sold U.S. dollar versus Swiss francs on Thursday. "With yields these low, there's simply very little appreciation value in the dollar," he said. "Until we turn the corner, until employment picks up and the Fed decides to start raising interest rates, markets will keep looking for higher returns elsewhere. And the dollar may be used to help fund those trades..."

Some analysts are cautious however on reading too much into the dollar's recent trading behavior. They note that when taken into account the implied volatility and yield spreads across currency pairs -- key measures to help gauge a carry trade efficiency -- the dollar doesn't stand out as a funding unit.

Analysts at RBC Capital Markets compile a "carry value barometer," which ranks funding currencies, using option prices and measuring yield spreads adjusted for volatility. According to the bank's latest reading the Canadian dollar is now the best funding currency, in particular for trades involving the Australian dollar, South African rand, the Brazilian real and the Turkish lira.

In comparison, the dollar ranked between the 4th and 6th best option among 8 currencies, involving the same pairs. "No doubt the low yields are hurting the dollar," said Todd Elmer, a G10 currency strategist for Citigroup Inc. in New York. "But I'm not sure about selling it to buy the yen and the Swiss franc for some potential marginal yield gain."

I don't need to spell out what it means when some traders view USD as a better funding currency for the carry trade than the yen given the state of the Japanese economy for the last two decades. We knew it all along: America stinks and so does its currency. Long live the carry trade! I think it's time I took a punt on AUD/USD...

Protecting Asia From the West's Financial WMD

Liberalize, privatize, and deregulate your way to almost paradise; that was the message the West propagated during the height of the Washington Consensus era. Like many other Asian countries, however, China did not heed this call, preferring to stay away from securitization in a big way. Instead, China's recent financial problems are more prosaic and involve large government-run banks being compelled to lend to state-owned enterprises with sometimes limited regard for their ability to repay these loans. This trope was prominent in the middle part of last decade, and has resurfaced during recent times as the PRC once again made state-owned banks (SOBs?) lend to spur investment. Critics often say that investment in export-geared enterprises is the last thing China needs at this point, but we have yet to see another massive wave of defaults.

Anyway, back to today's story. The LSE house journal Global Policy has an interesting feature from the chief advisor to the China Banking Regulatory Commission (CBRC), Andrew Sheng, on how China was able to avoid the worst effects of the financial crisis. Aside from prudent regulation, another important task was shielding the Chinese economy from aftershocks emanating from the subprime capital of the planet and other bastions of financial innovation. It's a different world we live in when China--now the second largest economy in the world which I'll have more about soon--gets to lecture the West on such matters. With nearly $3 trillion in foreign exchange reserves, I guess China has many reasons not to take any £$%^ from Westerners wanting to ply their market open without reflecting on how their practices have impacted the economies of their home countries. What follows are the abstract and key policy implications:

Abstract

Asia was not directly or significantly hurt through financial channels by the global financial crisis, but rather was hurt through trade channels. This article reviews the current regulatory reforms of global financial markets and how these affect Asia. The current crisis has exposed many weaknesses in the existing financial architecture, including the fragmentation of regulatory jurisdiction at the national and institutional levels. What is required is a system-wide and global view of market behaviour. The article uses a network perspective to analyse the issues and to propose solutions. The globalisation of finance and its fragmented regulatory oversight is a collective action problem that easily slips into a tragedy of the commons. Given the fact that there is no unanimity of views on how finance should be structured, there are differences in approaches to the reforms. Because Asian financial institutions and structures are less sophisticated, Asia is still struggling with how to make the financial system more efficient and responsive to real sector needs. The article suggests that Asia needs to identify its financial needs and can develop its markets through greater regional cooperation. Identifying the need to see financial markets as ecosystems through diversity, the article suggests that Asia can evolve through simpler but more robust financial systems.

Policy Implications

• As a matter of priority, Asia needs to strengthen domestic capital markets according to international standards.
• The Asian approach will tend to be more pragmatic, focusing on simpler rules more effectively enforced. Financial innovation should be encouraged with an emphasis on functionality for the real sector, rather than leverage for the financial system.
• Using the network approach means that Asians should build financial markets on a modular basis, ensuring that failure of one module will not destroy the whole system.
• Since it is recognised that global problems cannot be solved at national levels alone, Asia can increase its voice in the international arena through regional subsets of the Financial Stability Board, central bank grouping within the Bank for International Settlements (BIS), and the International Organisation of Securities Commissions (IOSCO) to help push implementation and enforcement according to global standards and to have regional input into global policy decisions.

Its a common theme that should resonate with reasonable-minded folks: financial practice should map closely to the real economy instead of being used to create virtual economies whose basis of and reason for existence is hard to determine.

Wild Days and Nights of Korean Won Intervention

Asian developing countries are noted for their highly involved approaches to foreign exchange policy. Perhaps this is a natural result of being export-oriented: sustaining large trade surpluses involves no small attention to currency matters. Just as Japan's model of export-led industrialization set a template for other Asian economies wishing to follow in its lead--Akamatsu-san famously called it the "flying geese model" (with Japan in front)--its policy choices have filtered down to other wannabe economic powerhouses. Although Japan has not intervened in the currency markets for a very long time, other Asian economies have not hesitated to demonstrate what exactly a "managed float," or more condescendingly, a "dirty float" is.

However, one thing most commentators (like American lawmakers, say) don't make more of is that Asian countries intervene to both strengthen and weaken their currencies based on perceptions of prevailing economic conditions. During the Asian financial crisis, the region was obviously preoccupied with maintaining the value of their currencies as speculators bet on devaluation. Many didn't beat the speculators, but some did. Around 2007 when the dollar was in a free fall, many of these same countries then began to buy dollars and sell their local currencies to ensure continued export competitiveness. And we all know what China has been up to all this time.

It seems old habits die hard. As you know, South Korea has been hit by political turmoil as the country grapples with how to deal with North Korea over the sinking of a warship that caused the loss of 46 lives. A formal peace has never been declared between these warring states and tensions are again high. Along with sinking equity markets, South Korea has been hit by volatility in the all-important currency market. Last Wednesday, its financial authorities signalled that they would be taking a more active approach to dealing with FX matters:

“Authorities will supply sufficient foreign currency liquidity if needed,” Vice Finance Minister Yim Jong Yong said at an emergency meeting of officials from the Finance Ministry, central bank, economy ministry and financial watchdog in Gwacheon today. “We will be closely watching for herd behavior in the currency market and take necessary actions in a prompt and active manner...”

South Korean Finance Minister Yoon Jeung Hyun said today the government is “ready to cope with” the volatility in financial markets given its substantial foreign-currency reserves. The reserves totaled a record $278.9 billion at the end of April, 31 percent more than a year earlier.

"Active" is the key word here. And so South Korea has once again waded into familiar waters of Asian currency intervention. Yet, an even more notable thing is the recent bounceback of the won being deemed as perhaps too excessive. Call it a fine line to walk between perceptions of a free-falling currency and maintaining export competitiveness. Instead of waiting weeks or months to see the fruits of their actions, Korea's central bank is believed to have step in again just a day after on Thursday to stem won appreciation!

The South Korean won soared nearly 3% during Asian trade Thursday on heavy buying by offshore players and exporters but pared those gains in the afternoon session following suspected intervention by the central bank. Traders were surprised by the central bank's suspected moves to support the dollar as it would mark a reversal from its reckoned selling of the greenback just days earlier, when the won had fallen to a 10-month low due to rising geopolitical tensions between the two Koreas.

"This seems to be a means to prevent excessive (one-sided) moves," given the won's sharp gains earlier in the day, said a local bank trader. "But I personally don't understand this." Authorities likely stepped in Thursday near the dollar's intraday low of KRW1,217.50, lifting it to KRW1,224.0, several local traders said. Two of those traders estimated the central bank to have bought between $500 million and $1 billion, possibly through two foreign banks.

You can make the argument that all this busywork is part of an overall effort to stabilize the won within an acceptable range. In line with this argument, financial authorities are keen on limiting derivatives trading involving the Korean won to also limit the range of currency fluctuation:

“The events of the past week gave us another reminder of the impact of capital flows driven by short-term market-driven dynamics rather then the economic fundamentals,” said Shin Hyun-song, the South Korean president’s senior adviser on international economy. Mr Shin said the government was considering “various options” for regulating currency forward positions for domestic banks and the Korean branches of foreign banks. He insisted that any measures would be introduced carefully to allow market participants a “smooth transition...”

At the end of last year, financial regulators limited the size of forward transactions by local companies to no more than 125 per cent of the revenues they were hedging. Exporters, especially shipbuilders, were accused of overhedging foreign orders, putting upward pressure on the won before the global financial crisis hit the country.

Talk about playing both ends with some mustard on the side. If true, these actions set a new standard for central bank activism. And you though the Chinese and Japanese were pretty active on the management of currencies front. South Korea, you are our new king of the hill in this arena. The "overmanaged float," perhaps?

Record US Foreclosures? Excellent News!

Call it schadenfreude, but I cannot but help applaud news that the United States is suffering record delinquencies and foreclosures (also see the MBA press release). Remember, these are the same folks who tried to impose upon the world "Washington Consensus"-style strictures of liberalization, privatization, and deregulation on the road to some sort of economistic paradise. Yet, when faced with troubles have happened at home, they've undertaken unprecedented deliberalization, nationalization, and reregulation. While this sort of double talk is to be expected from Americans (as other who've aspired to similar hegemonic entitlements in history), the only real question for me is why the rest of the world allows the United States to get away with this boorish behaviour.

What rising delinquencies and foreclosures demonstrate are obvious things folks in the blogosphere aside from me have reiterated over and over:

• You can't fix a problem caused by excessive borrowing by borrowing trillions more;
• Helping wipe out private finance for housing isn't a characteristic of a market economy;
• Massive losses by Fannie Mae and Freddie Mac indicate the rot of continuing patterns of government involvement in the US housing market;

Alike with the subprime crisis, the whole point is to reveal that massive state supports to housing are fiscally wrongheaded and, ultimately, senseless. The American Dream is a farce. Ditto for pretending that the fiscal consequences of extending a limitless lifeline to Fannie Mae and Freddie Mac do not exist. When you lie so much to others that you believe your own lies--Fannie Mae and Freddie Mac's deficits don't matter--don't expect sympathy from anyone else. Such is modern America; the "ownership society" is, in reality, the tent ownership society [1, 2]. This emperor has no clothes.

So, may the fates deliver those participating in these housing shenanigans to a very, very well-deserved fate. Our only regret should be that the US isn't being slammed even harder. Thankfully, we're getting there. Quit this nonsense or suffer the consequences. Throw them out. Throw them all out.

EU: Screw Credit Rating Agencies; We'll Do Rating

Credit rating agencies have long been bogeymen for those facing down financial crises. During the Asian financial crisis, Ferri, Liu, and Stiglitz (1999) found these agencies complicit in procyclical ratings that worsened matters. Here is the abstract of their paper:

We demonstrate that credit rating agencies aggravated the East Asian crisis. In fact, having failed to predict the emergence of the crisis, rating agencies became excessively conservative. They downgraded East Asian crisis countries more than the worsening in these countries' economic fundamentals would justify. This unduly exacerbated, for these countries, the cost of borrowing abroad and caused the supply of international capital to them to evaporate. In turn, lower than deserved ratings contributed – at least for some time – to amplify the East Asian crisis. Although this goes beyond the scope of our paper, we also propose an endogenous rationale for rating agencies to become excessively conservative after having made blatant errors in predicting the East Asian crisis. Specifically, rating agencies would have an incentive to become more conservative, so as to recover from the damage these errors caused to them and to rebuild their own reputation.

Well it's 2010 and it seems these same credit rating agencies haven't learned their lesson at all. In this game of perception, have a gander at the view of market participants at what EU actions mean. To them, the ECB allowing Greek bonds to be used as collateral regardless of their credit rating is the latest in a long line of concessions to erring EMU countries:

Still, crucially, this isn't the first key rule behind the euro to be scrapped. Greece, and a number of the other 15 euro members, have already disregarded the rule that borrowing levels should be kept low. Another perceived rule, that no euro member should bail out another, has also been ignored. Now, market watchers warn that this fresh rule-bending exercise creates a further dent to the solidity of the single-currency project. "Junk debt is junk debt. You can't have different rules for different members of the euro. Otherwise, what's the point of having a single currency?" said Simon Derrick, a senior currencies analyst at The Bank of New York Mellon in London

Ah, well. Markets will markets, eh? Far more interesting has been the response from EU bigwigs, In particular, Michel Barnier, Commissioner for the Internal Market and Services, has been keen on policing the dreaded Anglo-Saxon abuses of the credit rating agencies:

"I think we need to go further to look at the impact of the ratings on the financial system or economic system as a whole...," European Internal Markets Commissioner Michel Barnier told members of the European Parliament. "That's why I asked for responsibility to be assumed in the work they are doing." Barnier added: "If you look at Greece, for example, I was quite surprised by the quite rapid deterioration in rating." His comments follow a reminder from the executive European Commission to rating agencies to be careful in their work.

The kicker, though, is that he's now proposing that the EU itself do the job of rating (or at least sponsor an organization doing so on the EU's behalf):

The European Union is examining plans to set up a European credit-ratings authority for sovereign debt ratings in the wake of the Greek crisis, the bloc’s top financial regulator said today. Financial Services Commissioner Michel Barnier is also examining whether ratings companies have too much power, he told the European Parliament’s economic and monetary affairs committee in Brussels today.

“We are undertaking work on creating a European agency,” Barnier said. “We need a very fast, but not off-the-cuff reflection,” he said. “The power of these agencies is quite considerable, not just for products but also for states.” Scrutiny of credit-ratings companies intensified after Greece’s rating was last week cut to junk status.

Is it just me or are there similar conflicts of interest inherent here as when financial service concerns approached credit rating agencies soliciting business? While credit rating agencies' reputations are deservedly junk, you have to wonder if the alternative here can be made to be worth rather more. Yes, EMU countries are probably suffering from credit rating agencies' overreaction now as during the Asian crisis. However, the 'cure' may be worse than the disease.

PRC Crackdown on Hot Money: RMB Reval Imminent?

I almost forgot to post this one. Basically, you'd expect more inflows of "hot money" into China when speculators believe the revaluation of the Chinese renminbi will occur soon. Do the yuan traffickers know something we don't--perhaps some insider information about the timing of a revaluation to, say, appease America prior to the 15 April Treasury decision? Also factor in those wanting to take advantage of asset price rises in China as well as somewhat higher interest rates in the developing world. Once more, the currency watchdog, the rather amusingly titled State Administration of Foreign Exchange (SAFE), is conducting sweeps for illegally entering hot money. From our favourite official publication bar none, China Daily:

The State Administration of Foreign Exchange (SAFE) will conduct a special investigation in 13 provinces and municipalities during the first half of this year to examine whether international "hot money" was flowing into China under the cover of trade, foreign direct investment (FDI) and foreign debt, the Shanghai Securities Journal reported Tuesday.

China faces an increasing risk of net inflow of foreign exchange in the backdrop of a more complex and volatile international balance-of-payments situation in 2010, SAFE said at its annual meeting on foreign exchange in Beijing on Monday. There are more uncertainties in cross-border money flows this year, SAFE noted. The investigation will focus on trade in goods and services, individuals, FDI, international payment transactions and cross-border money flows, and will cover major channels, projects and entities through which international speculative money comes into China, the regulator said.

SAFE vowed to punish violators of foreign exchange law and regulations as well as to avoid adverse effects on normal trade and investment activities during the crackdown. Amid stronger market expectation of a yuan appreciation, the cases of illegal use of foreign exchange have been on the rise in recent months, according to the Shanghai Securities Journal.

Lu Zhengwei, chief economist with Industrial Bank, told the Beijing News that the increasing inflow of foreign exchange was mainly due to potential lucrative returns coveted by international speculative money under current conditions. He attributed China's attractiveness to four factors: the country's quick recovery from the world financial crisis compared with Western countries; strong market expectations of a yuan appreciation; low interest rates adopted by world major economies; and a surge in assets prices in emerging economies including China.

However, Lu also warned of a possible massive exodus of international money within the year as some institutional investors were already considering withdrawing from emerging markets. Whether massive pullouts would become a reality depends on when the US Federal Reserve raises interest rates, he said.

Is a crackdown a prelude to revaluation? It's certainly food for thought.

Yes, People See Through US Treasury AAA Farce

Burger King is not the only American concern that likes to sell Whoppers. Recently, we've asked "Where's the Beef?" with regard to the American Dream and the melting pot and have found both notions quite wanting to say the least. Returning to the realm of sovereign borrowing, let's turn our attention to that chestnut: triple-A "risk free" Treasuries. It seems the infinite appetite America #1-style cheerleaders ascribe to them as evidence of the Enduring Greatness of America is losing its lustre. To start with, the most recent TIC data release indicates that Chinese holdings of this stuff has fallen for a third straight month, unbeknownst to many of us as the FT summarizes; full summary here of the $33.4 billion decline in TIC flows for January:

Foreign governments and central banks sold a record amount of US financial assets in January as China continued to reduce its holdings of Treasuries, government figures showed on Monday. Demand for corporate debt also fell, with private foreign investors shedding a record $24.8bn of corporate bonds while also shying away from equities and US agency debt.

China sold $5.8bn of Treasury securities in January, the third month running that it cut its holdings. However, revisions to previous months helped it regain its position as the top holder of US government debt, overtaking Japan...Any move by China is closely watched because it is the biggest and most politically sensitive US trade partner. Mounting US debt levels and the need by the US to fund a record budget deficit have raised concerns that this may hit the US dollar and weaken demand for US assets...

“There is such an imbalance between trade and investment flows between the US and China, that it requires an increasing level of Chinese demand for government bonds,” said Michael Woolfolk, a senior currency strategist at BNY Mellon. “If China decides to stop purchases of government bonds, then we have a problem.” Analysts cautioned that the change in China’s monthly holdings was in part due to debt maturing. The US Treasury department pointed out that China’s investments often run through offshore entities, making it possible that its US investments were appearing as holdings in Britain or Hong Kong...

“It makes much more sense to look at the prices paid for US assets, rather than the quantities bought,” Capital Economics said...

Isn't it curious how the US Treasury is at pains to point out that China isn't deserting it? As per that last statement, we now observe that the yield on the ten year Treasury has recently spiked to 3.86%.

Accompanying this phenomenon is that of the swap spread turning negative and becoming more so on ten year dollar-denominated instruments. The swap spread is the difference in yield between an official instrument alike US sovereign debt and a swap rate of similar duration. That is, the swap rate represents the cost of entering into an interest rate swap where a stream of fixed income payments is exchanged for floating rate ones. In theory, this inversion should not happen since the latter bears the credit risk of institutions not borne by sovereign borrowers. Put differently, financial institutions' cost of funding, typically based on the London Interbank Offered Rate (LIBOR), should be higher than that of the sovereign given that banks aren't similarly rated "AAA".

Now there are many interpretations of why this phenomenon is occurring [1, 2, 3], but the most obvious one is that the markets do not believe Treasuries are "risk free." It is doubly head-scratching since many of the aforementioned banks are now ultimately guaranteed by the sovereign as the recent credit crisis has demonstrated (or, at least for those still around). Certainly, the inevitable debt tsunami of American issuance isn't helping the sovereign cause. Why would you want to enter into an interest rate swap, anyway? If your expectation is that interest rates are headed higher due to this unabated debt bonanza, then you can lock in current rates (the fixed component) and pocket the difference when prevailing rates rise (the floating component). More people starting to think this way should result in an even more negative swap spread.

At any rate (pardon the pun), America's well-deserved comeuppance should be something the world economy wishes for. Like in other areas of human endeavour, the US is a bully that thinks it can get away with all sorts of financial shenanigans and make others bear the costs of adjustment. Three pieces of evidence here--declining capital inflows, rising bond yields, and inverting swap spreads--suggest this abuse cannot go on forever, much as Uncle Sam would like. Others smiting down this chronic offender with undue haste is just deserts.

In the meantime, boys and girls, if you can't tell who the suckers of globalization are, they're those who invest in America.

Screw Japanese, Try Swiss Forex Intervention!

I am one of those incurable foreign exchange fanatics who watch these movements with no small amount of disdain for their sheer nonsensical gyrations. Today's example is that of the unbelievably oversold euro against Swiss franc or EUR/CHF in trader notation. Before I get to that, it is absolutely inexplicable as to why the euro is dropping in relation to the currency of a country (America) that piles on $221 billion in debt in a single month. Forex commentators offer what are, to my thinking, logic-free arguments. Here is the Eurozone displaying a willingness to hold its members' feet to the fire by suggesting Greece resort to the IMF in conjunction with support from member countries--just as yours truly has suggested--being punished for doing so. Meanwhile, the world's largest debtor nation is rewarded for...piling unprecedented levels of debt and doing nothing about it? You must be joking; mark my words, this situation won't last and will probably peter out once Greece has inevitably been forced to the trough.

Anyway, before I get sidetracked any further, today's story concerns EUR/CHF. Apparently, the Swiss franc has been gaining big on the euro in light of the much-publicized but largely salvageable Greek woes. Although the likes of yours lie in wait in the Forex Pumpkin Patch for signs of the Great Japanese FX Intervention, we are thwarted again and again as the Land of the Rising Sun hasn't done that sort of thing since 2004. There might be less of a need to do so at the current time as Japanese exports have climbed 45% on a year-on-year basis. Meanwhile, the Swiss are naturally concerned by the erosion of their competitiveness vis-a-vis most of their Western European trading partners and have seen it fit to engage in moral suasion (talking down the Swissie and sabre-rattling about intervention) and open market operations by actually selling francs in markets worldwide. From Bloomberg:

The Swiss franc rose against the euro for the eighth straight day [make that nine if EUR/CHF falls again today; click on chart for larger image], the longest run of gains in 17 months, on bets the country’s central bank will allow the currency to appreciate amid signs of an improving economy. The franc strengthened through 1.43 per euro for the first time even as Swiss National Bank President Philipp Hildebrand said the bank has a “broad arsenal” to prevent “excessive” gains by the currency. UBS AG, the world’s second-biggest foreign-exchange trader, increased its franc forecasts, predicting it will strengthen to 1.40 per euro in three months from 1.45 previously.

“The verbal intervention today has limited impact on the franc,” said Ian Stannard, currency strategist at BNP Paribas SA in London. “With the economic recovery gathering momentum, the trend is for the franc to rise. The market will keep testing the resolve of the SNB to find out what they meant by ‘excessive.’ It’s going to be a difficult transition for the central bank...”

The SNB began selling the franc on March 12, 2009, to stem its gains and stave off deflation. [SNB President] Hildebrand, making his first public speech since taking the helm of the central bank, also said “the instruments are clear. We’re purchasing foreign currencies, and we’re able to do that to a very large extent to counter any excessive appreciation.”

The currency has gained 0.6 percent against the euro since SNB Governing Board member Jean-Pierre Danthine said on March 18 that “households and firms should prepare themselves for a return, sometime in the future, to a world of higher interest rates, with exchange rates being guided by market forces...”

UBS also said the franc may appreciate to 1.42 per euro in one month. “The justification for large-scale interventions is fading fast with deflation disappearing and economic indicators strong,” wrote UBS analysts including Mansoor Mohi-uddin in Singapore. Any “sharp and sudden” moves in the franc “could still trigger SNB intervention, but with limited speculative positioning and strong fundamental pressures this would be unlikely to have much lasting effect,” they said.

It's always interesting to see central bankers trying to game the system. Many think FX intervention doesn't work given the sheer volume of trading in today's currency markets. Perhaps Japan has learned this lesson while the Swiss are still in the process of receiving it as commentary in the above article suggests. In the meantime, please join me in the Forex Pumpkin Patch as we lie in wait for the next coming of the Great Japanese FX Intervention. Like Godot, it is proving to be rather elusive.

UPDATE: More trader talk suggests the SNB has stayed out of the market today in fears of continued action leading to Switzerland being labelled a currency manipulator during the next biannual Treasury report [!] I couldn't make this stuff up; I'd take it with a grain of salt:

The SNB's Wednesday absence in markets as the Swiss franc plunged "may well be in response to the fact that based on the U.S. Treasury's mechanistic approach to ranking currency manipulation, it is arguably the case Switzerland has a higher chance of being named a manipulator than China in the 15 April 2010 U.S. Treasury report on International Exchange rate policy," said Sue Trinh, senior currency strategist at Royal Bank of Canada, in a note to clients.

America in Trouble: Social Security, Credit Ratings

There are endless America #1-style cheerleaders out there who doubt America is in decline and doubt the seriousness of its fiscal woes. Deficits don't matter, right? Unfortunately, IR/IPE stalwart Joseph Nye may be leaning in that general direction. In a recent Korea Times op-ed, Nye offers the following [you may want to cue Brooks & Dunn or similar Bushite favourites before reading further]:

First, the U.S. is not in decline. Americans and others have been predicting decline regularly over the years: after the Soviets launched Sputnik in 1957; again when Nixon closed the gold window in 1971; and when the American rust-belt economy seemed to be overtaken by Japanese manufacturers in the 1980s.

But when one looks at the underlying strength of the American economy, it is not surprising that the World Economic Forum ranks the U.S. second (just behind Switzerland) among the most competitive, while China ranks some 30 places below...True, if China dumped its dollars on world markets, it could bring the American economy to its knees, but in doing so it would bring itself to its ankles.

Dem's fightin' words, Professor Nye. Well, let me tell you why America is in decline now and not then, and it's largely down to demographics. There's no mystery here: American politicians are busy plying elderly citizens who actually bother to vote with goodies like health care, retirement benefits, and other sweeteners, while the next generation of Americans who don't bother to vote can't even get an education as states go belly up. As I've said before, the US and its expenditures are backward-looking and not the other way around as it splurges on retirees and leaves its future penniless in the finest American tradition.

Actually, you don't need to look far for further signs of American decline without bothering with China. I found the following from the Yahoo! front page, in fact. It is generally understood that Social Security's fiscal health is "better" than that of Medicare or Medicaid. Still, it's expected that Social Security payouts will exceed disbursements this year and only get worse from here on in. Time to draw on the "piggy bank," right? As many know, the federal government has been busy raiding Social Security to pay for fiscal shortfalls elsewhere for many, many years. End result: there's nothing left--time to borrow from the real owners of America--the Chinese:

The retirement nest egg of an entire generation is stashed away in this small town along the Ohio River: $2.5 trillion in IOUs from the federal government, payable to the Social Security Administration. It's time to start cashing them in. For more than two decades, Social Security collected more money in payroll taxes than it paid out in benefits — billions more each year. Not anymore. This year, for the first time since the 1980s, when Congress last overhauled Social Security, the retirement program is projected to pay out more in benefits than it collects in taxes — nearly $29 billion more.

Sounds like a good time to start tapping the nest egg. Too bad the federal government already spent that money over the years on other programs, preferring to borrow from Social Security rather than foreign creditors. In return, the Treasury Department issued a stack of IOUs — in the form of Treasury bonds — which are kept in a nondescript office building just down the street from Parkersburg's municipal offices.

Now the government will have to borrow even more money, much of it abroad, to start paying back the IOUs, and the timing couldn't be worse. The government is projected to post a record $1.5 trillion budget deficit this year, followed by trillion dollar deficits for years to come.

Well, er, yes, America #1--especially in deficits. But wait, it gets even worse. Credit ratings have received a fairly well-deserved beating due to credit rating shenanigans during the credit crisis when they slapped AAA labels on all sorts of toxic waste. Now, Moodys has joined Fitch's in recognizing that, gee, America ain't doing too good. They may be on the thick and dishonest side, but hey, even these guys eventually know a clunker when they see one:

Moody’s Investor Service, the credit rating agency, will fire a warning shot at the US on Monday, saying that unless the country gets public finances into better shape than the Obama administration projects there would be “downward pressure” on its triple A credit rating. Examining the administration’s outlook for the federal budget deficit, the agency said: “If such a trajectory were to materialise, there would at some point be downward pressure on the triple A rating of the federal government.”

It projects that the federal borrowing is so high that the interest payments on government debt will grow to more than 15 per cent of government revenues, about the same by the end of the decade as the previous 1980s peak. This time the servicing burden would be harder to reverse, however, because it would not be caused by high interest rates but by high debt levels.

FT Alphaville mentions the following graphic depicting the future trajectory of America's gut-busting deficits and the potential to reverse them, which declines as it accumulates more and more and more IOUs. You can download the entire Moody's Aaa Sovereign Monitor from Zero Hedge (catchy title that):

If only someone could put the US out of its misery. Call it fiscal euthanasia. I generally don't think a US downgrade is imminent because Washington can apply pressure on the rating agencies. Insofar as it alone grants them a license to rate US debt, it would be easy to threaten disenfranchisement, effectively putting them out of the business of rating the vast majority of dollar-denominated assets [1, 2, 3]. So, while I wholeheartedly believe US sovereign debt is little better than the subprime junk credit rating agencies also deemed to be AAA, calling a spade a spade may have to wait. But deficits don't matter, right?

Euro Crisis? I Spit On Your "Crisis," Speculators

Well, you could see this one coming: I generally pooh-pooh arguments that Europe's common currency is as vulnerable as the US dollar. As I've said again and again, the troubles of Greece are real but were blown out in all proportion to the challenges faced by the Eurozone. The main difference is, when push comes to shove, the EU will rein in recalcitrant economies, while the US is free to do its usual practice of running ever-larger deficits to fix problems caused by running large deficits in the first place. In the end, the ever-stoic Germans will not let the project of European integration be cast asunder by serial fudgers of previous Greek administrations and other riffraff. In America, of course, deficit-addled riffraff run the show who would like nothing more than to put one over you. Even "Washington Consensus" fanatics of years past become deficit lovers in the weird universe of Washington.

At any rate, all I want to point out is that, yes, the euro is mounting a fairly impressive comeback in hopes that the Greek authorities have finally decided to put their foot down on fiscal folly by actually cutting down on government excesses. The hourly chart above shows a healthy bounce in the common currency. After briefly dipping below $1.3450, it has since rebounded past the $1.37 mark. Other signs of easing abound:

Greek sovereign debt jumped on Wednesday after the country announced an additional €4.8bn ($6.5bn) in cuts to its deficit. George Papandreou, prime minister, announced the new austerity programme, the third in three months, in the hope of impressing on other members of the European Union that it can rein in its massive deficit.

The 10-year bond yield, which has an inverse relationship with the price, shed 12.8 basis points to 6.038 per cent, its lowest level since February 12...Meanwhile, the spread or difference between the Greek 10-year note and that of the equivalent German bund narrowed to 291 basis points, its lowest level since February 11.

Yields on Greek 10-year bonds have now fallen from about 6.7 per cent to below 6.04 per cent in the past four days, helping with the country’s short-term cash flow. But bonds worth €20bn mature in April and May, meaning Greece will have to increasingly look to the markets. The government said the new cuts would be achieved by higher taxes on fuel, alcohol and tobacco, while VAT was also being lifted. Meanwhile, it would also make cuts to public sector wages.

Also, the IMF has given a seal of approval to Greece's plan of action. A few days ago, yours truly called for a euro bottom because dollar sentiment was hitting highs unseen since last year in US currency futures markets. Well, I'll be damned if that's not what's happening at the moment. Meanwhile, another recent post was concerned with how the sovereign CDS trading was about to be curtailed. There apparently is a feeding frenzy of sorts as those speculating in this instrument are loading up before mooted legislation to limit trade in these instruments comes into effect. The UK's top financial regulator, Lord Turner, is on the case:

Hedge funds are raising their bets against the euro amid growing fears of a regulatory backlash against their trading positions on the specific sovereign debt of Greece and other weak eurozone economies. Many of the world’s biggest hedge funds have become increasingly concerned about fierce criticism by European politicians that their country bets have heightened the crisis of confidence in some markets...

While playing down the effect of so-called “naked” purchases of CDS – buying credit default protection without ownership of the underlying bond - Lord Turner said that a ban on speculative purchases “is something that should be discussed”. He said: “It may be that even if you banned it, it wouldn’t make a big difference [but] there are questions as to whether you should be allowed to take out an insurance contract where you don’t have an insurable interest”.

So once more, I spit on your Euro-crisis, Eurosceptics. Be my guest and bet against the common currency. It utterly befuddles me how any person with common sense would prefer dollars to euros. Entrusting your money to an economolester seems like the road to hell to me and many others and recent moves seem to verify this common sense conviction.

Death to Speculators 2010: Credit Default Swaps

In 1997 during the Asian economic crisis, then-Malaysian Prime Minister inveighed against currency punts he thought were causing Southeast Asia's currencies to devalue more than warranted. Although he never said it--just something approximating it--"Death to speculators!" became a rallying cry for those who believed vile casino capitalists were gambling with the lives of thousands in hard-hit developing economies. In any event, Mahathir never quite lost his suspicion of currency movements.

Meanwhile, in 2010, European governments are becoming increasingly wary of sovereign credit default swaps (CDS). Basically, sovereign CDS act as "insurance" against the possibility that a government will default on paying its sovereign debt. Let us first begin with Wolfgang Munchau in the pages of the FT. Munchau cogently argues that CDS are not really "insurance" insofar as many of those taking out these contracts are not actual bondholders but, you guessed it, speculators who do not own euro-denominated sovereign debt. Hence, he classifies those as "naked" sovereign credit default swaps insofar as it is not bondholders of official debt who trade these contracts. Munchau calls for an immediate ban on "naked" CDS:

Naked CDSs are the instrument of choice for those who take large bets against European governments, most recently in Greece. Ben Bernanke, the chairman of the Federal Reserve, said last week that the Fed was investigating "a number of questions relating to Goldman Sachs and other companies in their derivatives arrangements with Greece". Using CDSs to destabilise a government was "counter-productive", he said. Unfortunately, it is legal...

A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies...

So why are we so cautious? From conversations with regulators and law-makers, I suspect they are not always familiar with those products, to put it kindly, and that they may be afraid of regulating something they do not understand...Banning products with ugly acronyms that nobody understands seems like unnecessarily hard work.

I do not want to exaggerate the case for a ban. This speculation is neither the underlying cause of the global financial crisis, nor of the eurozone's underlying economic tensions. But naked CDSs have played an important and direct role in destabilising the financial system. They still do. And banks, whose shareholders and employees have benefited from public rescue programmes, are now using CDSs to speculate against governments.

Let's turn to another FT piece which, actually, suggests that Eurozone governments are keen on clamping down on these trades as soon as possible:

These days, however, as the eurozone reels in turmoil, it is sovereign credit default swaps that are becoming the new political villain in Europe. This is because the Greek debt crisis has prompted the French and Germans to consider banning their use for speculative bets in the markets.

Greek CDS, which measure the cost to insure debt against default, have hit record highs this year, with politicians blaming hedge funds for driving up the price of this insurance and exacerbating the financial crisis in Athens by panicking investors. The drama has triggered complaints that some ruthless investors are manipulating these markets to deliberately sow panic so that they can benefit through clever trades. This, in turn, has led to European calls for much tighter scrutiny of this market. Last month, Christine Lagarde, the French finance minister, first suggested that policymakers could clamp down on the use of derivatives linked to sovereign risk.

Since then, German officials have also raised concerns and there has been talk of an outright ban on so-called “naked shorting” – or investors using CDS to make bets about sovereign defaults, without the need to own an underlying bond. This idea is likely to be debated by regulators and politicians linked to the G20 group of industrialised nations in the months ahead...

In 2007 it cost only $5,000 to insure $10m of Greek debt against default annually over five years. This year, it reached $425,000 at one stage. Even today, for economies such as the US, UK and Germany, the likelihood of default is judged to be almost non-existent. That differs from the corporate world, where there is seen to be a genuine default risk...

Yet, until last year, sovereign CDS tended to command far less attention in the derivatives world than their corporate or mortgage counterparts. This is because the risk of default on industrialised governments was considered minimal, making the need to hedge or speculate less important. Even today, the outstanding volume of sovereign CDS is dramatically smaller than that of mortgage or corporate CDS.

However, as concern about sovereign risk has swelled in the past year, hedge funds and banks have become much more active in the sovereign CDS market – and the price of these contracts has correspondingly started to attract more attention...

One big difficulty is separating what is a speculative trade from a genuine hedge against risk. Steven Major, head of global fixed income research at HSBC, says: “For this reason, I think plans to regulate CDS are unlikely.” Other bankers say regulators could simply insist a buyer or seller has a position in the underlying reference instrument or bond before being allowed to enter the CDS market. CDS transactions could also be taxed to make it more expensive to buy or sell them.

Lawyers say regulators could target certain types of CDS trade as market abuse. Simon Gleeson, partner at Clifford Chance, says: “They’ve built the mechanism [that is, bans on short selling]. It’s a question of whether they’re going to use it in this new war. If we get the facts on the ground, that someone is known to have made huge profits, then it would give the French and German governments the ammunition that makes it highly likely something will happen.”

Some bankers also note that the CDS market is very small, relative to the government bond sector. This has meant there has been little evidence of the price of derivatives contracts affecting sovereign debt prices. Certainly, at the height of the Greek crisis at the end of January, CDS did not lead the bond markets. Rather it was the other way round as government bond yields rose faster and higher than CDS...Nevertheless, these points are unlikely to calm the fears of some continental European regulators, which worry that sharp swings in CDS prices could amplify panic in the eurozone in the uncertain months ahead.

The impediment here is identfying what is a "covered" as opposed to a "naked" sovereign CDS. What constitutes ownership of sovereign bonds or real exposure to risks of sovereign default? It's what needs to be determined in order to create effective legislation. Plus, there's the ever-thorny matter of getting a global consensus to implement these bans. Otherwise, regulatory arbitrage will remain a possibility.

Lastly, here is the chart comparing CDS and actual sovereign bond market activity:

Assaying the Fate of the Gravity Defying Dollar

As a standard-issue dollar bear, I am once again on the defensive as the greenback is gaining against the euro largely by default. That is, it is not the common currency at a time when Greece's fortunes are very much up in the air and knock-on effects lurk for other marginal Eurozone economies. Nevertheless, I ultimately believe that while Europe's fiscal health going forward measured in terms of national debt as a percentage of GDP are nearly as dreadful as America's, the former will eventually come out ahead for a number of reasons. First, there's the sheer size of America's forthcoming debt bonanza. Brother, can you spare me, say, $99 trillion? Second, there's the evident lack of a disciplining force in America. While the EU eventually cracked down on Greece, there's no such counterpart telling the US to shape up.

In any event, I do suggest you read Reuters' account of when the dollar will (somewhat inevitably) come back to Earth. What follows are the ending excerpts, though the rest is indeed well-worth reading:

Recently, the White House even pledged to double U.S. exports in five years, a goal that economists say would require a significantly weaker dollar. It's not clear how much other nations, particularly China, will go along.

In the post-Cold War era, currency talks are the rough equivalent of nuclear arms reduction negotiations. In language evocative of the U.S.-Soviet face-off, Chinese military officers have proposed punishing Washington with "a strategic package of counter-punches" that includes dumping U.S. government bonds. While the military plays no role in setting China's foreign exchange holdings, the comments underscored the rising level of tension and mistrust between the two powers.

Nicholas Lardy, a senior Peterson Institute fellow, dismisses such threats, noting that China's vast dollar wealth would start to evaporate and its currency to rise if it started unloading Treasuries. "The Chinese are in the classic dollar trap. They have so many dollars that they can't diversify," he said.

Marc Leland, head of Leland & Associates and deputy undersecretary of the Treasury during the first Reagan administration, said: "It's only leverage if one thinks they can pull the trigger. I don't think they can."

Morgan Stanley Asia chairman Stephen Roach isn't so sure. He said that if the U.S. eventually resorts to trade sanctions against China -- not unthinkable in a U.S. election year, with the unemployment rate near 10 percent -- Beijing would likely retaliate.

China might boycott a Treasury auction, he said, which could cause the dollar to plummet and interest rates to spike. "I spend a lot of my time talking to the Chinese about that, and if it happened, I think they would feel compelled to stand up and take strong retaliatory actions, even though, yes, there would be consequences for them as holders of Treasuries and other dollar-denominated assets," Roach said.

Merk, the investor who is betting against the U.S. currency, said the dollar's future may depend on Washington assuming a more humble attitude. "Once you believe that you are better and greater than everyone else, you have a problem," he said, "because today, the competition is right around the corner." That may be especially true for any winner of a reverse beauty contest.

Enron the Play? You Better Believe It

Are you kidding me? Did we take advantage? That's what we do, that's how the world works! If you want an objective morality, you're living in a dream. So when you ask, 'did we take advantage?', I hear, 'do you make a living?', 'do you breathe in and out?', 'are you a man?'! Yes, we took advantage. And the only difference between me and the people judging me is they weren't smart enough to do what we did. Now, are you gonna judge me or are you gonna help me? -- 'Jeff Skilling' in Enron the Play

Samuel Johnson is attributed with saying that a person who is bored with London is bored with life. Well, add this to London's brilliant parade. Some of you probably know this already, but in case you don't, they've been staging Enron the Play since November of last year and it has just extended its run based on initial success. This play mixes factual elements about the Enron story--routing Internet broadband through pipelines originally intended for delivering energy--with more fantastical takes on true-to-life elements such as CFO Andrew Fastow naming various investment vehicles designed to inflate earnings and conceal debts after Star Wars characters. So, it's a mix of fact and fiction. For good measure, they even throw in a love interest for the disgraced Jeff Skilling.

The play has been receiving quite positive reviews from the business and mainstream press, so yes, it's definitely something I have to see. If you are passing through London and have an interest in financial shenanigans and musicals, it's a must-see. Nixon in China? What we have here is more like artistic license with a heaping financial pretence. They even have an Enron Education Resource Pack [?!]

Given Enron the Play's success, I am once again shopping around my very own Tony Blair: The Musical!