Wednesday, April 28, 2010

LEH Redux?

"History doesn't repeat itself....but sometimes it rhymes"

-Mark Twain

Is Europe about to re-enact the Lehman Brothers experience? At the moment it sure does feel like it. The sort of slow-motion collapse that Greece is performing is eerily reminiscent of the last days of Lehman, complete with the breezy assumption in some quarters that the authorities would ride to the rescue.

After all, it was only a few months ago that Greece was fighting off yield hogs desperate for some 6% lovin'....remember those €25 billion worth of bids for the 5 year issue in January? That's now looking like a mistake similar to Dick Fuld playing hardball in discussing a sale of "his" bank in '08.
And just as LEH slipped through the Federales' safety net in '08, unleashing a hurricane of unintended consequences, so too has Greece foundered as the Europeans dither over a possible rescue package. is left to wonder whether Angela Merkel plays the violin.

It's really a no-win situation, of course. The prospect of pre-emptively bailing out what's popularly perceived to be a nation of lazy tax-dodgers is a political no-go in Europe's core. But financial black holes- whether they be in banking or sovereign balance sheets- are like cockroaches: there's never only one.

And just as Fannie begat Lehman, who begat AIG, who begat Merrill, who begat Citi (you get the picture) too might the collapse of Greece (a seeming inevitability now) herald similar difficulties for the rest of Europe. The last two columns in the table below show the change in 2y yields for various European sovereigns on the year and over the last month. Those that have risen are helpfully coloured red; unsurprisingly, Portugal and Ireland are under the most pressure.

And while the ECB can blithely ignore the ratings agencies when it comes to their collateral rules (which are going to take on a distinctly "make it up as you go along" flavour), private sector investors cannot. S&P's 3 notch downgrade relegated Greece to junk, and heralded its ejection from some European bond indices. Were Moody's to follow suit (and how can they not? They're now 4 notches above S&P on a country with 18% 2y yields!), Greece would leave more indices. The upshot is that real money managers benchmarked to these indices would have to sell all of their Greek bonds if they have (or had) not already done so. Bonne chance, mon brave!

And so we come to the euro, which has plumbed its lows of the year but remains some 7c above its 2008 crisis lows. Hard as it is to believe, the CB bid has remained (though might some of that be covert intervention from the Eurozone via the BIS? Enquiring minds want to know!), thereby dampening the sell-off that everyone expects.

Given all that's happened in Greece and elsewhere in Europe, EUR/USD has actually been a surprisingly difficult trade; it really ought to have fallen much further, more directly. But then again, what's new? Perhaps at this juncture equities are a better bet; divergence between the US and Europe has been steady all year, and seems very likely indeed to continue as Europe shoots itself in the foot.

Yesterday the story surfaced that Europe would convene a "Greek Aid" summit on May 10, with possible payouts a week or so later. All well and good, of course, but real time events are moving substantially quicker than policymaker negotiations. Again, it all sounds vaguely's Lehman redux.


t said...

Surely Greece is Bear, and it's Portugal or Spain that's Lehman?

Nemo Incognito said...

t I disagree - Greece is insolvent, Bear was (at the time) a liquidity driven event.

judyjl said...

greek tragedies always take forever to play out and besides, after the fiasco of the volcanic ash incident, the EU probably isn't dumb enough to sit back and watch - hopefully.It's the sharks circling that's worrying!

Macro Man said...

In terms of timing, I think Ireland = Bear...first one to go, but dealt with and (apparently) contained at the time. Greece, like LEH, has been a slow motion crisis for months with policymakers dithering.

2y apparently traded 38% today. They are toast.

Nemo Incognito said...

I'm still kind of amazed how cheap puts are across the board..... usual case of the equity guys not talking to the credit guys.

Skippy said...

Great note MM,

I have been absolutely amazed that the EUR has not fallen further - I guess it must be reserve managers providing support?

It also amazes me how many investors (people at my firm included) believe that will be 'contained' (even after yesterday's price action).

My blog alter ego is based on Skippy 'the bush kangaroo'- a TV show in Australia in the 1970s. When I was little I thought that animals could communicate with people and operate radio equipment. Skippy was always there to save the day.

The persistent belief in financial markets that events like 'Bear, Lehman, Thailand 1997 and Greece will remain contained has always been up there with a belief in the tooth fairy, easter bunny and skippy the bush kangaroo.

Rossco said...

"tch tch tch"
"what's that skip !?"
"tch tch"
"The repo system's about to take it in the arse? crikey !"

Right Field said...

Set Up Leads to Trapped Longs or Pain Trade

After another overnight trade of sovereign spread widening and noted Financial equity weakness, one has to ask the question why equity investors are not listening to credit more seriously. The simple answer is that the majority of US investors are stimulus “desensitized”. Point being, the FOMC announcement will once again provide real money with confirmation of the liquidity bubble and help the view that this recovery is the same as past ones. Unless there is a growth scare or change in the rate structure, real money will hold the view of a contagion relief rally and argue against a material equity correction due to the trajectory of positive data and earnings. The risk becomes real money is a buyer post the event which increases the likelihood of being trapped long should contagion accelerate to a point that real money cannot handicap. It is important to recognize that the professional community is now sensing the first real opportunity for a material correction. The divide between the two investor bases is very noticeable and this set up either leads to being trapped long or a pain trade higher, either way the move will be stronger than most can handle.

Nic said...

You are right RF but doesn't seem like they are listening: