No Surprise Here For Me

It was revealed yesterday that the Austrian bank - Erste Group - had $5.2 billion in undisclosed Credit Default Swap (CDS) derivative losses sitting on - or rather "off" - its balance sheet.  Here's a link from zerohedge.com if you would like to read about the details:  LINK

To zerohedge and its slavish readers, this is being described as a "stunner."  But I've been arguing all along that the big banks have off-balance-sheet problems that are potentially far bigger and more destructive than what is revealed by the "on-balance-sheet" public financials.  Indeed, this is no "stunner" to me - in fact I would bet good money that the true economic, what's the best bid for size/mark-to-market, losses are far larger than $5.2 billion.

What is a "stunner" to me is that the research arm of the Erste Group has written some of the most compelling and thorough research available in support of the precious metals market:  In Gold We Trust  One would think that an institution that so thoroughly understands the gold market and the dangers of the current fiat currency system would also understand the concept of "counter-party risk" and the fraud that belies the entire OTC derivatives market.

For some reason zerohedge wants to blame the Erste Group issue on its auditors.  To be sure, the auditors probably know a little about the true condition of the CDS portfolio.  But they operate within the confines of accounting and regulatory rules as set forth by the Government.  Furthermore, accountants are just counters.  It's not their job to go find out the true market values of these securities.  If they conduct a sample audit, that would just consist of calling up the CDS trading desk at maybe two or three trading firms that make markets in these securities and getting price indications.  Trust me, having traded junk bonds for 9 years, which are illiquid but considerably more liquid than CDS securities, a market "indication" often bears no resemblance to the true value of an OTC derivative, especially if the Erste Group (or fill in the bank U.S. TBTF bank) wanted to unload a big position in any specific security.  And THAT dynamic is one of biggest problems with accounting for these types of securities.  Its part of the massive accountability problem that has been destroying our system for quite some time.  One would have thought that this would have changed after the damage inflicted by Long Term Capital and Enron...

Now, with the Erste Group we're talking about $5.2 billion.  The Erste Group's balance sheet (assets/liabilities) is roughly $280 billion in size.  And Erste is not exactly a big player in the OTC derivatives market.  Let's look at one of the big U.S. TBTFs and just do a "broad stroke" comparison.  Bank of America, for example, has a $2 trillion dollar balance sheet - over seven times the size of Erste Group.  And Merrill Lynch - now owned by BAC, was one of the bigger players in the OTC derivatives market.  So just on a "scale" basis, it's very safe to say that BAC is likely sitting ten times the amount of undisclosed losses in its derivatives book as the Erste Group.  I would bet a lot of money that the actually losses are substantially larger than that.

But if you want to look at the work published by Wall Street research analysts showing the "financial ratios and condition" of U.S.  TBTFs, nowhere will you see anything mentioned about off-balance-sheet liabilities.  These wind-up circus monkeys simply transpose the GAAP balance sheet data onto a pretty spreadsheet and say "see, the water is fine, c'mon in."  And then this garbage gets regurgitated in the financial media and through the world of financial advisors and brokers who want to take your money as they mindlessly reference this highly flawed research and tell their clients that the U.S. banks are in good shape...it's pathetic.

But the golden truth of the matter is that lurking below the surface are financial nuclear bombs that could detonate at any time.  See Bear, Lehman, AIG for what this looks like.  And 2008 will have been "the good old days" once this daisy chain of disaster is triggered. Today there's not only the massive exposure to financial sector Credit Default Swaps, there's the massive exposure to sovereign debt CDS.  AND, the OTC derivatives holdings of the TBTFs are much larger than it was in 2008.

So yes, maybe the Erste Group disclosure was a bit of a surprise to some - and a "stunner" to the editor of zerohedge - but if we really dig for the truth and take a look at what's going on in our own backyard, there are not "stunners" buried, but massive catastrophes.

Today's Market Action Reflects The Latest Systemic Farce

Does anyone take the Merkel-Sarkozy dog and pony show seriously any more? Perception management is not a solution.  (see link below for quote source)

When I got onto my futures software yesterday and saw that the S&P 500 futures were up quite a bit I began to look for any credible news that might be the source of the ebullience.  Of course, the partial "bailout" of Dexia was not good news, especially with regard to paper currencies, and the bond market is rewarding Belgium for its action with higher sovereign bond yields today (that's a negative, in case you were wondering).

Then I saw that Merkel and Sarkozy, who were putting their heads together to solve the EU's problems over the weekend, had issued a statement that they would make sure that the EU Einsteins would eventually have a plan that would prevent the big banks from collapsing.  They would issue their plan for that plus saving Greece in three weeks.

Huh?  Seriously?  For whatever reason, the equity markets in Europe and the United States seem to be willing to suspend disbelief and put more blind faith into empty rhetoric.  Sounds like voters in the U.S. who still think Obama is doing good job. 

So I queried someone who's view and market knowledge/perspective I highly respect and who has plenty of his own skin in the game with this:  "Your thoughts here?  My inclination is that this is a low volume holiday short-cover ramp on basically no news and that we will sell-off either this afternoon or later this week.  That Merkel/Sarkozy statement is full of 'fluff.'"

His response was "my thoughts exactly," and sent me link to this brief commentary by Charles Hugh Smith, who I rarely read but with whom I often agree: 

The problems of the global economy are not based in perception, but in the reality of prices, balance sheets and income statements, vast concentrations of wealth and power, precarious systemic imbalances, ruthless exploitation, and command economies mismanaged by Central State/Bank policy and manipulation. Sarkozy and Markel's absurdist theatrics--"we have a secret plan right here in our pockets"--are not just incredible, they are uncredible

Here is the LINK  The same "gut" reaction I had when I saw the "Merkozy" statement last night and now I feel even more strongly about this conviction.

What this means is that I expect the markets to retrace today's theatrics once everyone in the U.S. has returned from their Columbus Day break.  I still believe there is a lot of disappointing and bad news ahead of us and the markets will soon reflect this by heading south again.  What I do believe is that the probability increases by the day that the next big downside "event" will be reflected in the markets by a massive rush into physical gold and silver.  This has been going on all along in India/Asia/Russia/Middle East anyway, while the short term-oriented U.S. funds dump all of their paper gold and silver (futures, GLD, SLV).

Hold on tight because once the downside volatility in the metals has "washed out," the upside will be breathtaking.

My Take On Today's Jobs Report

Aside from the fact that - for the most part - the report is nearly completely meaningless because it's so blatanly manipulated, here is a chart that is so horrifying, you can probably enlarge it and use it as one of your Halloween decorations.  Happy Halloween those who are unemployed and actually would like to find a job because they're sick of living off the Government tit:

I may have a post tomorrow if I don't get too distracted by all the great college football on!

Hugo Chavez Issues A Wake-Up Call To Paper Gold Shorts

Venezuela will begin repatriating its gold reserves from Western nations by mid-November, the central bank head said on Wednesday...first boat laden with reserves would be back by mid-November. "It will be here as soon as possible, no later than in a month-and-a-half," he said...Venezuela's gold abroad is in England, Switzerland, the United States, Canada and France

Here's the reuters LINK

I've been wondering when we would next hear about this ever since Chavez first announced the move during the summer.  Interestingly, the nations who hold VZ's gold are the very same nations who participate in active "fractional" bullion safekeeping storage operations.  This means that there are many multiples of paper claims - futures, forwards and OTC derivatives - issued against the actual known - i.e. "officially reported" - physical inventories held by the bullion vault banks in these countries. 

Anyone worried about counter-party default risk?  Ask Madoff investors and AIG counter-party banks (Goldman, JP Morgan, et al) how they feel about counter-party default risk...know where your gold is?

No Longer A "Barbarous Relic," Gold Is A "High Quality Liquid Asset"

The initiative is supported by the World Gold Council, who recently submitted evidence to the Basel Committee for gold to be included in banks' "Tier 1" assets by European banking regulators, recognising gold’s growing relevance as a high quality liquid asset.

The "initiative" refers to the decision by LCH.Clearnet (London Clearing House) - the world's largest clearing agency for fixed income securities - to accept gold as collateral for "clearing" trades.  This is huge. Here's the press release:  LINK

For those who don't know, every trade for every security needs to "cleared" - i.e. securities and cash need to be mechanically/electronically delivered and title to securities transferred.  The clearing house steps in matches the buy-side and the sell-side, making sure that both the funds to pay for the trade and delivery of securities occurs (let's keep it simple and not introduce naked shorting and all the rule violations that go on, especially in the U.S. and Canada).  If one side of the trade fails, the clearing house - in this case LCH - assumes the liability.

In other words, in exchange for guaranteeing both sides a trade, clearing firms require collateral deposits by anyone who wants to be a member of that particular clearing firm (i.e. these days anyone who wants to trade).  And we're not talking about just 100 share lot daytrader trades.  Typical institutional "block" bond trades are in the 10's of millions.  Big money.  Big counterparty risk. If you look at your own account, every security position in there will have the "fingerprints" of a clearing agency on it.  This is big business with big dollars involved and big risk if a big counterparty to the trade fails before it clears.

The acceptance of gold as collateral (remember the term "good as gold?" It's back) is beginning to proliferate.  JP Morgan announced several months ago that it would accept gold as collateral for loans;  the CME - parent of the Comex and one of the largest futures trading exchanges in the world - started accepting gold a year ago.  Another very large, global firm - ICE (Intercontinental Exchange, which trades futures, OTC securities and also functions as a clearing agency) made this move right after the CME did.  And the Russian Central Bank, within the last year, announced that it would accept gold as collateral in its member bank lending transactions.

Everyone see the trend here?  What is slowly creeping back into the mainstream business world is this idea of gold as a currency.  It took about 40 years from the time Keynes declared gold to be irrelevant until the world went fully fiat in 1971.  It's taking even longer for gold to be reinstated as the ultimate currency, but the truly sophisticated global market engineers are now moving in that direction (notwithstanding Donald Trump, who is not sophisticated but who recently announced that he would take gold as collateral in business deals - we all know he has plenty of worthless, bankrupt casino chips that no one will take).  Surely everyone understands by now that Keynes' economic theories are a complete failure...

Myself and a colleague back in 2002 predicted that one of these days we would be able to buy a dream house for less than 10 ounces of gold.  Based on what I'm seeing in the housing market and the developing markets in gold, I am still standing by that view.  The question in my mind is not "if," but "how many ounces less than 10 it will take?"

At some point, I don't know when, there is going to be a global rush into gold - when the majority of businesses and the masses begin to understand why these wealthy, sophisticated financial operators are now using gold in their mix of business - that will make everyone understand why some very bright people are forecasting eventual prices for gold that are unimaginable to most people who refuse to believe or accept what is going on in the global financial system.

"New Price"

I haven't given the condition in the housing market a good beating lately.  So, with a limited amount of time to write today, I wanted to share some thoughts/observations.  To begin with, with interest rates approaching zero in the area of the Treasury curve where mortgage rates are set per Fed policy, one would think that we should be seeing some sort of recovery in the housing market.  I think, to be sure, we saw an ever-so-brief-and-small bounce in prices and volume in some markets early in the summer.  This was likely fueled by a temporary drop in overall inventory in some markets, which occurred from the temporary slow-down/delay in foreclosures while the banks had their wrists slapped by the regulators.

Having said that, we never really saw any real month-to-month or year-over-year "bounce" in overall home sales this summer.  In fact, in the "heart" of the selling season this year sales declined.  As I eyeballed the weekly mortgage applications reports this summer, it looked like there was an occasional week-to-week bounce in the applications for purchases, but the majority of the mortgage activity, since rates were falling, was in refinancing.

The reason I was thinking about the housing market is that, over the last 5 or 6 years, I've grown accustomed to making a visual note whenever I'm driving around the metro-Denver to observe the number of "for sale" signs I see, as I tend to drive through a lot of different areas over the course of any given week.  Denver has always been considered a "homogenous" representation of what is going on demographically economically across the country. What I've noticed recently is that, despite the fact that the primary selling season is over, there are still a lot stale "for sale" signs and - at least in the area of Denver where I live - a lot of new signs have been put up in yards since Labor Day weekend.  And now I've been noticing multiple listings per block.

In addition,  I've been noticing a lot of "new price" or "price reduced" signs.  To be sure, it can be argued that my sample size is limited or not "random."  But I have been noticing this all over the city. One particular house was originally offered at the beginning of the summer for about 10% below the price it could have received at the peak of the housing market (yes sometimes I pull the tear sheet to observe offering prices).  I noticed yesterday a "new price" sign and the new price was 10% below the original price offered and the seller had changed brokers.

Now, there's a lot of "randomness" and statistical "noise" in just one observation like that.  But what the proliferation of signage as we go into the slow season for home sales tells me is that sellers are starting to get nervous/desperate again.  And at some point we are going to see a meaningful percentage of the "shadow" market transform into the actual market and prices will have to be competitively reduced in order for the most desperate to move their home.

Coincidentally, a colleague sent me this article on the precarious financial condition of those still making their mortgage payments and gainfully employed: 

One in three Americans would be unable to make their mortgage or rent payment beyond one month if they lost their job, according to the results of a national survey taken in mid-September...Sixty-one percent of those surveyed said if they were handed a pink slip, they would not be able to continue to make their mortgage or rent payment longer than five months.

Here's the LINK

Unfortunately, it looks like the housing market is getting ready to go into another downward death spiral.  Anyone who thinks that this is the bottom right now is living on another planet.  Even more unfortunate, I expect that Obama will exercise his ability to use Fannie Mae and Freddie Mac to try and prevent this death spiral with a massive Taxpayer subsidized mortgage refinancing program.  He's already hinted that he can do this without Congress.  He also claims that it won't cost this country anything...

Don't believe that any more than you would be willing to believe that the housing market has bottomed.  Obama's ploy will be nothing more than another whorish ploy to get votes as 2012 approaches.  The truth is, however, that we are on the verge of heading into another big systemic black hole that will make the one we went into in 2008 look mild...got gold?

Will Morgan Stanley Be The REAL Tipping Point For The U.S.?

GOLD -- Is not like any other asset.  Gold represents eternal wealth.  I accumulate gold, but I never sell it.  In a severe bear market, the only item that you can trust absolutely to survive is gold.  Gold is the ultimate insurance policy, which is why I don't worry about it and am not tempted to sell it when it declines.  - Richard Russell

Forget Greece/Europe.  To begin with, California alone is a bigger problem than the "PIIGS" less Spain, collectively.  Then throw in Illinois.  With Greece/Italy, we know what the Too Big To Fail Bank exposure is "on balance sheet."  And it doesn't look nearly as bad as that of the European banks.  HOWEVER, can someone please tell me what the "off-balance-sheet" exposure is?  We don't know.  What we do know is that the credit default swap and general derivatives holdings of TBTF's have gone up substantially since 2008.  This is largely an unregulated market and the accounting for it is largely hidden from sight, using off-balance-sheet accounts for which there is very little regulation and oversight - and almost no enforcement of that which is actually in place.  This off-balance-sheet "stuff" is what caused the de facto bank collapse in 2008.

This brings me to Morgan Stanley, the stock chart of which I have been watching for several weeks now, as it has performed even worse than its comparable banking rivals, like Goldman, JPM and Citi.  I saw an article last week which shed some light on this, and I didn't save it so I don't have a link, but it turns out that, including its off-balance-sheet exposure, Morgan Stanley is technically hugely insolvent if you were to do an honest mark-to-market valuation of its balance sheet.  And then there's this news out from the Financial Times which cites hedge funds who are pulling their business from Morgan Stanley: 

Morgan Stanley’s stock fell more than 10 per cent and the price of credit insurance on its debt rose to the highest level since early 2009 as nervousness around the bank caused some hedge fund clients to reduce their exposure, people familiar with the matter said.

Here's the LINK  Recall that in 2008, this was one of the red flags with Bear Stearns before it collapsed.  The reason you don't want your account with Morgan Stanley, or any big bank for that matter, if it collapses is that these banks take your securities and hypothecate them to banks, who lend them money against your securities.  In other words, broker/dealers use your securities as a source of liquidity and short term funding.  They can, in fact, leverage your property up to 140%.   SIPC doesn't cover the kind of numbers this game is played with by hedge funds.  So any hedge fund that doesn't want to stand in line and wait for their turn in the liquidation line will pull their funds from Morgan Stanley, thereby making MS scramble for liquidity.  It's an ugly, irreversible spiral once it's set in motion.

To circle back to my opening paragraph, IF in fact there is a run starting on Morgan Stanley, this could easily set off the kind of domino effect created by the Bear Stearns collapse in 2008, on whom the plug was pulled in March 2008.  But we didn't see the full effect of the behind-the-scenes damage until AIG collapsed and the former Goldman Sachs CEO who was Treasury Secretary jammed through the bailout of Goldman, et al.

I honestly believe that, short of a massive new printing program rolled out by the Fed and the ECB, we are going to see a systemic collapse that will dwarf that of 2008.  Here's a little color to back my view from the Telegraph UK, which is probably the most objective source of mainstream media in the anglo world:  LINK
 
All of the problems in 2008 were either completely "papered over" and discharged or overtly and not-so-overtly shifted to the balance sheet of the U.S. Treasury aka the Taxpayer.  None of the sources of the problems were fixed and many have become even more severe, such as the derivatives and bad asset problem.  What's even more severe is the counter-party default risk, which is why hedge funds are leaving Morgan Stanley.  This is the "tell-tale heart", in my view.  Interestingly, and before I saw the FT piece on MS today, I was discussing with a colleague about how for some reason this concept of "counter-party risk" has escaped the attention of the media and bubblevision gurus, when in fact it should be one of the main areas of focus for anyone making a serious attempt to either clean up the system or avoid disaster.
 
Given that no one will ever clean up the system short of complete collapse, here's what you can do to insulate yourself as best as possible.  Make sure your brokerage accounts are with non-bank brokers who don't do much in the prime broker area.  Charles Schwab and Fidelity would be my suggestion.  Second, move as much of your paper (cash) wealth as possible into gold and silver that either you safekeep yourself or you know damn well is not being hypothecated or used in some fractional scheme, like GLD, SLV, Kitco, Monex, etc.   If you're worried about gold, please read this commentary from the CEO of Seabridge Gold, who succinctly explains what happened over the last two weeks and why gold actually doing what it's supposed to be doing:  LINK