A financial crisis in the Eurozone has been postponed due to the efforts of a gaggle of politicians overcoming the urge to assault one another and instead come up with an incredible plan to stave of immediate default by Greece and potential default by peripheral Europe.

Unfortunately the plan misses the most important point. To understand this, we need to understand the Chapter 11 process in US bankruptcy. Basically, the basis of a debt restructuring in the case of an indebted and distressed enterprise is whether the business is viable in the first place. Only then is a new capital structure proposed. The analogous question therefore is, is Greece a viable economy in current form and if not, what needs to be done to make it a viable economy. We are not talking about Greek debt yet, only if it is a going concern. The answer to the question is, no, Greece is not a viable economy in current form and what needs to be done is to have a viable tax collection mechanism as well as structural reform in the form of a 30 – 40% deflation in Euro, or less painfully, a Drachma that can be immediately marked to achieve such a deflation. This is to make Greece competitive. Any debt restructuring without such ‘structural reform’ is merely refinancing a non-viable economy.

So it is a good thing that markets are rising once again. We need higher valuations to begin shorting. Again.

What should we be buying or selling? As markets rise, it makes sense to start shorting cyclicals again. The natural candidates will be expensive Emerging Market listings of businesses exposed to Europe and the US. The usual suspects are the exporters. The natural candidates to be buying remain in the resilient luxury sector as well as in the export sectors exposed to Emerging Market economies but listed in depressed developed markets such as Europe. Its an old story that will one day reverse but for now the game of chicken carries on.

Has anyone read the actual Euro Summit Statement?

Item 3, The EU must improve its growth and employment outlook… Very laudable. A roadmap to achieving this would be even more useful.

Item 4 is a statement of affirmation to continue with fiscal consolidation and reform. What kind? You mean like Maastricht? Well there were no details so we can optimistically hope for Maastrict type criteria or pessimistically wait for Godot.

Item 10 is an admission that the only chaps responsible for policing the austerity policies in Greece will be the Greeks. Time will tell how useful this is considering the Greek’s abilities thus far in tax collection.

Item 12 actually has numbers in it which is a guarantee of 100 billion euros of additional financing till 2014. The haircut on current Greek debt is also specified here, a whopping 50%. The precise language speaks of an invitation to develop a voluntary exchange at a nominal discount of 50%. The appropriate response of a creditor might be, no thanks I mate. You can pay me the whole thing. Presumably the EU has convinced the banks to agree but how about other bond holders? And what about CDS? Perhaps someone would like to consult ISDA on their take on this so-called voluntary exchange.

Item 13 is a step in the right direction. It commits the future cash flows of Helios and other privatisation revenues to reduce indebtedness. Hope they can make this stick. Especially as they plan that these cash flows will restore the EFSF. Cash trapping and cash waterfalls are a great concept for security and risk tranching.

Item 16 has all member states solemnly reaffirming their inflexible determination to honour their individual commitments to unspecified reforms and fiscal conditions. Its more useful to specify something you require unwavering adherence to. As opposed to ‘I promise to be good, honest.’


Item 19 talks about leveraging the EFSF basically requiring the EFSF to provide subordinated debt financing to support further leverage. This would provide more firepower to the bailout efforts. Consider this, however, that the EFSF commands a AAA rating, alright, so that means they are as solid as some mortgage backed CDO tranches, but by providing subordinated financing to insolvent sovereigns, the potential for loss becomes significant it not high. Even the a ratings agency would not be so blind as to not downgrade the EFSF. Providing guarantees to the EFSF would render it a mere conduit. The Germans and French may as well wire cash to the Greeks. The administrative costs that would save are significant.

Item 21 is a bit precarious. It calls for the Eurogroup to finalise terms and implementation in November, basically implying that terms have not been finalized and that nothing is yet under implementation.


Items 24 through 29 are statements of intent regarding economic and fiscal coordination, not a concrete plan. The intent is laudable but there are no action points.

The rest is governance which the Euro members can spend up to March 2012 debating.

Not a mention of the 1 trillion euros.

But markets are up today and not by a bit. Its total and utter relief that the Europeans have at last found resolution to the credit woes of Greece, Italy, Spain and Portugal. For Greece at least there is a respite. But while they remain in the Euro they are commercially inefficient and are likely burning through the capital lent them. Time will tell.

The Euro Summit Statement is a true product of Brussels, long on words and short on details, very few numbers, very few action points, very few deadlines, and lots of rhetoric about principles, broad objectives and a warm fuzzy feeling. For now the markets have forgotten the fear of the last 2 months. But absent a more well defined, clearly specified, quantified and milestoned plan, we’ll be back here if not in months then inside of 3 years. Bet on it.

I’ve been in Asia for a year now and I still don’t get the double handed business card pass. When an Asian does business in the UK, I don’t see them in bowler hats and tails with a James Smith cane or umbrella. Only James Bond villains dress like that. So I have to assume that any gwei lo in Asia bending over at the waist and proferring their business card like some sacred offering must be some kind of villain.

Its also highly impractical. In a large group I tend to deal my cards out like a croupier at the Rendezvous Club. In smaller groups I use a single hand exchange where I deliver between thumb and index and receive between index and mid. The counterparty can symmetrically engage. Its quick and efficient. If everyone in the room practices the double handed delivery we’d take all day to exchange business cards. And if we also have to bow, the likelihood is that the taller gwei lo is going to head butt the oriental on the way down. In my book assaulting a counterparty is not a good start to a business relationship.

The Occupy Wall Street protestors are dreaming if they think they’ll find any perps in daylight or that signs and slogans are a substitute for garlic, a crucifix, holy water and a sharp wooden stake.

But they miss the point. Principal businesses but risk shareholders’ capital which while dastardly only punishes those wealthy enough to own shares or silly enough to entrust their wealth to a fund manager or pension trustee.

No. The villains are those who run agency businesses. These are the chaps who insist that they work for you and your interests while placing rather too big a bet on red with your money while the croupier chants les jeux sont faits. Generally I avoid eating food cooked by emaciated botulism-wracked chefs. If you want to represent me, put up some capital ahead of me or alongside me. Don’t ask me for trust as refusal may offend.

When principal businesses blow up, its suicide with collateral damage. I’ve yet to see an agency business fail. When they do fail, they fail their customers, which is a bit more like premeditated homicide.

Ask the investors who owned AAA CDOs, securities sold to them by an agent, constructed by some hedge fund manager looking for unsuspecting prey, and with a shelf life shorter than sashimi on a tropical afternoon.

Look at the conspirators after the fact, the entire distribution chain which ends in bank sales desks and relationship managers stuffing German banks and insurance companies as well as private high net worth individuals alike. This is old news but these are crimes that remain unpunished.

Decrying the bailouts is barking up the wrong tree. Unless one is happy to live with more Lehman style collapses. And why not? Why has the capitalist system lost its stomach for creative destruction? Why are we trying to save every lemming like bank from a Greek default? Because they helped us buy a house we could not otherwise afford? Oh. That’s why We have to bail Them out? Fair enough then.

String up the central banks. Each and everyone is trying to engineer the right amount of inflation to erode the huge pile of sovereign debt. Controlled demolition is best left to engineers not central bankers. Recall how they collectively missed the last blow up royally when even a child looking at the Miami skyline could tell you that the cranes hadn’t moved an inch in hours. These central bankers mean to debase the money that even now sits precariously in your bank account as they go about printing away government debt. These are the chaps who cut interest rates and extend massive swap lines every time a Golden Sacks or Morgue M Stanley threatens to go belly up. Phil Silvers’ Sgt Bilko did this once at a casino. In the end someone stopped giving him money and gave him a revolver instead. All suicidal tendencies magically vanished. I’m sorry but a golf game where every third shot is a mulligan simply isn’t cricket. Its not even bloody golf.

And next time an American wants to buy colorful plastic novelty items made in Shenzhen, hold the vouchers, pay for it with real money instead please. The Americans misunderstand the Chinese. The Chinese couldn’t care less about the exchange rate beteen US treasuries and RMB, they care very much about the exchange rate beteen US treasuries and stuff made in the USA. Think about it. The Chinese are the ones who got the raw deal. They thought they were exchanging 10 thousand pairs of cotton knickers for an Apple iPad. Now its going to be 250 thousand pairs of knickers. And the iPads are being made by a Korean company with a factory in Guangdong anyway. You don’t see the Chinese Occupying PuDong or TianAnMen do you? Granted the last time they tried that it didn’t go too well.

Advice to Occupy Anything movements. Anyone who’s ever run up a ton of debt to buy a house they couldn’t afford, clothes they could never fit their lardy behinds into, cars they never had the reflexes to drive, or other novelty paraphernalia, should pack it up and go home. Do some homework. Learn some finance and economics; not from CNBC which thinks its all about handwaving, yelling as loudly as possible and proclaiming the end of the world as we know it on the eve of every recovery, learn it from first principles. Its not that hard. If you borrow you have to repay. No matter who you borrow from, ultimately you only borrow from your own future. Its that simple. There is nothing wrong with the American dream but there is no need to turbocharge it with recreational drugs such as a Home Equity Line Of Credit. And don’t take all that the politicians are saying at face value. Vote wisely. America’s bipartisanship is an ugly manifestation of what happens when the pie shrinks. The Europeans disarray is the manifestation of the desperation as the ship sinks.

We all lived beyond our means. We were aided and abetted by those who lent or invested beyond their means. Some of us will have to save more and consume less. Some of us will have to take losses on our loans and investments. Its not the end of the world. But for many it will feel like it. For those out of work, who’s skills are no longer relevant in a more sober and rational world. Politicians need to get real and help these chaps. If they don’t get that help, a man has to live. They will do their part for the free market and send an economic signal to their congressman. Possibly by holding up a liquor store and getting some free calories and smokes. Now that insider trading is no longer feasible.

I used to think that banks were a place which kept my money safe. And that they made money lending money out to people who wanted to borrow.

My economics teacher told me all about fractional reserve banking and when I asked her what would happen if everyone wanted their money back at the same time, she said it was a highly improbable scenario. Times have changed.

Somewhere along the way banks decided that if they were going to take risks they weren’t going to be paltry risks. In for a penny in for a few trillion dollars. And why not? The risks after all were not borne by the bankers. They were borne by shareholders.

Take trading for example. Its a great gig. The trader works for the bank for which they get a salary. If they make tons of money, they get a cut of it. If they lose lots of money, they are at worst, fired. Basically these gamblers are given a deal where if they succeed they are paid and if they fail they stop getting paid and can go home. Or to the next casino. If they make an obscene, unreasonable, not even vaguely humorous amount of money, its all kept very quiet, at least until they decide to launch their own hedge fund, when the track record gets trotted out. If they lose a bewildering, can’t be buried in a footnote, solvency threatening amount of money, they are given the perp walk like Nicholas, Jerome and Kweke. And then its all their fault. And all this time these compulsive gamblers are betting shareholders’ money. God forbid they should actually risk some of their own hard won money. So who put them in charge? Its either by design or by accident.

Bank capital rules were developed in part to deal with excessive risk taking. No problem. Banks simply got into agency businesses. For example where once the risk of a loan such as a mortgage stayed with the bank, these risks were later sold on to structured credit vehicles for ultimate distribution to yield hungry, ratings addled, credit drunk investors like pensions and endowments, and not uncommonly to other banks. The whole language of ‘origination’, ‘underwriting’, ‘manufacturing’ and ‘distribution’ draws parallels with the (also) illicit trade in certain Asian and Latin cash crops. At the end of each of these food chains, is always an addict. And agency businesses are always great businesses. There is little capital at risk and the fees are high. As in the Latin cash crop example, the danger lies when one starts to sample ones own (or a competitor’s) merchandise. Sometimes, the only way to sell these complex credit products was to have a taste of the product yourself in front of the buyer. You’d think it was smart of the buyer, but you cannot always protect yourself against a reckless dealer (of both the financial or agricultural kind.)

The regulators have woken up (if not wised up.) But what they propose to do is analagous to turning the Medellin Cartel into GSK. One is not sure which is more insidious. After the wheels came off in 2008 and the banks, the great conduits of credit, the brokers between savings and investment, teetered on the brink, public opinion has forced the politicians to scrutinize the banks more closely. Unfortunately, in order to save the patient, governments had to spend a sovereign solvency threatening amount on the equivalent of pharmaceutical morphine. The pain is gone, but the malady lingers on. And seems to have infected sovereign balance sheets as well.

Today, chaos and confusion are the rule. Banks are asked to raise more capital and to apply tighter capital rules to their risky activities. On the other hand banks are encouraged to lend to help resuscitate foundering economies. This is not something they are naturally predisposed to do. Banks prefer to lend to borrowers willing and able to repay. They should know this given how much they borrowed from their now shaky governments. Deadbeat borrowers can sink a strong lender.

I’d like to say that I have ideas for fixing the sinking ship. But I don’t. Lifeboats!

Salvation may lie in corners of the Shadow Banking System, not to be confused with the shadowy banking system, that’s the one we think we know. While a large part of the shadow banking system consisted of the refuse chutes, read ‘distribution’, of the banking system, much of it is useful. Guns are useful self defence equipment until placed in the hands of 14 year olds with a death wish and no respect for the law.

With Basel 3 throttling the banking system and as central banks stuff them from the other end with endless useless credit, the banks are little more than highly regulated utilities with litte upside and lots of downside.

Private equity, venture capital and mezzanine financing funds, part of the shadow banking system, provide the conduit between savings and investment without the liquidity mismatches inherent in fractional reserve banking. Flying under the radar of Basel 3, they allocate capital more efficiently with greater alignment of interest. Investors funding hedge funds or private equity where the managers do not risk a reasonable amount of their own capital deserve to be permanently separated from their capital. Managers who risk all of their own capital in their funds are either lying or psychopathic risk seeking maniacs and should be avoided. Where the fractional reserve system may be dysfunctional, private finance may fill the void.

Structured credit, that shadowy world of CDOs and MBS, is really an ingenious array of securitization and tranching technology. This technology has been demonized for facilitating excessive credit. It should not be demonized generally. Securitization can provide liquidity management solutions. Tranching technology can provide risk management and allocation solutions. But how do we keep these potentially mass destructive technologies a
way from the gleeful cowboy traders.

While structured credit derivatives have been blamed for the 2008 Grand Financial Crisis, the fact is that the problems mounted only when the demand for buying debt outstripped the demand for borrowing money. When that happens, grown men and women with single digit mental ages go in search of borrowers and collateral. In the old days credit was created when someone wanted to buy something or invest in something, needed the money, went to a bank hat in hand and had to prove themselves worthy of a loan. Today, yes, even today, a trip to the mall involves running the gauntlet of pimply youths who couldn’t legally buy their own alcohol trying to sell you financial products that their bosses would not understand, to make a buck for their banks, a buck which their shareholders would never see.

Retail financial products need to be regulated. But they need to be regulated sensibly. A banking system frightened into submission will over-regulate and miss the real risks. Ask any bank which has ever sold a toxic structured product to an unsuspecting investor. Financial education is a basic necessity. It needs to be taught in schools before the effects of drugs, alcohol and a sense of entitlement set in. Given its glamorous propensity for spectacular destruction, finance might even supplant knife fighting and agri-chemical skills in secondary schools. With a financially competent public, rational regulation can be a reality. Most people know that cholesterol is bad for you but how about short volatility financial instruments, a financial carcinogen?

A financially educated public should be protected from misrepresentation and fraud, but they should not be protected from themselves. Fully cognizant of the risks, psychopathic risk takers must be allowed to go for glory or destroy themselves in equal measure. Additionally, no financial intermediary or advisor can reasonably be expected to prevent suicide.

Back to structured credit. Take the European sovereign debt situation for example. Nothing bolsters a bailout war chest better than a ton of leverage. Into the valley of debt one must ride to the rescue with no reservation. Behind this doomed cavalry of first loss capital can follow senior tranches of debt with lower cost to hapless borrowers. With open ended liabilities, solvency can and does hinge on borrowing cost.

Cash flow waterfalls can save a country like Greece. Actually, maybe not. They need to get off the Euro first. But let’s assume that. In a post restructuring financing, providing first claim to a portion of tax receipts, subordinated debt can be raised to facilitate raising further senior financing at lower cost.

Asset backed securitizations and tranching technology can be employed in emerging markets to finance their economic growth. Lessons need to be learnt from the US experience of course. The LGFVs in China look suspiciously similar to the SIVs and SIV lites whose demise preceded the financial crisis of 2008. Principal agent issues need to be addressed to prevent ‘made to fail’ structures perpetrated by some hedge funds, gambits without which it seems, some hedge funds cannot survive.

Finally, there is no systemic risk solution better than risk of total and final financial failure. Drivers are more reckless with airbags and seatbelts. That is not to say that there won’t be the moron who will corner at over 25 mph in an SUV. These must be stopped. Where a manager’s failure results in systemic damage or losses beyond the limited liability of their firms, direct and personal recourse should be available. That’ll teach ’em.

Oh and ratings agencies. That’s like England’s tourism board paying an American weather forecaster for a sunny forecast for last week. Hedge funds have been known to hover around ratings news seeking lemmings to pick off. Their creed is a noble one, ‘a fool and his money must be separated, by me.’

Its time to end this rant. But anyone who regards this as advice is smoking a different brand… I’ve always considered the advice of others, I’ve never taken any of it blindly.