Friday, April 20, 2012 - Burning Down Spanish Debt, AMR and Unions

DOW + 65 = 13,029
SPX + 1 = 1378
NAS – 7 = 3000
10 YR YLD +.02 = 1.97%
OIL + 1.05 = 103.32
GOLD - .20 = 1643.40
SILV - .10 = 31.80
PLAT unch = 1586.00

Italian and Spanish bond yields rose after a draft statement released by G-20 finance chiefs who are meeting in Washington said that Europe's debt crisis still poses a threat to global growth. Spanish bonds briefly pushed above 6%. That helped push the cost of credit-default swaps to insure Spanish government debt up to a record high 503 bp and increased the cost of insuring Italian debt up to 474 bp, a 3-month high. Credit default swaps pay the buyer face value if the borrower - in this instance Spain - fails to meet its obligations, less the value of the defaulted debt. They're priced in basis points. A basis point equals $1,000 on each $10 million in debt.

Credit default swaps, or CDS, are generally considered insurance against default, but it's not really insurance because anybody can write CDS against anybody else; there is no requirement for “insurable interest”. For example, if insurance worked like CDS, I could write a fire insurance policy on your house and if your house burned down, I would collect the payment. You might think that would give me an incentive to burn down your house. Yep, that might be what you would think.

Now the bankers in New York and London might also have a little incentive to burn down Spanish debt. They are taking out insurance on the bet that Spain will default on their debt, and to further the point, they are pushing yields higher and prices lower. The bankers are shorting Spanish debt knowing full well that there will be massive capital losses as Spanish bonds deteriorate. And they fully expect that the IMF and the ECB will eventually bailout Spain. And then they'll sell their CDS and go long Spanish bonds.

The European Central Bank created put $1.3 trillion into a special fund, the EFSF, or European Fubar Slush Fund, in order to build a firewall to prevent contagion. Now they say they're going to need a bigger fund. European banks reportedly will have more than $750 billion dollars in redemptions by the end of the year. They come at a time when the banks have sustained billions in capital losses they can't make up.

Holdings of Spanish government debt by lenders based in the country jumped 26 percent in two months, to 220 billion euros ($289 billion) at the end of January. Italian banks increased ownership of their nation’s sovereign bonds by 31 percent to 267 billion euros in the three months ended in February. Since 2010, banks in France and Germany have retreated, cutting lending to the governments of Spain, Portugal, Ireland and Greece 42 percent The more banks stop cross-border lending, the more the ECB steps in to do the financing, so the exposure of the core countries to the periphery is shifting from the private to the public sector.

Worse, they've borrowed a staggering 316.3 billion euros ($414.9 billion) from the ECB through March, which is 86% more than the 169.8 billion euros ($222.7 billion) they borrowed in February. This accounts for 28% of total EU-area borrowings from the EU

Spain (#12 Economy in the World) has gotten so bad, so fast that it has made us forget Italy (#8) and we're all ignoring France (#5). France holds their elections on the weekend; apparently they think this will make it easier for people to vote. The Socialist candidate, Francoise Hollande is likely to win the election; it won't be completely decided this weekend; this is just round one.

Also this weekend the G20 is meeting. This morning, the Group of 20 nations committed $430 billion to bulk up the International Monetary Fund's war chest to fight any widening of Europe's debt crisis. The money was available because of a pledge from the BRICS, who are now demanding more voting clout. The G20 issued the following statement: "The tail risks facing the global economy only months ago have started to recede, however, growth expectations for 2012 remain moderate, deleveraging is constraining consumption and investment growth, volatility remains high partly reflecting financial market pressures in Europe and downside risks still persist."

This one nearly slipped by without notice; about a week ago, Spain imposed a ban on cash transactions over 2,500-euro, or about $3275-dollars. Those who violate the rule will face fines amounting to 25 per cent of the value of the payment. About two weeks ago we told you the story of the elderly man who in Greece who publicly committed suicide, which rallied the masses in Athens. Meanwhile, it's really an epidemic in Europe, with suicide rates up 24% in Greece, 16% in Ireland and over 15% in the overall EU and climbing rapidly. Spanish unemployment is already at 23% and climbing while the official Spanish government projections call for an economic contraction of 1.7% this year. The analysts say Spain appears to be falling into its second recession in three years; which is absolute garbage; it's not a recession; it is a depression – full blown and nasty.

Against this backdrop, the International Monetary Fund today released their Financial Stability Report, which assesses how the world's financial system is holding up. Here are a few key points:

The IMF says under existing policies there will be a $2.6 trillion credit crunch in bank assets that will lead to a result in a 1.7% drop in euro-area credit. Under a best case scenario, there will be a $2.2 trillion dollar credit crunch and bank credit will contract by 0.6%. Worst case is $3.8 trillion dollars and bank credit shrivels by 4.4%.

In turn, this would force the Euro-banks to sells assets and freeze up interbank lending. Spain and Italy would be hit very hard, and the UK would take a bigger hit than France and Germany. Go figure.

Beyond Europe, it is essential to start addressing now the medium-term fiscal challenges in the United States and Japan. This should be accompanied by stronger efforts to address US household debt and accelerate housing market reforms.

Now, what does this mean for you? The quick answer: short the euro and go long the dollar, which might be a positive for US Treasuries, and the reason is simple: when you talk about going long the dollar, you really mean treasuries and I don't see treasuries moving much higher, conversely there just isn't much room for yields to drop significantly lower. It might also be a short-term negative for gold and silver, except gold and silver have been holding up quite nicely. We seem to be in a fairly tight range around 1640 to 1660. You might have expected a hit to the metals but it hasn't materialized. If gold drops under 1620, it might be nerve wracking but might offer a dip for buying. It would have to drop under 1500 to make me really nervous, but I don't think we'll get that low because what you're really looking for is a move to safety. In the long run, nothing is safer than the metals. All these moves to prop up the euro are just part of the process of debasing the currency. Right now the dollar looks safe to a whole bunch of investors. Right now, the US dollar is the cleanest shirt in a hamper full of dirty laundry, but that doesn't mean it will smell sweet.

For the week, the Dow gained 1.4 percent, the S&P 500 added 0.6 percent and the Nasdaq fell 0.4 percent, down for a third week running.

About 81 percent of S&P 500 companies that have reported so far have beat expectations, which means 19% of the companies are too stupid to manage analysts.

Apple shares posted back-to-back weekly declines of more than 4 percent for the first time since late December 2008.

Labor groups at bankrupt American Airlines say they support a potential merger with rival US Airways in a deal they say would save more jobs than a plan by parent AMR Corp to reorganize as a stand-alone carrier.

The unions representing American's pilots, flight attendants and ground workers said they struck a deal with US Airways that would preserve 6,200 of the 14,200 jobs American says it would cut if it pursues its current plan.

Their joint statement supporting a merger is an unusual twist that comes ahead of a showdown next week with AMR over the company's request in bankruptcy court for permission to void labor contracts and impose new terms. AMR filed for Chapter 11 last November, citing labor costs. I can't think of another occasion when airline unions actively supported a merger, because those deals usually mean job cuts. For the American unions, it's a real indictment to the company's plan. But it doesn't necessarily mean there will be a merger.

US Airways CEO Doug Parker cautioned his employees in a letter today that the union deal does not mean a merger is in the works. He noted that a deal would need support from the AMR creditors management team and its board of directors.

"But this is obviously an important first step along that path and we are hopeful we can all work together to make this happen," Parker said.

Although AMR has tried for months to blunt speculation, US Airways has hired advisers to explore merger options with AMR, but has not issued a proposal.

AMR spokesman Bruce Hicks dismissed union support for merger talks, noting the company's right in bankruptcy court to create its own reorganization plan without interference at least until September 28.

"These statements do not in any way alter the company's commitment to pursue our business," the airline said in a statement.

Parker has been a vocal proponent of airline consolidation as a means to cut excess capacity on unprofitable routes. He said a deal with AMR would create a "preeminent airline with the enhanced scale and breadth required to compete more effectively and profitably." You might also argue that consolidation means less competition and fewer traveling options, but you can't deny that it is the current trend. Another undeniable trend is that the airline workers have been getting the short stick in consolidation.

Delta is also studying a potential bid for AMR, but the carrier has not presented a merger plan to AMR's unions or creditors in a way that US Airways has made an outreach to the stakeholders of AMR

Earlier this week, Citigroup shareholders rejected a $15 million dollar pay package for CEO Vikram Pandit; the first time shareholders have rejected a compensation plan at a major US bank. Now Pandit and the board of directors are being sued for breaching their fiduciary duties by awarding more than $54 million of compensation in 2011 to the executives, including $15 million to Pandit, though the bank's performance did not necessarily justify it. The complaint says the pay increase proposal "has cast doubt on the board's decision-making process, as well as the accuracy and truthfulness of its public statements."