Monday, June 4, 2012 - Euro-crisis Moving Faster

DOW – 17 = 12,101
SPX +0.14 = 1278
NAS + 12 = 2760
10 YR YLD +.06 = 1.53%
OIL +.15 = 84.13
GOLD – 8.00 = 1619.30
SILV - .42 = 28.36
PLAT – 19.00 = 1434.00

Finance chiefs of the Group of Seven leading industrialized powers will hold emergency talks on the euro zone debt crisis tomorrow. The economic problems have spread and the G-7 teleconference is at least an admission that the euro is breaking down as a viable economic undertaking. We are finally moving past denial.

There's something rotten in Denmark; the Danish central bank cut interest rates twice last week; they say they're battening down the hatches for a splintering of the European Monetary union. The European Commission said monetary union was in danger of "disintegration" and the European Central Bank said it was "unsustainable" as constructed. Felipe Gonzalez,the former Spanish prime minister says the Spanish economy is facing a “total emergency”, which is – just guessing here – a bit more problematic than a partial emergency. The Cypriot banking system is nine times the country's GDP and they are now begging for a bailout. What a shocker. Cyprus is on the verge of becoming Iceland South. Switzerland is threatening capital controls to repel bank flight from Euroland. The Swiss two-year note has fallen to -0.32%; if you want to park money in the safe haven of Swiss bonds, you pay for the privilege.

US 10-year note yield dropped down to 1.44%, lower than during the Great Depression. The United States is in no position to lead the world to economic recovery, not after the jobs report on Friday; today's ISM business index – a proxy for business demand – flashed a "screeching halt" in May, crashing to 49.9 from 61.2 in April, where anything below 50 denotes contraction. The US economy has not bottomed here but it isn't flying high.

China has been facing a dramatic downturn, so no help from the East or the West. Brazil wilted in the first quarter. India grew at the slowest pace in nine years. Russia can't even help Cyprus. All the economic engines are sputtering at the same time.

The ECB has so far sat on the sidelines as spreads on 10-year Spanish bonds reached a record 496 basis points over Bunds. The ECB is wary of moral hazard but it is a dangerous game for the financial technocrats to force democracies to their knees by switching intervention on and off. In this case it is spreading contagion to Italy and risks igniting a tinderbox.

There is no talk of firewalls, or of simply letting Spain go, or of the European banking system being re-capitalized to compensate for the losses that it would suffer. Nope. Spain is Too Big to Fail. Spain is the fourth largest economy in Europe. Spain is not a peripheral Mediterranean country. It is not an insignificant player in the political project. It is not a marginal going-along-for-the-ride-and-the-free-money passenger on the euro train. Not only is its economy so large as to be indispensable, but its ties with Italy mean that the Italian economy (which is the third largest in the EU) would be fatally compromised by its fall.

Europe is struggling with a fundamental flaw of its original design: that’s it’s a monetary and economic union but not a political or fiscal one. Once again we're hearing talk about the USE – the united States of Europe. That might be a stretch. So far, they can't even agree on Euro-bonds. They can't agree on European deposit insurance to stem the outflows of deposits already being seen from peripheral countries’ banks. They can't agree on allowing banks to access direct financing from the European Stability Mechanism — the region’s permanent bailout mechanism which currently is designed to be tapped by sovereign governments. Merkel has crushed talk of an immediate banking union. They can't seem to agree on anything except austerity, and the European population is telling the politicians and the bankers to stuff their austerity where the sun doesn't shine.

Germany's Spiegel magazine reported that Chancellor Angela Merkel is actively pushing Spain into the arms of the EU bail-out machinery, concluding that Madrid cannot hope to tap the open market for the about $60 billion to $110 billion needed to recapitalize banks. The recurring crisis in the eurozone is not driven by financial markets' demands for austerity in a time of recession, as is commonly asserted. Rather, the primary cause of the crisis and its prolongation is the political agenda of the European authorities -- led by the ECB and European commission. These authorities (which, if we included the IMF, constitute, the 'troika' of unelected technocrats that runs economic policy in the eurozone) want to force political changes, particularly in the weaker economies, that people in these countries would never vote for.

Mariano Rajoy, the current Spanish prime minister, demanded intervention by the ECB to cap bond yields and warned the EU authorities that they too had to deliver on their side of the bargain as his country swallows austerity. With the cost of borrowing heading rapidly towards 7 percent and most foreign investors already shunning Spanish debt, the government will find it increasingly difficult to refinance 98 billion euros of debt and find another 52 billion euros to fund its deficit this year. Local banks are barely lending, or offering loans at prohibitively high rates, squeezing companies and increasing the risk of a chain of bankruptcies which could send the economy into a nosedive. The banking system's total loans to the business sector were 44.6 billion euros at the end of March half of what they were at the end of the boom in 2007, and the contraction continues almost every month.

The latest data show that the real M1 money supply – cash and overnight deposits – for China, the eurozone, Britain and the US has been contracting since the early Spring. The world money data show that real M1 for the G7 economies and leading E7 emerging powers peaked at 5.1% in November and has since plunged to 1.6% in April. The data explain why commodity prices are falling hard, with oil down to $84 a barrel.

And that brings us back round to the banksters solution: more free money. Goldman Sachs expects Federal Reserve chair Ben Bernanke to open the door for QE in testimony on Thursday.

Stock markets rallied in Madrid and Milan led by bank shares on rumors of an EU plan to recapitalize banks directly with funds from the ESM bail-out machinery. The only thing that prevents it for now is polling data that sends a shiver up the back of the German politicians.

Merkel has no background in economics at all, and Draghi was formally an investment banker for Goldman Sachs. This is not about doing the right thing for the general population. The present crisis, which is largely the result of excessive credit expansion and poor risk management by EU banks, is being used by the European Commission and the ECB to establish a euro-wide "banking union" and to impose savage cuts to social programs, health care, and pensions. The response by EU policymakers is a social counter-revolution designed to transform the 17-member monetary union into a permanent "austerity zone" ruled by corporate elites and big finance.

The European Commission stated the objectives quite simply: "The eurozone must boost growth and cut debt to regain investor confidence but it should also move towards a banking union, consider eurobonds and the direct recapitalisation of banks from its permanent bailout fund.” This looks to be the end game, more money for the banks by means of bailouts, euro-bonds to recapitalize banks, a banking union to solidify the power of big finance over the individual countries.

Top executives at Bank of America Corp did not tell shareholders just before a 2008 vote on its purchase of Merrill Lynch & Co that Merrill's losses were mounting and expected to weigh down earnings for years; this according to papers filed in private shareholder litigation show.

Former BofA CEO Kenneth Lewis said in their own court papers that they should not be liable to shareholders who claimed to have lacked information that they needed to vote on the once $50 billion merger.

Lewis also said he had been advised by the bank's law firm and chief financial officer that no disclosure was necessary.

The papers, including sworn testimony from Lewis, were filed on Sunday night in class-action litigation accusing BofA of fraudulently misleading holders of shares and call options about Merrill's losses and bonus payouts.

They may also strengthen the contention that Bank of America withheld material information just before the December 5, 2008, merger vote, a characterization that Lewis resisted in a March 27 deposition by the shareholders' lawyers.

In all cases of securities fraud, the fight is always about who knew what, when. This deposition shows that before the actual shareholder vote, there was knowledge that the numbers were different. Call it large, call it substantial, but it is likely material.

The bad news just keeps on coming in the JP Morgan CIO scandal. We’re getting a lot of salacious detail, but the media manages to continue to miss the bigger picture. An article in Reuters explained: “JPMorgan dips into cookie jar to offset ‘London Whale’ losses”.

The main point of the article is that the ‘cookie jar’ contains $8 billion of unrealized gains from the profitable investment of excess deposits. The tricky bit for JPM, its depositors and inquisitive regulators, investors, external auditors, and disgusted citizens  is explaining why $1 billion of that reserve was gifted to the CIO desk to cover its trading losses. Trickier still is Dimon’s pledge of the entire $8 billion to cover any further CIO trading losses. Henry reports:

‘JPMorgan Chase & Co has sold an estimated $25 billion of profitable securities in an effort to prop up earnings after suffering trading losses tied to the bank’s now-infamous “London Whale,” compounding the cost of those trades.’

The story estimates that JPM sold $25 billion of the Investment portfolio assets to generate the initial $1 billion gain used to offset the $2 billion losses Dimon disclosed in the May10 press conference. There is no word yet on the size of the losses JPM has incurred since the announcement.

As a result of the sale, at least 12% of the total investment account reserves that were, in theory, set aside to protect depositors in the event of a market shock, have been raided to prop up the second quarter bottom line. But that assumes you buy the Dimon’s “excess deposits” party line.

One only raids the cookie jar in times of systemic stress. JPMs inclusion of the Investment account assets as part of the trading portfolio defies both accounting norms and historical precedents.

‘What he was trying to tell us’ is that these losses will continue to be buried in the investment account until such time as JPM determines that it is tax efficient to recognize offsetting gains. He has already hinted that these loss-generating CDS positions will take time to unwind, which signals that JPM will make every effort to reclassify the loss-producing hybrid trading-hedges as held to maturity positions against the investment portfolio.

Or until such time as the SEC and DOJ or any other regulator or Congress finally have had enough and call JPMs bluff.

And I finish with some sad news: 

Bob Chapman, the long-time editor of the International Forecaster newsletter, has died. It is my understanding that Bob had been fighting pancreatic cancer. Bob often had very different views, but that was part of what made conversations with Bob so compelling. He was a brilliant mind and a genuinely nice person. Condolences to his family.