Darshan's Blog

Darshan's Daily Market Ponderings

The $1 trillion Bail-Out Package - Everybody's Starry-Eyed!

Monday 10th May, 2010

"I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale." Thomas Jefferson (letter to John Taylor in 1816)

Well, it's been a long time since February - when the Greek issue first broke and the game between the ECB and the Market began. I documented the tit for tat game clearly on this very blog (http://is.gd/89Kej) the strategy was to play for time with bluff after bluff. However, with mid May fast approaching and the Dubai World deadline around the corner too, Thursday's 1000 point Dow drop - jerked the ECB into action. The game was on the last move - the time for action had come. Last night, with the organisational efficiency of a drunk Oompa-Loompa - the ECB missed their own press conference deadline of 9pm and over night it was confirmed that the world's biggest bailout package had been agreed.

$1 trillion will be thrown at the markets to create price stability. As early as today, France has already confirmed that it has begun open market operations and is buying bonds. The ECB will be buying public and private bonds. Quantitative Easing just arrived in a monetary system with an interest rate that is not near zero. We've officially arrived at the zenith of crazy monetary policy. On top of this the Fed is reactivating it's dollar swap lines. (Yes the ones, it closed only three months ago). The world will be pumped full of dollar liquidity - hello market saviour!

Wait though let's step back a bit? Wasn't the original amount meant to be 110bn?

Indeed it was, however, the EU leaders obviously are worried about contagion and in particular, Portugal, Spain and Italy adding to this issue. In addition to this, the market plunge on Thursday, has really worried the Central Bankers and these talks over the past weekend, turned into a 'how to stablise the markets' fiasco. Merkel, Sarkozy, Darling and even Obama (over the phone of course) - have somehow managed to agree on a rescue package worth $1 trillion.

The core Greece issue is being tackled by a one two punch of the IMF debt wagon and the Eurozone aid package. Let's break that down shall we? Well the IMF had approved a

30bn package to be dispersed over 3 years. Not to worry, Greece will get 5.5bn right away. That should allow it to service it's big 19th May deadline for it's 8.5bn bond redemption.

So that's okay then. We'll shuffle the debt about a bit and all will be fine. Nice. When you're done, can I please borrow a couple of billion too? I have bills to pay on the 19th too.

So that's the IMF side of things. Now we have the Euro-zone. Or rather should I just say, Germany. Seems the German Constitutional Court is siding with the Government and agreeing to let Germany provide Greece with funds. It's okay it's only a small amount.

80bn to be precise. (Remember when a billion meant something?).

This is meant to put an end to the sovereign debt crisis. All the chips are being played - the idea being this should scare the living daylights out of the commercial shorts - who should run a mile from their record short-side bets on the Euro and also not pull another move like Thursday. This should also make them take a break from hammering the credit-default swaps and hopefully stablise the cost of borrowing for Greece, Spain, Portugal and Italy.

Well all three have worked over night. The Euro has rocketed but crucially not broken resistance at 1.3150 (the prior low).

The credit-default swaps for Greece and most of the other Euro-zone countries tightened but as I write this up, seem to be widening again.

The markets are now above the point where they fell from on Thursday.

So you would think that the job is done. No. It's not.

You see this is a plaster on a wound that needs surgery and nothing more. Greece, Portugal, Spain and Ireland alone have $215bn of debt maturing in the next three months. They need almost

2 trillion in the next three years alone.

I guess what I'm trying to say is this: This coordinated action is to save a Euro-zone country from going belly-up and the counter-parties left holding worthless notes. The Governments will have to pay for this with cost-cutting and austerity measures. With that in mind, how great does this all sound to you now hey?

Historically, any measures that are not given the public support - tend to fail in the long run. People who do not support a decision, do not support the consequences. This is already evident, as Germany's Merkel already lost an important regional election this past week. She needs to convince the public, that this bailout is necessary but come on - if you were the German public - would you be happy about this? Knowing that this action opens the door for years of hardship for yourself?

For one thing - I am not even sure if this is all legal. Remember part of the reason for this protracted tit-for-tat game of 'who blinks first', was because the EU Treaty prevents bailouts. In fact it clearly states that a member state "shall not be liable for or assume the commitments of central governments, regional, local or public authorities...of any Member State.". It goes on to say that a member state's own central bank may not directly help another member state with a loan.

Luckily for Greece, there is a caveat and that is open to serious interpretation (Got to love lawyers hey!); if a member state is facing "severe difficulties caused by natural disasters or exceptional occurences beyond it's control" - then the EC can grant special permission for aid.

What a legal nightmare. Essentially, the EU leaders are using this clause to push this package through - arguing that Greece, Portugal, Spain and Italy are now doing everything they can to deal with their debt but investors are reluctant to wait for the results. Yes tenuous to say the least but that's where we are.

All in all, what we have today goes back to my post on Friday - that dip on Thursday was orchestrated to allow the big money back in at lower prices. Pure and simple. Computers rule the game and make it deadly efficient. Want to play a game against a computer? Then be prepared to lose.

Well ironically, the EU leaders are doing exactly that right now. The spreads might have tightened, the markets might have rocketed over night (when was the last time you saw the Dow gapping up 400 points?!), the Euro might have strengthened...but this is short term relief. I think they are playing another game and some confused bulls are about to get slaughtered again this week.

Stay safe out there - unless you are a bank - you have no chance of navigating this mess - while volatility is too high. I would advise you leave futures contracts aside, leave stocks aside and just play with options. At least your losses will be limited and stops weren't get wiped from under you - only for you to see the market rocket back above your stop-out point.

The ECB think they have solved the Euro crisis here - well bad news guys - they just threw all their chips into the middle of the table. The specs can now either bottle it or recognise this desperation and crank up the short interest on the Euro. I have a feeling they will opt for the latter. Trichet - you're a smart man but you have some right fools on your team right now.

I'll leave you with this to sum up the last four months:

http://www.youtube.com/watch?v=PULdPep_xfs

Stay safe and happy trading. You have a huge gap up on the US indices - there is a chance to play for some retrace on that but remember, if everyone is thinking that, they can still take the Dow to 10900 and the SPX to 1160/1170 before we revisit the lows from Thursday, to test the hammer.

As always, good luck!

Darshan

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