Greek Solution?

The Financial Times is reporting a possible solution to the Greek solvency crisis. The solution involves a back-door bailout of Greece through the German banks. The German banks continue to buy enough Greek debt to allow Greece to refinance. The Greek government enacts austerity measures. The German government gives the banks guarantees on new Greek debt they buy.

This solution sounds like it will work. The banks have an incentive to lend to Greece, while still keeping their government on a short leash. The German government doesn't have to worry about German banks losing on a Greek default.

I will close EUO on Monday. In fact, I may very well buy the Euro, or maybe a call on the Euro. I believe that this solution is strongly bullish for the Euro.

Housing Market

Earlier this week, the news came out that Jaruary new home sales fell to a 309,000 annual rate. This is the lowest number since the 80's. It suggests that the government stimulus has worn off and the market has resumed its contraction. Prices declined by a few % as well. Today this is confirmed as sales of existing homes fell 7.2% in January. Prices fell by 1.6% according to the FHA.

In other news, Fannie Mae and Freddie Mac posted losses in the $5-10 billion range (each).

Also, the spread of 30-year mortgages over Treasury bonds is 20 bips (0.2%). Traditionally, investors have been paid a point or two (1-2%) over Treasuries due to default risk and prepayment risk. This low spread is unsustainable. I expect that this will change later this year as the Fed stops buying mortgage backed securities at the end of this month. This could easily push interest rates to 6% (from 5% right now) by the end of the year.

There is also talk about Obama placing more restrictions on bank foreclosures. If he gets his way, banks won't be able to foreclose until the HAMP program reviews it. Look for banks to move to more short sales, and foreclose as fast as they can before the door closes on them. Also, who's going to lend if they can't get their collateral back?

What does this mean? In summary, falling prices are a buyer's market. Many people realize that if they can buy a house for less than renting, it doesn't matter if prices keep going down, because they're saving on the cash flow. Also, the pressure on banks will create opportunities as they try to get whatever they can and sell quickly.

Oh, and by the way, AIG may need more $. They lost $54/share last quarter, against expected losses of $4. But much better than last year's loss of $287/share. Green shoots, anyone?

Housing Market and Greece

New housing sales fell to an all-time low in January. The market's now fallen almost 90% from the peak of 2.5 million in 2005. In addition, Fannie Mae and Freddie Mac continue to lose billions every quarter. The FHA is almost out of capital to lend. The FDIC already is.

With the market in a 5-month topping formation, and the VIX at 20, I'm looking to load up on options. I want to take my option exposure (which is only 4% of my investments) from 30% (of that) to 70%.

I'm looking at EWA puts (play on Australia/commodity/China slowdown), SPY puts, KBH puts (no rebound in housing market), AGO puts (as a way to play muni defaults), IAG calls (upside to gold).

In other news, capital is fleeing Greece. I should have seen this coming. The Euro makes it very difficult to stop capital flight. All anyone needs is a bank outside Greece. Then you just transfer Euros over. 25% of the major accounts has already fled what people are sure will be higher taxes.

Implication of China's Foreign Reserves

Michael Pettis has another brilliant post explaining the nature of foreign reserves. He cuts through the myths and confusion that surround this topic. The most interesting thing he discusses is the role of foreign reserves in a domestic debt crisis. While foreign reserves protect a country against foreign creditors, they actually worsen a domestic crisis. This was one of the challenges faced by the U.S. during the Great Depression. At the time, the U.S. was the world's largest surplus nation, and had stockpiled more reserves (in gold, at that time) than anyone else.

The reason foreign reserves are a problem is because they are a sign of mismatched assets and liabilities. Every purchase of dollar assets by the PBoC is financed by a liability from borrowing or printing renminbi. By definition, these must always be in balance at the time of creation. By having a huge liability in Renminbi, the central bank is limited in the amount of domestic debt it can take on its balance sheet without raising interest rates.

German/French Bank Exposure to Greece

Bloomberg exposes the behind the scenes story of the Eurozone economy in "PIGS Exposure Explains ‘Shotgun Greek Wedding’: Chart of Day." Eyeballing the chart shows total exposure of $2.1 trillion to the PIGS. The exposure to Greece for German banks is $119 billion, and for all European banks is $253 billion.

In other words, the $73 billion the Greek government needs this year to refinance bonds is chump change.

At first glance, it seems obvious that there will be a bailout. In fact, with this kind of exposure, I'm shocked that there hasn't been one yet. But then again, it may be easier for France to bail out French banks after a Greek default than to bail out Greece.

So this throws a wrench in the game theory that we use to understand this. Germany and France especially are much more exposed to losses from Greece and the PIGS.

Overall, this means the Euro and its banking sector are weaker than they look. Short-term, however, this smells like a bailout waiting to happen, and I will look to sell at a good technical price.

Action: Hold EUO. Consider closing at a 10% premium to 50-day moving average (currently around $21.20).

The Greek "Fix"

It was a clear sign of hot air and no action. German Chancellor Angela Merkel, ECB President Jean-Claude Trichet, and Greek Prime Minister George Popandreou announced a deal that does nothing.

In a sign that the market partially bought it, Greek bonds were up, and the Euro was down. Gold is up, but no new bailout (and the associated money-printing) is actually bad for gold longer-term.

The details of the story are a little more interesting. It seems Germany has clearly commandeered EU monetary policy, as "the declaration was issued in the EU’s name before other leaders were consulted." It seems that Germany is determined to keep the Euro strong. Greece still needs to sell $72 billion in bonds this year, which is 20% of GDP. Now that Germany has hinted at a bailout (possibly loan guarantees) investors won't want to wade into the market until there is one.

So my thinking is that the Greek market will be tested again, but also that the bailout at that point in time would probably be swift. This time, though, I think I will hold my Euro short (EUO) a little longer, as the "bailout" really isn't a bailout (yet).

I was reading Russ Winter's blog today, and I posted the following comments:

re: China.

I Don’t believe currency exchange tax is viable. Isn’t 90% (we import 10 times as much from China as we export to China) of Dollar-Yuan exchange taking place in China? How do we tax that?

Instead, I believe we should look for U.S. policy to devalue the dollar (causing inflation in China) and trade restrictions designed to punish U.S. companies that move capital to China.

Everyone’s worrying about China dumping Treasuries. I think Ben and Obama can’t wait for this to happen. What better way to pay off our debt with a printing press?

Trade!

Mostly just housekeeping here. I'm closing the URBN short because the Christmas season news is out. While their P/E is still very high at 29, if I was going to short retail, I'd rather re-open my short of Abercrombie, which has jumped back up to almost $33 (from the $30 I closed it at).

Buy to cover 10% position URBN @ $30.87, -6%.

Trade

Bought an EWA Jul 2010 $19 put for $1.35.

This looks like a no-brainer to me. Implied volatility on the trade is 27, and the past year's volatility in the EWA Australian MSCI stock index is about 55. So if we get half the volatility of the last year, it will pay off. In addition, today, with the index dropping $0.90, the option cost only went up $0.35. We'll see if that gamma holds if this thing gets in the money.