French ( OAT ) and German ( BUND ) spread growing again…

Intraday:

Submitted by Charles Hugh Smith from Of Two Minds

Next In Line for Implosion: Pension Plans

Pension plans are based on 8% annual growth forever. What happens to these plans in a zero-interest rate world as the global economy and stock markets contract?

I’m afraid it’s time for an intervention. I don’t enjoy being the bearer of difficult news, but now that Europe has stumbled drunkenly into the pool and been “rescued,” it’s once again tearfully blubbering that this time it’s all going to change, and a new prime minister in each dysfunctional, insolvent EU nation is going to make the pain and the addiction all go away.

It’s time we face the reality that Europe and the U.S. are full-blown financial alcoholics, addicted to illusion and debt. And what do they turn to as “solutions”? The very sources of their pain: illusory “fixes” and more debt. Have you ever seen a global market as dependent on rumors of “magical fixes” for its “resilience” as this one?

What’s truly remarkable is the psychotic distance between the facts–Europe’s debts are impossible to service, its economy is free-falling into recession, the U.S. is already in recession, China’s real estate bubble has popped and cannot be reinflated– and the heady leap of global markets on every trivial rumor of a magic fix.

Since it runs in our family, I do not use the word “alcoholic” lightly. Those of you who have to deal with alcoholics know the drill: the liquor stashed behind the fridge, as if everyone doesn’t know it’s there; the stumbling into the pool, the humiliating rescue, the tearful promise of change which goes nowhere, and all the rest.

I seriously suspect the entire global economy is alcoholic–not about liquor, but about debt and the impossibility of paying entitlements which expand by 8% a year in an economy which grows by 2% a year at best. In all the millions of words printed about the subprime meltdown, the gutting of the U.S. financial and housing markets and now about Europe’s impossible burden of debt, how often have we seen anyone in the MSM or mainstream financial press confess that “borrowing our way of out of trouble” is not just financially bankrupt but morally bankrupt as well?

Like a full-blown alcoholic, the people and governments of the U.S. and Europe stagger from debt source to debt source, weaving drunkenly between “stashes” of new debt in the Fed, Treasury and private sector markets. Despite the abject failure of the magical-thinking “fix” of becoming solvent by exponentially expanding debt, we see the same pathetic pattern repeating in Europe, where the apologists for the alcoholic debt-binge continue to claim the risk of systemic failure and collapse of asset values is low.

While everyone is focused on the drunk being pulled from the pool–Europe’s sovereign debt–another drunk is teetering on the edge: public and private pension plans. Here’s the reality in a nutshell: pension plans only work if they earn average returns of around 8% per year, basically forever.

Gripped by the mono-maniacal desperation of an addict who sees no other path but another hit, central banks have lowered interest rates to near-zero to “spark growth.” Unfortunately the only thing being goosed is the future cost of servicing the additional debt.

How do you earn 8% on money which yields at best 3%? You can’t. How do you reap a gain on bonds when interest rates have already hit bottom and can’t fall any lower? You can’t.

Which leaves the stock market as the only hope for pension plans. Since the bottom in March 2009, central banks engineered a “magic solution” that generated fantastic stock market returns: by constantly lowering interest rates and increasing liquidity, central banks force-fed stock markets with demand (there was no other place to get a fat return) and the see-saw of interest rates and “risk-on” equity markets: as rates decline, equities floated ever higher.

Now that rates are near-zero, then the central banks are pushing on a string: there is no “magic” left to juice equity markets.

The equity markets are in effect living on vitamin C and cocaine: rumors of new “magic fixes” and the hit of central bank infusions.

Once rumor is no longer enough to float markets higher, then the consequences of depending on stock market returns will hit pensions with a terminal case of the DTs.

The “magic” of ramping up debt to create the illusion of a healthy economy only works once. The “fix” “worked” from 2009 to 2011, but now the high is wearing off. The next round of rumor and debt expansion won’t even create the illusion of growth, as the global economy is already careening back into the contraction that trillions in new debt staved off for three years.

I have covered the disconnect between the promises of 8% yields forever built into public pension plans and a slow-growth/no-growth economy many times:

Yes, There Will Be Armageddon: Government Goes Bankrupt (July 24, 2008)

How the Fed Pushed the Nation’s Pension Plans–and Local Government–into Insolvency (May 24, 2010)

Public Pension and Healthcare Costs and Financial Common Sense (February 28, 2011)

Every once in a while an MSM outlet addresses the issue directly, for example:

Pension issue balloons with soaring costs (S.F. Chronicle):

Pension costs are soaring to $800 million, tripling during the last decade, as Los Angeles faces years of projected budget deficits even with deep cuts in services and staff.

 

The main driver of higher pension costs is the stock market crash. CalPERS (California’s primary public pension plan) gets about 75 percent of its revenue from investment earnings. Its portfolio peaked at $260 billion in 2007, fell to $160 billion last year and now is about $204 billion.

Why economic growth isn’t enough to fix budgets:

But under the laws now dominating government budgets, many expenditures essentially are or will be growing faster than both revenues and the rest of the economy. In fact, in many areas of the budget, automatic expenditure growth matches or outstrips revenue growth under almost any conceivable rate of economic growth.

 

Now, so much spending growth is built into permanent or mandatory programs that they essentially absorb much or all revenue growth. Meanwhile, we’ve also cut taxes, widening the gap between available revenues and growing spending levels.

 

Consider government retirement programs. Most are effectively “wage-indexed” insofar as a 10 percent higher growth rate of wages doesn’t just raise taxes on those wages, it also raises the annual benefits of all future retirees by 10 percent. Meanwhile, in most retirement systems, employees stop working at fixed ages, even though for decades Americans have been living longer.

 

Today, so much of government spending is devoted to health and retirement programs that their growing costs tend to swamp gains we might achieve in holding down the ever-smaller portion of the budget devoted to discretionary spending. Still other programs add to the problem, such as tax subsidies for employee benefits, the cost of which grows automatically without any new legislation.

In other words, the entire system of state and local government is now based on the same 8% “permanent high growth” of the 1990s speculative market. Funding increases are wired in, regardless of how much tax revenues fall. That is a recipe for insolvency.

Now we get to the heart of the matter. Which institution engineered the heady stock market bubble of the 1990s that created the illusion of “permanent high returns” and growth of tax receipts? The Federal Reserve. Which institution has made the stock market the proxy for the economy? The Federal Reserve. Which institution has engineered a three-year stock market rally to put off the inevitable implosion of pension plans, entitlements and tax revenues that must grow by 8% annually while the real economy is flat-lined? The Federal Reserve.

We can ask the same questions of Europe and get the same answer there, too: the European Central Bank (ECB).

Addiction is a terrible disease, founded on the illusion that the pain of facing reality can be put off forever by dulling the pain of addiction itself with ever-higher doses of self-destruction. We are witnessing the self-destruction of economies and machines of governance that have chosen denial, illusion, rumor and magical thinking over facing reality. The drunk has been pulled from the pool once again, slobbering self-piteously and promising to really, really change tomorrow, and we believe the lie, at least until morning, because hope is so much easier than reality.

From FT Alphaville:

“Amid EFSF revamps, Greek politics, and ECB rate cuts, remember that in the end, it all comes down to Italy.

In particular, 10-year Italian government bond yields remain well over 6 per cent at pixel time.

The Italian endgame is getting nearer and a crisis is “increasingly probable, and would do much to expose the inadequacies of the bailout mechanism as a whole”, warns Citigroup’s Matt King (he of the seminal “brokers are broken” thesis from 2008 that we put back together on Wednesday).

King worries that the Papandrendum sets a precedent for future political leaders (“who can be against asking the people?”). He thinks China and the IMF will both think twice before funding the EFSF given political risk in Athens.

He’s also worried that the new EFSF is too big…

Its major flaw, judging from the few details we have, is its need for funding. At present, selling even €3-5bn of straight EFSF bonds seems to be a struggle. And yet the proposed SPV-structure would seemingly rely on selling hundreds of billions in much more complicated bonds. Technically, we see very little difference between these and senior CDO tranches, yet this one structure alone would have a size larger than the whole of the existing CLO market. The undiversified nature of the asset pool the SPV would invest in suggests that a large equity tranche would be required, meaning that 4-5x leverage might be hard to achieve, and that spreads on the senior notes ought to be really quite high.

… and too weak:

The guarantee proposals likewise seem better at first sight than when examined closely. The idea put forward in the EFSF Q&A2, suggesting that investors will want to buy protection from the EFSF simply because it (currently) carries a AAA rating, and without regard for wrong-way correlation exposure, flies in the face of universal market practice. As everyone knows, if you want to buy protection on Greece, you don’t buy it from a Greek bank. Such problems could be offset by collateral posting to some form of escrow account, but this would add to the EFSF’s overall funding needs. And no amount of collateral is sufficient compensation for the risk that the EFSF guarantees themselves are far from watertight: the idea that the EFSF might not use ISDA trigger definitions but adopt its own definition of default, as described in the Q&A, simply lacks credibility.

But these aren’t top of the worry list. Italy is. King notes that “BTPs have been close to these yields before; spread levels have not”:

Here’s King’s reminder of why this matters (emphasis ours):

We are also quite close to the point beyond which other sovereigns have found it very difficult to return, when yields breach 6% (Figure 3). This is partly because feedback loops kick in and additional widening could easily accelerate. For example, if spreads of 450bp on 10-year governments are exceeded for five consecutive business days, LCH haircut requirements for banks borrowing against Italian collateral will rise by 15%. If banks liquidate their BTP holdings, this will simply exacerbate the problem. If instead they choose to seek funding at the ECB (for example, if they are running short of collateral), publicity around different countries’ banks’ usage of ECB facilities seems likely to lead to more selling in both the banks and the countries concerned. This is part of the reason why when Portuguese spreads breached this point, not only did the sovereign yield quite rapidly back up further, eventually breaching 10%, but the rating agencies followed up with sovereign and bank downgrades for good measure. Admittedly this was all part of Portugal’s losing access to markets and applying for a bail-out, but we see no reason why the feedback loops should operate any differently for Italy.

Unsurprisingly, King — like probably everyone apart from the man himself — doesn’t think Silvio Berlusconi can stop this rot, and regardless, the “reform” measures will only cut Italian growth further. This leaves — guess who! — Super Mario. King thinks further, “quite aggressive” bond purchases are possible and “in theory, [the ECB] could easily do much more”. But…

…we struggle to think that a complete change in strategy lies immediately around the corner. Politically, the image of the new Italian riding to the rescue of Italy, at the expense of the ECB’s hard-earned German credibility, just seems too poisonous. Having lost two Germans over the issue of SMP purchases, they dare not risk losing a third. And we still believe that Draghi, like Trichet, fundamentally considers the job of rescuing sovereigns to be one for governments, not the central bank. He might cut rates, or increase repo purchases or try to help in some other fashion, but these seem likely to alleviate the market’s fears rather than resolving them.

In sum, we find ourselves largely back to where we were a couple of months ago. Really drastic action becomes possible only if a much larger crisis is priced in. In the meantime, markets are likely to become steadily more aware of the likelihood of recession next year, magnified by the combination of ever more fiscal tightening, bank deleveraging and diminishing corporate and consumer confidence. While we continue to see value in spreads from a long-term perspective, unless the macro risks can be sorted out, we suspect that most investors will not dare to touch them.

Well, the ECB board did unanimously cut rates on Thursday, and Draghi was more ambiguous than his predecessor on whether the central bank could continue buying bonds after the eurozone’s new bailout mechanism comes online. But he also made abundantly clear (he fired a question back at the FT’s man in Frankfurt!) that the central bank does not see itself as the lender of last resort that can solve the eurozone crisis.

Accelerating toward an endgame while going back in time — only in the eurozone.”

Congratulations Political “ELITE”. It seems that Mr. Market is getting nervous with BUND-OAT spread ( France / Germany bonds ).

Please tell them that this is NOT the way to solve problems !!!

BY TECH CRUNCH

From David Rosenberg of Gluskin Sheff

“The Europeans are living in a world of denial that they can continue to give funding to Greece as it continuously refuses to meet its fiscal targets

Well, once again a leaked press report from a pro-EU newspaper (the Guardian) has cooked together a new strategy that leverages up the EFSF and insures bondholders against first losses on their sovereign bond holdings has the markets in a brand new giddy mood. Equities are rallying across the planet (check that — what is with China down now two days in a row?) and safe-havens like the U.S. dollar and high-quality bonds are selling off (and we ask, why in this pro-cyclical buying of stocks and selloff in Treasuries and bunds is copper of all things down three days running? The red metal is down 1.2% today!). Again, not even gold is rallying, and we admit that we are becoming a tad perturbed over how the yellow metal is trading of late.

It’s an open question as to whether this is the deal breaker at this weekend’s EU leaders’ meeting but there is reason to be skeptical that nirvana has just been discovered with respect to this complex European debt crisis — involving governments, banks and all locked into a single currency zone. And nobody wants to pay the price for bad decisions made, so why not end up going through the back door by penalizing the taxpayers of the rich countries? In terms of commitments, Italy and Spain account for 30% (it’s interesting that Italy is committing to a program that will be used to backstop Italian bonds, no?). As one of the co-managers of our hedge fund, Michael Isenberg put it, “It is a quasi-euro bond — without constitutional, legal, historic, linguistic, cultural or political backing — so it’s weak.” Yet, the market sees a headline: wow, 2 trillion euros in a new fund — that’s QE — I better cover and get out of the way. So we have to recognize this and understand that we’re playing in a game where rules change every day.

I remember people saying the agreement to expand the power and funding for the EFSF on July 21st was going to be the panacea — the Dow actually swung +185 points that day (the amount it rallied yesterday), only to be totally erased in the next three sessions. How cool is it that we live in a world where complicated financial engineering in a radically overleveraged system forms the cornerstone of the solution to these debt problems. I would not be surprised at all to see stories coming out in the next few days that contradict this plan. In fact, now we see German Finance Minister Schaeuble saying that the EFSF firepower will be expanded to 1, not 2, trillion euros. Go figure.

Both Dow Jones and Reuters have run with ‘denial’ articles from EU officials, but don’t you see, it’s always like this with the equity market crowd — react first, worry about the details and repercussions later. At this stage, the surprise is that we have another ‘leak’ on our hands with no credibility, like all the noise someone in the media created ahead of last weekend’s finance minister meeting and we ended up with nothing but policy discord.

In fact, what is interesting is to go back and see how the markets reacted to each of the brave new plans unveiled during this crisis. The DAX, for example, surged 5.3% when the EFSF was first introduced back in May 9, 2010 and then rallied 1% on the July 21st agreement to expand the bailout fund; each rally faded. I have no reason to believe this one will be different.

Or just go back to the ‘leak’ late in the afternoon (these always happen about an hour before the close in New York — have you noticed that too?) on September 12th that China and other Asian sovereign wealth funds were going to line up and start to bailout out the Eurozone bond market. The very next day the DAX rallied 2% and over 3% the day after that and euphoria reigned … for about a week.

All these leaks are doing is generating more market volatility, though as we are told, one of them is bound to come to fruition at some point. Better to be a spectator here than a participant.

Let’s look at what else is happening that deserves attention that is not exactly validating this new announcement-led risk-on rally.

1. First, Spain’s credit rating was cut by Moody’s for the third time in the past 13 months to Al from Aa2 (note the two-notch downgrade and the ‘negative’ outlook was retained). This is actually big news because what it shows is that Spain’s vulnerability to market stress and event risk remains acute, and leaving the ‘negative’ outlook is a sign that there is no confidence in the country’s economic, fiscal or political prospects. Indeed, have a look at Spain Hit by Downgrade, Falling Home Prices on page A8 of the WSJ — home prices are deflating now for three quarters in a row and at an accelerating pace.
2. Second, and this is buried in the small print because the big print is all about the Guardian’s “extra extra!” but Standard & Poor’s, to little fanfare, downgraded 24 Italian banks and financial institutions last night (and people are buying the euro at levels that are 20 points above where the IMF pegs ‘fair-value’. What a bizarre world this is). Have a look at Martin Wolf’s column on page 11 of the FT—There Is No Sunlit Future For The Euro.
3. Third, there has been no relief so far in the Eurozone bond market, with Italian yields still backing up (now just lbps shy of 5.9%) even though apparently this new plan is intended largely to bring down debt-service costs in countries like that (Spain as well).
4. Fourth, France-German spreads have not reacted anything close to what the global stock market has as they remain near historically wide levels of 107 basis points (see Ratings Firm Warns on French Debt on page A8 of the WSJ as well). The spread of the problems to France is relatively new and as such makes ‘leaks’ necessary to buy time and adds extra pressure for a quick solution; a French downgrade would deal a huge blow as it would mean that the EFSF would lose one-third of its AAA-rated firepower.
5. Fifth, there is no sign of meaningful improvement in the fiscal situation and in the next two days Greece is going to be experiencing the most intense protests against austerity since the deficit-reduction plans were unveiled. In other words, the Greeks have had it with years of economic implosion and, as such, the risk of outright default is high and rising from a political standpoint. Will bailout money continue to flow in if the fiscal targets are deliberately abandoned?

Why are we so skeptical? Well, when you go back to the opening months of 2010, it was all about Greece and the prime goal was to prevent contagion to Portugal and Ireland. We know how that went. Then that fall, the risk was Greece, Ireland and Portugal and this was when the term PIG was coined. At that time, the goal was to protect Spain and Italy. And we know how that went. Then just this past July, the crisis moved beyond just Greece, Ireland and Portugal to include Italy and Spain (and this is where PUGS was coined). At this point it was about preventing contagion to the banks, but nothing has worked. The contagion has merely spread, and this is not the first time a late-day press release or policy announcement was leaked to juice the market.

The Europeans are living in a world of denial that they can continue to give funding to Greece as it continuously refuses to meet its fiscal targets. Ditto for Portugal. How will France be able to avoid a downgrade? And how do the banks not take a big haircut in all this? It’s not as if the countries have refrained from tough measures — they simply aren’t tough enough. In the meantime, creating a vicious cycle of deflationary and recessionary pressures that makes it impossible to maintain the fiscal austerity and hence the quality of credit continues to erode, alongside that, the quality of the assets in the European banking system.

The reason why EU kingmakers are in a rush is because even with all the ECB support, Italian bond yields are heading back to 6%, a level consistent with high and rising default risks. France and Belgium are now tarred with Dexia support. The dangerous game of not allowing a Greek default has continued because of the fear of triggering a CDS, and we have Tim Geithner convincing the Europeans that allowing Greece to default outright and have the bondholders take the pain invoke a “Lehman moment” (it’s not even clear that things would have turned out to be better if Lehman had been propped up … it’s not as if allowing WaMu to fail produced any long-lasting effects on anything and that was a biggie too).

So, we are still living in a world were levering up is somehow deemed to be a solution to a world of excessive credit and all this will do, again, is just kick the can down the road. Unfortunately, post-Lehman the concept of cramming down debt holders to arrive at a more sound financial position has been thrown out the window. Causing pain to bond-holders or equity holders is a sin right now, believe it or not. There will be a price to be paid down the road for failing to allow bad risky decisions to be penalized. Instead we paper over our issues with QE and financial engineering that may make things worse down the road.

It is truly hard to believe that a Greek default could produce any worse results than what we have already seen from all these bailout attempts. This too-big, or too-important to fail strategy has got to come to an end if we are ever to fully emerge from this increasingly unstable global debt cycle”.

WOW, congrats to the “Elite”… and they want to solve ALL problems with more DEBT… The END GAME is approaching fast and furious

http://finance.yahoo.com/video/cnbc-22844419/leading-economic-indicators-26787810