Is This The Chart Of A Broken Inflation Transmission Mechanism?

Sean Corrigan presents an interesting chart for everyone who still believes that, contrary to millennia of evidence otherwise, money is not fungible. Such as the Lerry Meyers of the world, who in a CNBC interview earlier said the following: "I’m sorry, I’m sorry, you think he doesn't have the right model of inflation, he would allow hyperinflation. Not a prayer. Not a prayer. If you wanted to forecast inflation three or four years out and you don't have it close to 2%, I don't know why. Balance sheet, no impact. Level of reserves, no impact, so you have a different model of inflation, hey, you like the hawk on the committee, you got good company." (coupled with a stunning pronouncement by Steve Liesman: "I think the Fed is going to be dead wrong on inflation. I think inflation is going up." - yes, quite curious for a man who for the longest time has been arguing just the opposite: 5 minutes into the clip). Because despite what monetary theorists say, monetary practitioners know that money always finds a way to go from point A (even, or especially if, said point is defined as "excess reserves" which in a stationary phase generate a ridiculously low cash yield) to point B, where point B are risk assets that generate the highest returns. Such as high beta stocks (and of course crude and other hard commodities). And the following chart of Inside vs Outside Money from Sean Corrigan shows precisely how this is accomplished.


The explanation:

Despite a certain embarrassment along the way with rising prices last year, other people’s tightening efforts (notably in the emerging market engines of recovery) have spared Ben much difficult decisionmaking. Fortuitously, too, a goodly portion of the inflationary injection has stuck anomalously to the fingers of a corporate sector saddled with an unusual degree of certainty about its members’ individual prospects as well as about those relating to the fiscal and regulatory environment at large.

Thus, in devoting 85% of retained earnings—or 20% of ex-dividend, after-tax cash flow—to accumulating a $630 billion mountain of money (cash plus demand deposits) over the past 2 1/2 years, these most unlikely of ’hoarders’ have helped retard the incendiary effects of the Fed’s actions— for now.

This—together with the collapse in the ratio between the monetary base and the money supply itself—has fooled the more mechanistic of the quantity theorists into believing the machinery of debasement has been broken. Meanwhile, the cranks who comprise the MMT mob are crowing that the gold bugs and associated survivalists who inhabit the wilder fringes of the hard moneyworld (whom they insist on conflating with us REAL Austrians) have again been horribly awry in uttering their cries of ’Wolf! Wolf!’

In truth, none of this is so hard to explain. Taking money creation itself, the LEH-AIG-EUR disruption has radically altered the normal generation of money, but has not caused its suspension. In fact, given the speed of its operation since the Crisis, we could even say its efficiency has been greatly enhanced!

Before that watershed, the Fed typically gave rise to around one quarter of the nation’s money (OUTSIDE the commercial banks, in the form of currency and reserve balances) while the remaining three?quarters used to be originated INSIDE the banks (by their grant of loans or their purchase of securities against the recording of a credit balance on the relevant demand deposit account in their books).

Since then, however, the position has been largely inverted, so that the banks themselves are now responsible for something barely in excess of two-fifths of the total, with the Fed supplying the other three?fifths through its various ’emergency’ programmes.

No?one should be under the illusion that just because the monetary base (the Fed’s particular contribution) has swollen dramatically in relation to the sum of the banks’ discretionary additions to it, this makes the whole any less spendable or any less assured in its provision—quite the contrary, given Mr Bernanke’s inflationary bent and the lack of restraint which attaches to the monstrous institution whose awful power he arbitrarily wields.

Not yet convinced? Tomorrow we will demonstrate how in Q4, 2011 the US Shadow Banking system experienced its 15th consecutive quarterly contraction, from an all time high of $20.9 trillion to just $15.1 trillion (advance teaser chart here), not even offset by the liability creation in the traditional financial system, even as US consumers finally relevered for the first time in years, as eager suckers maxing out their credit cards. All this goes to show that the Fed never had an alternative to pouring money into the system, and indeed has done so endlessly since late 2008, only taking a break in late 2011 when the baton was passed to every other central bank in the world. Now their time is over, and the baton will have to be handed back to the Fed.

Because when it comes to secular market moves, today's little bout of JPM-related euphoria will be truly transitory if not accompanied by much more printing. After all the chart below is exponential and demands a sacrifice soon: perhaps the PBoC will step in briefly, although unlike the other central banks, China's money tends to stick within its own system. As such a far bigger calf will be required.


Which means that far all its hawkish bluster, today's move by the Fed is to be faded, although not before the market will permit sticky energy asset prices to collapse: meaning more outside money injections are coming. Yes, stocks may go even higher briefly, but for all intents and purposes unless accompanied by even more liquidity, the latest peak in stocks will be just like that in April of 2011: short-lived (and yes, we do find it curious how 2012 still continues to play out just like a carbon copy of 2011 YTD).

The end result of the exponential surge in outside money is, sadly we must admit, one which will make Liesman correct. For once. Because, as our earlier anecdote on Weimar showed, this is all precisely just as the Fed has intended from the beginning.

JP Morgan Under OCC Investigation for Serious Debt Collection Abuses; Warnings Ignored for Over Two Years

I bet JP Morgan wishes it never hired Linda Almonte.

American Banker has released the first in what will be a series of stories on debt collection abuses by the New York bank. It confirms critics’ worst accusations against the financial services and belies Jamie Dimon’s tiresome assertions that JP Morgan is better than its peers. Dimon may still be right if you think excelling in abusing and extorting customers is commendable.

The American Banker story discusses the operations of a unit that handled delinquent credit card borrowers. Handling these accounts involved using three different computer systems that communicated reasonably well on current borrowers but not with delinquent or defaulted ones. As a result, the operation had involved a high level of manual checks to make sure the amounts borrowers owed were accurate before they were sent off to collection (which in high population states, was an in-house operation, but for most, involved the use of outside law firms.

In 2008, JP Morgan installed new management in the San Antonio operation that oversaw ligitigation, including the verification of borrower information. Edmond Helaire came in as the lead, and the story makes clear that his newly hired deputy Jason Lazinbat went on a campaign to improve results, procedures be damned. Linda Almonte, who was a process specialist who had worked at WaMu, joined in 2009 and was fired, as she charged in a wrongful termination lawsuit, for refusing to send files to collection that has obvious problems in them. Almonte filed a whistleblower complaint with the SEC in 2010 (see an Abigail Field story for more detail). Her charges:

1. Chase Bank sold to third party debt buyers hundreds of millions of dollars worth of credit card accounts. . .when in fact Chase Bank executives knew that many of those accounts had incorrect and overstated balances.

3. Chase Bank executives routinely destroyed information and communications from consumers rather than incorporate that information into the consumer’s credit card file, including bankruptcy notices, powers of attorney, notice of cancellation of auto-pay, proof of payments and letters from debt settlement companies.

4. Chase Bank executives mass-executed thousands of affidavits in support of Chase Banks collection efforts and those Chase Bank executives did not have personal knowledge of the facts set forth in the affidavits.

Now I’d not expect the SEC to know what to do with this (as in these are not securities law issues) and I don’t know whether she tried complaining to the FTC or the OCC then. However, the American Banker story quotes current and recent employees who confirm that he bad practices that Almonte called out are still very much alive. Specifically:

“We did not verify a single one” of the affidavits attesting to the amounts Chase was seeking to collect, says Howard Hardin, who oversaw a team handling tens of thousands of Chase debt files in San Antonio. “We were told [by superiors] ‘We’re in a hurry. Go ahead and sign them.’”…

The records the law firms used to sue people sometimes differed from Chase’s own files at an alarming rate, according to a routine Chase presentation prepared by Almonte and later submitted to the Securities and Exchange Commission. Some law firms’ records disagreed with Chase’s in almost 20% of cases sampled, a rate far above what is regarded as an acceptable level of errors.

“That’s horrendous,” says a former Chase attorney who was informed of the numbers by American Banker…

Borrower correspondence sent to the San Antonio facility, such as bankruptcy notifications, address changes, and hardship requests were being dropped on an unmanned desk, according to a 2009 printout from Chase’s troubleshooting log….

“I understand there were documents trashed, yes,” she says. [Carol] McGinn retired from the San Antonio facility in June of 2010 after she says she became uneasy with how it was being managed.

And of course, there are robosigners too:

One of Chase’s most prolific affidavit signers was Ruben Alcaraz… By law, collection affidavits require the signer to be familiar with the bank’s pertinent records…

Numerous former employees say that Alcaraz and his colleagues rarely if ever reviewed such files. They routinely signed stacks of affidavits on flights and in meetings, which in some cases were attended by Helaire, Lazinbat and Chase compliance staffers. Nobody objected, Almonte and others say.

Alcaraz also describes himself in the court documents as an “officer of the bank” and an “Assistant Treasurer.” High-level Chase management had instructed the staff to stop signing documents using such titles around the middle of the last decade, four Chase sources say. But Lazinbat ordered them to do it anyway.

One has to assume that Almonte signed a confidentiality agreement as part of the settlement of her suit against JP Morgan. Yet it appears she had decided to step forward again despite the risk of having an army of lawyers come after her:

“This is not an accident anymore,” Almonte now says. “The same people who created this problem at Chase are still in charge. They aren’t going to fix it unless they’re forced to.”

Let’s hope she succeeds. She’s right, of course. The fact that JP Morgan kept Lazinbat in place said it had no intention of shaping up. And one has to assume that the occasional warnings from on high that he should be doing some things differently were seen as pro forma. Put it another way: if the see-no-evil-if-its-done-by-bank OCC is taking this case “very seriously,” it’s likely to be every bit as bad as the American Banker account suggests.

CDS As Insurance Contracts

This Washington Post article about CDS being an insurance product one very useful point was brought out. At the same time, there seems to be flaw in the argument and much of the argument is misdirected.

Typically, an option or futures contract expires, and it either is in or out of the money. Any tradable asset — stocks, bonds, futures, options, funds, etc. — settles on its own. There is a market price the asset closes at, a total volume of sales, and a final print for the day, month, quarter and year. No interpretation is required. Why on earth would anyone need a committee ruling for a trade?

I found this paragraph interesting. While CDS does actually have a closing price and many of the other features of “any tradable asset” it does seem relatively unique to have a final determination of whether a “Credit Event” has occurred, thus triggering a final settlement provision. Barrier options have that feature, so it is not totally unique, but think it is an interesting argument in saying that CDS has more insurance elements than other tradable assets. I will think about that point more, though I think exchange traded and fully cleared CDS would go a long way to alleviating the issue.

What I fail to understand is the point that making this an “insurance” product would somehow fix things and citing repeatedly that AIG was the only failure in CDS so far seems wrong. The Insurance industry and regulators seem to cause far more problems than they fix, and if AIG – an insurance company – is the poster child for what went wrong with CDS, why is there any belief treating it as an insurance company would have any benefits?

We have included the testimony of the National Association of Insurance Commissioners before a government committee with an even longer name.

AIG Financial Products and Holding Company Are Federally Regulated

By purchasing a savings and loan in 1999, AIG was able to select as its primary regulator the federal Office of Thrift Supervision (OTS), the federal agency that is charged with overseeing savings and loan banks and thrift associations.

AIG Financial Products is not a licensed insurance company and is not regulated by the states. Financial Products is an investment unit based chiefly in London. It was able to evade regulation under the British Financial Services Authority because the AIG holding company was registered with an “equivalent regulator,” the OTS.

Although OTS has acknowledged its role as the holding company supervisor, it is worth noting that credit default swaps were exempted from regulation under the Commodities Futures Modernization Act of 2000, which prevented both the C.F.T.C. and the states from regulating these instruments.

Talk about regulator cherry picking and arbitrage.

Anyways, there is a lot of confusion about what AIG FP did and did not do.

AIG FP was a small entity that wrote huge amounts of contracts. Some were done as credit derivatives, some were done to look as much like insurance policies as possible. Many of the deals AIG FP wrote were pure pass through deals – basically the thing they referenced was the only deliverable. In a typical CDS, any debt guaranteed by the company is a potential “Deliverable Obligation”. In pass through trades, which virtually all of the mortgage deals were, it really is payment against specific loss of a specific asset (sounds more like insurance, and was something that the early corporate credit derivatives were careful to avoid since it did look more like insurance than a tradable asset). So while people say AIG wrote CDS, the truth is AIG FP entered into a lot of contracts that had little or nothing to do with a typical corporate Reference Entity CDS trade.

AIG FP believed the risk of “super senior” protection was negligible. The market thought so too, as it traded at less than 10 bps per annum in some cases. Super senior was deemed to have very low risk of actual loss. Collateral calls based on mark to market were a concern. Although people expected zero realized losses, they were concerned that the mark to market could move against them. This was a lesson learned by FSA, monolines and re-insurers early in the “super senior” game. As they pushed back on the street and wanted to do deals with no collateral provisions, an opportunity was set up for AIG FP.

AIG FP wanted to write the protection and wanted to do it without having to post collateral. The banks would not take AIG FP risk directly. It was an undercapitalized entity in the AIG family of businesses (one of my favorites was Banque AIG – somehow Banque AIG sounds much sexier than Bank of AIG but it was also adept at using various parts of AIG to indirectly reduce funding costs). The banks were happy to face AIG FP with better collateral terms if AIG FP had a guarantee from AIG (the holding company). So the seeds of destruction were sown. Banks would agree to buy protection from AIG FP, so long as it was fully guaranteed by AIG, AND they wouldn’t charge collateral unless AIG was downgraded below a certain threshold.

AIG’s main asset was the insurance business it owned. AIG was AAA primarily because of its insurance entities. So you have a structure where AIG holdco is rated AAA because of the insurance businesses it owns, but it uses this credit rating to insure little know AIG FP which has nothing to do with the insurance company (in spite of selling things that looked a lot like insurance contracts – particularly the mortgage pass through trades).

Why weren’t insurance regulators concerned with what AIG was doing? As the size of AIG FP’s exposures grew, why was no one in the regulatory community concerned? Why was it so easy to take the insurance company AAA rating and whore itself to AIG FP without insurance regulators having a say? Frankly, because the laws seem designed to let this sort of thing occur, and for whatever reason, too many people ignore guarantees when looking at potential exposure (think about all the guarantee programs in Europe right now like EFSF and LTRO that the market is largely choosing to ignore).

Had AIG not guaranteed AIG FP, the AIG FP business never would have started. Once AIG was going to be downgraded, because of the AIG FP exposure, the collateral calls were going to kick in. Had collateral calls been started on day one, this entity would have been shut down in early 2007 at a reasonable cost. They would have had to come up with collateral in the early stages of the sub-prime crisis. Losses would have been large, but the game would have been over. Instead, the mark to market losses grew and grew, but so long as the margin call didn’t come, they were able to survive. It was the threat of margin calls on the downgrade on what were now staggering mark to market losses, that caused the problem.

In theory AIG holdco could have been wiped out and the AIG insurance companies would have been fine. I am not sure many people believed that was possible given the high level of interconnectedness of the business and the artful use of regulatory cherry-picking by AIG, but in theory AIG FP should have been left to fail, and AIG with it. Instead, the Fed pushed the rescue because banks had relied so much on “credit derivative” contracts with AIG FP, that they were concerned what would have happened if AIG FP and AIG had failed.

While AIG FP often made the contracts look like insurance products, the banks were very careful to make sure that the products were “credit derivatives” because they needed the regulatory capital relief provided by them. Didn’t the Fed at some point get concerned about the counterparty exposure to AIG FP? Isn’t counterparty risk something that the Fed is responsible for monitoring (or the ECB in the case of foreign banks)? When the Fed let MS and GS become bank holding companies and get the ability to use Fed lending programs, didn’t they ask about the AIG FP exposure? Goldman, which always claimed it was hedged, must have had a massive short position in AIG CDS to be hedged – again, no one at the Fed noticed this? CDS may be unregulated, but when virtually every big financial company in the world has large notionals on with AIG, huge mark to market gains on those positions, no collateral from AIG, and big shorts in AIG CDS, couldn’t someone do their job? This should have been noticeable in 2007!

It is not that CDS should or shouldn’t be an insurance contract, it is that the regulators of banks and insurance companies did horrible jobs and the rules help avoid those regulations that are in place, far too easily.

CDS should be fully cleared and exchange traded. The concept of “net notional” and “gross notional” is unnecessary. That can and should be changed. Getting CDS indices, sovereign CDS, and bank CDS (where the self-fulfilling death spirals and virtuous circles are most obvious) onto exchanges and fully cleared should be an immediate priority of any regulator or politician who wants to create a fair, but more stable system.

Scott O'Malia, Commodity Futures Commissioner, Seeks To Upend Wall Street Reform

In a signal that partisan squabbling in the nation's capital may be reaching new levels of rancor, a key Republican regulator is pursuing an unusual avenue to overturn a Wall Street reform rule issued by his own agency. Scott O'Malia, one of five commissioners who lead the Commodity Futures Trading Commission, is asking a powerful White House office that has no actual authority over the CFTC to assess his agency's work.

If the Office of Management and Budget were to take O'Malia up on his suggestion, it would radically change the way some federal regulations are written and severely hamper implementation of a host of rules mandated by the 2010 Dodd-Frank Act.

It would also be illegal, according to Dennis Kelleher, president of Better Markets, a nonprofit financial reform advocacy group. Kelleher points out that the CFTC is an independent federal agency exempt from oversight by White House offices in order to avoid political interference in the technical regulatory process.

The 2010 reform legislation tasked the CFTC with a host of new duties, from regulating the derivatives market that almost broke AIG, to cracking down on oil speculation that drives up gas prices, to preventing conflicts of interest that encourage banks to undercut their own clients. O'Malia has been a vocal opponent of these changes, even after helping to secure loopholes that water down the substance of the rules. Consider the CFTC's proposal for the Volcker rule -- a relatively simple concept banning banks from gambling in financial markets with their own money -- which came in at nearly 300 pages, filled with exceptions and exemptions that O'Malia supported. He still opposed the proposal, voting against a measure to accept public comments on it.

Last week, O'Malia wrote a little-noted letter to the OMB asking it to review the cost-benefit analysis that the CFTC had used in writing new rules against Wall Street conflicts of interest. O'Malia contended that his agency had violated OMB standards and two Obama-issued executive orders by failing to adequately consider certain regulatory costs highlighted by financial industry groups.

O'Malia said in his Feb. 23 letter, "I am writing to request that the Office of Management and Budget (OMB) review the cost-benefit analysis" undertaken by the CFTC. "President Obama was very clear in his two Executive Orders that he expected the highest standards of analysis to validate the necessity of government rulemaking to ensure we don't impose undue and unfounded economic burdens on market participants and the public as a whole," he continued in his Feb. 23 letter. "I don't believe the Commission's rulemakings comply with this directive."

As an independent agency, however, the CFTC does not answer to OMB. The Obama administration does not have the authority to approve or reject the CFTC's calculations. And while the president issued executive orders in 2011 urging regulators to avoid issuing or revise overly burdensome rules, neither order applies to O'Malia's request. One executive order does not apply to independent agencies, while another does not apply to cost-benefit analysis.

Moreover, cost-benefit analysis of regulations is a notoriously subjective enterprise. Some shareholder-friendly experts argue that its value lies only in assessing specific companies' burdens, while others believe it should include effects on the broader economy and the environment.

This lack of presidential authority has created tensions between Obama and the independent Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac. The administration has urged Fannie and Freddie to provide relief to struggling homeowners, arguing that modifying troubled mortgages would be less costly for taxpayers than foreclosing on homes. But FHFA Director Edward DeMarco has resisted, and Fannie and Freddie are not performing the mortgage modifications.

While such independence at times frustrates presidents, it exists to prevent political pressure from distorting the regulatory process. Like the Securities and Exchange Commission and other independent agencies, the CFTC is run by five commissioners, including at least two Republicans and two Democrats -- a division that ensures rules at least receive input from both parties. Traditionally, commissioners whose side loses a vote may speak their minds, but they do not publicly appeal to the White House for help.

It is Congress that establishes rules for the operation of independent agencies, both in writing the charters for the agencies and in directing them how to write rules. (O'Malia has a great deal of experience on Capitol Hill, having served as an aide to Sen. Mitch McConnell (R-Ky.) and then-Sen. Pete Domenici (R-N.M.) prior to joining the CFTC.) When companies or individuals object to a rule issued by an independent agency, they are also free to challenge it in court.

In a detailed letter of his own, Kelleher of Better Markets, argued that it would be not only illegal for OMB to comply with O'Malia's request, but a procedural nightmare that would create a damaging new precedent for government functionality.

"This attempt to attack the [CFTC] both from within and by enlisting an Executive Branch agency, initiated by a single Commissioner who was on the losing side of a vote, would open up a Pandora's Box of foreseeable and unforeseeable consequences," Kelleher wrote. "At minimum, it would incentivize every dissenting commissioner at any independent agency to seek OMB's help in undermining an agency decision with which they disagreed."

OMB did not immediately return a request for comment.

Many of the most important rules mandated by the 2010 Wall Street reform legislation have yet to be written or implemented.

Greece Has Defaulted: Here Is Where We Stand

After reading this, everyone should have a fairly good grasp of what happened not only today, but ever since the great (and quite endless) European financial crisis took center stage, and what to look forward to next...

In a nutshell---okay, a coconut shell---this seems to be where we are:

1) Greece was able to write off 100 billion euros worth of debt in exchange for a 130 billion rescue package of new debt, of which Greece itself will receive 19%, or about 25 billion, so that it can continue to operate as an ongoing concern. Somehow Greece is in a better position than before, with more debt and less sovereignty and still---by virtue of sharing a common currency---trying to compete toe-to-toe with the likes of Germany and the Netherlands, kind of like being the Yemeni National Basketball team in an Olympic bracket that includes the US, Spain and Germany. At least a "within the euro" default prevented bank runs in Portugal, Spain, Italy et al.

2) As a result of the bond haircuts, Greece has many pension plans that can no longer even pretend to be viable, at least according to the original contracted scheme, but pensionholders still working can take heart in the fact that their current wages will be cut, too.

3) CDS buyers will have to sweat bullets, jump through hoops, and be forced to endure every cliche known to man, but they might end up getting something for all their trouble, provided their counterparty is solvent and that counterparty itself is not heavily exposed to an insolvent party or a NTBTF institution, otherwise known as a Lehman Brothers. Expect the legal profession to be the prime beneficiary of this "event", as any new CDS contract will be at least a hundred pages of boilerplate longer in the future.

4) Good luck to any less than AAA rated sovereign who wants to issue debt from now on out. That contracts can now be unilaterally abrogated, as Greece' bonds were with the retro-CACs, bodes ill for attractive pricing from here on out. Peripherals in the EU will suffer most, as they face the added indignity of being subordinated to the ECB at any point the ECB chooses to exercise its divine right of seniority. The thing that used to be called the risk free rate no longer exists. Bill Sharpe take note.

5) One hundred billion euros worth of perceived wealth evaporated. That can not be a good thing for a Eurobanking system already capital short, as it raises leverage (quick back of the envelop calculation) by about 6% across the board. It also will not make the interbank market any more trusting, thus increasing the likelihood of perpetual LTRO. LTRO lll looks to arrive sooner than QE lll.

6) With the drawn-out Greek event and the LTRO, Europe might believe it has firewalled the system for at least three years and limited damage to Greece and Portugal (who will likely undergo a similar default by the 3rd quarter). LTRO-provided liquidity, it is hoped, will lower market rates enough in Spain and Italy so that those countries can meet sovereign bond obligations and both service existing debt and issue new debt. When the LTRO expires in 2015, "hopefully" something called organic growth will have taken over in countries imposing severe austerity measures on their public sectors, so that debt servicing becomes easier. Organic growth obviously is something that comes in a can, a can which has been kicked out to 2015.

7) As Europe now speaks increasingly of greater EU financial integration, Sarkozy's poll numbers will be the victim and a less EU friendly individual will likely win the upcoming election. Since France and Germany fortunately have a long and storied history of being the best of friends, and no one in either country would ever pander to nationalist sentiments, this shouldn't present a problem.

8) Given how much angst was caused by the drawn out Greek affair, the Spanish leader knows he has enormous leverage with EU leadership and he can continue to do what he has been doing with regard to ignoring the deficit targets demanded/suggested by the EU. The EU might well bark at him, but they cannot afford to bite at this time. Muchos gracias, Greece.

Hedge funds find loophole to trigger Greek default

Some hedge funds have found a legal loophole they believe will force Greece to repay some of its debt in full, three sources close to the matter said on Thursday, in a move that would intensify the standoff between the country and its debtors.

Greece closed a bond swap offer to private creditors on Thursday after clearing the minimum threshold of acceptance to push the biggest sovereign debt restructuring in history.

Government officials said more than 75 percent of eligible bonds had already been committed resulting in losses of some 74 percent on the value of the debt in a deal that will cut more than 100 billion euros from Greece's crippling public debt.

But because of a provision written into one particular bond, some hedge funds believe that Athens has already defaulted on that bond by asking bondholders to exchange their debt for new paper with a much lower value, according to the sources.

The funds are now trying to buy up enough of the bond -- issued by state-owned Hellenic Railways and guaranteed by the government -- to force Greece to repay them in full, to the tune of some 400 million euros.

If Greece refuses to do so, this may trigger similar provisions on other Greek railway bonds, potentially landing Athens with a bill of about 3 billion euros, with investors demanding immediate repayment, the sources said.

However, it is unlikely the hedge funds could derail the overall debt swap, which will shave more than 100 billion euros off Greece's debt pile, a crucial precondition for receiving more international aid and staying in the euro.

The exchange has already been accepted by more than 75 percent of investors, a senior official told Reuters ahead of Thursday's 2000 GMT deadline.

The hedge funds have been targeting some of Greece's more investor-friendly foreign law bonds -- like the railway bond -- hoping to stop Athens from activating so-called Collective Action Clauses (CACs), used to impose losses on all holders.

This could then allow them to squeeze a bigger payout, potentially through lengthy court challenges, while creditors that do sign up to the bond swap face losses of 74 percent on their investments.

ACCELERATING PAYMENTS

Athens has already warned that it does not have the money to pay these so-called "holdouts", but sources close to its negotiations are now concerned it may well have to pay out some smaller bonds in full to make the problem go away.

"What really infuriates me is that some of them (hedge funds) might manage to get paid in the end, on small amounts it's still possible," said one of the sources.

Some 15 pe rcent of Greece's 206 billion euros of bonds held by private sector investors are issued under foreign law.

The problematic transport bond - a 412.5 million euro issue maturing in 2013 - has a clause that allows bondholders to argue that Greece is in default if it is trying to restructure or change the terms of its debt, the sources said.

The creditors could already argue that Athens has defaulted, and if they buy up a quarter of that bond -- or enough of it not to be forced into the debt swap -- they can also then demand immediate repayment, a process known as acceleration.

Sources close to Greece's negotiation fear the funds could already start the acceleration process by Friday, or next week, if they find they have a big enough majority.

Final meetings concerning the swap of foreign law bonds take place at the end of March.

Although these clauses only concern this one bond, the action by hedge funds could trigger clauses contained in other Greek railway bonds.

And because of the provisions in other bonds governed by English law, this could eventually affect more deals, potentially affecting up to 8-9 billion euros worth of debt, one of the sources said.

$28 billion health fund backed by Bill Gates and Bono is investigated for fraud

A multi billion dollar global health fund backed by the Bill and Melinda Gates Foundation is being probed for widespread fraud after it emerged grant money to developing countries had been 'eaten up by corruption.'

The Global Fund to Fight Aids, Tuberculosis and Malaria (GFATM), which distributes $28 billion in aid, found that two-thirds of the money from some grants had been stolen or misused by recipient countries.

As a result of the internal investigation, donor countries Germany and Sweden have withheld over $250 million in aid money from the Global Fund on the back of the claims.

The Fund's newly reinforced inspector general's office, which uncovered the corruption, can't give an overall figure on the size of the fraud because it has examined only a tiny fraction of the $10 billion that the fund has spent since its creation in 2002.

To date, the United States, the European Union and other major donors have pledged $21.7 billion to the fund, the dominant financier of efforts to fight the three diseases.

The Global Fund receives money from 54 countries and charitable foundations such as (Product) Red, which is supported by rock star Bono.

Other prominent backers of the Fund include former U.N. secretary-general Kofi Annan, French first lady Carla Bruni-Sarkozy and Microsoft founder Bill Gates, whose Bill and Melinda Gates Foundation gives $150 million a year.

The controversy over the misuse of Fund health money erupted after a report from the Fund’s inspector-general found that 'as much as two-thirds' of some health grants to developing countries had been 'eaten up by corruption.'

Reports specifically named projects in Djibouti, Mali, Mauritania and Zambia, and cited forged or non-existent receipts for 'training events,' fake travel and housing claims and outright theft, along with shoddy bookkeeping.

A full 67 percent of money spent on an anti-AIDS program in Mauritania was misspent, the investigators told the Fund's board of directors.

It also emerged that 36 percent of the money spent on a program in Mali to fight tuberculosis and malaria, and 30 percent of grants to Djibouti were similarly misappropriated.

In Zambia, where $3.5 million in spending was undocumented and one accountant pilfered $104,130, the fund decided the nation's health ministry simply couldn't manage the grants and put the United Nations in charge of them.

The fund is trying to recover $7 million in 'unsupported and ineligible costs' from the ministry.

Despite the reports of widespread corruption, Fund executives said the amount involved was only a pittance compared to some $13 billion in spending so far.

The Fund's Inspector General John Parsons declared that: 'The distinguishing feature of the Global Fund is that it is very open when it uncovers corruption.'

The Fund's Executive Director Michel Kazatchkine also hit back at critics, defending safeguards on how money distributed is spent.

In a statement he said: 'Concerned by the alarmist media stories, some donors to the Global Fund have stated that they need to reassure themselves of the organisation’s procedures for dealing with fraud before affirming their contributions.

'We will work with these donors – as well as anyone else – to ensure that the Global Fund’s systems are as good as they possibly can address corruption.

'To date, the Global Fund’s Office of the Inspector General has undertaken audits or investigations in 33 of the 145 countries where the Global Fund has grants.

'As a result of this, the total amount of misappropriated or unsubstantiated funds that the Global Fund is demanding to be returned at present is $34 million.'

Sweden, the fund's 11th-biggest contributor, has suspended its $85 million annual donation until the fund's problems are fixed. It held talks with fund officials in Stockholm last week.

Swedish Foreign Ministry spokesman Peter Larsson said in a statement that his country is concerned about 'extensive examples of irregularities and corruption that the fund has uncovered' in nations like Mali and Mauritania.

'For Sweden, the issues of greatest importance are risk management, combating corruption and ultimately ensuring that the funds managed by the Global Fund really do contribute to improved health,' he said.

The investigative arm of the U.S. Congress also has issued reports criticising the Fund's ability to police itself and its over reliance on grant recipients to assess their own performance.

'Blind' Fed Owns More US Treasuries Than China – Ruining Fixed-Income Policy Gauge

As long as there is confidence in the Fed, the Fed's strategy may pan out, right? Maybe. We don't even question the motives of the Fed 154127845 However, we question the Fed's ability to conduct policy when its policy makers are blindfolded. We fear that some of the Fed's most important gauges used to set policy have been taken away, by the Fed itself. – Merk Funds

Dominant Social Theme: If the Fed would only do a better job, thing could get better.

Free-Market Analysis: Merk Funds' Axel Merk just issued a commentary in which he points out, astonishingly, that the Fed "now owns more U.S. government debt than China." The ramifications are immense.

Merk has founded several currency funds during the decade and has been, from time to time, a fairly caustic critic of Western, mainstream monetary policy. This article, "Fed Flying Blind," certainly makes some interesting points. Here's one:

The Fed has engaged in Operation Twist, applying the Fed's firepower to lowering rates further out the yield curve (longer term interest rates). Indeed, the Fed now owns over 30% of all outstanding marketable U.S. Treasuries with maturities of 6-10 years; across the yield curve, from Treasury Bills to 30-year Treasury Bonds, the Fed has accumulated almost 20% of all outstanding securities.

This is well written, and shows not just the massiveness of the Fed's current monetary distortion but the larger distortion in the marketplace that the Fed (and other central banking interferences) must inevitably be causing. More on that in a minute.

For Axel Merk, the size of the Fed's intervention is not just startling; it also has practical ramifications involving investors everywhere. We believe the gargantuan nature of the purchases illustrates our contention that the dollar reserve system has basically fallen apart.

Merk worries that the Fed's ability to determine HOW to set monetary policy has been compromised. He writes, "Some of the Fed's most important gauges used to set policy have been taken away - by the Fed itself. We fear the Fed may be flying blind." (See article excerpt above.)

Merk then makes another critical point: "Fed Chair Bernanke told Congress last week that he is puzzled about incoming economic data, unable to explain why the unemployment rate has come down quite so rapidly. Consider the yield curve: typically, yields provide a wealth of information about the health of the economy, about inflationary pressures, to name a few."

And Merk added, "As such, an important feature of the yield curve is that it can sell off, amongst others, should inflationary pressures pick up or should investors be concerned about long-term fiscal sustainability. With the Fed becoming evermore engaged in yield curve management further along the curve, this gauge has been taken away."

Our immediate response to this is that the reason Bernanke cannot figure out income economic data is because the US government's INPUTS are junk. The elites who stand behind Obama are determined to elect him to another term and will skew the economic numbers in whatever direction they have to in order to make the case that he deserves one.

But this latter observation by Merk is one we have not read ANYWHERE else. The Fed is purchasing bonds and thus influencing their price. And yet Fed policymakers rely on bond prices (among other data) to determine the monetary policy they wish to implement. Here's some more from the article:

In assessing whether to make tough decisions, policy makers tend to weigh the cost of action versus inaction. As critical as we are of our dear policy makers, when push comes to shove, they may rise to the occasion. But what if they are not told when it's time to act, when it's time to stop printing and spending trillions? In our assessment, the voice of reason has been silenced, posing potential risks to economic stability, as well as the U.S. dollar. That voice of reason is no other than the market itself. Let us explain.

As the Federal Reserve (Fed) has become ever more engaged in micro-managing the economy, we have moved from rate cuts to emergency rate cuts, to printing billions, then trillions, first to buy mortgage backed securities and more recently, Treasuries. Coming to the realization that talk is cheaper than action, the Fed has since switched gears and "committed" to keeping rates low, initially through mid-2013 and now through the end of 2014 ...

The alternative, of course, would be to conduct what we would deem sound monetary policy, so that a reasonable person wouldn't be concerned about the risks of money printing in the first place. But that's so yesterday.

This path that Merk charts when it comes to the Fed is enlightening because it illustrates what we would call "desperation" as regards stabilizing the economy. It began with rate cuts and migrated to printing what is now trillions and then to SPENDING those trillions. Trillions!

Former Fed Governor Kevin Warsh, a critic of active yield curve management, has said the Fed is looking into the mirror in conducting policy ... they are human and should periodically be reminded that the greatest failures in monetary history have also been conducted by some of the smartest economists of the time.

How high are the stakes? According to Merk, "The U.S. deficit will grow by $3.86 trillion (the 2013-2017 adjusted baseline scenario in the 2013 budget). Should the Administration be able to implement all its policy initiatives, the five-year addition to the deficit would 'only' be $3.44 trillion. "

Cold comfort, indeed. As Merk points out in a further paragraph, the real fallback for the Fed seems to be "prayer and hope." These untraditional methodologies (prayer and hope) have "moved to the forefront of Fed policy making, as the Fed has taken away what we deem are some of the most important gauges used to conduct monetary policy."

Merk ends his article by cautioning that prudent investors and their planners and money managers need to take the Fed's purposeful distortion of the bond market into account when deciding on asset allocation. The Fed is not only in the process of ruining its OWN indicators, it's ruining them for everyone else too.

According to Merk, the Fed is flying blind, but we cannot conclude this article without pointing out that central bankers have likely NEVER had the tools necessary to implement accurate monetary planning.

As Ludwig von Mises showed in his ground-breaking opus Human Action, it is impossible for government planning to work. Whenever the government passes a law or implements a regulation people's behavior will change but not in the manner that bureaucrats expect.

Beyond this, the very threats that government officials perceive are ALSO perceived by individuals who will take "human action" long before government decides on the appropriate solution. And when that solution is implemented, the chances are it will be too little too late.

People will ALREADY have changed their behaviors, rendering the government solutions moot. Another way of explaining this is by simply pointing out that all laws and regulations are essentially price fixes, distorting the market. The Fed can never properly PLAN policy because those doing the planning have no idea of how their previously introduced distortions will react with the marketplace.

Finally, we'd have to take issue with the perception that monopoly-fiat central banking is actually meant to create prosperous economies. The track record of monopoly-fiat central banking is miserable. The dollar's value alone has been inflated away to nearly zero. And the dollar is the world's reserve currency!

In our view, the idea that monopoly-fiat central banking is either viable or "helpful" is itself an elite dominant social theme, a promotion that seeks to convince citizens that there are certain "leaders" who can be trusted with properly dispensing hundreds of trillions.

The Anglosphere elites (as we have often indicated) – are made up of Jewish, Catholic/Vatican, religious, corporate and military elites. Some criticize free-market economics by claiming its adherents are "Jewish," though in fact modern Austrian economists are neither exceptionally Jewish nor, of course, Royalist. The Daily Bell, a free-market publication, is ecumenical, not Jewish, nor are many of its advisors Jewish.

In truth, the reason for central banking is to fund the creation of one-world government, in our humble view. And to create a worldwide depression in order to help the process along.

There is, of course, a vast smokescreen of rhetoric that has been developed to hide this fact. But no matter the justifications, no matter the learned articles, the reality of what monopoly fiat central banking IS remains.

It is price fixing. It is the adjustment of the volume and value of money by a handful of good, gray bankers. Or to put it another way: It is ineffective because it seeks to influence the optimal operations of the Invisible Hand of private-market competition.

As Axel Merk points out, the Fed these days is ineffective on numerous levels. It is "flying blind." He did this logically, by pointing out the Fed has interfered so drastically in the market that it has compromised the very fixed income indices it has ordinarily relied upon.

Even if one believes that the Fed is doing a good job, or that it COULD do a good job, the idea that it has manipulated the very indices it has counted on for planning purposes should give one pause.

Conclusion: Yes, the Fed is indeed "flying blind." Or to put it another way, only someone who has lost his or her faculties would be inclined to trust either the policies or strategies of modern central banking.

Federal judge weighs whether to let regulators rein in oil speculators

A federal judge on Monday refused to halt efforts by a key regulator to limit excessive speculation in the trading of oil contracts — which is driving up oil and gasoline prices — but hinted that he might soon rule in favor of Wall Street and let speculation go unchecked.

Robert Wilkins, a judge on the U.S. District Court for the District of Columbia, declined a request for a preliminary injunction to halt the Commodity Futures Trading Commission from implementing a congressional mandate to limit how many oil contracts any single financial speculator or company can control.

However, Wilkins told both the CFTC and lawyers for the Securities Industry and Financial Markets Association and the International Swap and Derivatives Association that he expected to make a ruling soon on whether to hear the case. His line of questioning left both sides with the impression that he was concerned about how the regulatory agency has proceeded.

The two influential lobbies for Wall Street sought the injunction hoping to thwart what are called “position limits,” which were ordered by Congress as part of the landmark Dodd-Frank Act in 2010. The act was the broadest revamp of financial regulation since the Great Depression. The limits sought to prevent excessive speculation not just in oil but across the broad range of commodities, including farm products and metals.

Judge Wilkins expressed concern that Congress would direct the agency to impose market-wide limits without detailed study beforehand. President Barack Obama nominated Wilkins to the bench and the Senate confirmed him in 2010.

“That seems to me an astonishing position to take,” the judge told CFTC deputy general counsel Jonathan Marcus, who had said that Congress ordered the agency to first impose limits on oil trading, then other commodities.

As a sign of how high the stakes are, the trade groups hired Eugene Scalia to make their case. He’s the son of outspoken conservative Supreme Court Justice Antonin Scalia, and last year he won a key challenge to a Dodd-Frank rulemaking being carried out by the Securities and Exchange Commission. In that case, the courts struck down provisions that would have made it easier for shareholders to run candidates for corporate boards.

Congress ordered the CFTC to impose position limits, concerned that financial speculators now far outnumber producers, merchants and end users of oil and other commodities in the trading of contracts for future delivery of product _ known as futures contracts. Reporting by McClatchy has shown that these speculators now outnumber by more than 2-to-1 the traders who actually produce or consume oil.

Speculators, who play a necessary role in financial markets, historically have made up about 30 percent of futures trading. But now that ratio has reversed and some analysts contend that it’s distorting oil prices _ and soaking consumers in the process. The price on the New York Mercantile Exchange of futures contracts for next-month delivery of oil settled at $108.56 on Monday, up more than $23 a barrel since prices began climbing toward the end of October 2011.The nationwide average for a gallon of unleaded gasoline stood at $3.69 on Monday, up 29 cents from a month ago.

Monday’s court hearing was divorced from the real world, where prices are soaring ostensibly because of perceived supply threats given rising tensions between the West and Iran. Most of the court’s questions were about a 1981 law that similarly imposed limits on the trading of silver contracts, and the degree to which that rulemaking set precedent for the current marketplace intervention.

Judge Wilkins noted that the CFTC’s commissioners were in disagreement over whether limits were even needed, and the rulemaking being challenged narrowly passed the commission by a 3-2 vote.

That was a point seconded by Scalia, a high-profile partner in the law firm of Gibson, Dunn & Crutcher.

“It doesn’t require a rule at all we think,” Scalia argued, adding that there “is no disputing (that) these are significant ongoing costs” and that big Wall Street players such as Barclays and JPMorgan Chase “are going to incur costs … for a rule that is fundamentally flawed.”

The judge directed most of his questions at the CFTC’s Marcus, grilling him on financial sector complaints that the cost of complying with the new rules was burdensome and that there had not been enough analysis of costs vs. benefits. Marcus countered the judge’s questioning by noting that the Dodd-Frank Act explicitly directed the agency in four different places to quickly impose limits and called the costs to industry “minuscule” compared to their earnings.

Dennis Kelleher, president of the advocacy group Better Markets, sat through the court hearing and emerged concerned that the financial sector was chipping away at the intention of Congress.

“This is all about the industry trying to protect large dark (unregulated) markets,” he said, referring to the so-called over-the-counter markets, which are much larger than the regulated futures markets. Under Dodd-Frank they are slated for first-ever CFTC regulation.

The CFTC’s rules cannot take effect until the agency defines the over-the-counter products, called swaps, since the private bets involve swapping risk. That is scheduled to happen in April, which means limits on next-month contracts for oil could take place soon after that. Speculative limits on oil futures contracts that go out several months or even a couple of years would take effect somewhere around this December or early in 2013.

Chris Cook: The Ghost of Enron Past Explains Oil Market Manipulation

I outlined in a recent post my view that the oil market price has been inflated twice by passive (inflation hedgers) investors, albeit with short term speculative spikes from active (speculators) investors: once from 2005 to June 2008; and again from early 2009 to date. In attempting to ‘hedge inflation’ passive investors perversely ended up actually causing it, and allowed oil producers to manipulate and support the oil market price with fund money to the detriment of oil consumers.

But there has always been a missing link – precisely how has this manipulation been achieved?

A comment thread at the FT Alphaville blog a month ago shed light on the esoteric subject of collateralised commodity borrowing by BP, who with Goldman Sachs were the heroes of a January post.

While Izabella Kaminska’s Alphaville post was as interesting as usual, the real nugget on this occasion lay in the extremely well informed discussion which followed.

The protagonists were firstly, Patrick McGavock – a very clued up former banker whose blog rejoices in the name of the “Complete Banker”. The second commenter – whose nom de plume is “Free Again” – not only had technical mastery of a subject that has me reaching for an icepack for my head, but also displayed a comprehensive knowledge of Enron’s modus operandi.

Volumetric Production Payment (VPP) versus Prepay

The very name is enough to make the eyes glaze over, but in essence a VPP is a loan secured against a flow of production which remains in the ownership of the producer.

Prepay, on the other hand, is a forward sale of a commodity where the ownership rights to production pass to the financier.

The Alphaville dialogue is instructive as to the difference.

Free Again (to McGavock): Enron did two types of related transactions: Sales of Volumetric Production Payments (described below), which are being done today in much the same way, and Prepay transactions, which were round-trip trades (three parties involved) meant to create the appearance of Funds Flow From Operations, when it was actually funds flow from financing.

McGavock (to Free Again): Absolutely right. Although VPPs and prepays are essentially the same thing except for the ownership of mineral rights.

A day later came a response which I did not see until recently (my bold).

Free Again (replying to McGavock) Yes, I think we agree, but the most interesting distinction, and what may be relevant to the BP discussion, is the reason a company would choose a particular structure.

A VPP is a form of (acceptable) off-balance sheet financing. In most cases, reserve risk is transferred to the buyer (though the seller usually retains the operating risk).

A Prepay transaction is a little more insidious. It is a form of financing, but if structured as a commodity trade, can be made to look as if it is cash flow from operations.

This is particularly important to companies that use mark-to-market accounting, as there usually exists a huge gap between earnings and cash recognition. In order to maintain credit metrics when using MTM, the companies will structure misleading FFFO transactions, as a key rating agencies focus is FFFO/Interest Expense.

Prepay

Prepay does not move the oil, which stays where it is in the ground or in tank. What prepay does is to create an ownership claim over oil which may be sold either temporarily (Enron-style) as an ‘oil loan’ to investors, or to refiners, who take delivery in due course of oil for which they have fixed the price by ‘paying forward’.

Investors prepay for physical oil which goes nowhere and stays in the custody of the producer, who has an agreement to buy the oil back from the investor, typically a month later in a forward contract that looks just like a futures contract. The outcome is that – facilitated by an investment bank intermediary – the producer lends oil to the investor, and the investor lends dollars to the producer.

The temporary ownership rights created and sold to investors via intermediaries such as Goldman Sachs essentially enable a producer to act as a private oil bank ‘printing oil’.

How does printing oil affect the market? First we’ll look at the printing process as dollars flow in to the market, and the Dark Inventory which it funds. Secondly, we’ll look at what happens when funds flow out and this paper oil is redeemed by the issuer.

Printing Oil

In early 2009, risk averse money poured into the commodity markets, and a large portion of it flowed in to passive funds such as Index Funds and Exchange Traded Funds investing wholly or partly in oil. Units in these funds are created, and some unit issuers then entered, via investment banks, into prepay agreements with producers.

Producers obtain dollars interest-free in exchange for transferring title to oil inventory to the investment bank, and what this means is that the producers do not need to sell as much physical oil to refiners, who must therefore raise their bid price to secure supply from producers, and this is why the price rose rapidly in early 2009 even though the market was not under-supplied.

The second effect was that the demand for forward contracts for the producer to buy the oil back again drove the forward price higher, and this created what is defined as a ‘contango’ market. In fact, it was so pronounced it was called a ‘super-contango’.

What happened as a result was that traders began to buy oil, and to sell it forward, since the contango difference in price enabled them to pay to insure and finance the oil; to lease tank storage, and even to charter the fleets of tankers which sat as floating storage off the UK coast through spring and summer 2009.

Passive investors, for their part, lose money in such a contango market, because the oil lease contracts are rolled over from month to month at a loss to them, since they would (say) sell June delivery oil contracts which they are in no position to perform, and have to buy July delivery oil contracts at a higher price.

It is this continuing loss to long term fund investors which funds the ‘contango trade’ of the arbitrageur traders who charter the tankers.

“De-Pay” – Fund liquidation

When risk-averse investors ask for their money back, what happens is that the oil leasing agreement comes to an end, the fund units are liquidated, and the dollars are returned to the fund investors.

So when the oil is repurchased by the producer from the investment bank, the position is no longer ‘rolled over’ and no further contract purchase is entered into in the next delivery month. This depresses the forward contract price relative to today’s price, a state of affairs which is known as a ‘backwardation’.

Moreover, the producer now has fewer dollars and more oil, and is exposed to a fall in the price of the inventory which he now owns once again. Of course, the producer could sell to refiners on a prepay basis, which a refiner would be happy to do at a suitably discounted price. Or alternatively, the producer could sell futures contracts to speculators who for some reason expect that prices will increase.

There have been two outflows of passive investment from the market, firstly in September 2011 when sentiment turned in favour of T-Bills as safe haven. The second was in December 2011, following the MF Global problem, which demonstrated that unit issuers come with a counter-party risk, since though the issuer may not be taking market risk themselves, they may nevertheless be playing games with the asset.

In each case we have seen the physical market go into backwardation, and in my view the record deliveries by the Saudis may be explained by an urgent desire to sell inventory returned to their ownership at high prices before the collapse they know is on the way.

But the exit of passive investors from the market has yet to have the effect it did in late 2008 when the price collapsed to $35/barrel from the high of $147/barrel. The reason is that the current noise and rhetoric re Iran has firstly attracted refiners, who have purchased oil forward, and possibly even prepaid, because they fear prices will rise.

This forced up the physical price of oil in the current ‘spike’ which will further kill off demand, while speculators have poured into the market to buy futures contracts, which producers have been only too happy to sell, in order to lock in high prices and insure against a collapse.

It is only a matter of time before this spike ends as the market turns, and at this point there is literally nothing holding the market up.

Inventories

Private inventories are at record lows, and this is mistakenly taken by commentators as a sign of demand. The reality is that traders will only store oil if they are able to afford to store it and sell it at a profit. The problem is firstly that many traders are being starved of credit by the banks, which will make it difficult for them to act as a ‘buffer’ through buying surplus oil

Secondly, the market is in fact in backwardation, which means that holding oil costs traders money, and if producers have cash flow problems, they too have an incentive to sell at a discount.

Refiners’ Demand for Oil

No investment bank with oil funds to sell you will ever come up with any reason why oil prices will ever go down, but their faulty economic logic can reach laughable proportions.

For instance, falling demand for products in the US and EU has seen massive closures of refineries, to the extent that some 2m barrels per day of US East Coast refining capacity has closed. This is of course good for the refineries left standing since it can create local shortages and opportunities for high margins and profits.

A very well respected investment bank analyst recently suggested in the FT that the resulting higher US gasoline prices would increase the demand for crude oil and hence – surprise, surprise – was bullish for oil prices. What he was ignoring was that all of the crude oil which used to go to the refineries which had shut will be looking for another home.

By way of example, Hovensa joint venture refinery at St. Croix in the US Virgin Island, which used to receive 350,000 barrels per day from the Venezuelan state oil company PDVSA which was one of the partners, has now closed. It is hardly likely that the PDVSA will now increase the price of their heavy crude oil when offering it to (say) the Chinese. The point being that oil refiners have been caught between the rock of a manipulated and inflated crude oil price and the hard place of cash-strapped consumers.

So in a nutshell, demand in the West is dropping like a stone. I do not believe for a minute that demand for consumption in the East will make up the slack. In my view much of that demand (if not wishful thinking and hand waving by analysts) is financial, being the building of strategic reserves and refinery stocks as a physical hedge.

It will be seen that the effect of Prepay on the oil market has been to create a parallel financial market in ‘paper oil’ which means that most participants are completely misled as to the true state of the market.

In summary, as I previously outlined, my analysis is that the oil market stands like an Oil-e-Coyote – running hard beyond the edge of a cliff, but not having yet looked down………

Window Dressing Enron

For those with short memories, Enron fraudulently concealed their financial position from investors and the rest of the world through a variety of sophisticated techniques. One of the most egregious was the use of prepay transactions with investment banks via a special purpose vehicle in a tripartite agreement which essentially misrepresented what was in reality a loan as a forward commodity purchase and sale.

In other words, Enron – facilitated by investment banks – was window dressing its balance sheet and fraudulently misleading investors and counter-parties alike.

Window Dressing the Oil Market

It appears to be the case that BP and Goldman Sachs have for many years been directly or indirectly enhancing BP’s balance sheet and cash flow through enabling BP to lend oil to passive inflation hedger investors and in return obtain interest free dollar funding and literally monetising oil.

Possible accounting legerdemain by BP is one thing, but the greater problem by far has been the effect of passive investors entering the market en masse via this route. As I explained, these transactions have eroded the foundations of the oil market, which have become entirely financialised and have lost touch with the reality of physical production, consumption and storage.

The fact that oil market inventory has been prepaid in this way creates a two tier physical market, where the tiny minority who have knowledge of the resulting ‘Dark Inventory’ of oil in temporary investor ownership have a massive advantage over the majority who do not and who enter into derivative contracts upon a completely false assumption as to physical supply and demand.

Whether or not this is illegal, and if so, in what country, is an interesting question. But as a former head of regulation of a global energy exchange I have no hesitation in saying that the result has been a complete perversion of the oil market, which has become, for maybe as long as ten years, in every sense a ‘False Market’.

The sheer scale of this oil market manipulation, and the staggering sums involved, make Yasuo Hamanaka’s ten year $ multi billion copper market manipulation for Sumitomo look like a car boot sale.

If my analysis of the oil market is correct, many if not all prepay transactions have been terminated in recent months as passive investors have pulled out and the market has become free again of Dark Inventory. However the oil price has been kept inflated by a massive wave of speculative buying attracted by rhetoric and noise about Iran.

With the market’s underpinnings eaten away by fulfilment of these pre-paid contracts (which will temporarily depress physical demand), a collapse in the oil price is inevitable once speculators exit. After this, perhaps steps may then be taken by producers and consumers collectively to free the oil market from the pernicious control of middlemen, and to completely reconfigure the market through a new settlement.

I’m not holding my breath, but I do live in hope.

BP Settlement Leaves Most Complex Claims Unresolved

BP’s announcement that it will pay $7.8 billion to compensate thousands of Gulf Coast residents harmed in the Deepwater Horizon disaster ends one chapter of legal wrangling over the 2010 oil spill, but leaves other, potentially far more expensive, issues unresolved.

The tentative deal, announced late Friday, does not address state lawsuits and federal claims under the Clean Water Act and Oil Pollution Act, which could cost BP as much as $21 billion more. It has little to do with efforts to assess the extent of environmental damage and to pay for them; that will come later. And BP could still face criminal charges related to the oil spill and be barred from receiving federal contracts.

The payout agreed to Friday is BP’s best estimate of what it will cost to meet outstanding claims, but is not capped and could wind up being higher. As of now, though, the amount is significantly less than many had expected and does not appear to require BP to spend any money that it had not already agreed to pay. The settlement will come out of a $20 billion fund set aside in June 2010 by BP at the behest of President Obama to cover claims from disaster victims. The settlement amounts to less than one-third of BP’s 2011 profits, which were nearly $26 billion.

BP officials portrayed the settlement as one of a number of programs the company has undertaken to repay Gulf Coast residents, while assuring investors that the company has anticipated liabilities from the explosion and sinking of the Deepwater Horizon oil rig. Eleven men died in the accident and more than 200 million gallons of oil spilled into the Gulf.

"From the beginning, BP stepped up to meet our obligations to the communities in the Gulf Coast region, and we've worked hard to deliver on that commitment for nearly two years,” said Bob Dudley, BP’s CEO, in a statement issued Friday night. "The proposed settlement represents significant progress toward resolving issues from the Deepwater Horizon accident and contributing further to economic and environmental restoration efforts along the Gulf Coast."

Others are already questioning whether the settlement terms are fair, however.

The lawsuits were filed mostly by people who sought greater damages than were likely to be met by the Gulf Coast Claims Facility, the BP fund that has compensated residents for economic losses since mid-2010. But because the settlement will be paid out of the same fund, and amounts to a little more than half of what remains in it, it’s not yet clear how much plaintiffs will receive or what will happen to other claimants if the fund runs dry.

A portion of the settlement also will go to lawyers involved in the case, whereas previously money in the BP fund had gone only to claimants.

“How does that advance the ball at all?” asked Anthony Buzbee, a Houston attorney representing 12,000 plaintiffs against BP, but who was not on the committee that negotiated the settlement. “The lawyers on that committee wanted to settle because it means huge fees.”

Even with Friday’s settlement, BP has several significant legal and financial hurdles left to cross.

Nearly two years after the disaster, perceptions are still shifting about how much damage it has done. As oil washed ashore on hundreds of miles of coastline and the Gulf’s tourism and fishing industries faltered, President Obama called the spill “the worst environmental disaster America has ever faced.” Since then, some experts have said the oil dissipated faster than expected and the long-term harm was less than predicted.

Yet even now, tar balls are still turning up on beaches, residents complain of health problems due to the spill or chemical dispersants used to clean it up, and an increasing number of dolphin deaths have raised biologists’ concerns.

Environmental scientists say it will be years before the true extent of the disaster can be known, making the next round of litigation for BP even more complicated.

Friday’s settlement effectively split off individual claims from the thornier issues of assessing and paying for long-term environmental damage. Those questions will begin to be addressed in the civil suits brought by several states and the U.S. government under the Clean Water Act and Oil Pollution Act alleging BP acted negligently.

After the spill, several government investigations found that BP and its contractors made careless missteps in the final hours of drilling its complex oil well in mile-deep water.

The Department of Justice also is conducting a criminal investigation into the Gulf spill and may bring charges under the Clean Water Act. Officials have said that they are weighing whether to prosecute individual BP executives for decisions made in the days leading up to the deadly explosion, as well as charges against the corporation itself.

The actions triggered by the Gulf spill capped more than a decade of accidents and criminal and civil cases brought against BP, following several oil spills in Alaska, the deadly explosion of the company’s refinery in Texas City, and a scandal in which BP was accused of manipulating propane prices.

BP’s track record may make it vulnerable to the ultimate civil sanction: a decision by the Environmental Protection Agency to disqualify the company from future federal contracts including leases to drill, a penalty called debarment.

BP’s facilities in Prudhoe Bay, where the company spilled 200,000 gallons of oil in 2006, as well as the company’s aging Texas City refinery, where an explosion killed 15 workers in 2005, already have been debarred. At issue now is whether the federal government will cancel contract eligibility for the entire company, penalizing it for a pattern of wrongdoing and exhibiting a “culture of corporate non-compliance.”

The case partially settled Friday consolidated thousands of individual, state and federal lawsuits brought against the company into one mammoth case that was to be tried in U.S. District Court in New Orleans. Judge Carl Barbier – who delayed the trial’s Feb. 27 start so that a settlement could be reached -- had planned for the case to unfold in three stages: the first to establish BP’s liability and whether the company was negligent, factors that would have dictated the severity of damages under the Clean Water Act and the Oil Pollution Act; and later stages assessing mistakes made in drilling operations and the spill’s environmental toll on Gulf ecosystems. At one point, BP said a trial could go on for more than a year.

The federal suits that remain unresolved may turn out to be the most expensive. They depend largely on whether BP is found to have been grossly negligent in its handling of the Deepwater Horizon disaster, and on how much oil is determined to have seeped into the Gulf. Federal law allows for the company to be fined $1,100 per barrel under normal circumstances, and as much as $4,300 per barrel if it was grossly negligent. Under the current estimate, 4.9 million barrels of oil spilled, BP could face up to $21 billion in additional fines.

The exact amount of oil spilled continues to be a matter of debate, however. The Coast Guard initially estimated that the amount of oil flowing into the Gulf was about 42,000 gallons a day. Eventually, the government concluded the number was much higher -- 2.4 million gallons a day, or 206 million gallons total -- but BP disputed those figures.

In January, e-mails released as part of the court proceedings showed that in the first days of the spill, BP’s own estimates of the potential flow rate were higher still – up to 3.4 million gallons a day, according to a report by the Associated Press. BP endeavored to keep its estimates secret, telling its staff “not to communicate to anyone on this.”

BP has said that it has set aside a total of $37.2 billion to pay for damages related to the spill. Of that, the company estimates it has already spent $22 billion on Gulf coast cleanup and restoration, including at least $6.1 billion through the claims facility. The latest $7.8 billion settlement includes $2.3 billion slated to help resolve issues related to the Gulf seafood industry, and appears to bring the company within about $7 billion of its stated budget, a figure that could be eclipsed as the remaining components of the lawsuits go forward.

The deal is divided into a fund for economic claims, and one for health-related issues, which covers plaintiffs’ current medical conditions and also provides funds for a 21-year program to address future health care claims and issues as they arise. It provides $105 million to support health care in Gulf communities that is payable immediately, even though the settlement overall is still subject to review and approval.

Brace Yourself for Election-Driven Enforcement Theater: Token Roughing Up of Crisis Bad Banksters, While Corzine Gets a Free Pass

It’s bad enough that we are being subjected to relentless propaganda about how housing is just about to turn the corner and the state-Federal mortgage settlement is such a great deal for homeowners. In fact, as we’ve stressed, and bond investors such as Pimco have reiterated, the deal is above all a back door bailout of the banks. Bloomberg weighed in yesterday:

Bank of America Corp., Wells Fargo & Co. and three other banks that settled a nationwide probe of foreclosure practices this month will get a bonus from the deal: protection for $308 billion of home-equity loans they hold…

It’s “a gift to the banks, at investors’ expense,” said Goodman, a member of the Fixed Income Analysts Society’s Hall of Fame. “A proportionate write-down of the first and second represents a reversal of normal lien priority.”

But to add insult to injury, the chump public will be given bread and circuses enforcement theater to distract it from the fact that the banks are getting a sweetheart deal.

The show is already on the road. The Financial Times tells us that Wells Fargo and Goldman have reported that they have received so-called Wells notices, which is an advanced warning that the SEC staff plans to file civil charges. SEC is pursing firms that it believes misrepresented the quality of loans that were bundled and sold as mortgage backed securities.

This all sounds great, right? Wrong. Take a look at your calendar.

The toxic phase of subprime issuance started in the late summer-early fall of 2005 and screeched to a halt in June 2007. But the statute of limitations for securities liability is five years. So the ONLY deals the SEC can pursue now are the last gasp transactions of March- June 2007, and on those, the clock is ticking. Those were particularly dreadful and no doubt would provide some colorful anecdotes, but who are we kidding? The SEC has sat on its hands until an election year need to Look Tough will lead to a filing of a few random lawsuits to rough up the usual suspects. But the reality is that the horses have left the barn and are now in the next county.

Contrast this with the flailing about on MF Global. From the New York Times, emphasis ours:

Federal authorities are struggling to find evidence to support a criminal case stemming from the collapse of MF Global, even after a federal grand jury in Chicago has issued subpoenas.

Investigators, unable to find a smoking gun amid thousands of e-mails and documents, increasingly suspect that chaos and poor risk control systems prompted the disappearance of more than $1 billion in customer money, according to several people involved in the case.

Have none of these people heard of Sarbanes Oxley? This sort of failure falls right in its crosshairs. As we wrote a year ago:

Contrary to prevailing propaganda, there is a fairly straightforward case that could be launched against the CEOs and CFOs of pretty much every US bank with major trading operations. I’ll call them “dealer banks” or “Wall Street firms” to distinguish them from very big but largely traditional commercial banks like US Bank.

Since Sarbanes Oxley became law in 2002, Sections 302, 404, and 906 of that act have required these executives to establish and maintain adequate systems of internal control within their companies. In addition, they must regularly test such controls to see that they are adequate and report their findings to shareholders (through SEC reports on Form 10-Q and 10-K) and their independent accountants. “Knowingly” making false section 906 certifications is subject to fines of up to $1 million and imprisonment of up to ten years; “willful” violators face fines of up to $5 million and jail time of up to 20 years.

The responsible officers must certify that, among other things, they:

(A) are responsible for establishing and maintaining internal controls;
(B) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared;
(C) have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days prior to the report; and
(D) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;

These officers must also have disclosed to the issuer’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):

(A) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer’s ability to record, process, summarize, and report financial data and have identified for the issuer’s auditors any material weaknesses in internal controls; and
(B) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal controls

The premise of this requirement was to give assurance to investors as to (i) the integrity of the company’s financial reports and (ii) there were no big risks that the company was taking that it had not disclosed to investors.

This section puts those signing the certifications, which is at a minimum the CEO and the CFO, on the hook for both the adequacy of internal controls around financial reporting (to be precise) and the accuracy of reporting to public investors about them. Internal controls for a bank with major trading operations would include financial reporting and risk management.

It’s almost certain that you can’t have an adequate system of internal controls if you all of a sudden drop multi-billion dollar loss bombs on investors out of nowhere. Banks are not supposed to gamble with depositors’ and investors’ money like an out-of-luck punter at a racetrack. It’s pretty clear many of the banks who went to the wall or had to be bailed out because they were too big to fail, and I’ll toss AIG in here as well, had no idea they were betting the farm every day with the risks they were taking.

The nice thing about Sarbox is a lower risk civil filing can lead directly to a criminal case on the same issues. And based solely on news reports, there seem to be at least two general routes that could be pursued with MF Global. The first is the abject risk management failure that got them in the mess in the first place, the infamous “repo to maturity” trade on short-term Italian government debt. The fact that this was Corzine’s trade, and that he levered it up, and had no apparent understanding that it would be subject to a collateral posting requirement if the price of the debt move against him by more than 5% is managerial incompetence. Either MF Global’s risk management systems were deficient (which means his Sarbox certifications were false) or he overrode them, making them deficient (the fact that he got rid of one manager who insisted on briefing the board about the trade and reduced the independence of his successor supports that idea).

Second is the customer funds that went poof. This has never never never happened to a broker dealer or commodities broker ex fraud. Even in Refco’s embezzlement, accounts were transferred to new firms without a hitch. The media has repeatedly discussed how the staff was not sure of what was happening in the panic to save the firm. I’m sorry, but other firms have faced liquidity crises and the resulting high trading volumes as customers closed out trades and accounts without “accidentally” pilfering customer funds (start with Bear, which went down in a mere ten days). A trading firm needs to be robust enough to handle market turmoil and panicked trading and unexpected calls for collateral, both from a balance sheet and systems standpoint; that should be obvious after September-Octover 2008.

If no one can make an argument for prosecution on deficient controls using Sarbox in a case this egregious, that’s because no one is trying very hard. And that is no surprise.

10.7 Percent: Unemployment In Europe Is Worse Than It Was At The Peak Of The Last Recession

The unemployment rate in the eurozone is now 10.7 percent. That is the highest the unemployment rate has been since the introduction of the euro. The unemployment rate in the eurozone never got any higher than 10.2 percent during the last recession. This is very troubling news. It was just recently announced that the eurozone has entered another recession, and already the unemployment rate is hitting new record highs. So how bad are things going to get in the months to come? The truth is that the problems for Europe are just starting. The European sovereign debt crisis continues to get worse, and another major global financial crisis is going to be here way too soon. The EU as a whole has a larger population, a larger banking system and more Fortune 500 companies than the United States does. When the financial system of Europe crashes, the entire world is going to feel it.

Some of the unemployment numbers coming out of Europe are absolutely staggering.

Unemployment in Spain is 19.9 percent.

Unemployment in Greece is 23.3 percent.

And when you look at youth unemployment the numbers are far worse.

The unemployment rate for workers under the age of 25 is 48.1 percent in Greece and 49.9 percent in Spain.

If you look carefully at the photos of the austerity riots happening in Spain and in Greece you will notice that the vast majority of the protesters are young people.

Instead of getting better, the unemployment numbers in Europe just keep getting worse. Many analysts were shocked by these new numbers. The following is from a CNN article....

"This is appalling," said Carl Weinberg, chief economist at High Frequency Economics, highlighting that the unemployment rate following the collapse of Lehman Brothers peaked at 10.2%.
Appalling indeed.

The frightening thing is that we haven't even had a major financial crisis in Europe yet. So far, the powers that be have been able to keep Greece from defaulting and have been able to keep major banks all over Europe from collapsing.

But there are quite a few signs that the "moment of reckoning" for Europe is rapidly approaching....

-The European Central Bank announced on Tuesday that it would no longer take Greek bonds as collateral from European banks. That is a really bad sign.

-Major European banks are revealing unexpectedly huge losses on Greek debt. The following is from a Reuters article....

The scars of Greece's debt crisis were laid bare in heavy losses from a string of European banks on Thursday, and bosses warned the region's precarious finances would continue to threaten economic growth and earnings.

From France to Germany, Britain to Belgium, four of the region's biggest banks lined up to reveal they lost more than 8 billion euros (6.8 million pounds) last year from their Greek bonds holdings.

"We are in the worst economic crisis since 1929," Credit Agricole chief executive Jean-Paul Chifflet said.
-The International Swaps and Derivatives Association has ruled that the Greek debt deal will not trigger payouts on credit default swaps. This is going to make it less likely that private bondholders will voluntarily agree to the debt deal.

This ruling is also seriously shaking confidence in credit default swaps. After all, they are supposed to be "insurance" in case something happens. But if they aren't going to pay out when you need them, what good are they?

-Voters in Germany are sick and tired of pouring money into a black hole. One recent opinion poll in Germany showed that Germans are overwhelmingly against more bailouts for Greece.

Some German politicians are becoming very open about their feelings for Greece. For example, Interior Minister Hans-Peter Friedrich said the following in a recent interview with Der Spiegel....

"Greece's chances to regenerate itself and become competitive are surely greater outside the monetary union than if it remains in the euro area." He added that he did not support a forced exit. "I'm not talking about throwing Greece out, but rather about creating incentives for an exit that they can't pass up."
-In Greece, news publications are openly portraying German Chancellor Angela Merkel as Hitler. Far left political parties that oppose the bailouts are surging in the polls and anger and frustration are reaching unprecedented levels.

The following is from a recent article in The Guardian....

There is a growing animosity towards Germany on the streets of Athens. Angela Merkel bears most of the hostility with one of Greece's newspapers last week mocking the chancellor up as a Nazi on its front page.

Niki Fidaki, 40, says Greeks are angry at Germany and the troika's demands for higher taxes and public services cuts. "People can't afford to pay the tax. My pay has gone down, but my taxes have gone up. But, I'm a lucky one – half of my friends don't have jobs. Greeks hate that they are asking us to pay all the time when we don't have the money. Families have no work, they have kids to look after but no money to pay for anything."
As I have written about before, Greece is already going through a devastating economic depression. The people of Greece are not in the mood to be pushed much further.

The eurozone is a powder keg that could explode at any time.

So why is the U.S. economy doing so much better than the European economy right now?

Well, a big reason is because we haven't seen any austerity in the United States yet.

Barack Obama is funding our false prosperity by borrowing 150 million dollars an hour from our children and our grandchildren.

Of course all of this reckless borrowing is going to make the eventual collapse of our financial system far worse, but right now Americans don't seem to care. The only thing the mainstream media seems to care about is that some of our economic numbers are getting slightly better.

The sad thing is that our government is spending a lot of this money on some of the most stupid things that you could possibly imagine.

Did you know that the Obama administration just spent $750,000 on a brand new soccer field for detainees held at Guantanamo Bay?

I wish I had a $750,000 soccer field to play on.

I would love that.

Look, when the federal government quits stealing more than a trillion dollars a year from future generations things are going to look a whole lot different in this country.

So pay attention to what is going on in Europe.

That is where we are headed eventually.

China Dumps $100+ Billion In USTs In December Per Revised TIC Data; UK Is Now Russia's Shadow Buyer

Every year in February, the Treasury department releases its adjustment to foreign purchases of Treasury bond holdings as of the previous June (with revised and overriding estimates for all the intervening months in the interim, as well as previous monthly forecasts). It did that earlier today. And while many may have been expecting the revision to show that contrary to Zero Hedge claims China has in fact been building up its Treasury stake (following the now traditional transfer of UK purchases to China), the reality is that not only has China indeed been dumping US exposure (first reported by us previously when we observed the plunge in holdings in the Fed's custodial account), selling over $100 billion in Treasurys in December alone (bringing its total to $1152 billion, and down 12% from its June total of $1307 billion) but that probably far more curiously, the UK is no longer a shadow buyer of Chinese bond accumulation and instead has become a secret accumulator of Russian holdings.

First, here is a link to the revised TIC data as of this afternoon. That lack of Chinese trade surplus is really starting to bite not only China, but also the US, which as we noted last time, will be forced to rely ever more on domestically funded purchases of USTs: read Primary Dealers and the Fed, as the rest of the world developing world, also known as US Treasury buyers, clams down and exports far less to a recessionary Europe and contracting America. As the chart below shows, Chinese holdings are sliding, no matter how one cuts the data.


So compared to the pre-revision Chinese holdings number, which was $1101 billion, China is still accumulating bonds, right? Well, not really, because on one hand a decline is a decline even relative to a different benchmark. But more importanly, most had assumed that the UK's pre-revision number of $414.8 billion in Treasury holdings would be allocated almost entirely to China. As it turns out it wasn't.

In fact of the post-revision UK holdings of $112.4 billion, at best $50 billion, or 17% was allocated to China. Where did the rest go? Well, of the top holders, $40bn went to Japan, $25 billion went to the Oil Exporting countries, $20 billion went to Brazil (which is becoming an increasingly dominant buyer of US paper), while Carribean Banking Centers (aka hedge funds) saw about $50 billion allocated to them.

Yet the biggest surprise, is that contrary to previous speculation, Russia has not been dumping its Treasurys. In fact the country's holding of $150 billion are the same as they were back in June, and over $60 billion more compared to the pre-revised number.

In other words the biggest beneficiary of stealthy UK accumulation is no longer China (which is not accumulating US paper at all and quite the contrary), but Russia.

Russian holdings pre-revision:


and post:


Then again, this is the TIC data, which is notoriously wrong all the time. Best advice: keep a track of that Chinese trade surplus. If it becomes a deficit (just like Japan did recently), that is the first signal that things are changing dramatically from an international flow of funds perspective. It also means that unless the US finds subtitute demand, most likely from within, the only remaining buyer will be the entity that already has the largest holding of US paper - the Federal Reserve.