It's amazing that just late last week that the market seemed to come together to sing Kumbaya. Stocks were soaring and people (okay mostly idiots) were thinking the EU crisis might finally be solved. Fast forward to today and you find we've just had the 8th largest bankruptcy in history and it looks like absolutely nothing with regards to Europe is set in stone. Or even written in the sand. Or drawn on an imaginary chalkboard.
Anyway, let's start with the bankruptcy of MF Global which has a lot of people joking about what the MF stands for (you can use your imagination). Despite the fact that it was run by Jon Corzine, former Governor and Senator from New Jersey and, most importantly, co-head of the cabal at Goldman Sachs, the firm went bankrupt on a massively wrong bet on Italian debt (really, you're betting on the Italians righting their ship? Didn't Prime Minister Berlusconi say he wanted to change his party name to Go Pussy!?) and appears to have funneled money from client accounts in the process. So there is a possibility that some of MF Global's clients could be wiped out in all this, forcing them to sell many of their other holdings to fill the hole created by MF Global. Also, and this could be more serious, any time any of the smaller firms get even a whiff of a bankruptcy rumor around them people will just want to pull their money first and ask questions later, and will practically have a fiduciary responsibility to do so. This would basically cause runs on all the smaller brokers out there and cause major market dislocations in very short order. As I mentioned before, losing confidence in a stock or an economy is one thing, losing confidence in the actual functioning of the market is far, far worse.
I'm also amazed at how quickly MF Global imploded after the supposedly great EU summit in which they came up with a plan (or more precisely a goal with no details). I think part of the reason it happened the way it did is because of the shenanigans related to credit default swaps (CDS) and Greek debt. As I mentioned last Thursday, the plan to give investors a 50% haircut without triggering the CDS's would wreak havoc on the bond markets. Everyone who bought a CDS as insurance would realize they are probably worthless and their 0% default risk exposure might be 100%. This will cause them to sell the government bonds with default risk to lower their exposure. So as other investors started selling their Italian bonds, this caused MF Global to really feel pain, and if they owned any CDS's they would feel double pain as the value of those would be going down as well (as people lose confidence at their value). Instead of having a hedged position where movement in bonds is mirrored by opposite movements in CDS's they would actually see the two of them move in tandem. Basically, they may have found themselves in a situation where instead of 0% exposure, their portfolio acted as if they had 200% exposure (both the bond and the hedge going down at the same time instead of offsetting), a very dangerous thing with a levered book, as MF Global had. When hedges don't work the way you think, bad things happen.
Then you have the announcement of the Greek referendum which has everyone shocked and appalled as they know there is a significant chance that a referendum on the bailout package would fail and Greece would messily default. Of course the reason the bailout would fail is because it a) doesn't solve anything and b) severely punishes Greek citizens, many of whom probably didn't benefit at all from the debt binge (at least not directly). The reason I say it doesn't solve anything is that the 50% haircut is not on ALL debt, it is only on debt held by private investors. The ECB and IMF will face no haircut at all and other publicly held debt will only face a 21% haircut. So after all that Greece will still have 275 billion euros of their original 350 billion euros outstanding. And then to top it all off, after all the austerity plans the hope is that Greece will end up with debt-to-GDP at 120% in 8 years, which by all historical accounts is still an unsustainable amount (historically anything over 90% leads to default eventually). Why again should a Greek citizen vote yes to the proposed referendum? I know that if I were a Greek version of the real me (far from retirement and working in the private sector) I would definitely vote no. I would want us to go back to the friggin Drachma which will allow us to print our way out of this mess and without the damn Germans telling me what to do. The initial contraction will be deeper but the time spent in pain will be much shorter. I guess everyone understands this logic or they wouldn't be flipping out like this. Even if enough pressure is put on Greece to cancel the referendum I think the ruling socialist government is done for and there could be new Greek elections in a matter of weeks where I think the anti-Germans-telling-the-Greeks-what-to-do forces will probably prevail (the fact that many of those are the ones that cooked the books in Greece in the first place is besides the point).
All of this is really only good news if you are short the market or if you are a Cain supporter. It really looks like Cain got lucky again as, in this new cycle, nobody but diehard pundits who watch C-Span for fun even care about the allegedly inappropriate but non-sexual gesture he might have made over a decade ago. Or his suspect denials.