Best News for You

So the financial world has collectively woken up and realized that the latest EU bailout scheme is fraught with problems and loose ends. Amongst the various problems are:

1. The Greek private bondholders are furious that the ECB isn't taking a haircut on its bonds too.
2. German courts and voters aren't too pleased with Merkel's decision to go "all in" on the Euro experiment.
3. The Greek default isn't nearly large enough to render Greece solvent again
4. The default has set a precedent for the other PIIGS countries to follow
5. The CDS/ derivative issue regarding Greece's default is not over by any stretch
6. The entire EU banking system remains far too leveraged (26 to 1) and needs another $1.5+ trillion in capital at the minimum.

The markets flew into this deal based on rumors and short-covering and are now waking up to the plain obvious facts that you cannot solve a debt problem with more debt. Also, it might be worth considering just where the EFSF bailout money will be coming from when various EU members can't even stage successful bond auctions without the ECB stepping in.

Again, the primary issue for the EU is a lack of capital. There is TOO MUCH debt there. And issuing more debt, no matter how cheap, is not going to help. Especially when your strongest member (Germany) sports a REAL debt to GDP above 200% and hasn't recapitalized its banks.

So the EU will be crumbling in the coming weeks. This was the final hurrah for the EU and the Euro in its current form. On that note, the Euro was rejected at resistance at 142 and has already taken out support at 140.

Once we take out 139, look for this breakdown to pick up steam (pulling stocks with it).

Indeed, the financial world is talking about how this was the biggest move in stocks since 1974. Unfortunately, few remember that after that move in 1974, the markets cratered.

Some thoughts on stocks... isn't it a little strange that the market fell exactly 20% (the "official" bear market level) before kicking off the biggest ramp job in 30 years? How about the fact that this move came for no real reason other than rumors of another bailout (what are we on #3 for this?).

Can this move really be attributed to Euro choosing to let Greece default (which is what happened in reality)?

Regardless, stocks were deflected from resistance at 1,275 or so. They're now on their way down again. The market is extremely overbought and susceptible to a fast violent move downwards.

Indeed, the credit markets remain jammed up and are anticipating even more haircuts from Greece. And the rest of the PIIGS will be following suit in the default game.

Ignore stocks, they're ALWAYS the last to "get it." The credit markets are jamming up just like they did in 2008. The banking system is flashing all the same signals as well.

The markets are exploding higher this morning on news of the expanded Euro Bailout. The numbers at the moment are

1. A 50% haircut for private Greek bondholders
2. European banks have eight months to raise about $147 billion in capital
3. An expansion of the European Financial Stability facility to $1.3 trillion.

First off, let's call this for what it is: a default on the part of Greece. Moreover it's a default that isn't big enough as a 50% haircut on private debt holders only lowers Greece's total debt level by 22% or so.

Secondly, even after the haircut, Greece still has Debt to GDP levels north of 130%. And it's expected to bring these levels to 120% by 2020.

And the IMF is giving Greece another $137 billion in loans.

So... Greece defaults... but gets $137 billion in new money (roughly what the default will wipe out) and is expected to still be insolvent in 2020.

Forgetting that any and all official estimates for Greece's financial condition have been off by a mile, not to mention that Greece still hasn't paid back its first round of bailout funds, this move is nothing short of moronic.

The reasons are:

1. The default is not big enough (I expect Greek bondholders to get 20-30 cents back on the Dollar at best in the future)
2. It accomplishes nothing of significance (Greece is still broke), and...
3. It will trigger a credit event and has the makings of systemic risk.

Let's put some of the other numbers from this deal into perspective. According to the agreement, European banks are supposed to raise $147 billion in new capital by June.

Well, German banks alone need to raise $173 billion in new capital. So... this new capital "requirement" from the deal is pointless.

Indeed, the European banking system as a whole is insolvent.

Consider that with leverage levels of 26 to 1, European banks in general need to raise capital equal to 46% of ALL banking assets to bring their leverage levels in line with those of the US banking system (13 to 1).

With OVER $46 trillion in assets outstanding, this means that European banks would need to raise $21 TRILLION in capital to bring their leverage levels down to 13 to 1.

Yes... $21 TRILLION... an amount greater than one third of TOTAL GLOBAL GDP.

Now you see why the extra $147 billion in new capital is pointless. It's like pouring a bucket of water into a desert and expecting it to sprout a jungle.

Folks, let's get honest here. This deal accomplishes nothing. It's just more "kicking the can" to avoid the reality. The reality is that the entire European Banking system is leveraged at near Lehman Brothers levels. And European banks need to roll over between 15-50% of their total debt (depending on which country they're in) by the end of 2012.

The credit markets know this, which is why they're predicting more Greece haircuts in the future. It's also why IMF has decided to lend Greece another $137 billion... right as the country defaults.

Ignore this latest pop in stocks and the Euro. This mess isn't over... not by a long shot. And before the smoke clears, much of Euro will be in default/ banking collapses.

Merkel and Sarkozy claim they've got everything under control. They're lying. Anyone who uses common sense can tell this. The reason...

They've never considered the true price tag for the leveraged EFSF. I'm not talking about money, I'm talking about funding costs for France and Germany when they lose their AAA rated status as a result of backing up Greece.

First off, while France and Germany are the most solvent members of the EU, they're not exactly models of fiscal austerity. Consider that both countries officially have Debt to GDP ratios of roughly 80% (Germany's is 78% and France's is 84%). And that data point doesn't include off balance sheet risk or unfunded liabilities for either country.

Indeed, Germany, which is widely thought to be super solvent, is in fact sitting on a REAL Debt to GDP ratio north of 200% when you consider unfunded liabilities such as pension plans and so on.

Before you label me as crazy, consider that this statistic comes from Axel Weber... the head of Germany's CENTRAL BANK (Bundesbank).

Folks, this is a CENTRAL BANKER, admitting his nation is in fact far more broke than people realize. And let us not forget...

Germany hasn't RECAPITALIZED ITS BANKS YET!

Indeed, by the German Institute for Economic Research's OWN admission, German banks need 147 billion Euros' worth of new capital.

To put this number into perspective TOTAL EQUITY at the top three banks in Germany is less than 100 billion Euros.

Debt to GDP ratios north of 200%... banks needing 147 billion Euros in new capital... and somehow Germany is going to bailout Europe? Give me a break. German has its own fiscal disaster approaching.

Not to mention the following:

1) Over half of Germans want out of the Euro

2) 75% of Germans are against increasing the bailout fund.

Of course, there is no limit to political idiocy, so it's possible German politicians may go "all in" to prop up Greece. But I'm here to tell you that the short term upside to this move is minimal as it will result in Germany losing its AAA status and will only speed up its own funding crisis/ banking collapse.

In plain terms, Europe is finished. This isn't even about Greece anymore. Even the most stable and "solvent" European nation (Germany) is facing its own funding Crisis. So the notion that Germany and France (which has an even worse REAL Debt to GDP than Germany) can somehow bailout Europe is ridiculous.

With that in mind, the time to prepare for what's coming is NOW before this situation results in systemic failure in Europe.

Yes, systemic failure.

Greece is not the issue here. The issue is that Europe as a whole is broke, facing massive unfunded liabilities, and running out of viable creditors to band-aid its banking crisis. We are literally talking about a banking system collapse over there.

In plain terms, what's coming to Europe (and then the US due to the interconnected nature of the financial system) is going to make 2008 look like a picnic.

Traders have gunned the market higher over the last two weeks courtesy of:

1. Short covering
2. The Euro rally on French liquidity concerns
3. Rumors of yet another Euro bailout

Regarding #1, short interest on the NYSE was at March 2009 levels going into this rally. With this kind of short interest, even a small rally will become explosive as the shorts cover (buy stocks)... which sends the market higher... which in turn results in more shorts cover.

This same dynamic is playing out for large financial institutions in France resulting in #2. French banks are facing major short-turn funding shortages. As a result they are selling long positions and cover shorts to free up capital. Because of this, the Euro is rallying hard, just as the US Dollar did in 2008 when the US banking system was in collapse.

Because stocks are moving in lock-step with the Euro, the Euro move has pushed stocks higher in a big way.

Finally, regarding #3, it is obvious to anyone that the EU is completely out of ideas that will possibly work. The kick the can mentality is ending. I know Merkel and Sarkozy claim to be working on some great plan to fix things... but the reality is that if those countries do go for the leveraged EFSF then they will lose their AAA status... which comes with its own set of major problems.

Will France and Germany go "all in," and choose to lose their AAA status to bailout Greece again? Hard to believe that will be the case. And we see reports emerging of Germany preparing for a Greek default and bondholders taking a 60% haircut.

It is literally a case of "pick your poison." If German and France backstop Greece again with the leveraged EFSF, they will lose their AAA statuses and we'll see a bloodbath in Europe. If they don't backstop with the leveraged EFSF, we'll see a bloodbath in Europe.

With that in mind, the Euro is coming up against major resistance at 140:

We're facing a quick correction here to 135 if not 130 in short order. Long-term I expect we'll see Greece default followed by a domino effect in which all bankrupt European nations restructure. When this occurs the Euro will break below the 2010 lows of 118.

In terms of stocks, we've been in a large trading range between 1,125 and 1,220 on the S&P 500. We're now testing the upper end of this range, which sets us up for a return to the low end of the range.

Given the economic backdrop in the US and Europe, I remain convinced we're breaking out of this range to the low side. I've warned to get defensive for over a month now. This week looks to be a good time to add to shorts as I expect we're going to likely see a top this week as earnings season kicks into higher gear and the usual options expiration nonsense ends.

However, larger picture, I believe we're facing systemic risk... as in another 2008 event. The most likely culprit for this will be Europe, which is literally on the ledge of a cliff.

Indeed, the facts remain that Greece will default. End of story. Greece is broke. The market knows this which is why it's pricing a Greek default at 100%.

Once Greece defaults, Spain and Italy will follow suit. When that happens we're facing a situation that will make 2008 look like a picnic. The powers that be know this... which is why the IMF has warned we are facing a "global financial meltdown." And the Bank of England says we're facing the "worst financial crisis in history."

Folks, these are the guys in charge of holding the financial system together... warning that we're facing a meltdown. Did they do that in 2008? Nope. So how bad are things going to be? BAD.