Spanish Intelligence Suspects Coordinated Attack on Sovereign Debt

They are learning fast.

Spanish intelligence probing debt "attacks"-report
(2/14/2010 Reuters)

"MADRID, Feb 14 (Reuters) - Spain's intelligence services are investigating the role of investors and media in debt market turbulence over the last few weeks, El Pais reported on Sunday.

"Citing unnamed sources, El Pais said the National Intelligence Centre (CNI) was looking into "speculative attacks" on Spain following the Greek debt crisis.

""The (CNI's) Economic Intelligence division...is investigating whether investors' attacks and the aggressiveness of some Anglo-Saxon media are driven by market forces and challenges facing the Spanish economy, or whether there is something more behind this campaign," El Pais said."

Not that there's no reason to worry about Spain. On the contrary. Spain's budget deficit is 11.4% of GDP (note: US's number is 10.6% for 2010); many economists doubt the Spanish government's GDP growth projection of 3% by 2012.

Still, it is reminiscent of the "bear raids" on Bear Stearns and Lehman Brothers in 2008, both of whom collapsed under the intense attacks from certain investors taking naked long positions on the CDSs (credit default swaps) - holding only CDS without holding the underlying debt - and naked shorting of their stocks. These attacks coincided with certain media news that turned out later to be utterly false (news like "Goldman would not accept the counterparty risk of Bear Stearns", as reported by David Faber of CNBC).

The article's last paragraph indicates what kind of "attack" that the Spanish government may be investigating:

"Underscoring those doubts, the premium demanded by investors for buying Spanish rather than German government bonds ES10YT=RR has risen in recent weeks and the cost of insuring Spanish bonds against default by the government has also risen."

In other words, CDS on Spanish sovereign debt.

So who are the "investors" attacking Spain's debt? The usual suspects - Goldman Sachs, J.P.Morgan Chase, Citigroup, etc.? We can probably add Barclays and Deutsche Bank. Maybe HSBC, too. Throw in several big hedge funds, and we can't be very far from truth, can we?

But what could be their end-game? Unlike Bear Stearns and Lehman Brothers, they can't possibly bankrupt the PIIGS countries and still profit from it, can they? Or can they?

Or is it to make sure that PIIGS will be bailed out financially by Germany (who, by the way, rejected the creation of a European fund to bail out the fiscally troubled countries like PIIGS), so that they don't lose on their CDS or their cash flows?

Or is the end-game more geopolitical than just financial? Is the end-game to drain Germany economically and fiscally, by making sure the sovereign debt crisis happens and that it gets worse until Germany pays - whether by setting up a bailout fund or by gorging on the Greek imports as Financial Times' columnist and internationalist Martin Wolf urges?

If it is the last one, it could involve other parties than just greedy bankers.

Who wrote those CDSs on the sovereign debt of PIIGS anyway?

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Matt Taibbi: Bad, Bad Goldman Lobbying Against Naked Short-Selling

Matt Taibbi, who wrote "Great American Bubble Machine" for Rolling Stones Magazine in June detailing Goldman Sachs' central role (as he sees it) in the booms and busts since the Great Depression, has another story coming up that will look at the history of Bear Stearns and Lehman Brothers collapses.

One of his focus seems to be naked short-selling, which SEC is now supposedly moving to ban. In the article that appeared in Lewrockwell.com (originally on True/Slant), he attacks naked short-selling as "crime" and lobbying of the Senate by Goldman Sachs against naked short-sale ban "disgraceful" and "hilarious" (borrowing the words probably from the Senate aids who gave him the Goldman's 'fact sheet'.):

An Inside Look at How Goldman Sachs Lobbies the Senate
(Matt Taibbi, 10/3/09 Lewrockwell.com)

After reading his article, several questions popped in my mind. Here, I want to discuss two of them in particular:

Question No.1: Did naked short-selling cause the crash in Bear Stearns and Lehman Brothers share prices?

For that matter, did it cause the huge drop in share prices in companies like Morgan Stanley, Wells Fargo, Citigroup, Bank of America, AIG, GE, and Goldman Sachs over 8 months from September 2008 to March 2009, when the market finally bottomed (for now)?

Andy Kessler wrote a very interesting article that appeared on Wall Street Journal in March. He thinks the bear raids, which caused the financial stocks to plummet and thus brought down the entire stock market, were done not by short-selling (naked or not) but by going naked long on CDS (Credit Default Swaps) that these financial firms held on their CDO and MBS. The article didn't get much publicity, but I think he is right on the money:

Have We Seen the Last of the Bear Raids? (Andy Kessler, 3/26/2009 Wall Street Journal)
"In a typical bear raid, traders short a target stock -- i.e., borrow shares and then sell them, hoping to cover or replace them at a cheaper price. Once short, traders then spread bad news, amplify it, even make it up if they have to, to get a stock to drop so they can cover their short.

"This bear raid was different. Wall Street is short-term financed, mostly through overnight and repurchasing agreements, which was fine when banks were just doing IPOs and trading stocks. But as they began to own things for their own account (MBSs, CDOs) there emerged a huge mismatch between the duration of their holdings (10- and 30-year mortgages and the derivatives based on them) and their overnight funding. When this happens a bear can ride in, undercut a bank's short-term funding, and force it to sell a long-term holding.

"Because these derivatives were part of the banks' reserve calculations, if you could knock down their value, mark-to-market accounting would force the banks to take more write-offs and scramble for capital to replace it. Remember that Citigroup went so far as to set up off-balance-sheet vehicles to own this stuff. So Wall Street got stuck holding the hot potato making them vulnerable to a bear raid.

"You can't just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet." [emphasis is mine]

Question No.2: Does Matt Taibbi really think the purpose of Goldman's lobbying effort is to prevent the lawmakers from enacting the ban on naked short-selling?

I don't think Goldman Sachs cares one way or another if naked short-selling is restricted, because that's not how they maneuver the market. CDS is one very effective and less costly way to manipulate the value of the underlying assets, and thus affecting the share price of a company who holds those assets. More bang for the buck (i.e. leveraged). If politicians' attention is focused on naked short-selling, all the better, as long as there are unregulated, OTC derivatives markets. Have you heard anything going on to regulate the CDS market? There was some talk right after Lehman's collapse and AIG's rescue by the Fed/Treasury, but since then, zero. Zip. Nada.

Also, do you remember the ex-Goldman Sachs employee who was arrested just before the Fourth of July weekened, which burst open the high-frequency trading practiced most successfully by Goldman Sachs? Have we heard anything about it recently? No. Despite the demonstrable injury to small retail investors and professional investors, the talk of regulating or banning the practice died off almost completely. And here we are, making issues with naked short-selling which may or may not have caused the crash?

Goldman's lobbying actually reminds me of the supporters of the Senator Aldrich's bill to establish the Federal Reserve. When that bill died with the change of administration (Taft out, Woodrow Wilson in), a new bill was drawn up by (no other than) Glass that was basically the same as the old Aldrich bill (Owen-Glass bill, which was enacted as Federal Reserve Act in 1913). What did the supporters and co-conspirators of the central bank do? They vehemently opposed the passage of the bill. They lobbied against it. The perception was created that since the bankers were opposing, they must be really afraid of creation of the new powerful regulator (the Fed). The bill was passed, to the great benefit to the member banks, particularly large New York banks.

I smell a similar thing going on with Goldman Sachs lobbying against naked short-selling.

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Credit Default Swaps market update

US Credit Default Swaps Little Changed, CDX Trading Shows (Bloomberg.com)

Watch out for this for the market direction in general, and financial stocks in particular (C, BAC).

That's where the heavy betting by big traders seems to be: CDS market.

They are speculating on the company's ability to repay its debt (or the government's willingness to protect the debt holders). Some people believe this was what caused the crash in financial stocks last year, and that's what they are doing now again.

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