What to do when leaving the Eurozone!

What if a country had to leave the euro zone?

It would need to do the following:

• Announce and immediately impose capital controls
• Impose immediate trade controls (because companies would otherwise falsify imports in order to get their money out)
• Impose immediate border controls (to prevent a flight of cash)
• Implement a bank holiday (to stop citizens from withdrawing their money and running before the devaluation) and - although this is somewhat hard to imagine - stamp every euro note in the country, converting it back to the national currency.
• Announce a new exchange rate (presumably not floating at the beginning, given capital and exchange controls) so that trade could  continue.
• Decide how to deal with existing outstanding euro-denominated debt, which would probably entail a major government and private-sector debt restructuring (that is, default). This might be easier in the case of government debt, which tends to be governed by domestic law, in contrast to the debt of major corporations, which normally governed by UK law (but we would assume enactment of laws declaring a haircut here, as well).
• Recapitalize the (insolvent) banks to make up for losses from defaults
• Determine what to do with the non-bank financial sector, the stock and bond markets, and every company account and commercial contract in the country.

Any break up would lead to significant turbulence in financial markets - just think about the number of CDS outstanding - and a worldwide recession. The OECD has warned that a breakup of the euro zone would lead to 'massive wealth destruction, bankruptcies, and a collapse in confidence in European integration and cooperation,' leading to 'a deep depression in both the existing and remaining euro area countries as well as in the world economy.' The chart above describes a breakup scenario and its potential implications.

Goldman Sachs on Italy

I would recommend reading the following since many decisions in Europe following the semi-resignation of Berlusconi will be taken by Goldman boys.

From Goldman Sachs:
Italy - What's Next
After seeing his parliamentary majority decline further in a routine vote earlier today, Italian PM Berlusconi offered to resign once Parliament approves new austerity measures, possibly towards the end of next week. We see three possible outcomes at this delicate stage, with different implications for the BTP market and Italian risk premium more broadly:
Most likely scenario: In the coming weeks, the current centre-right coalition of the Northern League and PdL moves to rally round another candidate who can gain wider acceptance domestically and internationally. In order to broaden its support, the new government may reach out to smaller centrist parties which can advance their own political agenda.
A centre-right executive backed by a broader coalition and committed to implementing the ‘troika’s' economic platform could eventually stabilize markets. But the newly appointed Cabinet would need to prove itself first, and the protracted uncertainty would weigh on economic growth. Furthermore, reforming the pension system could meet resistance from the Northern League. Still, it would be hard for the ECB and Italy’s EMU peers not to stand by a new Italian government genuinely trying to pursue reforms. Under this scenario, thanks to the ECB’s interventions, we would expect BTPs to remain capped at around current levels (400-450bp) over the average of Germany, France and the Netherlands until measures are gradually approved.

Second most likely scenario: The centrist parties ultimately turn down the offer to join a broader coalition. In this case, more MPs from Berlusconi’s PdL party could join forces with formations at the centre of the political spectrum. This could pave the way for a government of national unity of sorts, led by a highly reputable ‘outsider’. Like during the crisis of the early 1990s, the advantage of such a ‘technocrat’ government is that it would be sworn in after some ‘initial contracting’ on its programme (economic reforms agreed with the ‘troika’, plus a new electoral law), which should lower the implementation risk. A technocrat government could use its credibility to introduce more growth enhancing measures that would pay off further down the road. Lastly, it could focus on improving governance (fiscal rules in the constitution, a smaller public sector, etc).
We view this as the most market-friendly outcome, as it would lead over time to a decline in sovereign spreads and in Italy’s risk premium more broadly. The front-end would re-price more than intermediate- and long-term maturity bonds because investors would likely take advantage of the rally to reduce exposure at higher prices. Nevertheless, we would expect BTPs to fall to around 350bp over Bunds in fairly short order.
Least likely scenarios: After Berlusconi’s resignation, general elections are called. These could be held in mid-January at the earliest, although they would most likely be postponed until the Spring amid market turmoil.
This would represent the worst scenario for markets, in our view. Since President Napolitano is aware of this, he will probably try to resist dissolving Parliament at this juncture. Also, most centrist parties would want to change the electoral law before a new vote takes place.
All these scenarios will take some time to play out, a couple of weeks at least. In the meantime, the higher priced Italian government bonds will continue to be sold, as gradually higher margin requirements are applied. On our central case, intermediate to long-end bonds should continue to be supported relative to AAA-rated securities by the ECB.
In conclusion, we are most probably approaching the highs in Italian yields (currently around 500bp over German Bunds in the bellwether 10-yr sector, and 600bp in 2-yr maturities), but a volatile and unsettled market remains our base case until Italy’s sovereign creditors can be reassured that long-awaited structural reforms to lift the country’s growth rate will be put in place.

Berlusconi resigned or is he just taking time?

Today the dream of many Italians could have become reality with Berlusconi announcing his resignation after the approval by the end of this month of the austerity budget.
Although my feeling and knowledge of Italian politics would suggest a more cautious attitude.
First he has not resigned yet and he will be in power till approval of the austerity budget, which is supposed to take place at latest by the end of November but given the epic ability of Italian politics to complicate things either willingly or unwillingly could very well last longer regardless of all proclamations of urgency.
Secondly knowing the mindset of Berlusconi he has either struck a deal with the Italian President Napolitano for an amnesty in exchange for his quiet exit from power or he is simply trying to buy time to recover from a majority loss.
It was clear today that Italy was on the edge of bankruptcy if no answer was provided to the total horror of the Italian spread and CDS rates. Italy is clearly weeks if not days away from economic collapse and the total inability of the government to deal with this crisis was shouting for some decisive answer to the markets.
It remains to be seen how many days this resignation promise of Berlusconi will buy before markets will realize that nothing has changed in Italy and that the inability of Italian politics to offer a serious and credible alternative to Berlusconi will not stop the economic collapse.
There is still the thought back in my mind that Berlusconi faithful to his reputation of a shameless crook will pull another trick of his, finding a way to turn this impasse to his advantage. Let's hope it will not be a delaying tactic to block the approval of the austerity package because Italy will be under deep scrutiny and any whiff of fraud will resume the spiral death of the Italian economy.
Furthermore the IMF is going to Rome this week to scrutinize the Italian books as previously done in Greece and we have to hope they will not find ugly surprises or black holes of debt courtesy of our fraudulent still to be Prime Minister Berlusconi.

Dexia's nationalization and Greece de-nationalization

On many occasions in the last two years when it should have been time to let Greece go to greener pastures, Euro bureaucrats had cold feet and decided to keep the circus rolling for another show.
This time although it could be finally the right time to unload the burden and let Greece default.
Judging from today's comments the giant Euro Ponzi scheme is reaching the limits of manipulation and it could have been decided to start the end game.
 
ECB head Draghi says the bank in Europe have funding problems (aka a liquidity crisis), the Finland Finance Minister has said he does not want an expansion of the EFSF nor does he expect a solution on the collateral "row", saying a Deal on EFSF Collateral is uncertain, and lastly, Spain's Salgado has said there is no need of "quantitative amplification" of the EFSF.
In other words, with the EFSF meeting imminent, it appears that pretty much nobody aside from France, and some Economical PhDs, are any longer concerned about the domino effect, the Euro project or marginally of the necessity to keep Greece afloat.

This could have something to do with the fact that banks which were supposed to be in real danger with a collapse of Greece are already falling with or without a Greek default.

Dexia CDS is skyrocketing and the Sunday Times announced an imminent nationalization of the bank which hold assets amounting to 180% of Belgium's GDP. It appears Belgium will have to intervene soon with a bailout or total nationalization to prevent the institute premature demise.

At this point to avoid throwing away more money to a lost cause such as Greece it is retrenchment time for the ECB, with all the ideals of European unity being thrown out of the window.

Greece is assumed to default in a matter of days

It appears the end game for Greece is approaching fast and Italy appears to be next in line.

Bloomberg reports Germany Said to Ready Plan to Help Banks If Greece Defaults

Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said.

The emergency plan involves measures to help banks and insurers that face a possible 50 percent loss on their Greek bonds if the next tranche of Greece’s bailout is withheld, said the people, who spoke on condition of anonymity because the deliberations are being held in private. The successor to the German government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks, one of the people said.

The existence of a “Plan B” underscores German concerns that Greece’s failure to stick to budget-cutting targets threatens European efforts to tame the debt crisis rattling the euro. German lawmakers stepped up their criticism of Greece this week, threatening to withhold aid unless it meets the terms of its austerity package, after an international mission to Athens suspended its report on the country’s progress.

Greece is “on a knife’s edge,” German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7, a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament.

Longer term, euro countries will “only preserve the common currency if there is more integration” in the European Union, Merkel said in a speech in Berlin today. The EU “won’t be able to avoid treaty change.” While intensive discussions lie ahead and the path won’t be easy, policy makers “shouldn’t be afraid” of tackling the challenge, she said.

And this email is making the rounds and catching most traders' attention:

From colleague: trader friend just hit me with the following: There is “Chatter” in the market of a Greek Default this Weekend - and their CDS is over 400 wider…  Soc Gen is off 7% on exposure - German CDS more expensive than UK;s - despite the ballooning in the CDS prices for Lloyds and RBS.

Market crash 'could hit within weeks', warn bankers

From The Telegraph:

A more severe crash than the one triggered by the collapse of Lehman Brothers could be on the way, according to alarm signals in the credit markets.
Insurance on the debt of several major European banks has now hit historic levels, higher even than those recorded during the 2008 financial crisis.
Credit default swaps on the bonds of Royal Bank of Scotland, BNP Paribas, Deutsche Bank and Intesa Sanpaolo, among others, flashed warning signals on Wednesday. Credit default swaps (CDS) on RBS were trading at 343.54 basis points, meaning the annual cost to insure £10m of the state-backed lender's bonds against default is now £343,540.
"I think we are heading for a market shock in September or October that will match anything we have ever seen before," said a senior credit banker at a major European bank. 

read more HERE
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A new bailout looming: Cyprus downgraded and italy under pressure

And the hits keep coming! After the launch last week of the Great Euro Marshall Plan which was supposed to cure all economic diseases once for all, the bond tragedy has resumed relentless.
Yields on Italian 10-year bonds spiked to 5.8pc on Wednesday while Spanish yields punched through 6pc once again. Analysts remain perplexed by the decision of Italy's treasury to cancel bond auctions in mid August due to lack of liquidity and "reduced financing needs". Italy was expected to raise €68bn (£60bn) in August and September.
In the meanwhile there is a new entry in the bailout club.
Cyprus has been downgraded today two notches from A2 to BAA1 due to "fractious politics", exposure to Greece and the disaster of the energy crunch caused by the explosion and destruction of his main power plant on the 11th of July which destroyed 60% of Cyprus electricity output.

The darkening picture in Cyprus raises concerns that a fourth eurozone country might soon need some sort of rescue, exhausting bail-out tolerance in Germany, Holland, Finland and Slovakia, where a wing of the coalition has denounced the EU accord.

"The markets have started to see all the flaws in the summit deal," said David Owen, of Jefferies Fixed Income. "They know there has been no increase in the size of the European Financial Stability Facility (EFSF) and that it will not be in any position to intervene in the Spanish and Italian markets for quite some time because the changes have to be ratified by all parliaments."

"Unless the European Central Bank (ECB) steps in to buy bonds, this is going to be tested by markets over the summer. EU leaders have sent absolutely the wrong signal by thinking they have done the job and can now go on holiday," he added.
But the most interesting and scary piece of news today is the following:
Italian bank stocks fell sharply in Milan with Intesa down 5pc and Unicredit off 4pc.
Deutsche Bank said it had cut its exposure to Italian debt from €8bn to €1bn since the end of last year, mostly by purchasing credit default swaps (CDS). This suggest Europe's banks have been the main buyers of Italian CDS for hedging purposes, rather speculators as claimed by Italian leaders. It appears that core Europe started now for quite a while to dump the peripheral PIIGS.
The economic outlook continues to darken in Italy. The manufacturing index fell for a fourth month in July, dipping below the contraction line of 100. Italy's business lobby Confindustria said growth would be "almost nil" this quarter. The group's leader Emma Marcegaglia said Italy's political system was unravelling, leaving industry to its fate.

Net foreign liabilities in Italy have reached 26pc of GDP, the Italian government leitmotiv has been always that Italy is safe since most of the debt is owned by Italian families, this has not been the case since now for some time regardless of the Prime Minister's media propaganda.
Italy is cushioned for some months and the traditional summer shutdown will let the country slumber through till September unless of course a major event wreak havoc on the international markets.
September though will be torture for PIIGS.

Italy crisis gaining momentum

Italy crisis gaining momentum while the spotlights are moving from the Greek crisis to the Euro core.
Bloomberg issued an interesting chart below showing what would be the impact of a country default on the CDS.




What the market is most confused by is that Spain, which everyone thought would be the next to fall after Portugal has been skipped (sort of) by the bond vigilantes who decided to go straight to the gateway to Europe's core. Italy.
Italy is on the grill and the pain is only just beginning: as the chart below shows, there are dozens of Treasury issuances about to be unleashed by the Italian Treasury.


The biggest surge though in recent months in net notional has not been Italy, nor Spain, nor any of the other PIIGS, but.. France, the domino effect has started already and it could be already too late to contain the infection.

Credit Default Swaps Casino coming soon for everyone!

Image by Getty Images via @daylife

Ever felt excluded from the list of people who can (allegedly) buy insurance on their neighbor's house, and then burn it down? That's all about to change. The CBOE has announced that that on Tuesday, March 8, the Exchange will begin trading newly-designed Credit Event Binary Options (CEBOs) contracts. In essence these will be like Credit Default Swaps, accessible to everyone, which will have a $1000 payoff per contract in the event of a bankruptcy before contract expiration.

Credit Event Binary Options contracts allow investors to express an opinion on whether a company will experience a "credit event" (bankruptcy).   Due to inverse correlations between credit and equity markets, CEBO® contracts can be used as a hedging tool for individual stocks. The contracts also provide the advantages of price transparency available through a regulated exchange, currently unavailable in over-the-counter credit default swaps markets.

A CEBO contract has just two possible outcomes - a payout of a fixed amount if a credit event occurs or nothing if a credit event does not occur.

This sudden opening of the market to retail bets on corporate bankruptcy will have huge bilateral repercussions on every single asset class and we can only imagine what will happen when ordinary citizen will start gambling on companies defaults, it seems the race of Wall Street to compete with the Gambling business is taking a new turn, de facto encouraging everyone to bandwagon on the derivatives insanity that has brought us down.