After Greece is Italy: M'sian layman investor the next sitting duck if not careful

In Malaysia, the stock market is at all time and the government-owned press is making a big deal of it. But the fact is the region as a whole is not doing that well and smart money has already moved out. When the markets crash, it will be the layman that will be left holding the baggage.

The world of high-finance is complex, murky and above all inter-connected. At the moment, Europe continues to weigh heavily on the global system. Another month another implosion and now it is Italy. There are fears about Italian banks, which are failing stress tests and have the biggest exposure in Greece debts. Adding to the concern is that the Italian Finance Minister Tremonti is resigning and this might push the Italian dominoes over.

Trading in Italian bank UniCredit SpA stock tanked 7.9 percent last Friday and has been halted as fresh waves of fears that the Credit Contagion is spreading. It is the most active stock traded in the MTF Europe which is the European version of the Goldman Sach’s Sigma X dark pool. To make things worse, Italy’s main index S&P/MIB has dropped by a whopping 23% in the past 5 trading days.

Dark pools where the big boys swim

Dark pools are similar to normal exchanges but the difference is that its transactions are not available to the public. It offers institutional investors an avenue to buy and sell large block of shares without disclosing their identities and the amount of shares transacted so that it won’t affect the market price of that particular security. Talk about fair trading and transparency!

Thanks to the recent disclosure by Themis Trading, ordinary investors can now observe what is being traded on Goldman’s Sigma X, Chi X , Citi’s Citi match, Credit Suisse’s Crossfinder and other dark pools. It shows that ONLY 30% of all trading occurs in open exchange venues while the rest change hands behind the scenes in places like Sigma X , Chi X and so on. This means that while HFT (high frequency trading) algos drive up daily volumes in most top 10 counters, the real action is in the most actively traded dark pools, where the big boys are actively trading. It is estimated that up to 80% of daily traded volume in NYSE, 60% in Europe and 50% in Asia are contributed by HFTs.

Europe suddenly found itself in a state of shock last Friday when it realized that Italy has more than 1.3 trillion euros in debts and its debt/GDP is 119% and only second to Greece in terms of Sovereign debt ratios. Moreover Italy’s CDS has been dominating the Sigma X trading in the past several weeks.

On Monday morning European Council has called an emergency meeting with top officials dealing with Eurozone debt crisis after a sharp sell-off of Italian assets last Friday. In other words, the debt crisis has ALREADY SPREAD to Italy.

Ponzi musical chairs

Bond vigilantes have been dumping Italian debts and buying up all the CDS available. A senior ECB official said that “we can’t go on for many more days like last Friday and we are very worried about Italy”.

Another stunner came from Die Welt which reported that the European rescue fund is not sufficient to bail out the latest biggest loser in the game of 'Ponzi; musical chairs. As reported in Reuters, a central banker quoted as saying “the rescue fund in Europe is not sufficient to provide a defensive wall for Italy because it was not designed for that”. It also reported that the rescue fund might need to be doubled up to 1.5 trillion euros.

The earlier rumors that the Italian authorities may ban naked short selling in a desperate attempt to preempt the bond vigilantes from taking down the country’s financial market have now been confirmed. The latest being Consob (same as Securities Commission of Malaysia), requiring shorts to immediately disclose their short position in an effort to “increase market transparency”.

The powers that be are now in a state of panic trying to contain the dark pools. But it is already too late because The Titanic has already hit the iceberg and all these measures aimed at keeping order will be futile and it will only a matter of time before the scramble for lifeboats begin.

Downgrade by the biggest buyer

The final nail in the coffin comes from the Chinese Ratings Agency Dagong Global Credit Rating Co. The first ratings agency to downgrade the US, Dagong said on Monday that it is putting Italy’s Sovereign Debt on negative watch and possibly for a downgrade. The Italian government debt to GDP is about 119% and most of it is coming due in the next few years. In November last year, it cut the ratings of the US to A+ from AA with a negative outlook.

Dagong is the more credible ratings agency because it represents the world’s biggest buyer of bonds whereas US ratings agencies like S&P, Fitch and Moody’s represent the biggest seller of Bonds and often controversial because they also represent the very banks that own them.

Italy’s 10-year bonds yields hit a high of 530 basis points (5.3%) last Friday and it is expected to rev up another 200-300 basis points by next year. By that time it will be impossible for Italy to service its debts. As Jacques Cailloux of RBS said “We believe the European Sovereign crisis might be entering a new phase with contagion reaching the larger economies”

By the way, things in Europe are getting exponentially worse with the contagion now hitting Spain and Italy. Both of them have seen their spreads massacred and the CDs blown out in the past week's trading. Latest as of Monday, 2-year bond trading in Europe, Portugal hits 18.36%, Greece 31.34% and Ireland 17.83% and these are new records.

Not a pretty picture in Malaysia

Coming back to the home front, Malaysia’s public debt/GDP at 55.1% (source: IMF 2010) and household debt/GDP at 76% (source Bank Negara 2010) are not pretty pictures either.

Despite the record high stock market, Malaysia too will not be spared from another crisis unless the government take steps to rein in both its expansionary monetary and fiscal expenditures.

Direct negotiations and close tender should be terminated to pave the way for more open tenders so as to allocate its resources more efficiently. Malaysia must put its act together before the European crisis reaches our shores. By that time, further austerity measures by the government will only put more burden on its people as currently the government is lifting its subsidies on most controlled items, and that is already eating into the lives of most Malaysians.

As for the rest of Asia, things aren’t as rosy as it seems. Stock markets around South East Asia are trading at their highs and it seems to be the right time for a huge take down in the markets. Smart money has already moved out of the region and when it crashes, it will be the layman that will be left holding the baggage.

Europe is now burning with Italy-Bund spreads hitting new highs, the US is 9 days from being bankrupt and China has failed to sell half of its proposed 50 billion of local government bonds with a yield of 3.93% at an auction, thanks to the rise in SHIBOR (Shanghai Interbank offer rates).

The SHIBOR for 3 months yuan loans was fixed at 6.24% today which is a tad lower than the record high set in June of 6.46 %. Who is going to buy local government bonds when interbank offer rates is so high? Not helping things is the Chinese rate hike last week which is the third time this year to curb inflation which has risen to 6.4% in June from 5.5% in May.

In short the financial crisis just went GLOBAL. - Malaysia Chronicle