Evolution Securities Warns Of �Total Carnage And Meltdown� As European Bank Sales Of CDS On European Sovereign Debt Soar

As much as we hate to say it, Europe is now without a shadow of a doubt the new AIG, only this time such heretofore considered insane (in retrospect) activities as doubling down to infinity on ones TBTF status are out in the public record for all to see. At least AIG conducted Joe Cassano�s �made in London� $2.7 trillion bet on home prices never dropping in the shadows of Curzon 1. Whereas two days ago we made it clear [16]how the unwind of trillions in rehypothecated securities could be the avalanche that buries first Europe and then the world, we explicitly excluded the impact of synthetic products such as CDS. Now it is time to bring the picture full circle, and put CDS front and center. As Bloomberg reports,

�BNP Paribas SA, France�s biggest bank, sold a net 1.5 billion euros ($2 billion) of credit- default swaps on the nation�s sovereign debt, according to data compiled by the European Banking Authority. UniCredit SpA, Italy�s biggest lender, and Banca Monte dei Paschi SpA are net insurers of more than 500 million euros each of their government�s bonds, and Oesterreichische Volksbanken AG, the Austrian lender which has yet to pay interest on 1 billion euros of state aid received in 2009, has guaranteed a net 839 million euros of its national debt, EBA data show.� (EBA source - link [17]).

For those confused by the above, here is the explanation: European banks, in order to generate modest cash flow from collecting on the pariodic interest premiums owed to them in order to plug increasingly large capital shortfall holes that otherwise would simply keep growing ever larger, have sold and continue to sell massive amounts of default protection on their very own host countries! As a reminder, it was precisely this that destroyed AIG when the illusion of the credit bubble burst.

in order to satisfy what likely threatened to become a self-feeding margin call as the (previously) $600 trillion derivatives market collapsed on itself, banks had to sell more, more, more derivatives in order to collect recurring and/or upfront premia and to pad their books with GAAP-endorsed delusions of future derivative based cash flows. Because derivatives in addition to a core source of trading desk P&L courtesy of wide bid/ask spreads (there is a reason banks want to keep them OTC and thus off standardization and margin-destroying exchanges) are also terrific annuities for the status quo. Just ask Buffett why he sold a multi-billion index put on the US stock market. The answer is simple - if he ever has to make good on it, it is too late.

Most importantly, this means that now US bonds are now completely irrelevant and don�t need to blow out for the final unwind to occur: all that needs to happen is for European bonds to continue collapsing, which will in turn put the banks who have sold CDS on said countries into bankruptcy, as what selling CDS effectively is is a marginless way of going long the underlying security, i.e. naked longs. And no, ISDA�s attempt to destroy the sovereign CDS market will have no impact as an event of default does not need to occur: banks will simply bleed to death due to daily variation margins demanding more and more and more cash each and every day as spreads blow out wider. Recall that in CDS trading, variation margins has to be posted and positions netted at the end of the trading day with virtually no exceptions. Which means that a CDS trading at infinity (or the underlying bond trading at zero which is equivalent) will put the seller of such product into insolvency, whether or not an actual event of default has been declared, thus making ISDA involvement irrelevant.

At this point we would like to request a moment of silence for Europe (and thus America, which will promptly implode without its transatlantic counterpart) because it is now inevitable that AIG�s fate will be shared by Europe when (not if) global central banks finally lose control of European rates, which in turn will collapse.

And once again, lest we be accused of hyperbole, here is Bloomberg [19], citing the head of fixed income at Evolution Securities

�Some of this is trading rather than pure hedging,� said Gary Jenkins, head of fixed income at Evolution Securities Ltd. in London. �If European counties the size of France or Italy actually defaulted and triggered CDS, there would be total carnage and meltdown. It would be the end of the world, and at that stage it�s likely your counterparty would be the least of your worries.�

Alas, since nothing will ever change until the final blow up destroys everything, the time to start quoting T.S. Eliot [20] has arrived. �