Tuesday's Top 10 with NZ Mint: Greece's almighty mess; Reining in the shadow bankers; Christchurch's grass roots revolt; The ECB's back door money printing; Dilbert

Here's my Top 10 links from around the Internet at 2 pm in association with NZ Mint.

I welcome your additions in the comments below or via email tobernard.hickey@interest.co.nz.

I'll pop the extras into the comment stream. See all previous Top 10s here.

Jon Stewart is hilarious on Iran, if that's possible, at #10.

1. A hedge fund gun to Greece's head - The impasse between owners of Greek government bonds and the Greek government over the size of the haircut creditors will take is now the centre of attention in global markets.

They need to do a deal within the next couple of weeks to make sure Greece doesn't formally default on its debt and spiral uncontrollably out of the Euro zone, unleashing financial market chaos as it goes.

The apparent collapse of these talks over the weekend is worrying some people. It's worth having a look at the points of contention.

Brown Brothers Harriman currency strategist Marc Chandler says it seems the IMF and the Greek government now want a 75% haircut, much bigger than the 50% one talked about late last year.

Now the complication is that a bunch of hedge funds may have bought the bonds on the open market and aim to trigger the default swaps on those bonds to get back more money than they paid.

They're essentially betting that the banks who backed the Credit Default Swap contracts can afford to pay out and may deliberately force a default...

Watch this space.

Here's Harriman via Credit Writedowns with a very useful explanation of these negotiations of the PSI (Private Sector Involvement) in Greece's restructure. One implication is that any deal could wipe out the European Central Bank, which is thought to be holding €40 billion of this dreck, and may have to take some losses.

Participating in the haircut damages the ECB. It is possible that the loss, even from the discounted levels it purchased the Greek bonds, would wipe out the ECB’s capital. Alternatively, as we have point out previously, if the ECB does not take a haircut, it undermines the effectiveness of its sovereign bond purchases. The more the ECB buys the greater the haircut the private sector ultimately faces.

There has been a suggestion that one work around would be to have the ECB sell its Greek bonds to the EFSF at purchase price, which would keep the ECB whole. The Greek bonds sold to the EFSF could then be returned to the Greek government as part of the second aid package.

Another potential challenge comes from the hedge funds. There have been press reports that some hedge funds have reportedly been buying Greek bonds with the idea in mind to refuse to participate in the PSI. The argument is that in this case it could become a credit event that triggers the CDS they own on Greece. Alternatively, the Greek government pays the hedge funds off in full.

2. Grumblings in Christchurch - The Press' Sam Sachdeva reports a grassroots campaign is growing in Christchurch to stop the council CEO Tony Marryatt from getting a payrise. HT Hugh via email.

Protest organiser Peter Lynch said residents had donated money and time to produce and distribute the leaflets, while others had taken matters into their own hands. "Some people have been downloading the fliers, going to photocopy shops and using their own private money to print them out. It's just blown me away."

Lynch said news of Marryatt's pay increase was "the final straw" for earthquake-hit residents who were sick of the "dysfunctional" council. "People are no longer apathetic in Christchurch. They're far more informed, they want to do something and they see this as the catalyst."

3. Rein in the shadow bankers - Former Goldmanite Mark Carney (and current Bank of Canada Governor) Mark Carney is campaigning to rein in the US$60 trillion shadow banking sector and solve the problem of 'Too Big To Fail'.

I wonder though what that would do to financial markets and asset values. Trying to unpick a morass formed in the dark and run by people who by definition are brighter than a bunch of regulators sounds like a recipe for unintended consequences.

Whatever the outcome, the FT's Brooke Masters reports Carney, the head of the Global Financial Stability Board is determined to push back against the bank lobbyists:

The FSB head, who also serves as governor of the Bank of Canada, also told the Financial Times that bankers must stop trying to delay or water down the reforms so they can return to “business as usual”.

“The old normal was deformed,” he said. “For all the perceived difficulties the industry has ... [with] regulatory overload ... it pales in comparison to the difficulties, the lost output, the lost jobs ... quite frankly, the suffering that’s happening in a variety of economies.”

4. The amazing expanding ECB balance sheet - Chris Wood from CLSA is saying the European Central Bank could lend €1 trillion to European banks when it reopens its 3 year unlimited lending window on February 29 (talk about a leap year).

The theory is the ECB is essentially printing money by stealth by lending very cheaply (about 1%) to the banks against dodgy collateral. Those banks then lend the money back to Italy and Spain at 3-4% and made a nice little profit on the way through that bolsters their balance sheets.

So far the Germans have been quiet about the moves by the new ECB boss Mario Draghi, who is an Italian and former Goldmanite. The chart below is spectacular showing how much and how fast the ECB's balance sheet has exploded with new loans. No wonder the euro has devalued...

Here's Chris Wood via Zerohedge:

True, the above upbeat mood can be undermined in a second by a word from Berlin indicating that Germany does not approve of Draghi’s only too evident easing intentions. It is also the case that criticism is already coming from Germany about the latest draft of the fiscal compact which contains a derisory lack of “teeth” in terms of actual measures to enforce good fiscal behaviour. Still Draghi’s responsibility is monetary policy not fiscal policy. And based on GREED & fear’s observations thus far, it is clear that former investment banker Draghi is a smooth if not slick operator who is adept at saying one thing and doing another.

He will also understand that the goal of monetary easing will be undermined if it arouses German opposition. For that reason investors should assume for now that he will have the political skills to keep the Germans onside. Meanwhile, for the moment it is politically correct in Berlin to keep the banking system liquid via ECB extension of credit courtesy of dramatically relaxed collateral standards, even if it is not yet “PC” to monetise Eurozone government debt outright.

The resulting backdoor quanto easing in Eurozone is clear from the recent surge in the ECB’s balance sheet relative to the Fed’s. Thus, the ECB’s total assets have risen by 38% from €1.94tn on 1 July 2011 to €2.69tn on 6 January 2012. While the Fed’s total assets have risen by only 1% from US$2.87tn to US$2.9tn since July 2011.

5. But are they buying the bonds? - Italian Political Economy lecturer Benedicta Marzinotto writes via Project Syndicate that the European banks who borrowed from the ECB are not using all the money to buy European bonds.

So far they have put €230 billion of that €489 billion back on deposit at the ECB.

But no matter, because ultimately the ECB is the lender of last resort anyway. When these bonds eventually go bad, as they all will, then the ECB and its constituent central banks will absorb the losses and monetise the debt in the same way the Fed has.

Banks have bought only short-term assets, mainly with maturities of about three years (to match their liabilities with the ECB). This means that there is no appetite for supporting governments beyond what the ECB itself is willing to do. More importantly, the ECB is de facto the lender of last resort, while foreign banking systems are sharply reducing their exposure to risks abroad.

The ECB’s wall of money is likely to support the real economy only mildly. By contrast, if banks use the money now parked at the ECB to continue buying short-maturity government bonds, that wall of money would have a large impact on eurozone countries’ financial inter-linkages. Instead of falling on foreign banks in just a few exposed countries, a default would land mostly on the ECB’s balance sheet, whose losses are distributed to all eurozone central banks – a soft form of debt socialization that may well prepare the ground for Eurobond-type solutions.

6. More on the hedge fund blackmailers - Zerohedge has more here on the strategies of the hedge funds when buying distressed European debt, and focuses again on what the ECB might do.

The worry is that the ECB will become a type of 'super creditor' of European bonds that essentially creates a two tier system where some are holding subordinated government bonds and others (especially the ECB and European Stability Mechanism) are not. This in turn creates yet more uncertainty.

Here's Zero:

The fear of future subordination alone is why demand for peripherals will likely plunge even more, paradoxically allowing activist funds to build up even bigger blocking stakes at cheaper price, throwing Europe into a toxic loop where courtesy of its stupidity it will now have to pay fund managers, the same ones it vilified, billions and billions, so they don't pull the plug on Europe.

Zero also cites the S&P downgrade statement in focusing on the subordination issue.

We expect eurozone policymakers will accord ESM de-facto preferred creditor status in the event of a eurozone sovereign default. We believe that the prospect of subordination to a large creditor, which would have a key role in any future debt rescheduling, would make a lasting contribution to the rise in long-term government bond yields of lower-rated eurozone sovereigns and may reduce their future market access.

7. Volatility helps CEOs but hurts investors - Rotman Management School Head Roger Martin writes a fascinating piece at Huffington Post showing how US CEOs benefit more from volatile share prices than from high share prices because they get granted cheap options after a share price slump.

It's a fascinating insight.

Therein lays the fundamental problem eating away at the core of American capitalism -- and generating anguish of the 99%. American CEOs are paid to generate volatility -- so they did just great over the last five years while the 99% took it in the teeth. And that wasn't some kind of accident -- it is inherent in the current system.

The 99% would love nothing more than slow and steady growth, but that is not what maximizes incentive compensation for corporate executives. As far as CEO compensation goes, under the current stock-based compensation model, it is unambiguously better to have your stock plummet and then partly recover than to have the stock price stay steady over the same period. In fact, the most bloody-minded and self-interested CEO would be wise to drive its stock down immediately after taking over -- and blaming the prior administration for all the problems found -- and then get the stock back to the initial level. The CEO will make a small fortune doing that -- while shareholders make nothing -- and it is a lot easier than producing stock price increases from the initial level.

Stock-based compensation has produced a volatility machine and that volatility is wrecking the American economy, while it makes CEOs and hedge fund managers rich. The crash of 2008 wasn't a rogue event and it will happen again as long as our rogue system of executive compensation stays intact.

8. The problem with hedge funds - Martin also makes some good points about how the incentives behind hedge funds encourage the same sort of short term and volatility based thinking rather than long term value enhancement.

Rather than enjoying preferential tax treatment, hedge fund managers should face adverse tax treatment and pension funds should not be allowed to invest with any manager that charges both a fee for assets under management (e.g., 2%/year) and a carried interest (e.g., 20% of the upside). This is exactly the compensation structure of a CEO with a luxurious base salary plus lots of stock options.

As we found in the dot.com bubble, this salary plus stock options provides nothing but an incentive to swing for the fences because you can do very nicely on the base (here the 2%) and if you hit a home run, you get wildly rich. If, as is likely, you strike out, someone else (the investor) pays 100% of the price. Providing an incentive for hedge fund managers to swing for the fences is absolutely counter to the interests of pensioners or educational institutions that count on endowment income, as so very many found to their chagrin in 2008-2009. Hedge funds need to be taxed aggressively and have their supply lines of capital cut off for the good of the economy now and in the future.

9. Delay and Pray - Jonathan Weil argues at Bloomberg that Zombie banks are increasingly reluctant to write off bad loans because of what has happened to others such as Italy's Unicredito, which fessed up, and what happened to America's Regions Financial, which didn't fess up.

UniCredit was willing to take something of a hit to the intangibles on its books and use the chance to raise cash in hopes of saving the company. It’s doing the right thing, relatively speaking, and its stock is down 74 percent in the past year. Regions did the three-card monte, and its shares are down just 34 percent during the same period.

Other struggling lenders in Europe and the U.S. will see both examples as more reason to paper over their losses, which will make their problems and the eventual cleanup worse. Delay- and-pray is never a good strategy. Unfortunately it’s the only one a lot of zombie banks have left.

10. Totally Jon Stewart on the Iranian nuclear ambitions. He makes fun of the Straits of Hormuz.