1. July 13th 2012
Fasanara Capital | Bi-Weekly Notes
With the anti-spread device introduced earlier on this month, the ECB attempts at manually
removing a major catalyst from the market, yet again. The list of centrally-planned
backward-looking ‘manual removals of catalysts’ along the way gets longer and longer. At
the end of last year, it was wholesale Dollar financing for European banks (as reflected by
eurusd currency basis) and central banks reacted with unlimited $ liquidity financing.
Shortly afterwards, it was bank’s liquidity and inter-banking financing (as reflected by OIS-
Libor spreads) and the ECB reacted delivering the LTROs. It was then about financing for
Sovereigns (as reflected by spreads to Bunds and absolute yields) and the ECB reacted
making those same banks buy local government paper. Now, the banks dry powder for
purchasing government securities has evaporated, with spreads rising again to cracking
levels, so the ESM/ECB have reacted with attempting to manually cap them via the anti-
spread mechanism. We expected the ECB’s SMP operations (as opposed to LTRO) to be
utilized as best bang for the buck, and this device is just a substitute for it (and a weaker
one). From here, we expect the next potential catalyst to be bank capital, in addition to
bank liquidity, and we may see the ECB moving from LTRO and SMP to larger Asset
Purchases programs (TARP-style), at some point this year or next, to replace over-valued
assets with cash and capital at an inflated bid. Listening carefully to Draghi’s own words last
week may make it transpire.
Two immediate consequences can be expected on such ECB’s crisis resolution policies.
Firstly, incidentally, you may have to wave bye bye to the traditionally-shaped distressed
opportunity in Europe, executed via fire-sales from banks’ balance sheet, as it will be
postponed yet some more. Our own conversations with banks these weeks point in that
direction. Forcing market participants like us into unconventional ways to play on that table,
as we believe there are still mechanisms to capture that value. Secondly, this course of
action will also lead to a more meaningful side-effect, in preventing or further postponing
the full disclosure of losses, ring fencing of bad assets, the removal of such bad assets and
insolvent institutions from the system and the subsequent recapitalization of viable
(illiquid but solvent) institutions; thus critically missing key commonalities to previous
successful crisis economics: resoluteness, transparency, removal of uncertainty. All in all, a

2. multi-year period of slow deleverage, prolonged stagnation and system-wide forbearance
seems more likely than a quick recovery of some sort (and therefore remains the central
case scenario under our Multi-Equilibria market theory). This also means that, as it stands
right now, in the intentions of policy makers, a Japan-style outcome might be the most
likely and luckiest one for Europe.
More generally, the common denominator of such reaction-only ‘manual removals of
catalysts’ policymaking seems to be adding new debt on old debt, leverage expansion of
the public sector to avoid a disorderly deleverage in the private and public sector,
transferring the costs of the crisis to the future, and to still unaware taxpayers and EUR
holders. As opposed to face reality and tackle the overleverage with financial
restructurings/rescheduling/haircuts and the likes (which we have so far seen only in
Greece’s and Ireland’s PSIs, while having helped fix Sweden’s quick recovery in the early
90’s). Financial engineering on the balance sheet of the ECB , leveraging banks’ balance
sheets to buy government paper, crowding out the private sector and killing trading
volumes to un-precedent levels, soon replacing banks assets with brand newly printed cash
from the ECB itself, are all ingredients of the same debt-laden intervention policy.
Such behind-the-curve policies may work as long as one specific segment of the economy
reaches its tipping point, when it breaks out and calls the bluff. Over the course of the
economic history of previous bubbles, a coveted asset is the object of speculation, typically
Real estate/housing/equity, rising above its fair market value, helped by credit expansion/
easy credit, until it busts and ignites deleverage. Perhaps, given the institutional sovereign
and supra-national players involved, this time around the coveted asset may be debt itself,
debt on debt, as an addictive compulsive behavior with inevitably diminishing returns over
time and larger doses needed next time around, at both the private and public levels, as it
represents a growingly unbearable share of either GDP, government revenues or
household income (which are all declining further as debt grows, under the weight of such
debt itself, and under the cover of deceptive zero-bound interest rates). Imbalances are
building up, as the spread widens and widens between an excessive debt burden and the
real productive economy, industrial output and long-term growth.
Interestingly, as too much cash was parked at the ECB deposit facility, last week the ECB cut
the rate of return from 0.25% to 0%, causing a drop from ca. 800bn to ca. 325bn. Time and
again, deceptive zero-bound interest rates are attempting to push risk-off cash into risk
taking activities, in sort of a desperate way. Next time Draghi will have to either prohibit

3. parking cash outright (war-time capital controls) or put a negative interest rate there. As a
matter of fact, the ECB’s move has not so far yielded any result, as cash simply flowed from
the ECB deposit facility (falling from 800bn to 325bn) into the ECB current account (rising
from 70bn to 500bn), leaving the excess reserves at the ECB broadly unchanged (at 780bn).
To be true, we do not dispute that the ECB, and global Central Banks in general, have
more bullets at their disposal. We are convinced that they do, and may be in a position to
use it, with the appropriate political backing behind it. Expanding their balance sheet by an
additional 20%/30% is a possibility, in our eyes. In fact, we do expect a reflation to new
highs following decisive Central Bank activity at some point over the next few months
(especially should the market correct markedly and spur panic). However, we are doubtful
that they will be surely successful in doing that, as the market is currently pricing in, on our
count. After all, central banks’ balance sheets have quadrupled over the past five years. The
two key questions on investors’ minds should be: why haven’t they then sorted it out by
now? Can they quadruple it again over the next 5 years?
Differently than other market players and observers, we doubt that the latest round of
policymaking has bought much time. Actually, we believe the next 6 months will be will be
key to assess the probability tree diagram around potential outcomes, and may
consequently represent the most interesting window of opportunity for our Fat Tail Risk
Hedging Programs.
The main checkpoints on our count are the following: (i) Germany: from here, it will be
interesting to see, whether Germany will allow its Target2 exposure to rise much further.
It remains to be seen. If they do, then the trade will be to short them against peripheral
Europe, as they will have become, de facto, jointly and severally liable with other European
economies, on many scenarios. But not as yet. Until then, as explained in our last bi-weekly
note, we retain a smaller (than before) long Bunds RV play. (ii) In southern Europe austerity
has not really kicked in, as yet, and political support is at risk already. What we saw in
Greece is still months away in Italy and Spain. Unemployment is there, having prepositioned
at dangerous levels (52% youth unemployment in Spain, 36% in Italy, and rising), waiting to
react to the full wrath of such austerity measures. In Italy, domestic support seems to be
rapidly evaporating. Spain too is dangling on a string, with 52% youth unemployment,
ever-falling real estate valuations and deposits on a steady decline.
Where we watch such key vulnerabilities playing their magic is on the actual money flows
beneath the surface, as opposed to policy actors’ brave words, and the incidental headlines

4. that they engineer out of them. Look no further than Eurosystem flows. For instance,
money spent by the SNB and the Nationalbanken to defend the Swiss Franc and the Danish
Krone against appreciation vs the Euro. SNB has reserves for 60% of its GDP already, having
bought some 50bn Euro while defending the currency floor. Nationalbanken imposed a
negative return of -0.20% on its deposit facility. How much more manoeuvring
room/willingness can be left there to defend those undervalued currencies? And the last
currency peg under stress, most obviously, is the EUR itself. If history is any guide, three
conditions were met in past currency crisis and emerging market crisis: an over-valued
currency (read, the EUR to countries like Italy and Spain), over-indebtedness, as a share of
GDP or the productive economy (rephrased, too much debt and no growth against it), and
current account deficit. By any objective criteria, all three levers are met for certain
countries in southern Europe, making the case for a reshaping of the EUR-fixed currency
regime a genuine one. In advanced economies the readjustment may be slower to occur
than in emerging economies (as we learn from the attached interesting piece looking at past
banking crisis), but it may still do occur over time, including a currency-driven one.
Opportunity-Set
In opportunity land, it would be imprudent not to take advantage of such market resilience
to provide one’s portfolio with your own home-made backstop facilities and firewalls, as
you cannot expect Central Banks to do it for you too. In fact, Risk Premia are nowhere near
where they ought to be should one factor in the even vague possibility of partially failing
European policy making. Our leit-motiv remains to take advantage of current market
manipulation and compressed Risk Premia to amass large quantities of (therefore cheap)
hedges and Contingency Arrangements , thus balancing the portfolio against the risk of
hitting Fat Tail events in the years to come. If we do not hit them, then great, it will be the
easiest catalyst to us hitting the target IRR on the value investment portion of our portfolio
(what we call Safe Haven, or Carry Generator). If we do hit one of those pre-identified low-
probability high-impact scenarios, then cheap hedges will kick in for heavily asymmetric
profiles (we typically targets long only/long expiry positions with 10X to 100X multipliers).
Such multipliers are courtesy of market manipulation and ‘interest rate rigging’ provided
for by Central Bankers. Look no further than that, as we believe that they represent the
only truly Distressed Opportunity right now in Europe. Timing-wise, the next 6 months
may provide the most interesting window of opportunity, for theses uses and purposes.

5. What I liked this week
Denmark to Eurozone: keep your darn euros out. After the ECB set the deposit rate to zero,
Denmark's central bank, had to do one better to keep these people out, setting the deposit
rate to negative 0.2%. Denmark's banks will be losing money on deposits they take in
(unless they charge rather than pay interest), which should keep these banks from taking
large amounts of DKK (converted from euros) from Eurozone depositors. Read
The Deleveraging Trap Read
Draghi's zero deposit rate policy kills euro money market funds Read
Just another scary Spanish capital flight chart Read
W-End Readings
A recent research from BAML, The Longest Pictures, helps put things into perspective as it
collects the longest series possible for a number of key financial variables. Amongst other
stats, a few numbers captured our attention: (i) 10yr treasury yields are at their 220-year
lows in the US, 140years lows in Japan, (iii) adjusted for inflation, equity markets had
negative real returns in nearly 1 out of every 2 years since 1871, and after prior secular tops
(1907, 1929, 1968, 2000) stocks took 20-30 years to recover back to their previous highs (iii)
equities are in their 4th secular trading range, whilst bonds are in their second secular bull
market: every equity breakout has coincided with a secular inflection in the bond market.
The curse of advanced economies in resolving banking crises. The average crisis in advance
economies lasting about twice as long as in emerging market economies. It argues that
macroeconomic stabilization policies in advanced countries often delay the necessary
financial restructuring. Read
The tragic error of excessive austerity Read

6. Francesco Filia
CEO & CIO of Fasanara Capital ltd
Mobile: +44 7715420001
E-Mail: francesco.filia@fasanara.com
16 Berkeley Street, London, W1J 8DZ, London
Authorised and Regulated by the Financial Services Authority
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