Over the summer we were introduced to Make Believe Mondays, where everyone believed that all of Europe's problems were solved because there wasn't a default over the weekend.  We'd see Friday sell-offs followed by Monday rallies.  Looking at the S&P futures this morning and the news behind the large gains, I think we need to call today Fantasy Friday.

Bloomberg is reporting that a compromise is in the works to leverage the EFSF (the bailout fund that sparked the late June/early July rally) to $1.3 billion instead of the $2 billion that France wanted.  The details are murky & trying to understand them is really a waste of time until we see what they finally agree to.

To sum up the issue, France needs their own banks recapitalized because of heavy exposure to PIIGS debt.  If France were to recapitalize them with their own money, they would lose their AAA credit rating.  If Germany agrees to the way France wants to recapitalize the EFSF (turning it into a "bank" backed by all the EU countries) Germany could lose their AAA rating and Angela Merkel will lose her job in the next election because the Germany people are overwhelmingly against backing the other EU countries' debt.

The bond market is showing why there may be such a big divide between the two countries.  Look at the spread between French and German bond yields (courtesy of Business Insider):

I think what everyone is missing as they try to guess what the solution for the crisis will be is that all the past solutions have done little to stem the bleeding.  The ECB has been actively buying Spanish and Italian bonds, yet their interest rates continue to rise.  The original EFSF has been in place, yet banks in Europe are still having a liquidity problem.  There is so much going on beneath the surface that we won't know all that went on until something blows up and committees are formed to investigate.

CNBC had an interesting article discussing how the European banks have been borrowing money from the Fed.  Basically the ECB gets a line of credit with the Fed and then the European banks can call and ask for money whenever they need it.  In return the Fed gets Euros as collateral.  All of this is done by entering the data in a spreadsheet -- no real money exchanges hands.  How big has that entry gotten on the spreadsheet?  Take a look at an updated chart (courtesy of Zero Hedge):

Focusing on the Big Picture

As I looked at the headlines yesterday the Social Uprising was very clear to me.  Whether it was the rioting in Greece or the capture and murder of Mommar Gadhafi or the ongoing Occupy Wall Street movement we are seeing the beginnings of the 4th and ugliest stage of the Social Cycle.  The leaders do not have a clue of how their decisions are playing right into the uprising.  They have no ability to focus on the big picture.  They are only concerned with pushing back immediate suffering.  Here are some of the thoughts I had yesterday:

It's a slippery slope when governments decide which companies or countries deserve to survive and which ones deserve to fail (or have their dictators killed or replaced.)

Our government decided which companies deserved to be saved and which ones didn't. They chose to give money to the "too big to fail" banks expecting them to do the right thing and they've turned around and hoarded their money, paid record bonuses, and committed foreclosure fraud.

You wonder why the Tea Party and Occupy Wall Street are so upset.....it's because the government "for the people, by the people" has decided they will do whatever they want regardless of what it does to the rest of the country.

They are doing the same thing in Europe right now & they wonder why the people that are supposed to have a say in the government have to resort to riots in a feeble attempt to get their voices heard. Why do the Greek banks or the French banks for that matter, that made bad loans deserve to be saved, while the government votes to fire thousands of government workers? What about the banks that didn't make bad loans? They are now put at a disadvantage for doing the right thing because their government has decided to support the banks that made the bad decisions.

Remember in the 80's how Americans were so outspoken about the subsidies that Japan was giving to their companies, putting our companies at a "disadvantage"? We've done the same thing. We can criticize China for keeping their currency artificially low, but our Fed is attempting to do the same thing.

Again it's a slippery slope when your government tries to pick who will succeed and who will fail.

What ever happened to letting cycles, free markets, and free will take its course?

I hope we don't see the type of violence we are seeing in Greece, Libya, Egypt, etc, but really could you blame Americans that are stuck in the middle and feel hopeless because their government has decided that they are not worth saving?

I also think that the OWS & the Tea Party have a lot more in common than most people realize. Both have had it with the way government has chosen to spend our money. This is very typical at this point in the social cycle. You have the "entitlement" generation in the twilight years of power. After focusing on their own selfish interests for all these years they are doing everything they can to get their last agenda items (and security for their own retirements) pushed through regardless of what it will do to future generations.

I think with both OWS & the Tea Party movement, we are seeing the younger generation stand up and say ENOUGH. I truly believe that there is a middle ground that most Americans want to pursue and that after the leaders that brought us into this mess are thrown out of office we will see some quick, although painful solutions.

So while everyone is focusing on the European "solution" keep in mind the slippery slope that the leaders in Europe are once again venturing down.  They've already been given a glimpse into the future, yet they continue to ignore the ramifications of their decisions.

Heading back to the sidelines

Our systems do not like the action that has developed this week.  Our Price Divergence System that sold a portion of our holdings on Tuesday, sold the rest of its position yesterday due to the lack of institutional activity in the market.  That brings EGA down to 23% equity and EPA down to no equity exposure.

It's likely to be a volatile Friday.  Not only do we have the fantasy that all will be solved in Europe in the near future, but we have options expiration today.  Fasten your seatbelts and enjoy the ride!

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