30 November 2010

Ireland rescue package: some more details

Further to yesterday’s information contained in the EU press release, I found some additional details that may be of interest to readers:
  • The EUR 10 billion capital injection will raise core tier 1 ratios to at least 12%.
  • The Irish National Pension Reserve Fund will provide EUR 12.5 billion.
  • Any banks whose core tier 1 is seen falling below 10.5% will receive additional capital through a EUR 25 billion contingent capital facility established through the program. The stress tests will include a third party review of asset quality to garner additional credibility.
  • Liability management of subordinated bank debt will be "more widely applied" than just Anglo-Irish bank.
  • A special distressed banking law will be introduced in 2011 for the small 'credit unions' sector
  • The 5.8% interest rate is an average since the maturity of loan will range from 4 ½ years to 10 years.
  • Ireland will have an extra 12 months, i.e. until 2015, to lower its deficit down to 3%.
  • Ireland will discontinue its financial assistance to the EU loan to Greece.
The Irish contribution coming out the INPRF represents 50% of its total assets: as noted yesterday it is a disgrace. I do not understand how Ireland accepted this.
Still, this agreement has to be accepted by the Irish Parliament; the vote should be passed successfully despite only 2 seats majority (2 independents).

The new loan participation breakdown for any new EU rescue is:


France and Germany bear 50% of the total burden: unsustainable, at least for French finances if its AAA rating is to be retained (necessary for the EU lending vehicle to be AAA rated); I have therefore difficulties to see how the EUR 750 billion package decided in May could be raised in its entirety. My conclusion is that European countries cannot afford a Spanish bailout.
© Markets & Beyond
Deutsche Bank: Thoughts on Ireland's aid programme

29 November 2010

Ireland bailout: what’s next?


Ireland bailout

The 12% of GDP Irish budget deficit (32% including a banking rescue) was unsustainable and a few details emerged about the bailout agreed Sunday:
The contribution from Ireland will come from the cash pile the Irish Treasury has accumulated and the National Pension Reserve Fund - a disgrace; the fund, which holds EUR 24 billion of assets, was set up in 2001 to pay pensions from 2025. This means that Ireland is its own contributor for 20% of the total rescue package which worries me.
The loan has a 7 ½ year tenor and will bear a 5.8% interest more than the 5.2% granted to Greece (which I do not know where it comes from since a 5% ceiling was agreed for Greece).
EUR 10 billion will immediately go to recapitalize Irish banks and EUR 25 billion for further needs, the balance, EUR 50 billion, covering budget deficits.
It is worth noting that Germany dropped its demand of having bondholders taking part of the burden. The ECB, and other European countries, feared that such a move would translate into higher cost of financing and even close the market for more countries adding new losses for banks. Banks have played the yield curve by borrowing at near zero cost with the ECB and investing in longer date sovereign (riskless!) bonds, compounding the crisis.
Another interesting paragraph not linked to Ireland: “The Eurogroup will rapidly examine the necessity of aligning the maturities of the financing for Greece to that of Ireland”. This confirms my analysis that Greece is in no position to reduce its budget deficit down to 3% of GDP in 2014, and even less to be able to repay the emergency EU and IMF loan after 2013. Is the interest rate going to be adjusted? Is it going to be the same as Ireland? In any case these rates are administered like Albania in the good old says… Where is capitalism?
One last question (and I did not find any answer anywhere or even any question about it anywhere): how do these rescue loans rank compared to senior debt…?
Finally, the EUR 40 billion loan represents an additional EUR 8.8 billion for Italy, EUR 10.0 billion for France and EUR 1.7 billion for Belgium (if Spain is not excluded as I did, it would add EUR 4.9 billion, or 4% of its debt requirements for 2011, and reduce pro rata the other countries ).
2. What’s next
Looking at the market this morning, this plan fails to alleviate fears of contagion:
  • After a short (small) rally bank stocks are down again
  • The EUR is also under pressure after a short rally
  • 10 year bonds in PIIGS countries are more or less unchanged
  • German 10 year bund yield is at a 6 months high
The second bailout of the eurozone is nothing more than hiding dust under the carpet; the rescue package is not a game changer since it does not improve competitiveness and does not reduce the debt overload, to the contrary: liquidity support does not work out insolvency. There are calls to double the EUR 750 billion commitments, since the current one would be insufficient to rescue Spain and Italy (besides Portugal and add Belgium and France).
Portugal will be the next country to ask for a bailout and Spain will follow quickly behind due to its exposure to Portugal (EUR 78 billion at the end of June); then if Belgium or Italy fails, France would be engulfed with an exposure of EUR 253 billion and EUR 418 billion respectively.
In order to repair their balance sheets instead of cleaning them up one for all, the ECB and European politicians (lobbied by banksters) encouraged banks to play the yield curve by investing in peripheral European sovereign debt to get a nice spread pick up over their financing cost, and then, when things started to look ugly earlier this year, the ECB bought this sovereign distressed debt whatever the rating (against the ECB rules, but who cares…). The only effect has been to compound the crisis for gaining 1 year maybe 2 or 3 at most.
And Trichet, alongside most European politicians, continue to play this game by refusing bond holder (read banks) to share the burden (I even do not see why we, the tax payers, should we pay for any bailout when investors made wrong decisions). This, in effect, (temporarily) transferred the insolvency from banks to States without getting to the roots of the crisis.
It will carry on until and unless Germany stops playing musical chairs; in-between the crisis will deepen with debt continuing mounting and inflating it late seventies/early eighties style, the only way out.
I continue to believe that an orderly bailout of over indebted countries and banks is the only way to cleanup the house and build again on sound foundations. This is not the way Europe has gone so far, preferring dogma over sound governance. Europe is facing enough challenges (an ageing population and pension payments being the most important) without having to drag ongoing debt problems: let’s investors who made wrong investment decisions bear the burden, this is how capitalism works and wash aside the socialist and interventionist approach which repeatedly failed.
Continue to stay clear of financial shares and buy precious metal on setbacks.
Council of the European Union: Statement by the Eurogroup and ECOFIN Ministers

26 November 2010

Ireland, PIGS and the Eurozone: Here we are…

1. Bailout, bailout and bailout
A few numbers on loans provided by the IMF and the EU:
Greece: EUR 29 billion (+ EUR 9 billion to be paid in January)
Ireland: EUR85 billion (will see during the WE what the final number is)
In January, Greece will get EUR 9 billion for its third installment (I have no doubt that even if they are dissent countries, arm-twisting will do the job), representing a total of EUR 38 billion i.e. 35% of the EUR 110 rescue package dedicated to Greece. Ireland will get EUR 85 billion i.e. 11% of the 750 billion EU and IMF backstop line.
The EU/IMF bailout will take total debt to GDP of Ireland to well in excess of 100%, and, realistically, it is most probable that the total burden of debt will be shared with creditors.
The cost of a bailout on the Irish scale for Portugal would cost EUR 100 billion, based on a package of 60% of GDP. According to Bloomberg, for Spain a bailout of 60% of GDP would cost EUR 632 billion. For Italy, the region’s second-most indebted nation after Greece, the figure would be EUR 820 billion, but I am not so worried about Italy, for reasons I will explain later, I am more worried about France
The EUR 860 billion double barreled package looks rather thin when the uphill task is contemplated. Even based on 30% of GDP, there is a shortfall, and don’t forget that a number of banks would not be able to sustain the shock.
Wednesday in Paris, European Central Bank council member Axel Weber said governments can increase the size of the European Union-led bailout fund if necessary to restore confidence in the euro. “If not [the EUR 750 billion recue], it will have to be increased.” In a worst-case scenario, the fund would need an additional EUR 140 billion, an amount that would not jeopardize the survival of the euro, Weber said Thursday in Berlin. EUR 140 billion? Why not 250 or 300 or 100? And which worst-case scenario is he talking about? And can governments that are already over-indebted increase their commitment? I doubt it, and in any case not in the current format.
2. The Eurozone is a (sad) farce
I note that all the Irish banks successfully passed the EU regulators’ tests in July; as discussed in this blog at the time, these tests had no credibility being designed to defuse the risk of a EUR collapsing even faster at the beginning of the summer: fact have stayed, waffle has gone. Likewise, ongoing declaration from European leaders have no credibility at all went they explain that the crisis is under control and that Spain will not need a bailout: why Spain should be much different from Ireland when they also had a real estate bubble of the same magnitude (true there are difference regarding the solidity of the banking sector, but in essence the situation is similar)…
On November 18, the Irish Finance Minister said, as reported by the FT:
“...Brian Lenihan, Ireland’s finance minister, told Irish radio early on Wednesday the banks had “no funding difficulties.”
On November 25, asked in an interview on Punto Radio in Madrid if Spain risked having to seek a rescue like Ireland or Greece, Salgado said “absolutely not.
” The euro faces “speculative attacks”. [Ah! The speculators are back, the usual scapegoat for politicians]
“I should warn those investors who are short-selling Spain that they are going to be wrong and will go against their own interests,” 
Zapatero said in an interview with Barcelona-based broadcaster RAC1 today.
Bloomberg continues reporting:
“Merkel and Sarkozy are “impressed” by government’s budget cutting plans, today’s statement said.”
Really? I am also impressed by their consistent denial of reality. Anyway, during a financial crisis do not trust banks and politicians the least.
Let’s carry on with some spice from Portugal’s Prime Minister latest declaration: 
“There are those who think that the best way to preserve the stability of the euro is to push and force the countries that at this moment have been more under the floodlight to that aid…But that is not the vision or the political option of the countries that are involved”
Add Austria Finance Minister Josef Proell who mid-November said the EU was postponing the payment to January to wait for a final estimate of Greece's fiscal numbers, since denied. However, the IMF added:
"So far the government has been able to offset these [revenue] shortfalls by underspending at a state level, that's why the overall targets are still being met. That's clearly not a sustainable strategy going forward…The sustainability of achievements to date will only be maintained if there is a very determined effort to move on structural reform".
Whatever, it shows that dissenting is getting more voiceful, after the Slovak parliament refused to participate in the bailout for Greece on 11th of August.
This crisis is moving towards a fully blown political crisis.
This is a farce, a sad screen play written by incompetent and dogmatic politicians who are driving Europe to the wall and its citizen to poverty. Nobody listened when I claimed numerous times to some European elites that the over-indebtedness of Europe will drive to lower standard of living unless tough and unpopular measures were implemented quickly: just watch Ireland, Greece, Spain, France et al. And this is only the beginning since countries have no longer money available to soften the effect of the crisis, to the contrary. The chart below gives you a flavor:

3. The foundations of the Eurozone are flawed
As written several times, the one-fits-all does not work. A union that was meant to foster economic convergence has fueled divergence. I can only agree with David Fuller:
“The Euro is based on the assumption that one monetary policy would be appropriate for 16 different fiscal policies. The peripheral Eurozone debt crisis highlighted how incorrect that hypothesis is and policy initiatives are currently being put in place to improve fiscal cohesion. However, this does not heal the very real debt problems that were allowed to develop over the last decade.
Without currency union, countries such as Ireland, Portugal, Greece, Spain or Italy would have recourse to a significantly weaker currency to help defuse their debt problems and improve competitiveness. On the other hand, today's Euro is probably considered by many at the Bundesbank to be too weak to contain nascent inflationary pressures in Germany. This is another contradiction that will eventually have to be dealt with.
German, French and UK banks are most exposed to bank and sovereign debt in the periphery. Greek and Portuguese sovereign debt, Irish banks and Spanish banks and Cajas pose a serious threat to already weakened financials in the rest of Europe. It is for this reason that governments have been forced to absorb private sector debts. The core Eurozone quite rightly expects those who borrowed to pay their debts. Bailouts on the periphery are seen as preferable to defaults and bailouts in the core. It remains to be seen whether voters in high deficit countries will be willing to accept the amount of economic hardship required to bring debt levels back into line with Eurozone requirements.

Over the medium-term, the big question is about competitiveness. The last decade saw countries such as Ireland, Greece, Spain and Portugal substitute a focus on exports and balanced budgets for spending and higher wages and inflation. The contraction in labour and other costs, if allowed to run its course, will improve competitiveness and set the stage for a medium-term recovery. Longer-term, it is to be hoped that voters display the fortitude and integrity necessary to make sure politicians with a focus on fiscal responsibility are put in power, lest the boom to bust pattern of development prove interminable. “ [emphasis mine]
It is time for weak European countries to sit down with creditors and agree on an organized debt restructuring and an haircut; I have advocated this since the beginning of this year as I do not see any other proper way out.
4. Who is really at risk?
The data provided by the Bank for International Settlements provide some useful information which I tabulated in the following table with some added flavor.

France, Germany and the UK are by far the most exposed to PIGS countries with EUR 1 trillion. Portugal is rather over-exposed considering the size of its banking sector. One big surprise is the very low exposure of Italy, particularly when compared to France.
When the net number is calculated (even if netting does not really work this way, but at least it provides a better idea of the real exposure and the arm twisting that can be used – remember Iceland), Italy and the UK are in an enviable position, being net negative.
This is the first reason why I am more negative on France than Italy.
The next table, borrowed from Morgan Stanly, confirms that French banks are the most exposed (besides the usual winner: RBS).

The second reason is derived from the following table:
Whilst France is less indebted than Italy, the sovereign debt growth is 4 times quicker in France than in Italy, and France will catch up Italy in absolute terms next year.
In addition, Italy has a trade balance in equilibrium whilst France is heavily in deficit, showing that Italy is more competitive, an important ingredient for a recovery and eventually the reduction of the sovereign debt.
A last word, this morning, I was hearing on the French radio that residential real estate in Paris was up by 13% so far this yearwith the average square meter above EUR 7,000, , a record high, thank to low interest rates and revolving credits again available: Central banks low interest rate and liquidity creation policy is again fuelling asset bubbles (including the mother of all bubbles: government debt).
Have a nice week-end!
FT: Dublin fails to dispel eurozone debt fears
Bloomberg: Portugal Says EU Can't Force Governments to Accept Rescue Aid
Bloomberg: Salgado Dismisses Bailout Risk as Borrowing Costs Surge to Euro-Era Record
Moneynews: Greece Cleared to Get Next Bailout Installmenthttp://www.moneynews.com/Economy/EU-Greece-Financial-Crisis/2010/11/23/id/377895
BIS: Locational Banking Statistics
Eurostat: European Economic Forecast - spring 2010

Quantitative Easing explained...

... with a touch of humor, but sadly true.

19 November 2010

Ireland, PIGS, QE2, the Euro and the melting pot

Today, I am going to reflect on the continuing crisis within the eurozone and the usefulness QE to spur the economy, a nice melting pot.
Greece is back behind the curtains and Ireland is on the stage under the spotlights for the continuing show of the eurozone crisis.
Summary of the previous acts
Policy makers did not want to face the harsh consequences of 20 years of easy money that led to over-indebtedness (act 1) and take the tough measures needed due to cronyism and the human nature of politicians who prefer to spend money to buy votes instead of telling voters the difficult reality of past policy mistakes. There is one reality that central bankers did not want to see is that excess liquidity leads to mal-investment, since lower returns are deemed reasonable and outright speculation becomes the norm (from individual with real real estate or stock markets - some succeeded, most failed - to CEOs who engaged in huge M&A deals to flatter their ego and grow their bank account - most created value for themselves).
The act 2 started with the financial crisis in August 2007 which reached its peak in the aftermath of Lheman’s debacle and the collapse of the real estate market. Central bank opened without any restraint the liquidity tap (should I say fire hose…) for banks 1) to get rid of junk assets (they still have quite a bit in their accounts) and 2) play the yield curve to repair their balance sheet and gain time via short term financing at no cost and investment in longer dated Government securities (you know, the famous riskless sovereign debt), making a couple of hundreds of basis points (by the way the most profitable business since you only need a couple of people to do it and you can leverage!). There is no reason to stop since Ben Bernanke QE2 is a clear signal that the FED will continue managing the yield curve to limit the cost of financing of the US Treasury whilst letting banks carry on playing the curve.
Banks (European ones in particular) poured cheap money given by central banks into government securities, without properly analyzing the inherent risks of such assets, replicating with Greece, Ireland and other PIGS (add France and Belgium), that same mistake as for CDOs and et al to gain some tens or hundreds of basis points of additional return: complacency at best...
This led to the eurozone debt crisis during H1 this year with Greece. Now, Ireland is taking the stage. In both cases, the sins lied with them, even if they are of a different nature: on one hand a cheater which did not reform itself and is totally uncompetitive and on the other hand a country that had balanced budgets and let its success running away with real estate speculation that drove its banks to the knees, hence their costly rescue and a spiraling budget deficit expected to reach 32% of GDP in 2010 despite austerity measure taken in 2009 (the first country in Europe to do so)!
This profitable yield curve play had in itself the seeds of a contradiction: why should banks lend money to a depressed real economy when they have to be more strict in their lending practice (well, financing a speculative property market is not really the same as financing the real economy, but this is an other part of the debate) and can easily make money at “no risk”.
Ant now we arrive to act 3.
Act 3
Germany had enough to pay for the sins of profligate countries; after all, and until proven differently, Germany is not a Charity. Merkel, with a reason, is fed up for Germany to become the tax payer of last resort and wants other stakeholders to pay their share of the burden: shareholders should be wiped out and bondholders (banks among the largest ones…) take a haircut. I would add, and it may be the most important act for any sustainable recovery, Boards and management should be fired (politicians too - an other story).
Large European countries, Brussels and weak eurozone countries are bullying Ireland to accept a rescue package from Europe and the IMF, while Ireland has no immediate need for funds (EUR 22 billion in their coffers). Different reason for the same objective: weak eurozone countries fear contagion and the Franco-German axis together with Brussels are targeting Ireland’s low corporate tax rate. This is the first clear of arm twisting to impose a converging taxation (upwards of course) within the eurozone. This is stupid: Ireland will be able to get out of this mess quicker than most via its competitiveness and attractiveness for foreign companies, and a low corporation tax rate is part of the solution; not the case wit Greece which has not much to show and seems however better treated than Ireland...
Between Irish and Greek bonds, you know where I would go for if I had to choose between the two. If I were Irish, I would play hard balls with the French, Germans and Brusselites to get as much as I could: this is the annoyance power since arm twisting is more or less the only language understood in Brussels, Berlin and Paris.
QE 2
The second QE decided by the FED will fail to stimulate the economy. Whilst it allowed interest rates to substantially decrease during QE 1, and therefore release pressure on many homeowners and relieve banks as well as spur the stock market, QE 2 will not add much to consumers who are either out of job with no prospect of a rapid improvement, and the wealth effect is more than dubious this time (after the crisis we are muddling thought which demonstrated that not only assets cab go down as they go up, but also collapse, who, with some sanity, is  going to borrow in order to consume on the back assets that went up thanks to the FED actions?).
QE is merely boosting asset classes, not the real economy, and attempting to inflate in order to reduce the US debt burden and debase the USD to increase export will not work, but may be temporarily - and I even have doubts (Germany have always had a revaluing currency in relative terms and continued to be the world n° 1 or n° 2 exporter; they got the products clients want: consumers want BMWs not GM cars). Playing the currency card only works if at the same time structural reforms are undertaken to become competitive on the international stage by offering the right products at the right price.
On sure thing, savers and pensioners are going to loose at this game.
I attach an interview with Jeremy Grantham, Chief Investment Officer of GMO, one of the best value investor in a generation or two, who discusses QE 2 and prospects for asset classes.

07 November 2010

Chart of the Day: Stock market rallies since 1900

Chart of the Day had an interesting chart showing the length of bull markets; as they commented:
the current Dow rally (hollow blue dot labeled you are here) is still somewhat short in duration and below average in magnitude when compared to all the stock market rallies that occurred since 1900
Chart of the Day adds:
Most major rallies (73%) resulted in a gain of between 30% and 150% and lasted between 200 and 800 trading days.
Whatever the imperfection of such data (where are the rallies in bear markets, that can be extremely profitable), this a useful reminder that the current bull market (or rally in a bear market) is not yet de end if history repeats itself.

Chart of the Day: http://www.chartoftheday.com/20101105.htm?T