16 December 2011

A week in Europe – 20 years after the Maastricht Treaty

Last week’s Brussels’ summit delivered what has been hailed in most media and the usual politician consensus as being THE grand plan that will save, the euro and Europe, nothing less. Let’s reviews what was announced:

  • A new concept of fiscal rule (“fiscal compact”) is introduced whereby the budget deficit cannot exceed 0.5% of GDP and this rule will be enshrined in national constitutions. An automatic correction mechanism will be triggered if the ratio is deviating from this level.
  • Sanctions will be automatic when a country breaches the Maastricht Treaty criteria of fiscal discipline (maximum 3% GDP/budget deficit and 60% debt/GDP), but for a qualified majority of EZ members, and will be monitored by the Commission and the Council.
  • The private sector (read banks and insurance companies) will no longer participate in the cost of bailing out European countries beyond Greece.
  • The ESM will be brought forward to July 2012 and in case of emergency a qualified majority is set at 85% (subject to Finland Parliament approval). Together with the EFSF, it will amount to EUR 500 bn to be reviewed in March 2012.
  • Up to EUR 200 bn will be provided by EU members to the IMF via bi-lateral loans to reinforce its intervention means (to be confirmed within 10 days of this agreement), including EUR 1500 bn from EZ countries.

This plan, like all the other ones designed over the past 19 months, will fail:

  • The text, like the previous ones, contains a lot of waffle: many words but nothing immediately concrete whilst the liquidity crisis is hurting right now and the solvency one is round the corner, all final decisions and details being pushed back to March 2012. The objective was once more to kick the can down the road…
  • The fiscal compact falls short of a true fiscal integration. And without it, the ECB (the Bundesbank) will not finance European sovereign debt until the very last minute if any, i.e. when the cost will be horrendous for European citizens.
  • Rules are tightened to curb future debt but nothing is done to resolve the current insolvency of banks and over-indebted countries. The crisis is now, not next year or in two years time.
  • EUR 500 bn is nowhere near what is required: EUR 1-2 tr (Euro-area governments have to refinance more than EUR 1.1 tr of debt in 2012 plus aprox 300 bn of new debt without the potential bailout of a few banks).
  • The private financial sector is lo longer accountable for its mistakes increasing moral hazard.
  • There is no guarantee that the sanctions to be imposed on deficit countries will have any effect since they know that it is doubtful the would be thrown out of the EZ (otherwise Greece should have been kicked out over a long time ago); the only efficient threat of sanction is for countries to loose their voting and vetoing powers with the EU institutions and put such countries under tutelage. Politicians do not care about other (financial) sanctions.

The three main roots of the crisis are not addressed:

    • Unbalanced financing of sovereign debt deficit: The EU does not lack savings but Northern investors are rightly reluctant to finance Southern Europe. Domestic retail investors should be called upon with attractive enough terms.
    • Unbalanced trade: the competitive north increases its competitiveness vis-à-vis the south which has a growth model based on consumption, which is not viable long term and showed its limits.
    • Lack of growth, itself a result of the absence of fundamental social and economic reforms in Southern Europe.
The ECB is the only institution with the means to backstop European sovereign debt and provide unlimited liquidity to banks. This must be accompanied by deep structural reforms including pushing back the age of retirement (at least 65 years and probably beyond if no sharp improvement in the fecundity rate of Europeans), lengthening the weekly working hours to at least 40h and probably 42h without a commensurate salary increase and drastically reducing the functioning cost of government and local authorities by reducing the number of civil servants or their salaries (its increase rate should be limited to a maximum of 50% of the GDP growth rate).

The alternative is debt restructuring or outright default.

As it stands today, the grand plan lacks credibility.

Markets also seem very skeptical…


European Council: Statement by the Euro area Heads of State or Government

European Commission: Economic Governance in graphs

Bloomberg: Euro Leaders Push Budget Rigor 20 Years After Maastricht With Onus on ECB


08 November 2011

European rescue package: truth and fallacy

It occurred to me that the EUR100 bn private sector participation to the latest Greek rescue might no be as large as trumpeted by European leaders on 27th October. 
The statement:
“…we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors.”
The facts:
1. Greek’s sovereign debt holders split:
  • Commercial banks: EUR81 bn
  • ECB: EUR45 bn
  • EU/IMF: EUR65 bn
  • Others (SWFs, asset managers, central banks, public sector funds): EUR159 bn
2. As per EBA data published in July stress test, Greek banks shared 59% of the total held by commercial banks, i.e. EUR48 bn. The reduction in Greek debt will be at least partly compensated by a bank recapitalization (I estimate it at around EUR30 bn – same as the EBA): the net effect on the Geek sovereign debt reduction is therefore rather minimal at approximately EUR18 bn (assuming that Greece and not the EFSF recapitalizes). 
3. According to a research published by Barclay’s Bank in July, EUR11.3 bn are held by EZ Insurance companies: 50% is EUR5.7 bn.
4. Non-Greek European banks will take a EUR16.5 bn loss.
5. Remains private assets managers and smaller holders of Greek bonds which I believe are not significant: say EUR 30bn to be generous or a EUR15 bn loss.
The total losses realized by the private sector would therefore amount to EUR55 bn, far from the EUR100 bn trumpeted.
If non-Greek European private sector banks would write-down +/- EUR16.5 bn, one may wonder why the EBA requires them to raise EUR76 bn whilst they are profitable enough (but for a few exceptions) to absorb losses on Greece and reach the 9.5% Basle III capital requirements.
Because, there is more to come; then EUR106 bn will not be enough; watch non-performing private sector loans in Greece and elsewhere as well as Italy, France, Portugal, Belgium, etc. sovereign debt… Italy’s interest rates on its debt are close to unsustainable at 6.6% and France together with Belgium are rapidly going the same way: any 1% increase translates into +/- EUR19 bn additional interest payment in a full year for Italy and EUR17 bn for France.
The EUR1 tr EFSF will not be enough, nor the EUR200 bn recapitalization recommended by the IMF: but for a euro split/collapse, the only remaining solution would be for the ECB to monetize sovereign debt for BIGSPIF. Germany has already started to eat its hat; when enough will be enough for Germans?…
BIGSPIF: Belgium, Ireland, Greece, Spain, Portugal, Italy, France 
07 November 2011

European Banking Authority: The EBA details the EU measures to restore confidence in the banking sector


The Institute of International Finance: Press Statement on Euro Area Stablization Measures


European Commission: Euro Summit Statement

03 November 2011

Eurozone as we have known it: end of story

1. Greece

Tuesday’s announcement by the Greek Prime Minister, Giorgios Papandreou, of an impeding referendum on the second rescue package concluded a few days before sent market rolling and policy makers tangling in despair and frustration.

It was doubtful that this rescue package would work, but at least it was buying (wasting) a bit more time.

Interesting enough Wednesday’s evening discussion between Merkel, Sarkozy and Papandreou ended up for the first by mentioning the exit of euro for Greece if Greeks vote no to the rescue package, which so far was dumb impossible… As I wrote to JC Juncker in July, Europe lacks credibility and its first task should be to reinstate it: For 2 years, the opposite way has been followed by a succession of denials and scapegoating.

If I were Greek, I would go straight away to my bank and get all my cash to hide it under the mattress; so, expect a run on Greek banks that are bankrupted anyway with their load of junk Greek sovereign debt.

November-December 2011 debt redemption schedule:
11 November: EUR 2 bn (26 wk T bills) + 49 mio interest
18 November: EUR 1.6 bn (13 wk T bills) + 18 mio interest
12 December: EUR 2 bn (26 wk T bills) + 50 mio interest

23 December: EUR 2 bn (13 wk T bills) + 46 mio interest

According to Papandreou, Greece has enough money to survive until mi-December, so just after the referendum due to take place 4th December.

Well, if there is a referendum (there are rumors it would be called off; what a farce!!): Papandreou called a vote of confidence for Friday; if he does not win then new elections would be called and the referendum becomes history. The EU and IMF would provide Greece with its EUR 8 bn 6th tranche from the first EUR 110 bn rescue package.
Alternatively a Government of national union could be formed with the opposition. This would be the best outcome for the EZ and the euro.

2. Italy

Friday’s bond auction witnessed an interest rate increase to 6% (so before Papandreou referendum announcement) and since, borrowing costs have reached a record high (10 year bonds reached a high of 6.399% today), not seen before the creation of the euro. The cost of debt is not sustainable.

Wednesday evening Berlusconi could not get cabinet approval when his Northern League ally refused to increase the retirement age from 65 to 67 years as demanded by Merkel-Sarkozy for the G20 meeting in Cannes, which castes doubts about Italy’s ability to implement unpopular measure to reduce its (slowly) mounting debt.
Whilst Italy’s economic situation is on many indicator much less worse than France’s, its weak political system, large legacy debt and slow growth are making the country the target of markets.
France is however not far behind.

3. France

On many indicators, France is in a worse situation of Italy: debt increase (will soon catch up Italy), primary budget deficit, trade balance and unemployment.

The 2012 budget is based on a 1.75% real GDP growth that will not be reached: the consensus stands at 0.9%. This means finding EUR8-9 bn to maintain the objective of deficit reduction down to 4.7% in 2012 and 3% in 2013. However, most of the rumored measures are in the form of tax increase and not economies. Yet with the previous EUR11 bn deficit reduction announced a few weeks ago, EUR1 bn was made of cost cutting whilst EUR10 bn were tax increases. France has always the tendency to increase taxes instead of reining in it overload civil service (in particular with local authorities which has boomed for the past 10-15 years).
Markets are taking notice and spreads with Bunds have trebled since early July:
France is next in line (together with Belgium) and is at risk of loosing (should loose) it AAA rating which is the cornerstone of the EFSF together with Germany’s AAA. Any downgrade will pressure rates at which the EFSF borrows ; yet, Wednesday, the EFSF had to postpone a EUR3 bn bond issue schedule in the next fortnight and 10 yr spread over German Bunds increased to 1.5% from 0.7% in September.

The current crisis exemplified, if needed to be convinced, that the construction of the EU and EZ is a Franco-German affair. Whilst Germany is clearly in the driving seat (in the end who gets the money decides), there still is an appearance of equality between the two countries: would France loose its AAA, this balance would be shattered and Germany could, politely, pursue its own interest, eastwards…


France is the hidden weak link of core EZ and this begins to appear openly. I very much doubt that France will be able to abide by its budget deficit forecast without number muddling (France can always call on the CDC – a large French state-owned financial institution- to get a couple of billions euros).

After this crisis, the EZ cannot be the same: the way it works, decisions taken, budgets voted, Maastricht criteria respected (or even more stringent ones: no budget deficit), money spent, will make the EZ, if it survives, a different planet. Even its perimeter can be challenged. I still believe that a narrower EZ with a euro DM is a possible outcome: the question is, would France be part of it?
Anyway, Europe will be German or will not be.
03 Novemberg 2011


Bloomberg: Europe’s Financial Crisis Deepens as Greek Government Teeters


Bloomberg: Berlusconi Arrives at G-20 ‘Empty-Handed’ After Vowing Economic Overhaul


Financial Times: EFSF postpones €3bn bond issue


28 October 2011

Euro summit: kicking the can down the road once more

1. The agreement
As for a well written movie script, the 4 am press conference concluded weeks of discussions, haggling and wrangling about this Greek drama. Like the other 10 or so summits about the eurozone crisis, this is meant to be the final shock and awe response to years of denial, the ground-breaking decisions.
The agreement can be summarized as follows:
  • Nominal write-down of 50% (EUR 100bn) of Greek debt in private hands; Greek debt owned by official lenders not touched (so the ECB will not need to be recapitalized)
  • Remaining Greek debt will be refinanced at preferential rates
  • Bond swap to be done by end-January 2012
  • Closer supervision of Greek adherence to the program
  • EFSF to be levered 4-5 times
  • No ECB involvement in EFSF 
  • President Sarkozy will speak with China on EFSF
  • EFSF will have both a direct insurance and SPV element; looking for EM/IMF support for the SPV
  • Estimates of EFSF firepower ranged from EUR1.0-1.4 tn
  • Italy to deliver specific budget 
  • Banks will raise EUR 106 billion of Core Tier 1 capital by the end of 2012 to reach a 9% capital ratio (plus an additional EUR40 bn capital buffer).
Thursday, market reaction was enthusiastic with bank stocks gaining double digit (Crédit Agricole up 23%!) and the EUR jumping 2% vs. the USD. This looks however more like a relief of not being dead than anything really of substance so far since there is a lack of detail and a lack of surprise. Today’s (Friday) Italian bonds yields are reaching 6% again and French bond spreads to Bund are widening close to 1%.
Finance Ministers will decide details in November: as always the devil is in the details.
2. Analysis

  • The 50% haircut the private sector will “voluntary” write-down represents EUR 100 bn (EUR350 bn - EUR70 bn Troika loans - EUR75 bn held by the ECB)*50%: this pushes the debt/GDP ratio down to 120%.
  • The press release indicates: “…with an objective of reaching 120% [the debt/GDP ratio] in 2020”. So, if I correctly read this section of the press release and based on September IMF numbers, it means that the Greek situation will not improve for the 10 coming years or so at double the Maastricht Treaty criteria and back to where the ratio was in 2009. In addition, I doubt that structural reforms, if really implemented, will produce results before years to come and a GDP decline is to be expected for the next 1-3 years in the absence of currency devaluation.
  • Finally, according to IMF projections, and nothing beyond the EUR 100 bn forgiveness has changed, the debt/GDP would reach 143% in 2012.
  • Investors could question the quality of the EFSF guarantees (which only apply in case of default) since the ISDA declared that the 50% haircut being “voluntarily” gun-to-my-head does not constitute a credit event therefore a default. The same thinking could apply in the future to the guarantees provided by the EFSF on bond purchased from Greece (or other Eurozone countries). In addition:
    • Since it is meant to be voluntary, some could choose not to exchange their current holdings for new bonds weakening this frail restructuring if numerous enough
    • No detail on how it would be structured: maturity of new bonds, interest rate, guarantees if any, ruling law, to name a few
    • Other EZ countries could give up and ask part of their debt to be forgiven
     Despite the EUR100 bn debt default, this is not going to have much impact on the Greek budget: for over a year, Greece has not borrowed on capital markets but with the Troika and short term T bills at c. 5% and not at secondary market rates of 20%+.
Saving: EUR106 bn*5% = EUR5 bn i.e. +/- 25 % of current interest payments or 2% of GDP.
This will leave the country with a negative primary budget running at about EUR1.5 bn/month or 30% of state’s revenues.
  • All this is gaining some time, but does not address the issue of the lack of state cash flows generated by the absence of growth, a weak central state and a large black as well as uncompetitive economy.
  • EUR106 bn of new core capital will not be enough if other Latin European sovereign debt is marked-to-markets (just think Italy).
All this edifice also assumes no AAA downgrade for France, which I do not believe: France does not deserve a AAA rating.
This week’s measures bring some short-term relief but are far from being the shock and awe required and is short in details: European leaders once again kicked the can down the road, farther this time, I admit.
The winner is China that will have a strong hand with Europe while protecting its largest market from collapse as well as its EUR 600 bn of European debt.
As a side comment, European leader were prompt (and rightly) to name and shame leverage as the culprit of the financial crisis and are doing the same with the EFSF.

European BankingAuthority: The EBA details the EU measures to restore confidence in the bankingsector


26 October 2011

European banks’ recapitalization

When the EBA stress tests on 90 European banks were published in July, I titled them a mockery. I conducted my own analysis according to a 50% and 75% haircut on sovereign debt in PIIGS countries to abide by the 9.5% core capital to be reached by 2019 according to Basle III rules (many banks said they would get there well ahead of time): this analysis produced the numbers I mentioned in several articles on this blog.
In the table below, let’s look at German and French banks’ exposure to the Greek sovereign debt (being the main holders, I do not include other banks):
A 50-75% Greek default would result EUR 36 and 40 billion new capital required, split 1/3 for Germany and 2/3 for France. This does neither take into account their exposure to the banking and private sector nor guarantees/commitments/derivatives (including CDS). The German situation is not much worse with respectively EUR 9.7 billion additional exposure (including EUR 2.1 billion with Greek banks) and EUR 5.3 billion; French banks’ are in a much more difficult position with EUR 43.5 billion (including EUR 1.6 billion for banks) and EUR 8.3 billion.
To be fair, these numbers reflect the situation at the end of December 2010 and French banks have significantly reduced their exposure on their Greek sovereign debt during H1 2011: BNP Paribas from EUR 5 billion to EUR 3.5 billion and Société Générale from EUR 2.7 to EUR 1.9 whilst producing a net 6 months result of EUR 4.7 billion and EUR 1.6 billion, so enough to absorb a 100% default. However, as for Dexia that went under mainly because of its exposure to the non-sovereign credit book, I do not know what the quality of the private book is.
Let’s add a 100% default on Greek banks and 15 % on the private sector (guarantees and commitments included but not derivatives), the banking needs required to abide by Basle III rules is north of EUR 50 billion for German and French banks that were subject to the EBA stress test.
The total number of EUR 100 billion rumored to be in the starting blocks to recapitalize European banks is probably right on a Greek basis alone. In order to weigh the minimum possible on government budgets already under dramatic strain, this recapitalization should be undertaken via profits, cutting dividends to zero and reducing bonus payments (say by the same amount as the Greek default). It is however far from addressing the rest of BIGSPIF sovereign risk.
Nevertheless, the EUR 100 capitalization does not address the core of the matter: the sovereign insolvency and lack of economic competitiveness. More on this in a forthcoming article: France - EZ weak link.
BIGSPIF = Belgium, Ireland, Greece, Spain, Portugal, Italy, France

09 October 2011

Who should be single A rated: Italy or France?

I am amazed that France rating has not been downgraded as yet: it does not deserve a AAA by a long margin.

First, have a look at current rating for European countries (please note that since this table was published, Moody’s downgraded Italy 3 notch to A2 from Aa2, i.e. the same as Poland or Cyprus). This downgrade is probably justified in itself, but I am questioning how France can retain the top rating.
From data published by the OECD in May and the IMF in September, France is in a worse shape than Italy according to many indicators.

1. Debt/GDP

If the debt/GDP is the Achilles heel to Italy, its growth is nowhere comparable to France’s which is catching up quickly: +6% for Italy for the period 2000-2012 and +52% for France.
2. Real DGP growth

France is much better off with GDP growth twice the pace of Italy during 2000-2012 at 1.5%. French growth is however mainly due to domestic consumption spurred by the state welfare that France can no longer afford.
3. General Government Financial Balances

The French welfare state largess translated into higher budget deficits whatever the Government (France hasn’t had any balanced budget since 1978): the Maastricht 3% deficit ceiling was respected only 4 times since 2000, France doing much worse than the eurozone average since 2008 (-5.9% vs. -4.6%); - Italy fared better with -4.1%.
Analyzing further the budget, the situation looks even much worse for France: its primary budget balance has been negative for 10 years whilst Italy had always been positive (note that Italy’s primary budget is even much better than Germany). The IMF does not expect France’s primary budget to become positive before 2015.
4. Trade balance (goods & services)

This indicator is not helping out France’s precarious position, to the contrary. Since 2005 France has experienced increasing trade deficits, together with Italy but with an incomparable magnitude: USD 489 billion cumulated, 2.3 times more than Italy; Germany in the meantime accumulated a USD 1550 billion surplus. In percentage of GDP the analysis is the same.

True France enjoys a net investment income whilst Italy is negative, which translates into a comparably better current account for France.
5. Unemployment rate

Unemployment is another indicator where France is not comparing well with Italy, underperforming since 2003.

France does not deserve the top rating with the three main rating agencies (by the way, when European politicians accuse these agencies of an American plot against Europe, beyond being a “scapegoating” affirmation, they should remember that Fitch belongs to a French company, Fimalat).
According to the indicators presented, France should hardly be better rated than Italy.

Add guarantees to be given by France for Dexia’s failure (where France should bear most of the burden since most of the problem arises from Dexia CLF - the French part of the group with 259 x leverage!) and I do not see how and why France will keep its AAA. Belgium is under watch for possible downgrade following Dexia’s bankruptcy. It is also quite “funny” to watch France arm twisting Belgium to bear most of the burden in order to keep its AAA (that it will loose anyway): how guarantees for the EUR 95 billion impaired portfolio will be shared (EUR 66 billion in Dexia CLF balance sheet)…

The “funniest” of all is that Dexia CLF is going back to CDC (the French state owned financing vehicule) where it originally came from under the name of CAECL. From privatization to nationalization, 20 year of incompetent board of directors that let an incompetent management expand all around the world into risky businesses without the means (read capital) of their ambitions.

Please note that I do not blame the new management that arrived after the 2008 rescue since Dexia was doomed: there was not much they could do, and they probably did what they could with the legacy they got.


WSJ: S&P Cuts Italy's Sovereign-Debt Rating


IMF: World Economic and Financial Surveys


© Markets & Beyond
OECD: OECD Economic Outlook No. 89


Markets & Beyond: Dexia in 2 slides and a few words


05 October 2011

Dexia in 2 slides and a few words

I warned about Dexia weeks ago, and during private discussions over the summer I discussed with a top official in Luxembourg about its demise and breakdown.

Leverage core equity / total assets: 75 x! (36x if using the Basle II Tier 1 capital definition): so, doomed in a recessionary environment where nearly 50% of loans are with local authorities that have difficulties to balance their budgets.
The French part of Dexia (formerly Crédit Local de France) is where most the group mess is coming from: the same ratio is much worse at 259 x!!! Even LTCM was not leveraged like this…

Dexia BIL (Luxembourg) is rather sound with a ratio of 18 x and its exposure to PIIGS (EUR 5 billion including EUR 536 million of sovereign debt) is manageable. DEXIA BIL will be bought by a bank like ING. I guess that Dexia BIL “legacy portfolio” (EUR 10 billion) will be consolidated with the other ones of the group into a bad bank.

Prima facie, the consolidated “legacy portfolio” does not look so bad: “only” EUR 7.7 billion non-investment grade; well, (1) what is investment grade today may rapidly become sub- investment grade tomorrow (see Greece) and (2) the EUR 4.1 billion allocated capital to the “legacy division” is not sufficient to match a 30% loss on the NIG loans.

In 2Q11, Dexia’s portfolio was reduced by EUR 6.8 billion vs. end of March 2011 with a loss of EUR 4 billion, i.e. ~60% mark-down.

Greece was provisioned for 21% (the IFF* agreement); the final loss will be between 50% and 75%, somore losses to come.

Short-term Funding need down EUR 47 bn which can only be funded with central banks, since I guess that Dexia is shut down from the interbank market.

This is a remake of the Irish banks: Dexia successfully passed the 2011 EBA test which was meant to be much more stringent: a joke I wrote in July.

* Institute of International Finance: the international professional organisation of banks

After Irish banks last year, Dexia situation exemplify the inadequacy of EBA tests which were politically motivated. For 3 years, the policy of denial followed by policy makers regarding Greece default and banks recapitalization has spurred volatility in markets: investors are reacting to hard facts and hate uncertainty and lack of action. Markets do not want words but acts.

It also shows how the poor quality of blinded European politicians made a limited disease become metastatic.

Continue to stay clear of European financial stocks (if you are a long term investor, there is better value elsewhere – if you are a trader volatility is always good): with Basle III and other rules, the finance industry will deliver lower long term returns on equity as written on this blog for 2 years.


Dexia Group: semi-annual report June 2011


Dexia CLF: Rapport financier semestriel au 31 juin 2011


Dexia BIL : Rapport semi-annuel au 30 juin 2011


20 September 2011

Greece: this is THE week

As reporter by Bloomberg: “European Union and International Monetary Fund inspectors hold a teleconference call today with Finance Minister Evangelos Venizelos, to judge whether the government is eligible for its next aid payment due next month and on track for a second rescue package approved by EU leaders July 21.”
So, here we are, finally, decision have to be taken after months of wrangling, (badly) communicating and ignoring reality.
To raise EUR 78 billion in 5 years, Greece is to bring additional taxes, including a property levy for EUR 2 billion: I am wondering how the Government intends to implement the measure since the new land registry is not yet finalized and how will they be able to privatize without a certainty regarding title of assets (real estate is part of the EUR 50 billion privatization program); the initial deadline was November 21 and December 30 2008 depending whether your are Greek resident or non-resident, then postponed to H1 2010, and now October 31, 2011. The fun is that Greece first launched a project to record the use and ownership of land in 1995, with EU subsidies, but it ran into repeated delays and nobody at EU did react… When the blind leads the blinds…
As reported by the English speaking Greek newspaper
Ekathimerini: Greece hopes to complete the registration of all its land by 2020. So far, 13.8 million titles have been recorded on the cadastre.” 2020!
Ekathimerini is an endless source of information on Greece dysfunctions: “The Citizens’ Protection Ministry Tuesday rebuffed a report in the Financial Times indicating that Greece may be temporarily ejected from the passport-free Schengen travel area for its failure to keep undocumented immigrants out of the bloc […] It added [the Greek Citizens’ Protection Ministry report] that the Commission should support member states “managing the massive burden” of guarding the bloc’s external borders from illegal immigration.” Oh, yes, give me more money!
Do you want more? Yes? Let’s carry on:
“Whereas more than 1,000 Greeks were losing their jobs in the private sector every day in August, the government was assuring civil servants with lifetime tenure that their job privileges were not in danger and the so-called reserve pool was not intended for them but only for employees in the greater public sector. […] In the meantime, many Greeks were surprised to hear the government had hired between 15,000 and 20,000 people in the public sector in various forms since the start of 2010.”
About the need to reduce expenditures: “…closing down one or two money-losing state entities, such as the the Hellenic Railways Organization (OSE)…”
This is a topical and typical subject: the Hellenic Railways. A few numbers tell you all; for 2009 consolidated accounts:
Turnover - EUR 174 million
Operating loss - EUR 359 million
Total loss – EUR 937 million
Accumulated losses – EUR 2.5 billion
LT debt EUR - 7.8 billion
Interest paid - EUR 388 million (2x the turnover!)
Employees’ compensation - EUR 291 million (more than the turnover)
The auditors commented that they could not conduct a tangible asset and inventories impairment test as well as updating the fair value of investment real estate assets.
I could not find the same information for 2010. According to data released by the Ministry of Finance, on a non-consolidated basis, for the 5 months to May 2011, the situation has improved but remained catastrophic, the turnover is 3x less than personnel expenses (EUR 40,000 / employee / year as an average i.e. 4x the minimum wage, quite nice, and excluding various benefits – EUR 48,000 in 2010), the net loss amounting to EUR 164 million.
As a whole, during the same period, public entities had revenues of EUR 512 million personal costs of EUR 399 million and losses of EUR 534 millions (more than revenues). This tells you all, and the situation is “better” than in 2010…
Greece’s officials are willing to raise taxes and cash via privatizations; good luck! For example privatizations raised EUR 400 millions whilst EUR 5 billion was planned for 2011 – 3 months left…
However, I have no doubt that Greece will get its EUR 8 billion early next month.

Ekathimerini: Investors sought for land registry
Ekathimerini: Land register invites private bids
Ekathimerini: Ministry rebuffs Schengen report
Ekathimerini: Civil servants in the firing line
Ministry of Finance:
Hellenic Railways Organization: Annual financial statements for 2009

14 September 2011

Greece’s race to default and European Banks’ recapitalization

What I wrote 18 moths ago is unfolding and Greece is racing toward default and policy makers must decide who will bear the burden: taxpayers by continuing extending credit lines and the ECB buying sovereign debt in the secondary market to artificially maintain low interest rates and allow banks to offload their junk assets, or the private sector by recapitalizing banks - bondholders taking an haircut.
European banks’ share prices are nearing their lowest since the nadir of the financial crisis in 2008-2009, and French banks are now over 50% down compared to their 2011 high and counting. According to Bloomberg, European banks are trading at 0.58 X book value, indicating that there is not much trust in the value of their assets.
1. Greece
Greece is asked to deepen its austerity measures in a self-fulfilling downward GPD spiral (and lower tax receipts) that will lead to a full-blown depression for Greeks together with  social unrest, and possibly a threat to democracy when the population will become so desperate it will take desperate actions (and what will happen to Greece can occur elsewhere in Europe). Greece needs economic growth to fulfill its commitments and austerity without devaluation is just a death kiss.
GDP growth was downgraded in September to -5.3% in 2011 (-3.5% forecasted by the EU in May) and these GDP numbers were helped by a plunge in the trade deficit (not surprising for a country entering into depression). The HCPI is flat from January to August but is sharply down in July and August. I have stopped assessing the impact of continuing downgrades and a worsening situation; my last calculation early September was a EUR 29 billion deficit for 2011 (EUR 19 billion in the Greek budget), 160% debt/GDP and 13% deficit/GDP at the end of the year.
I do not see how Greece could even issue 13 and 26 weeks bills, the more at acceptable yields, with EUR 2 billion due on each of October 14 and 21; add interest payments plus deficit to plug and a default is there by end of October or at the latest end of November where EUR 5.6 billion of debt are coming due (Greece has still a bit of cash at the Treasury plus could ask the Central bank to sell some gold or pay an exceptional interim dividend or any other form of transfer). In addition, at the end of July, Greece had EUR 6.5 billion in arrears to third parties… Greece’s CDS are pricing de 98% risk of default.
On Monday, Greece’s bond yields reached a record with the 1 year at 110%, 2 year at 63% and 10 year at 21% which just tells you the story: at these levels it is meaningless; Greece is bankrupt and European leaders have failed their mandate so far whilst they have a fiduciary duty to defend their citizens and must restructure unserviceable sovereign debt. Numbers from the EBA show that financial institutions as a whole can sustain such a restructuring with a haircut of 50% (even 75% is workable). For the banks that need to raise equity/dispose of assets where existing shareholders and bondholders do not act, their ownership will be transferred to a more competent stewardship, existing shareholder being wiped out and bondholder paying the price for bad investments. This would most probably translate into larger deficits which would be better accepted by markets since we would have seen the trough of this crisis and, hopefully, sound foundations would have been laid down.
In any case, but for a massive fiscal transfer which is most unlikely, I expect the standard of living of Greeks to go down anywhere between 40 and 50% over the next few years.
It strikes me that instead of pouring money at Greece et al, it would be better for European Government to recapitalize banks if the private sector is falling to do so; yes, this would end up nationalizing some banks, so what? Temporary nationalizations would be preferable (with the firing of boards and management) than a rampant crisis that will not be solved adequately by throwing good money after bad.
2. Banks
Following, a recent article published on Markets & Beyond where I analyzed banks’ risk on a PIIGS’s sovereign default, I found a few estimates concerning the need for recapitalizing European banks ranging from EUR 200 billion (IMF - before a downward revision after a EU complaint – sic!) to EUR 1 trillion (Goldman Sachs – they talk their own book) in order to cover all Bank’s write-downs, and not only sovereign debt.
Crédit Agricole and Société Générale ratings were downgraded this morning with negative outlook, and BNP Paribas will probably follow: they will cut assets to boost capital ratios, the deleveraging process has much more to go. Most spreads are increasing, some dramatically, at a time where their access to short term financing is cut by some large money market funds: share prices are 50%+ down since the high of the year, French banks being particularly hit (I repeat once again that Italian banks as a whole have a meaningless exposure to PIGS and are less risky than French ones– they are hit because of their holding of Italian sovereign debt but I do not believe that Italy will default). I have written several times that France is in a worse situation than Italy I many ways.
The sharply increasing cost of financing for many banks is not sustainable beyond the short term and will start soon to fuel through the real economy weighting further on a dismayed European growth. Some will see their access to the interbank market closed, if not already occurring.
On Monday, Dexia CDS spread shoot up to 1569 basis points at mid-day (+225 b.p.), worse than Portugal and Venezuela: this is just telling what the market thinks about the quality of Dexia asset portfolio and exposure to local authorities and municipalities debt (do not forget that Dexia was the largest foreign borrower with the FED during the 2008-2009 financial crisis); its exposure to Greece sovereign debt is the worst of any bank surveyed by the EBA but BNP Paribas (yes, worse than Commerzbank!), with a  total exposure to PIGS (sovereign, banks and other private sector) standing at EUR 43.9 billion (EUR 10.6 billion excluding Spain) according to the numbers published by the EBA: Dexia has EUR 17 billion of core capita, enough to absorb a Greek default, private sector included (and a Portuguese one – no exposure to Ireland). However, Dexia could not sustain a collapse of banks in Spain with a EUR 23.6 billion exposure. I also guess that the interbank market is closed to Dexia.
The OTC derivatives, CDS in particular, represent the last frontier concerning risk. I have not read anywhere sensible information about who owes and who owns what to/from who, so it is impossible to figure out who is at risk and for the owners of CDS what is their counterparty ability to fulfill their commitments. This really is a black hole.
A few last words:
  • During the weekend, there was rumors that Germany was preparing for a Greek default (50% haircut – it maybe more up to 75% in my opinion) and plan B was design to shore up/save German banks from a collapse (I guess via a recapitalization). Germans are sensible people (like Finns).  Those who do not survive will be bailed out, but shareholders and bondholders would take the first hit this time, at last.
  • European banks volunteered for a 21% haircut, which would be a very good deal for them since the Greek debt is trading at much lower prices in the market. It is worth mentioning that some do not believe that their losses would be limited to that number (RBS provisioned 50%). I doubt it is a good deal for Greece.
  • RWA with zero allocation for sovereign risk is non-sense. There are insisting discussions/rumors that Basle III would be toned down in order to avoid a collapse in banks lending and increase in the cost of financing: this is again an efficient lobbying by banks but pure bullshit (see conclusion).
  • The ban on short selling to avoid the so-call (ugly) speculators to drive financial stocks down demonstrated that “proper” investors are driving them sharply down.
  • Since the financial crisis was triggered in August 2007, the strategy followed has been to concentrate risk instead of a largely mutualizing it, i.e. shareholders and bondholders bearing most if not all the cost of wrong investments/governance and leaving both complacent/incompetent Boards and greedy Management at the helm of now endangered financial institutions. This strategy was wrong.
  • Bank of England Chief Economist John Vickers has recommended the separation of banks’ consumer and investment banking activities: this is going in the right direction (in fact back to the period before the “Big Bang” in the late eighties)
  • Board of directors should be accountable before courts and pay-back all remunerations received since the trigger of the financial crisis in 2007; they should also not to be able to hold any directorships in the future as well as serve a suspended jail sentence (say one week) to make the point: it is really time to name and shame.
Banks can survive a PIGS default on a sovereign basis with existing shareholders’ funds. When taking into account the exposure to the private and inter-banking sectors, Spain might be a different story with debts due to banks in the Europe totalizing USD 568 billion and who knows how much of the private sector assets are at risk. Italy would be a game changer. So the crisis needs to be contained to the PIG; this could have done at a much lower cost in 2009 and 2010 and the spill over risk was much more limited.
It is most likely that the ECB will step up it purchase of Italian and Spanish (and Belgium and French) debt since this is the only viable European institution which can on the spot respond to the debt situation and expand its balance sheet quasi-indefinitely by printing money. It is also most probable that this over-indebtedness will be resolved via inflation as usual (at 5% per annum – an inflation rate perfectly sustainable - over 5 years 22% of principal are wiped out and 39% over 10 years).
Please, beware of lobbying by the financial sector: Empirical evidence doe not support the affirmation that much higher levels of equity funding, and less debt, would mean that banks’ funding costs would be much higher. A recent Bank of England report concludes:
“In retrospect we believe a huge mistake was made in letting banks come to have much less equity funding – certainly relative to un-weighted assets – than was normal in earlier times…We believe the results reported here show that there is a need to break out of the way of thinking that leads to the “equity is scarce and expensive” conclusion. That would help us get to a situation where it will be normal to have banks finance a much higher proportion of their lending with equity than had been assumed in recent decades to be acceptable. And that change would be a return to a position that served our economic development rather well, rather than a leap into the unknown.”
We must also go back to the roots of capitalism where success is rewarded and failure is sanctioned otherwise success is meaningless, and success needs to be clearly redefine to adequately reward it.
It is also time for a new generation of politicians (I am not discussing age but attitude) to replace our failed leaders who share the responsibility of the mess we are in, at best by incompetence and sheer populism, at worse by complicity: democracy as we have known it is at stake. The eurozone creation was “sold” to the public as a mere unified forex zone where tourism would be easier and inflation checked (a lie), and never as a monetary union that demanded homogenization among participating countries on a social and fiscal basis. Under the current structure and membership the eurozone is a failure: a structural change or a different geographical perimeter is required.
Credibility and psychology are key and European leaders lacked both, hence the absence of confidence by markets and European citizens. This needs to be redressed, urgently.Finally, a word from Romano Prodi, EU Commission President, in December 2001:
“I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.”
Bank of England: Optimal bank capital
Bloomberg: Europe Banks Valued at Post-Lehman Low
Greece Ministry of Finance: General Government Monthly Cash Data and Arrears
Hellenic Statistical Authority
UBS Investment Research: Euro break-up – the consequences
Goldman Sachs: Banks as bystanders at the sovereign stage of the crisis
Bloomberg: Britain to Implement Vickers’ Bank Protection Plan by 2019