Are European lawmakers panicking?

Since Monday, we have had a series of announcements and water-testing:

• Last night, Germany's financial regulator decided to ban naked short-selling of certain euro-zone debt offerings, certain credit default swaps and 10 financial stocks (some discussion this morning about a European wide ban on shorting bank stocks)
• May 18th EU finance ministers passed the draft text of a new Alternative Investment Fund Managers Directive to the European Parliament(text to be finalized in July)
• There are insisting talks of a tax levy on all financial transactions 
• Legislators want to increase custodians’ liability for the assets they look after

All this looks uncoordinated and adds a sense of panicky decisions. From memory, the ban on short-selling for financial stocks during the 2008 meltdown, did not stop bank stocks falling but for a very short period of time. And the market may wonder whether the German authorities know something we don't. In short, European authorities by their actions for the past couple of months are just adding volatility, fear, suspicion, incertitude and overall lack of confidence.
Anyway, it will lead to over-regulation and costs without changing anything to the roots of the problem; it seems that many politicians in Europe are becoming convinced that there is a coordinated plot to kill the euro: pitiful.
They even don't understand that all these measure are going to trigger a flow of funds and skills out of the EU to more friendly places in Europe, Asia, Middle East and the US.
Barring European investors buying offshore funds will not improve the euro-zone economy and its imbalances, the root of the problem. It will only reduce their return on investment. In an open world, there is no point to become introverted, it is the surest receipt for a prolonged sub-average growth and durable impoverishment of Europeans. More regulation in Europe will lead to more outflow.
To European individual investors, don't worry, open accounts outside the EU and be free to invest in the best of breed that suits your risk/return profile.
In the meantime, the euro will continue falling (I wonder whether the European politicians, beside the rhetoric, are not doing everything possible to push the euro down).
Look at European stocks that will benefit from the euro fall and continue to remain clear from banking stocks. Precious metal have probably entered a consolidation phase and will provide entry points during the summer.
Finally, I have not changed my stance: Greece will default whatever it will be called.
Source:
The Economist: The AIFM directive - An other European mess

http://www.economist.com/business-finance/displaystory.cfm?story_id=16156357

Bloomberg: Germany to Ban Naked Short-Selling at Midnight

http://www.bloomberg.com/apps/news?pid=20601010&sid=ao6BsFTFFiKc

Bloomberg: Swaps Soar on Germany’s ‘Act of Desperation’: Credit Markets

http://www.bloomberg.com/apps/news?pid=20601087&sid=ajxxDiFsQuto&pos=2

Greece: the final chapter … at last?

During the Weekend, with the help of the IMF, eurozone Finance Ministers agreed to a EUR 110 billion rescue package spread over 3 years and Greece came with additional austerity measures amounting to EUR 30 billion also spread over 3 years. Greece also obtained 2 years grace period to come back to a budget deficit/GDP of 3% in 2014.

Will it be enough? The short and straight answer is no.

In my view this package has more to do saving the euro from a spiraling downfall than saving Greece from an immediate banqueroute. Jean-Claude Juncker and Christine Lagarde declared that Greece was a special case and there no risk of the crisis spreading to Portugal and Spain that are in a totally different position.

True Portugal and Spain did provide statistics that were not manipulated (as far as we know). However, the size of their budget deficit, lack of competitivity and high unemployment do not bold well for the future. According to the economist of JP Morgan Chase and Royal Bank of Scotland, it is not EUR 45 billion, EUR 110 billion but EUR 600 billion needed to bailout PIIGS countries. And France is in a very bad shape: its bank are over-exposed to the Greek debt (not talking about the Spanish debt...), budget deficit patterns are similar to Greece and Portugal with successive deficits whilst the GDP grew and its productivity is worse than Greece. If between 2002 and 2008, Greece is the eurozone country that displayed the highest budget deficit / GDP with 5.5% a year, Portugal was second (4.5%) and France third (3.9%). Investors will soon have a closer look at France.

Europe has been facing for years a euro-centric dogmatism, where it own dynamic became the sole objective with no regards to pragmatism. The euro construction was flawed since its inception because the one-fits-all does not work when grouping economies as different as Germany and Holland on one hand and Greece and Portugal on the other hand without automatically enforceable convergence criteria with tough penalties (including vote suspension in all Europeans institutions and stopping transfers). It is even worse since Brussels did not see (or did not want to see), the Greek fraud whilst this country received tens of billions from Europe.

I simulated a new budget between 2010 and 2013 according to the new package (even if I do not believe one minute that Greece can implement its new revenues and spending cuts).

Methodology

I used the data contained in the Greek Stability and Growth Programme as published in January and March 2010 that I adjusted with the new information provided this week-end, even if I do no believe that the additional 2% VAT will bring any new tax revenues with a 4% fall in GDP (1.7% GDP growth in the SGP!).

I used a 5% interest rate on any new debt as agreed by eurozone countries for the bilateral loans (I assume the IMF rate will be the same).

EUR 6 billion economy in 2010 (6 months) and EUR 12 billion for each subsequent year.

0.7% of Vat revenues on the GDP (same as the 2% VAT increase for a full year)

3.5% GDP growth in 2013 (a bold assumption)

For 2013 the computation results are:

• EUR 73 billion additional cumulated debt vs the SGP
• EUR 121 billion additional cumulated debt vs 2009
• Debt/GDP of 170%
• Budget deficit/GDP of 14%
• Interest payment / GDP of 5%

Well, there is only one solution: rescheduling the debt whatever it costs to the European ego.

Greece will not be saved from a default on its debt (chapter 3)

1. Greece budget assumptions and projections

Greece Stability and Growth Program is based on the following assumptions:

I note that all discussions are centered around the baseline scenario, which is overly optimistic. As the SGP plan dated January 2010 outlines (emphasis mine):

“For more than ten years the Greek economy experienced high GDP growth rates... was however largely based on increases in demand, fuelled by the easier availability of credit to enterprises and households at the lower interest rates which accompanied the adoption of the euro”.

This leads me to 2 conclusions:

(1) How do the Greeks expect to have a positive nominal GDP growth when the economy is still uncompetitive and tax increases and wage / pension freeze (at best) are going to weigh on an economy which has been geared for so long towards consumption?

(2) The euro has not been an instrument of convergence but of divergence since interest rates did not reflect the competitiveness of each eurozone country but a melting-pot hiding large discrepancies and not providing any incentive to converge due to the lack of stringent enough and automatic rule’s enforcement of the Stability Pact.

Beyond more fiscal and social austerity measures, has Greece any additional revenues they could fund? I see two sources: selling state owned assets estimated to represent EUR 9.2 billion (figure rather optimistic to obtain when you are a well-known distressed seller) and multi-years pre-payment of EU structural funds (everything is possible in Brussels to save face - it would be counterproductive and disastrous for the EU credibility on the world stage).

Overall, it will not be enough.

2. SGP execution

Prima facie, the implementation of the SGP is going rather well with a 39% decrease in the budget deficit for Q1 2010 vs Q1 2009, but the evil is in the details:

• First, 45% of the progress comes from a deep reduction in the Public Investment Program which, by the way, is due to slightly increase for 2010; at the current monthly spending, Greece is EUR 6 billion behind. So do not expect any improvement to come from this item; to the contrary, there is a lot of catch up to do by the end of the year to reach the EUR 10.3 billion spending contained in the SGP.
• Second, interest payments are zooming up. The subsidy that Greece will receive from its eurozone partners will however limit the negative aspect of this item
• Third, the primary expenditure is making very slow progress
• Fourth, the EUR 870 million special levy on profitable firms was mostly collected in January
• Fifth, payment of EU EUR 1.4 billion structural funds is being accelerated

 

 3. Markets & Beyond projections

It is quasi- impossible to project the success or failure of the SGP measure being implemented or the additional cost of any deviation in unemployment numbers from projections. What is less difficult to assess is the reality of GDP growth and therefore the level of debt requirements and whether the eurozone and IMF subsidy will be enough or not.

I do not believe one second that Greece will have a positive growth in 2010; commentators and analysts are broadly discussing about a 4% GDP contraction.

I started with the SGP numbers and I applied 2 different nominal GDP growth factors under 2 scenarii: one taking SGP alternative scenario and one with less optimistic GDP figures. In each case I calculated the additional debt and cost of interest at 5%, assuming that eurozone members will be willing to continue financing at subsidized rates...

SGP alternative scenario: the debt/GDP ratio continues deteriorating, whilst at a slow pace. This is obviously overly optimistic since any negative delta compared to the baseline scenario would translate in lower tax revenues which are not taken into account in Markets & Beyond calculation. The additional debt is rather sustainable in 2010 and 2011 marginally and increases the debt/GDP ration for the 4 years under review. I do not take on-board this scenario either.

Markets & Beyond scenario: the situation is unsustainable and the GDP projections are quite aggressive and do not take into account lower tax receipts. This will result in a default that would occur at the latest in H1 2011 (and probably by March 20 or May 18 2011 when two bonds are maturing – EUR 8.6 and 6.6 billion) but for additional financing from the IMF and other eurozone countries (it was reported last week that Axel Weber, the Chairman of the Bundesbank, said that EUR 80 billion would be required in 2010). Either Greece will default abruptly (not my scenario) or its debt payment rescheduling / will be negotiated (my scenario).

Conclusion

The rescue package, if finally delivered (watch Germany), will not be enough to plug the widening gap; it is merely buying time and any reprieve will be short lived. The EU, the IMF and Greece should prepare a managed default and start discussing with creditors, which are mainly European (this should facilitate negotiations), to reschedule the debt and the haircut they will need to take (in my view in the 50% region to make the debt burden manageable for Greece and be within the 60% zone of the Maastricht criteria).

Sources:

Hellenic Ministry of Economy and Finance

http://www.mnec.gr/en/

Hellenic Ministry of Economy and Finance: Accounting Office

http://www.mof-glk.gr/en/home.htm

Lehman Liquidator Wins Court Approval to Spend $1.4 Billion to Buy Loans!

I love this one. I did not see this Boomberg article reproduced or commented anywhere.

The liquidator (the firm Alvarez & Marsal) is entitled to a bonus depending on the value realized from the sale of assets:

(emphasis mine)

“The more money Marsal brings in to Lehman’s bankrupt estate, the more its creditors can recover -- and the more his New York-based restructuring firm will make in bonuses.

The firm’s contract with Lehman entitles it to a bonus of 0.175 percent of all amounts above $15 billion recovered for unsecured creditors. That’s capped at 25 percent of the fees A&M gets for dismantling Lehman, according to court documents. Based on fees collected so far, the bonus cap would be $50 million."

And you bet, A&M is going to buy discounted loans for a $3.5 billion face value. If the market goes the right way, A&M will pocket up to $50 million bonus. If they are wrong, they will still get their fixed fees (already got $200 million) and creditors, who cares?

What an irony: a liquidator speculates with assets belonging to creditors, from a bankruptcy originating from the same ill-conceived bonus system that brought down the system to near collapse (Don’t misread me, I am totally for bonuses, but on realized profits, not notional ones)!

Change the remuneration formula: if your speculative actions go wrong, up to 75% of your fees will not be paid; believe me, A&M will not take the risk.

Doesn’t this remind you something? Face I win, tail you loose… The banks’ traders…

Source:

Bloomberg: Lehman Wins Court Approval to Spend $1.4 Billion to Buy Loans
http://www.bloomberg.com/apps/news?pid=20601087&sid=a7HolQlBOPkg&pos=5

What’s in it for 2010?

Where were we in 2009?

After a disastrous 2008 that witnessed a global financial and economic meltdown not seen since the 1929 crisis, the trough was finally reached on 9 March 2010 in the West (China bottomed out late 2008) with an additional 35% decline in the US stock market from 1 January when the market finally realized that Armageddon will not concretized with central banks all around the world reflating the economic activity to unprecedented levels in history.




Fiscal policies added to the glut of liquidities created by central banks that found their way into risky assets, since deposit returned next to zero. Unsurprisingly, emerging markets stubbornly outperformed developed ones, reflecting higher economic growth, less affected financial systems and much higher saving rates.

Whilst inflation fell, deflation did not spread.

Yield curves steepened and spreads narrowed significantly, many back to pre-crisis levels (particularly TED and OIS indicating a return to normal conditions in the inter-banking market). Volatility in equity markets decreased as the year passed, with financial and information technology stocks the outright performers together with low-quality securities that were on fire-sale during the nadir of the financial crisis.

Where are we today?
The unprecedented Government stimulus induced an economic growth from Q2 2009 but did not mend the structural problems:

1. Banks’ balance sheets are still weak and they are not lending to the real economy. The private sector has not taken over the public spending.
2. Unemployment is high and should move higher during Q1 and probably Q2 2010; even if growth increases as many suggest, unemployment will remain high.
3. Commercial real estate and credit cards delinquencies are still increasing; residential real estate is still very weak and look to be at a standstill in the US (the refinancing of many a couple of hundreds of billion dollars in 2010 will have to be closely monitored); all measures taken have postponed the purge, not solved the problem.
4. The huge deficits and additional debts accumulated by western countries will not be able to re-engineer a second stimulus package if the private sector remains idle. The reduction of public debt and budget deficits will need to be addressed.
5. Over the past years consumption and therefore economic growth, particularly in the US, was build on over-indebtedness: the deleveraging has not ended yet and what model, if any, will replace it?

So, what are my 2010 predictions?

1. Western economies will have a positive growth, below average (currently 2.2% vs 7.3% during a recovery phase), and will significantly underperform developing economies.
2. Job growth will start to show up in H2 2010, but moderately and well below what we were used to during a recovery phase.
3. Inflation will not yet be a major worry.
4. Gold and precious metals after a consolidating period will forge ahead but will not run away until inflation becomes a real worry and / or there are political troubles in sensitive countries/regions (mainly the Middle East and Afghanistan/Pakistan/India).
5. Interest rates will rise, making fixed interest rate securities a bad investment. Buyer of Western debt will need and want a higher return for a higher risk since I do not expect Western Government seriously tackling the deficit and debt problem hoping growth will do the job.
6. Selective equities will outperform cash and fixed income securities.
7. Energy, commodities (including agriculture), information technology and healthcare will outperform. Retail will also outperform if consumers go back shopping (which I dot expect in significant terms).
8. M&A activity will jump.
9. China will continue to assert its emerging superpower status and conflicts with the US will be more numerous and acute (the question is who has the most annoyance power – my guess is China at this juncture; just see the Copenhagen summit on the environment). This will be particularly true in securing access to commodities and energy sources.

To conclude, I expect the start of 2010 to be fine, then to deteriorate quite rapidly (2-3 month) with a correction of 20-25% in equity markets and then partially recover in H2 2010 if there is no economic policy mistake or no unexpected external shock. Right now, and according to David Rosenberg from Gluskin Sheff, the current S&P 500 level discounts a 5% growth for 2010, which is way over the top. In any case, I do not expect a great year for equities as a whole: if the economy improves, markets will fear interest rate tightening and otherwise will discount a worsening situation. I would be short financials and long technology, commodities/energy and pharmaceuticals.