Greece: August 20 will not be the day of reckoning

After The ECB rejected a proposal by Greece to delay 1 month a EUR 3.2 bn bond repayment, Athens issued EUR 5 bn worth of 13 wk T-Bills August 14, including non-competitive bids, which was bought by local banks on a meager 1.36 x cover ratio (the worst to date) which really shows that even short term financing is becoming difficult. These banks will probably use the T-Bills as collateral with the Greek central bank to access its emergency liquidity assistance (ELA).

Below is the current schedule of T Bills redemption until year end, i.e. EUR 15.2 bn.

The situation remains most precarious. The lack tax collection, in particular due to a continued fall in the GDP y0y and to some extent persistent fraud, does not bold well for the Greek budget. The debt is again on the increase with a sharp EUR 23 bn QoQ: after investors wrote-down EUR 105 bn in March, reducing the debt to EUR 280 bn, end of June it was back above EUR 300 bn at 304 bn.

The budget execution is rather dismay, revenues being 24% behind plan for the period January-July 2012. Looking at it in more details, the PIB item is again manipulated this year in the turn EUR 1.4 bn to present an acceptable bottom line picture.

Despite the debt write-down, interest payments remain as elevated as last year but in line with the budget.

With no GDP improvement in the foreseeable future, and the troika requesting EUR 11.5 bn additional spending cuts in order to provide further financial assistance, the squeeze will continue on the population. This being said, even if Greece does not abide by its commitments, I have no doubt that they will get additional financial aid from the EZ (In my opinion the objective is until the 2013 German elections, but I doubt markets will allow it without the ECB jumping in full gear by buying EZ sovereign debt in the primary and secondary markets with no limit).

Source:

Greek Ministry of Finance: Budget Execution Bulletins

http://www.minfin.gr/portal/en/resource/contentObject/contentTypes/genericContentResourceObject,fileResourceObject,arrayOfFileResourceTypeObject/topicNames/budgetExecutionBulletin/resourceRepresentationTemplate/contentObjectListAlternativeTemplate

Eurozone falling chikens’ choice: internal or external devaluation?

1. An awful political background

Since the financial crisis started in 2007, 8 elections in Europe have driven incumbent parties out of business. Whether justified or not, it shows how the European population is disgruntled by a generation of politicians whose lack of courage led to the current over-indebtedness mess (N.B. voters share the responsibility by voting for the same politicians they despite now).

For a couple of years I have written that Greece could not be saved and I strongly believe that European politicians did not give a damn about Greece to solve the crisis, and were solely interested in insulating their banks from a Greek default: to succeed, (1) time needed to be garnered (hence the succession of costly bailouts) and (2) the ECB involved by buying sovereign debt from banks and extending unlimited liquidities; banks used these liquidities to buy more European sovereign debt (the 3 years EUR 1 trillion LTRO is meant (1) to provide some breezing space for deficit prone Southern European countries –France included- and (2) give a free return to banks to strengthen their balance sheet in the turn of 2-4% i.e. EUR 20-40 bn a year, a disgrace– as a side comment, none of the executives of European banks benefiting from the ECB largess should get any bonus since the profitability of banks has nothing to do with managerial acumen, and should in fact, for many of them, be bankrupt; as I have advocating for so many years banks’ executives and theirs boards should have been fired: what shareholders are waiting for?).

Greece will again go the poll in June and I do not see why results would favor a corrupt and incompetent political arena which has ruled Greece for 30 years, and all poll are giving the extreme left SIRYZA party a large lead. Despite disguised threats to the Greek electorate (80% want to remain within the EZ but with no austerity but an open check book from the Germans – they are living in Cuckoo land) from policy makers about a possible exit from the EZ (if your vote is wrong i.e. you do not abide by our integrationist rules, then it will be a disaster for you and no more money from us), the PASOK and the so-called liberals will be out of business for good, hopefully. The trick is to propose at the same time a referendum about the exit of Greece from the EZ which would end up in a rather strange situation where the majority would vote for an anti-austerity parliament and at the same time vote again the exit from the euro whilst bailouts are linked to austerity; the discussions about adding growth to austerity are fine but will not address the roots of the problem: lack of competitiveness.

After the failure of economic convergence within the EZ, we are witnessing Greece’s standard of living fast converging not with Northern Europe but with its European neighbors, Romania and Bulgaria!

For the time being, Greece got its EUR 4.2 bn rescue payment from Europe last week (add EUR 1.6 bn if the IMF disburses its part of the deal) that will cover its liquidity needs for June and probably until late July since Greece has hardly any repayment due in July.

Parliamentary elections in France, also taking place in June, will see the current Sarkozyst party (UMP) lose a considerable number of seats pending unofficial local agreements with the FN, Mrs. Le Pen populist party. The socialist party will win the elections, the question being by which margin: if their victory is large enough, after gaining control of the Senate in September 2011 for the first time under the V^th Republic, they could hold 2/3 of the congress (Senate + Parliament gathering) to modify the constitution as they wish.

Germany’s Chancellor Angela Merkel registered a strong defeat in North Rhine-Westphalia state election in May, the most populated region. However the increased lead for the SPD (the center left) does not mean that this will end the austerity imposed onto Southern Europe since it is the SPD that enshrined budget balance in the Constitution: Germans will not agree to finance ad vitam aeternam Southern Europe for the sake of “peace and the European construction”, which is the dogmatic and untrue eurocratic motto.

2. An awful economic background

Economic forecasts for 2012 and 2013 are between bad and disastrous for Club Med countries (the IMF is less confident than the EC, and private forecasters are even more pessimistic), and downward revisions will crawl along the year and next.

As the table below exemplifies, GDP will turn negative this year and more deeply so in 2013, with hardly any EU country escaping, the EZ being more affected, and within the EZ, Southern Europe the most

In the case of France, the new President, François Hollande, based his economic program on official, and as usual over-optimistic, growth forecasts of 0.7% in 2012, 1.75% in 2013 and 2% until 2016, whilst the country will be in negative territory in 2012 and 2013 at least. Add a Greek default and you get an asset that becomes a straight loss in the turn of EUR 15 bn from the first bailout already paid plus any recapitalization of the ECB.

France’s deficit will not be reduced back to the 3% Maastricht criteria in 2016 and its debt will continue on its upwards trajectory. Expect 2 notch rating downgrade within 12 months.

 Like other Europeans, the standard of living of French citizens will keep up contracting.

The key issue of low competitiveness is structural, and economic, social and tax reforms are not addressed. Policy makers have focused for too long on what they thought, incompetently or dogmatically, were liquidity issues.

3. The choice

This foolish blindness is leading to one of two tough choices: internal or external devaluation to quickly regain competitiveness.

Let’s come back to my preferred equation:

PIB = Public spending + private spending + commercial balance

The World has huge imbalances which result from demand led economies (USA for example) whose consumption is satisfied by export driven economies (China for example), and these imbalances must be corrected to go back to some economic and financial normality.

Looking at the equation, and taking into account the state of debt and budget deficits in demand driven economies in the West, they MUST shift their focus to improving their trade balance, and export driven countries MUST stimulate domestic demand.

There are two ways to improve the trade and services balance: either increase exports or reduce imports or a combination of the two.

To increase export one needs to propose goods that others want to buy by focusing on added value products (there is no way to be competitive for goods very elastic to prices) or unique goods and improve competitiveness. Wage and social costs are the items a country controls which impact productivity and no Club Med country will escape harsh austerity. Energy is also quite important and must be addressed (the USA is thriving in becoming self sufficient again in the years ahead thank to technology which allows shale oil and gas recovery – this will all also have a substantial positive impact on the US trade balance).

To reduce imports, goods must become too expensive for consumers or find the same ones locally at attractive prices. This can be achieved via custom tariff and/or other tricks or via unfavorable exchange rates.

Therefore, taking the extreme case of Greece (but it is valid for Spain, Italy, France, etc.), to rebalance the economy and improve the terms of trade, the choice is between external or internal devaluation.

External devaluation corresponds to the exit from the fixed exchange rate mechanism (the euro) where the Drachma will loose 50-70% of its new parity with the euro (or DM) leading to much higher imported goods thus lowering consumption and more importantly lowering imports; this assumes that the goods and services needed will be substituted with locally produced ones, otherwise the country will continue impoverishing itself. The terms of trade for exports will also dramatically improve, assuming Greece will produce goods other countries want to buy. For the country not to crumble under debt servicing, this will be accompanied with a debt default (restructuring, straight default, inflating the debt away, you name it). Competitive exchange rate devaluation has always been and still is an economic policy tool (see the US and China manipulating their currencies at will).

Internal devaluation is where countries have chosen austerity without currency devaluation: the only adjustable variable is real wages and social benefits which must be reduced and this must be equivalent to a currency devaluation. The terms of trade will not improve and trade imbalances will remain. Debt servicing becomes unsustainable by eating a rising portion of taxes collected. This can only work with fiscal transfers from other countries if a social collapse is to be avoided, i.e. Germany continuing paying.

Whatever the course of action followed, the standard of living of Europeans will continue to fall for years if not for a decade. However, the internal devaluation route, if followed, would end up very nastily.

I will never sufficiently outline the need for Europe to focus on innovation (strength of the US which also explains why I am more positive on the US economic prospects than the European one) and demographics, an other factor of economic growth: spending money in these areas instead of Greece et al. would have been more beneficial to European growth long term.

Source:

Capital Economics: European Economic Outlook Q2 2012

http://www.capitaleconomics.com/

Stop Press: Markit Eurozone Manufacturing PMI – It’s really bad

I usually do not post this kind of economic data, since there are so many published every week. I am doing so since the numbers are striking, France in particular is a real disaster. As I indicated many time, forget about Portugal, Spain (well not really, do not forget Spain!) and Italy, France is the sick man.

Greece: 3 month high but still in contraction territory @ 41.3

France: 33 month low (yes, you read it right!) @ 46.7 (I heard on the French radio that the 2 French auto-manufacturers – Renault and Peugeot – had sales 30% down in March; the French auto industry, Peugeot in particular, is entering the danger zone for its survival).

The roots of the problem have not been addressed, and politicians are still in denial territory: the construction of Europe for the past 20 years is a failure due to a dogmatic approach.

Source:

Markit:  Markit Eurozone Manufacturing PMI® – final data

http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9330

Greece, Europe and the rule of Law

On 23^rd February 2012, the Greek parliament passed a Law which at the time went mostly unnoticed in one of its provisios: the retroactivity of the CAC (Collective Action Clause) for Greek Law bonds. Greek bonds holders who do not accept the debt swap will be forced to do so.

EUR 205 bn were eligible for the debt swap:

Investors (well, banks) holding EUR 152 bn Greek law bonds accepted the offer (85.9%)

and EUR 20 bn of non-Greek law (69.9%), i.e. 83.7% for the aggregate.

The invitation period (to the public offer) for each series of PSI-eligible foreign-law bonds and of bonds issued by state enterprises and guaranteed by the Hellenic Republic has been extended until 9:00 p.m. (C.E.T.) on March 23, 2012. Note that not only content to renege on past contractual agreements on Greek-Law bonds, Greece is threatening to default on bonds held under foreign (Brtiish) Law if bondholders do not accept the terms of the bond swap agreed (read forced) on March 8.

I thought retroactivity of laws was the benchmark of totalitarian regimes, but no, it is happening in 2012 within Europe, in the birthplace of democracy. All European leaders are applauding to something they should utterly reject, but for futile self-political interest. There is one basic principle of democracies: the non-retroactivity of laws.

I feel that any investor would successfully challenge this before the European Court of Human Rights.

Source:

Hellenic Republic – Ministry of Finance: Press release PSI

http://www.minfin.gr/portal/en/resource/contentObject/id/baba4f3e-da88-491c-9c61-ce1fd030edf6

Eurobank EFG: Greece Macro-Monitor

http://www.eurobank.gr/Uploads/Reports/FOCUS%20GREECEPSI%20March%209%202012.pdf

ISDA: Unofficial translation of the Act of the Governor – Bank of Greece

http://www.isda.org/uploadfiles/_docs/Act_of_the_Bank_of_Greece_9_March_2012.pdf

Greece 2011 Budget execution and the (bleak) future

A year ago, European politicians were hailing the progress made by Greece stating that the nadir of the crisis was behind and difficulties ahead would be dealt with forcefully. As my readers may recollect, I did warn that the plan will fail and the Greek situation would worsen, the country being bankrupt.

Let’s see what happened in 2011 in the Greek Budget:

Note that the last column was the planned 2011 budget as of December 2010, whilst the column (5) contains the budget post-revisions.

A few remarks:

• Compared to the original plan, the budget implementation failed miserably with a EUR 5.5 bn wider borrowing requirement, i.e. a staggering +23%.
• A much larger gap would have been registered (EUR -3.3 bn) without deep cuts in military spending (EUR -1.3 bn.) and the Public Investment Program (EUR -2 bn) during the course of the year compared to the initial budget.
• Revenues were lower than in 2010 and EUR 5.5 bn less than in the initial budget, EUR 6.7 bn if it was not for a new line of revenues that “miraculously” appeared in November and December, registering EUR 1bn (“special revenues from licensing public rights”). Primary expenditures were contained but did not decrease enough to compensate.
• Interest payments were marginally higher than in the initial budget, but EUR 3 bn more compared to 2010.

As I forecasted early 2011 (and also in 2010) the situation has worsened, not improved. Greece is insolvent with a 155% debt/GDP, a 10% budget deficit/GDP (there are rumors that it would finally be closer to the 9.1-9.4% mark thanks to an emergency property tax representing a good EUR 1 bn –looks like a desperate trick to “improve” the picture of a desperate situation) and EUR 350 bn debt (not talking about high unemployment, dismay current accounts and trade balances, insolvent banking system, deposits going abroad, weak productivity, antiquated social welfare state, continued weak tax collection – whilst improving -, etc.). 

As of this Saturday morning, discussions with the financial sector are ongoing regarding the level of write-downs, or more exactly the strength of guarantees on the new bonds to be swapped with the existing ones.

The schedule of T-bills maturing during the next 5 months is:

26wk	09-Aug-11	10-Feb-12	1,000
13wk	15-Nov-11	17-Feb-12	1,600
26wk	06-Sep-11	09-Mar-12	1,455
13wk	20-Dec-11	23-Mar-12	1,600
26wk	11-Oct-11	17-Apr-12	1,600
13wk	20-Jan-12	20-Apr-12	2,000
26wk	08-Nov-11	11-May-12	1,600
26wk	13-Dec-11	11-Jun-12	2,000
26wk	13-Jan-12	13-Jul-12	2,000

In March, add two 5 years bonds due for redemption:

5 yr	07-Feb-09	20-Mar-12	7,000
	05-May-09	20-Mar-12	7,433

Therefore, Greece will need to auction T-Bills next week and the following one to refinance maturing ones (which should go fine if nothing dramatic occurs with the discussions between banks and Greece on existing debt) and find EUR 16.5 bn in March, i.e. EU and IMF money.

To regain solvency, the discussions are centered around how much the financial sector would forgo, and the latest discussions are 70% of their current debt holdings, beyond EU/IMF rescue packages and drastic austerity measures. Would this be sufficient? No: Europe is at best growing flat, debts continue to go north and trade imbalances between countries are not reduced, and these imbalances are one of the reasons of the current crisis, themselves a result of the widening competitiveness gap between countries, with no currency adjustment possible within the euro.

This crisis cannot be solved by only reducing the stock of debt but also by improving cash flows, i.e. growth. Whether the financial sector forgoes 70% of its Greek debt pile (estimated at EUR 200 bn with themajority of it held by Greek banks and, in my view, a substantial chunk of thebalance with the ECB), this is just kicking the can down the road as it has been done for the past 2 years (well, really for the past 10 years). Let’s see the simple equation below:

GDP = private sector consumption + public sector consumption + (exports – imports). This is a very important equation largely overlooked by commentators.

For Greece all of theses items are negative yoy, according to the latest official statistics, and in many countries at least two items are negative: in the current economic environment there is no way that Greece (and others) can get out the over-indebtedness black hole. Greece and Club Med countries (France included) need to improve competitiveness to gain/regain a positive trade balance.

Growth based on retail demand in southern Europe was unsustainable with negative trade balances, and the potion to remedy to this situation will be very bitter indeed: a sharp fall in the standard of living. This is compound by the fact that within a state welfare, redistribution represents a substantial chunk of revenues for individuals, which these countries will drastically reduce to get their finance in order. To regain competitiveness, salaries/social transfers are to decrease by 15-35% - depending on countries - multiplied by the productivity differential with the main exporting countries. The euro is indeed a kind of gold standard where individual countries can no longer devalue their currency to adjust their lack of competitiveness and boost exports.

None of the European political sphere is addressing what is at the core of a flawed eurozone construction.

The table below provides the effort required to get Greece’s finances back under control: this is unsustainable since I do not believe official figures of a EUR 50 bn privatization plan, and will lead to social unrest to a scale not seen so far, the more so that the OCDE announced that the situation is worse in the tune of EUR 15 bn and the EFSF/ESM is not large enough:

“The current EFSF/ESM resources of € 500bn are not enough. Furthermore, the EFSF/ESM has not found it easy to raise funds at low yields even with guarantees.”…

Source:

Hellenic Republic - Ministry of Finance: various publications

http://www.minfin.gr/portal/en

The Telegraph: Eurozone bail-out funds not enough, warns OECD

http://www.telegraph.co.uk/finance/financialcrisis/9057597/Eurozone-bail-out-funds-not-enough-warns-OECD.html

OECD: Solving the Financial and Sovereign Debt Crisis in Europe

http://www.oecd.org/dataoecd/14/25/49481502.pdf
Markets & Beyond: European rescue package: truth and fallacy
http://marketsandbeyond.blogspot.com/2011/11/v-behaviorurldefaultvmlo.html

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 27^th 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.

Conclusion

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

Source:

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

http://www.eba.europa.eu/News--Communications/Year/2011/The-EBA-details-the-EU-measures-to-restore-confide.aspx

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

http://www.iif.com/

European Commission: Euro Summit Statement

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125644.pdf

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 4^th 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 6^th 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…

Conclusion

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

Source:

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

http://www.bloomberg.com/news/2011-11-03/europe-s-financial-crisis-dominates-g-20-talks-as-greek-government-teeters.html

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

http://www.bloomberg.com/news/2011-11-03/berlusconi-arrives-at-g-20-empty-handed-after-vowing-revamp.html

Financial Times: EFSF postpones €3bn bond issue

http://www.ft.com/cms/s/0/47f3998e-0546-11e1-a3d1-00144feabdc0.html#axzz1cdb7yxNB

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.

Conclusion

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.

Source:

European Union: Euro summit statement

http://consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125644.pdf

European Banking Authority: Capital buffers for addressingmarket concerns over sovereign exposures

http://www.eba.europa.eu/cebs/media/aboutus/News%20and%20Communications/Sovereign-capital-shortfall_Methodology-FINAL.pdf

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

http://www.eba.europa.eu/News--Communications/Year/2011/The-EBA-details-the-EU-measures-to-restore-confide.aspx

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.

Hopeless.

Source:

Ekathimerini: Investors sought for land registry

http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_07/07/2011_397548

Ekathimerini: Land register invites private bids

http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_04/08/2011_401150

Ekathimerini: Ministry rebuffs Schengen report

http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_13/09/2011_406189

Ekathimerini: Civil servants in the firing line

http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_18/09/2011_406931

Ministry of Finance:

http://www.minfin.gr/content-api/f/binaryChannel/minfin/datastore/bf/75/78/bf7578dec0e469420b8d6f742d5815d182d31eee/application/pdf/5-month+period+2011+comments+ENG.pdf

Hellenic Railways Organization: Annual financial statements for 2009

http://www.ose.gr/LinkClick.aspx?fileticket=eVoOiPOHPnY%3d&tabid=541

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.

Conclusion

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.”

Source:

Bank of England: Optimal bank capital

http://www.bankofengland.co.uk/publications/externalmpcpapers/extmpcpaper0031.pdf

Bloomberg: Europe Banks Valued at Post-Lehman Low

http://www.bloomberg.com/news/2011-09-11/europe-banks-at-post-lehman-lows-show-sovereign-risks-escalating.html

Greece Ministry of Finance: General Government Monthly Cash Data and Arrears

http://www.minfin.gr/content-api/f/binaryChannel/minfin/datastore/ec/24/33/ec24332a7c775c1d903893a03dcc52be7bdf10b3/application/pdf/general+government+data+7month+2011.pdf

Hellenic Statistical Authority

http://www.statistics.gr/portal/page/portal/ESYE

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

http://www.bloomberg.com/news/2011-09-12/u-k-banks-may-have-to-separate-retail-units-in-11-billion-vickers-plan.html