Monet exhibition in Paris: December 2010- January 2011

For once, nothing about finance or the economy, just a link for a wonderful digital journey into Monet's work during his long painting life:

http://www.monet2010.com/en#/home/

These paintings were in display at at the Paris "Grand Palais" exhibition center.

Enjoy!

Europe and the euro zone at the forefront again

In Europe, the beginning of the year started at full speed from day one.

First, the EU earmarked Estonia joining the euro zone as a proof of the continuing success and attractiveness of the euro as if this event would fool any sensible investor.

At the same time tensions reappeared with spread widening again for PIGS countries debt ahead of Portugal and Spain financings. These debt auctions however went rather well which eliminated the immediate need for action and spreads contracted whilst still at unsustainable levels for the long term.

Finally, the Eurogroup and ECOFIN met in Brussels on the 17th and 18th of January to prepare the head of states meeting due to take place on the 4th of February. The main purpose of these meetings was to discuss potential changes to the European Financial Stability Fund (EFSF) to create a permanent rescue mechanism where 4 options will probably be discussed:

1. Do nothing (suicidal)

2. Increase the size of the EFSF (the preferred solution for many but the Germans so far)

3. Reduce the interest charged on EFSF loans (cosmetic)

4. Increase the scope of sovereign debt purchases (complements point 2)

Whatever, with its endless printing press, the ECB could expand the scope of its purchase of government debt in the secondary market, even if the Germans would hate it. So I do not expect the collapse of the euro zone but for the German blowing the whistle - most unlikely - (I am awaiting the decision by the German High Court of Karlsruhe about the constitutionality of the EFSF): politicians are making the taxpayer pays the highest price to save the euro.

There are many reasons why designing a better system for managing the euro zone is proving very difficult. Virtuous countries rightly want the pain to be felt by profligate ones which in turn try to limit/postpone tough austerity measures, any politician having permanently his eyes on the next poll and being always reluctant to decisively act with unpopular measures, even when necessary. The fundamental problems of the euro zone remain unresolved:

1. Over-indebtedness of sovereign states

2. Toxic assets in banks’ balance sheets

3. Over-leveraged banks

4. Much slower growth in the euro zone than the rest of the world

5. Competitiveness gap between Northern Europe and Southern Europe

I continue to believe that (1) adding debt to an over-indebtedness problem will only postpone the final cure and make it sourer and (2) an early and orderly restructuring of the liabilities of de facto defaulting countries will begin to solve this mess.

This would imply bondholders taking a haircut which might lead to some banks being bankrupt – sensible when the wrong management decisions were taken (ok, the question of imposing haircuts on bondholders has to be addressed); alongside a mechanism should be implemented to ensure that savings will be safeguarded for both individuals and corporations. And I do not take on board the bullshit that banks spread about the need to save them so they can lend to the economy: so why do they have so much sovereign debt on their balance sheet? Because it was an easy way to play the yield curve to replenish their shareholders’ funds investing in sovereign “risk free” debt and continue business as usual despite the rhetoric (a bit a remake of the subprime, but made in Europe this time: no analysis of risk, invest in riskier –but not so risky…- assets for a small yield pickup, instead of doing a proper job). So far, the taxpayer is the only one on the hook: this is neither a balanced solution nor an efficient one. My guess is that the burden of the crisis will be more evenly shared.

This would also result in some pension funds and other bond and money market investment vehicles incurring losses, and so what? Did anybody guaranty pension funds, equity investment funds or individuals for their 2008 stock market losses? No, investors act by either re-allocating assets with other managers or classes, or by waiting (hoping) for a recovery.

As Martin Spring’s writes in his January’s newsletter: “As long as Europe’s toxic debt problem remains unresolved, we can expect further currency crises as speculators seek to profit from politicians’ cowardice like Vikings raiding poorly-defended shores.”

Source:

The New York Time: Support Grows for Larger European Rescue Fund

http://www.nytimes.com/2011/01/18/business/global/18euro.html?scp=1&sq=brussels%2017%20&%2018%20january%202011&st=cse

Winners & Losers in 2010

Source:

Bloomberg via Saxo Bank

Detailed exposure of banks to PIGS countries

he BIS latest publication provides interesting details which are usually kept away from public eyes; I talked to the BIS which confirms that they were able to publish these detailed data following an authorization from Central Banks in Europe. I guess this disclosure had only one objective: to show that Spanish banks gross commitment to banks and public sector in Portugal, Greece and Ireland is minimal at USD 19.2 billion vs a total exposure of USD 98.3 billion, i.e. 20%.

These statistics also confirm my previous analysis of a very low exposure of Italian banks to PIGS countries at USD 76.3 billion, 5.4 X less than France and 6.7X less than Germany. This number is even lower if exposure to banks and public sector only is considered (7X less than France and 9X less than Germany). France and Germany have a total exposure to PIGS of USD 410 billion and USD 512 billion respectively, nice numbers which explains a lot about the Greek and Irish rescues...

The bar charts show that banks have substantially reduced their exposure to the PIGS countries during Q2 2010, even if unevenly (Germany for example cut 25% of its exposure to the non-bank private sector in Ireland whilst increasing it by 5% to banks). I have no doubt that this has continued since, with all the sovereign debt reduction flowing to the ECB balance sheet.

Source:

Bank for International Settlement: Highlights of international banking and financial market activity

http://www.bis.org/publ/qtrpdf/r_qt0703b.pdf

Tracking the Global Economy: United States

The latest release by the FED of St Louis confirms that the economic situation of the US continues to (slowly) improve.

Source:

Federal Reserve Bank of St Louis: Economic Research

http://research.stlouisfed.org/economy/us/gdpdata.html

What did the financial crisis did teach us about the Eurozone?

 

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In any crisis, one can become depressed and see the glass always half empty and not learn lessons, continuing the same mistakes or inventing new ones, even worse. One can also learn from past mistakes and improve.

The financial crisis taught us a few things which were hidden deep within its foundation due to a flush of liquidity, low interest rates, deflation imported thanks to industrial delocalization and the absence of control:

• The Euro is a political currency, not an economic one and will fail if the latter does not dominate the former; please understand me, I do not wish the fall of the Euro, I am just explaining the inevitable if politicians in Europe continue to act blindfolded for the sake of the Eurozone and EU enlargement for themselves.
• Behind the smokescreen of European solidarity, European countries are participating in rescue plans to save first  their banks, second the countries which are bankrupt, not the other way around (why do you think the UK is participating in the bailout of Ireland and not the one of Greece?). Without banks at risk in France and Germany, I doubt we would have witnessed such bailout, in particular Ireland that most European politician abhor (too low taxes to their taste and a former economic success, not like Greece – Europe prefers cheaters).
• The root of the crisis is not addressed with the past and yet to come rescue packages: the one-fits-all does not work without the loss of sovereignty on fiscal and social policies, i.e. the end of sovereign states in Europe – if you don’t control your fiscal policy, you are no longer independent.
• Without a mechanism of automatic sanctions, strong enough to discourage Government not to abide by the convergence criteria (60% debt/GDP, 3% budget deficit), there is no way the Eurozone can work; past experience has demonstrated the lack of courage of politicians in front of voters.
• The all idea of economic convergence behind the Euro has in fact witnessed the contrary with a competitiveness gap increasing between the North and the South of Europe. The rescue packages extended to Greece and Ireland are not solving anything, just adding debt to already overly indebted countries and plunging them into a deflationary spiral making these debts even more difficult to service despite artificially low interest rates. Oh! Yes, we are gaining a few years, as if it were be enough. 

There are two different ways to address over-indebtedness. Whilst Iceland and Ireland had both too much private-sector debt and a banking system massively overleveraged, their response to the crisis has been rather different. As BCA Research analyses it: 

“Iceland and Ireland experienced similar economic illnesses prior to their respective crises: Both economies had too much private-sector debt and the banking system was massively overleveraged. Iceland’s total external debt reached close to 1000% of its GDP in 2008. By the end of the year, Iceland’s entire banking system was crushed and the stock market dropped by more than 95% from its 2007 highs. Since then, Iceland has followed the classic adjustment path of a debt crisis-stricken economy: The krona was devalued by more than 60% against the euro and the government was forced to implement draconian austerity programs. In Ireland, the boom in real estate prices triggered a massive borrowing binge, driving total private non-financial sector debt to almost 200% of GDP, among the highest in the euro area economy.

In stark contrast to the Icelandic situation, however, the Irish economy has become stuck in a debt-deflation spiral. The government has lost all other options but to accept the €85 billion bailout package from the EU and the IMF. The big problem for Ireland is that fiscal austerity without a large currency devaluation is like committing economic suicide – without a cheapened currency to re-create nominal growth, fiscal austerity can only serve to crush aggregate demand and precipitate an economic downward spiral. The sad reality is that unlike Iceland, Ireland does not have the option of devaluing its own currency, implying that further harsh economic adjustment is likely.”

The graph below exemplifies the result of both policies: the winning one is quite obvious…

The major mistake made by Ireland in 2008 was to guarantee the debt of Irish bank.

I disagree with the ECB and many European politicians who do not want bondholders to participate in mending the current crisis: bondholders must take a haircut in a package designed to manage an orderly default of at least the PIGS countries, like any investors they must pay for their wrong analyses and bad investments. It is how capitalism successfully works. The taxpayer should not pay for the private sector.

Politicians and others at the ECB fear that investors would not invest again in European sovereign debt? Bullshit; investors have short memories, and more importantly, good investors are able to do their own analysis of risk/reward profiles; offer them an interesting story and they will invest, otherwise reform yourself to present such a story.

Banks are going to be under pressure? Yes, and so what? They would need additional capital? Ok, raise it with shareholders. Probably unsuccessful due to the sheer size? Sell assets. Not enough? Sell yourself. OMG! We are going to risk loosing control of “national” banks; we can’t do that! Ok, get the taxpayer to become shareholder and get rid of the Management and the Board, then sell back to the private sector at a profit.

I continue to believe that we should not test the German resolve to act as taxpayer of last resort, otherwise Germany will take its currency back accompanied by the virtuous Europe (and France will not be part of it) – just look at the trade balance GDP growth, unemployment, etc. to figure out.

Source:

BCA Research: Iceland, Ireland And The Role Of The Currency

http://www.bcaresearch.com/public/story.asp?pre=PRE-20101202.GIF

A E-bond: a good idea? Certainly not!

Jacques Attali, the former advisor to French President, François Mitterand, has been a strong advocate of E-bond issuance for some time, in particular in his book “Tous ruinés dans dix ans? Dette publique: la dernière chance”. This idea was repeated at the Luxembourg for Finance conference in June 2010 attended by Jacques Attali and Jean-Claude Junker, Prime Minister of Luxembourg and President of the Eurogroup.

Today, in the Financial Time, Jean-Claude Junker and Giulio Tremonti, the Italian Finance Minister, floated the idea of an E-bond. Under the premises that

© Markets & Beyond

Europe must convinced markets and European citizens of the irreversibility of the Euro, their reasoning is as follows:

1. The issuance of E-bond in sufficient quantity would provide investors with a deep liquid secondary market, second only to the US Treasury market.
2. Up to 50% (read at least!) of EU members sovereign debt issuance would come from E-bonds.
3. Up to 100% of debt issuance would come from E-bonds in case exceptional EU members could not access capital markets under “normal” conditions.
4. Sovereign debt could be switched to E-bond at a discount to reflect the credit risk which in turn should strongly incentivize countries to reduce their deficits.
5. A single e-bond market for the Eurozone sovereign debt would reduce the necessity for emergency interventions in the secondary market.
6. “A new market would also ensure that private bondholders bore the risk and responsibility for their investment decisions”. Investors (read banks) would have a better collateral with the ECB by switching from sovereign debt to E-bonds whilst they would take a loss on conversion; this would also ensure transparency regarding solvency ratios.
7. In case of difficulty, the new mechanism would allow borrowing states to be able to secure  funding at better rates than presently and not to be exposed to short term speculation
8. Profits coming from conversion discounts would accrue to the European Debt Agency (“EDA”) that would in turn permit lower rates for borrowers. And the taxpayer would not be in line.

I am afraid in the real world, there is no win-win situation. Let’s review this fairy tale:

1. Fine. In normal market conditions, this might translate in a lower cost of funding, not by a lot, maybe a few basis points, everything being equal.
2. So, they are talking about moving debt from one place to the other: Debt will not be reduced whilst one of the keys to the crisis is over-indebtedness.
3. In case of crisis, more debt could be issued under the EDA, and less at the sovereign level; again, no debt reduction but more debt.
4. Well, I would be interested to know how the discount would be decided/calculated, since if transparency there is, this is quite a key point (more later). And I do not see why countries would be more incentivized to reduce their deficits via the discount mechanism than currently when they are under tremendous stress.
5. The intervention in the secondary market by the ECB was implemented (1) to manipulate the cost of borrowing of the sovereign states and (2) to allow banks to get rid-off of bonds resulting from bad investment decisions. This the path Europe decided to follow, rejected any other solution, as displeasing they might be for their ego.
6. No need of a new market: just let bondholders take a haircut right now. And I do not see any difference for banks taking a haircut in the current situation or via a discount mechanism on conversion. Opacity has not been the result of markets but of continuous intervention by the ECB and refusal by politicians of an organized Greece default and possibly the failure of several banks, meaning shareholders wiped out and bondholders severely affected.
7. Indeed, they would access the market at better rates, since Germany would pay for it via the E-bonds. These E-bonds would result in an increasing cost of financing for virtuous European countries to benefit profligate ones. Believing that the E-Bonds would be at German rate is just plain foolishness.
8. Yes, the EDA would benefit buying at a discount from PIGS countries, but what about Germany or The Netherlands? The EDA would buy at a premium, hence a loss.

 All this mechanism does not address the point: European economies must deleverage. Jacques Attali, a very clever man, sells his idea by stating that the EDA would have no debt and could therefore borrow huge amount of money… Well, hold on and what about existing debt? Would it have disappeared? Would the economy had grown much more? Would the European population suddenly increased much to maintain the per capita debt? Come on, this idea is just to institutionalize the mutualization of the sovereign debt across Europe and its associated costs which in turn would force a fiscal integration (without a social integration, it does not make much sense anyway).

This proposition aims at fostering a European integration much farther whilst the root of the problem -the one-fits-all does not work- is not addressed, and make the euro irreversible.
European politician are not ready to admit their failure. Dogma instead of pragmatism still governs Europe, sadly.

Source:

Financial Times: E-bonds would end the crisis

http://www.ft.com/cms/s/0/540d41c2-009f-11e0-aa29-00144feab49a.html#axzz17LijTvh5

The Eurozone crisis and competitiveness

Several times, I wrote on this blog and in articles that the premises of the construction of the Euro were flawed from the beginning, mixing countries displaying stages of economic development too far apart, increasing debt and artificially low cost of financing creating a smokescreen. I also wrote that, in the absence of a two tier Eurozone (strong countries/weak countries), only a fiscal and social integration, with a loss of sovereignty (a German Europe), was a viable solution since the competitiveness gap has increased instead of decreasing for the past ten years or so: this is at the heart of the current crisis.

All the EU/IMF sponsored rescue packages and ECB intervention -buying PIGS debt from banks to lower their cost of financing and relieve banks which loaded themselves to play the yield curve (encouraged by the ECB)- are not mending the root of the problem: lack of competitiveness of the PIGS countries (I always hesitate do add another “I” for Italy) that will take at least 10 good years to improve.

The World Economic Forum published “The Global Competitiveness Report” which exemplifies this:

Source:

The World Economic Forum: The Global Competitiveness Report http://www.weforum.org/en/initiatives/gcp/Global%20Competitiveness%20Report/index.htm

Ireland rescue package: some more details

Further to yesterday’s information contained in the EU press release, I found some additional details that may be of interest to readers:

• The EUR 10 billion capital injection will raise core tier 1 ratios to at least 12%.
• The Irish National Pension Reserve Fund will provide EUR 12.5 billion.
• Any banks whose core tier 1 is seen falling below 10.5% will receive additional capital through a EUR 25 billion contingent capital facility established through the program. The stress tests will include a third party review of asset quality to garner additional credibility.
• Liability management of subordinated bank debt will be "more widely applied" than just Anglo-Irish bank.
• A special distressed banking law will be introduced in 2011 for the small 'credit unions' sector
• The 5.8% interest rate is an average since the maturity of loan will range from 4 ½ years to 10 years.
• Ireland will have an extra 12 months, i.e. until 2015, to lower its deficit down to 3%.
• Ireland will discontinue its financial assistance to the EU loan to Greece.

The Irish contribution coming out the INPRF represents 50% of its total assets: as noted yesterday it is a disgrace. I do not understand how Ireland accepted this.

Still, this agreement has to be accepted by the Irish Parliament; the vote should be passed successfully despite only 2 seats majority (2 independents).

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

Belgium	3.64%
Germany	28.43%
Ireland
Greece
Spain	12.47%
France	21.35%
Italy	18.76%
Cyprus	0.06%
Luxembourg	0.26%
Malta	0.09%
Netherlands	5.99%
Austria	2.91%
Portugal	2.63%
Slovenia	0.49%
Slovakia	1.04%
Finland	1.88%

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

© Markets & Beyond

Source:

Deutsche Bank: Thoughts on Ireland's aid programme

https://gm-secure.db.com/welcome.html

Ireland bailout: what’s next?

1. Ireland bailout

The 12% of GDP Irish budget deficit (32% including a banking rescue) was unsustainable and a few details emerged about the bailout agreed Sunday:

The contribution from Ireland will come from the cash pile the Irish Treasury has accumulated and the National Pension Reserve Fund - a disgrace; the fund, which holds EUR 24 billion of assets, was set up in 2001 to pay pensions from 2025. This means that Ireland is its own contributor for 20% of the total rescue package which worries me.

The loan has a 7 ½ year tenor and will bear a 5.8% interest more than the 5.2% granted to Greece (which I do not know where it comes from since a 5% ceiling was agreed for Greece).

EUR 10 billion will immediately go to recapitalize Irish banks and EUR 25 billion for further needs, the balance, EUR 50 billion, covering budget deficits.

It is worth noting that Germany dropped its demand of having bondholders taking part of the burden. The ECB, and other European countries, feared that such a move would translate into higher cost of financing and even close the market for more countries adding new losses for banks. Banks have played the yield curve by borrowing at near zero cost with the ECB and investing in longer date sovereign (riskless!) bonds, compounding the crisis.

Another interesting paragraph not linked to Ireland: “The Eurogroup will rapidly examine the necessity of aligning the maturities of the financing for Greece to that of Ireland”. This confirms my analysis that Greece is in no position to reduce its budget deficit down to 3% of GDP in 2014, and even less to be able to repay the emergency EU and IMF loan after 2013. Is the interest rate going to be adjusted? Is it going to be the same as Ireland? In any case these rates are administered like Albania in the good old says… Where is capitalism?

One last question (and I did not find any answer anywhere or even any question about it anywhere): how do these rescue loans rank compared to senior debt…?

Finally, the EUR 40 billion loan represents an additional EUR 8.8 billion for Italy, EUR 10.0 billion for France and EUR 1.7 billion for Belgium (if Spain is not excluded as I did, it would add EUR 4.9 billion, or 4% of its debt requirements for 2011, and reduce pro rata the other countries ).

2. What’s next

Looking at the market this morning, this plan fails to alleviate fears of contagion:

• After a short (small) rally bank stocks are down again
• The EUR is also under pressure after a short rally
• 10 year bonds in PIIGS countries are more or less unchanged
• German 10 year bund yield is at a 6 months high

The second bailout of the eurozone is nothing more than hiding dust under the carpet; the rescue package is not a game changer since it does not improve competitiveness and does not reduce the debt overload, to the contrary: liquidity support does not work out insolvency. There are calls to double the EUR 750 billion commitments, since the current one would be insufficient to rescue Spain and Italy (besides Portugal and add Belgium and France).

Portugal will be the next country to ask for a bailout and Spain will follow quickly behind due to its exposure to Portugal (EUR 78 billion at the end of June); then if Belgium or Italy fails, France would be engulfed with an exposure of EUR 253 billion and EUR 418 billion respectively.

In order to repair their balance sheets instead of cleaning them up one for all, the ECB and European politicians (lobbied by banksters) encouraged banks to play the yield curve by investing in peripheral European sovereign debt to get a nice spread pick up over their financing cost, and then, when things started to look ugly earlier this year, the ECB bought this sovereign distressed debt whatever the rating (against the ECB rules, but who cares…). The only effect has been to compound the crisis for gaining 1 year maybe 2 or 3 at most.

And Trichet, alongside most European politicians, continue to play this game by refusing bond holder (read banks) to share the burden (I even do not see why we, the tax payers, should we pay for any bailout when investors made wrong decisions). This, in effect, (temporarily) transferred the insolvency from banks to States without getting to the roots of the crisis.

It will carry on until and unless Germany stops playing musical chairs; in-between the crisis will deepen with debt continuing mounting and inflating it late seventies/early eighties style, the only way out.

I continue to believe that an orderly bailout of over indebted countries and banks is the only way to cleanup the house and build again on sound foundations. This is not the way Europe has gone so far, preferring dogma over sound governance. Europe is facing enough challenges (an ageing population and pension payments being the most important) without having to drag ongoing debt problems: let’s investors who made wrong investment decisions bear the burden, this is how capitalism works and wash aside the socialist and interventionist approach which repeatedly failed.

Continue to stay clear of financial shares and buy precious metal on setbacks.

Source:

Council of the European Union: Statement by the Eurogroup and ECOFIN Ministers

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/118051.pdf