For all his claims of orthodoxy and credibility, it seems like Draghi has picked up where Trichet left off. Remember the Greek treasury auctions? In this operations the Greek treasury borrows "in the market" at 4.5%. In reality, the Greek treasury sells the bonds to the Greek banks who in turn get the cash from either the Greek Central Bank (they still function AND, contrary to popular belief, issue currency) or the ECB. The purpose is to maintain the fiction that markets are still working (Greek bonds trade at rates that go from 50 to 100%).
Today, as he declares he is against indiscriminate buying of government bonds, Mr. Draghi is indeed buying most of the much celebrated Spanish auction in the "hope" (a favorite financial term) that others will believe Spanish bonds are a good investment.
How is this done? The European banks (presumably heavily represented by the Spanish cohort) buy the debt at the auction. Then, they turn around and pledge the same bonds to the ECB for cash. Here is an article that describes the operation.
The problem, however, is that this does nothing to improve Spain's competitiveness and/or stimulate growth. The point, on the other hand, seems to be to keep the banks alive until, by virtue of some miracle, the economy begins to grow again. With borrowing rates this high, it is unlikely.
Thursday, December 15, 2011
Monday, November 28, 2011
Why The European Plans Do Not Work
As we are writing this, equity markets around the world are having a euphoric session allegedly on a new-new-new European solution to the debt problem. In this case, multiple solutions are being announced or rather disseminated with the usual glib by the press. For instance, the story that the IMF is about to lend $600 billion to Italy, which has now been repeated around the world, conveniently neglects to mention that the IMF does NOT currently have 600 billion to lend. Not to mention that 600 billion is an enormous sum of money, and thus, would give governments pause before it is approved (as opposed to go from theory to fact over a weekend). After all, the much touted EFSF (the European Stabilization Fund) failed to even raise $3 billion in its last attempt (eventually they completed the offering by lending to themselves!)
The reason these plans haven't worked and are unlikely to work in the future (we use unlikely instead of the categorical won't since it is hard to prove a future negative) is rather simple, they are all based on the fallacy that says that the so-called European debt problem is a temporary phenomenon. Thus, according to this line of thought, all that we need is for confidence to come back. If confidence comes back, other people (i.e. not the IMF, the ECB or the EFSF) will buy Italian, Spanish, Portuguese, and Greek debt moving the clock back to 2007 when all these governments financed their borrowings via private investors (another name for other people).
The question the politicians fail to ask themselves is: who are these private investors, why did they stop buying and how likely are they to come back? Contrary to popular belief, most government financing is NOT obtained by direct loans but rather by selling securities (bonds) in the open market to, mostly, institutional investors as diverse as global money market, pension, wealth management and other mutual funds. These investors buy government bonds because they are deemed to be safe and NOT because of their potential high returns. In that sense, perversely, the higher the yields go the less attractive the bonds are. In particular, once a credit is tainted (i.e. deemed not safe) the risk-averse money market fund is unlikely to buy it at any price. This is what has been happening for some time to European bonds as these links illustrate:
Japan's Kokusai bond fund drops Italy, Spain, Belgium
U.S. Money Funds Reduce Spanish Bank Holdings; Overall Euro Exposure Remains Significant
U.S. Money Funds Reduced Lending to French Banks by 44% in September
This process is relentless and ongoing, however, it will not grab any headlines because most journalists and politicians fail to understand how the global market works. In any case, you can rest assured that the combination of all these types of investor are much bigger than the IMF and the EFSF (if it ever gets off the ground) put together. Furthermore, it is not necessarily the case that these people avoid Italian bonds because they believe Italy is about to go bankrupt. In fact, most of them believe something will be done, however they do not want to take the risk just in case.
The conclusion is simple, it took years for non-Italian investors to believe that Italian government bonds were safe, they may feel so again in the distant future but not now.
The reason these plans haven't worked and are unlikely to work in the future (we use unlikely instead of the categorical won't since it is hard to prove a future negative) is rather simple, they are all based on the fallacy that says that the so-called European debt problem is a temporary phenomenon. Thus, according to this line of thought, all that we need is for confidence to come back. If confidence comes back, other people (i.e. not the IMF, the ECB or the EFSF) will buy Italian, Spanish, Portuguese, and Greek debt moving the clock back to 2007 when all these governments financed their borrowings via private investors (another name for other people).
The question the politicians fail to ask themselves is: who are these private investors, why did they stop buying and how likely are they to come back? Contrary to popular belief, most government financing is NOT obtained by direct loans but rather by selling securities (bonds) in the open market to, mostly, institutional investors as diverse as global money market, pension, wealth management and other mutual funds. These investors buy government bonds because they are deemed to be safe and NOT because of their potential high returns. In that sense, perversely, the higher the yields go the less attractive the bonds are. In particular, once a credit is tainted (i.e. deemed not safe) the risk-averse money market fund is unlikely to buy it at any price. This is what has been happening for some time to European bonds as these links illustrate:
Japan's Kokusai bond fund drops Italy, Spain, Belgium
U.S. Money Funds Reduce Spanish Bank Holdings; Overall Euro Exposure Remains Significant
U.S. Money Funds Reduced Lending to French Banks by 44% in September
This process is relentless and ongoing, however, it will not grab any headlines because most journalists and politicians fail to understand how the global market works. In any case, you can rest assured that the combination of all these types of investor are much bigger than the IMF and the EFSF (if it ever gets off the ground) put together. Furthermore, it is not necessarily the case that these people avoid Italian bonds because they believe Italy is about to go bankrupt. In fact, most of them believe something will be done, however they do not want to take the risk just in case.
The conclusion is simple, it took years for non-Italian investors to believe that Italian government bonds were safe, they may feel so again in the distant future but not now.
Monday, November 21, 2011
Why Worry About Spain?
As the Spanish election came and went without any reprieve from the financial markets (why did anyone expect anything different is still a puzzle to us) we are being bombarded by financial articles asking why the markets perceive Spain as risky as Italy given that the former's national debt, at 61% is much lower than the latter's comfortably over 100%.
For instance, look at what Der Spiegel says today:,
Markets are complex mechanisms which journalists, politicians, and investors often oversimplify with disastrous consequences. The reasons why Spain may be riskier than it looks are not too obscure, however. First, Spain still has a budget deficit of about 9% which means the debt keeps growing. In addition, it is well known (at least in Spain) that the so-called cost cutting measures are mostly comprised of forced financing from government suppliers (i.e. the government doesn't pay their bills on time) and other accounting gimmicks. Second, unlike Japan, Spain runs a structural current account deficit, which means they need foreign financing. Foreigners can be notoriously fickle in their risk perceptions. Last, but not least, Spain's total debt (i.e including non-public) is at the level of Italy's. The 61% quoted on the article above accounts only for the debt of the Kingdom of Spain (excluding the bills they do not pay which are not counted anywhere) and ignores the debts of the Comunidades Autonomas and other politically connected entities, like the local banks. Ireland was at one point the country with the lowest debt to GDP ratio in the eurozone until they decided to bailout the banks.
As we have seen recently in Ireland, the UK and the US, when the crisis comes and the politicians have to decide between bailing out a locally relevant entity (a bank, a state, a car company, or a defense contractor) and respecting the promises made to the bondholders, many of whom are foreign and, thus, do not vote, the latter don't stand a chance.
For instance, look at what Der Spiegel says today:,
Still, Spain is not just another victim of the euro crisis. The country's relatively strict banking regulations allowed it to survive the international financial crisis with only light damage. And in the current debt crisis, the Spanish have been model students: With a national debt at some 61 percent of gross domestic product, Spain lies far below Greece (145 percent) and Italy (118 percent) -- but also comfortably below Germany (83 percent).Except Argentina went bankrupt with a debt to GDP of 55% and Japan has already crossed the 200% barrier while comfortably borrowing, in Yen, at less than 1% for 10 years (the lowest borrowing cost in the world).
"Even panic-mongers can't find terrible stories to tell about Spain," says Nicolaus Heinen, an analyst at Deutsche Bank. "The level of national debt isn't critical and important reforms have been put in place." But none of that seems to have helped. "The markets are now punishing any country vulnerable to even a whiff of doubt about contagion," Heinen said.
Markets are complex mechanisms which journalists, politicians, and investors often oversimplify with disastrous consequences. The reasons why Spain may be riskier than it looks are not too obscure, however. First, Spain still has a budget deficit of about 9% which means the debt keeps growing. In addition, it is well known (at least in Spain) that the so-called cost cutting measures are mostly comprised of forced financing from government suppliers (i.e. the government doesn't pay their bills on time) and other accounting gimmicks. Second, unlike Japan, Spain runs a structural current account deficit, which means they need foreign financing. Foreigners can be notoriously fickle in their risk perceptions. Last, but not least, Spain's total debt (i.e including non-public) is at the level of Italy's. The 61% quoted on the article above accounts only for the debt of the Kingdom of Spain (excluding the bills they do not pay which are not counted anywhere) and ignores the debts of the Comunidades Autonomas and other politically connected entities, like the local banks. Ireland was at one point the country with the lowest debt to GDP ratio in the eurozone until they decided to bailout the banks.
As we have seen recently in Ireland, the UK and the US, when the crisis comes and the politicians have to decide between bailing out a locally relevant entity (a bank, a state, a car company, or a defense contractor) and respecting the promises made to the bondholders, many of whom are foreign and, thus, do not vote, the latter don't stand a chance.
Friday, November 18, 2011
Where Do They Think The Money Comes From?
Nobody talks about the European bailout fund anymore (EFSF). Apparently, only two weeks after the "historical" meeting in Cannes, the Europeans seem to have given up their dreams of having their debts paid by the likes of China, India and Brazil. After all, how fair would it be for a country like India, where many leave on less than $1 a day, to bailout rich Italy?
Or have they? Someone said that politicians never change, only voters do. They don't want to fund the EFSF? No problem, we have the IMF. Never mind that the IMF is supposed to intervene as a lender of last result to bridge liquidity gaps during a currency crisis (Europe does not have a liquidity but a solvency problem and there is no currency crisis at this point). The objective, as with all of these plans, is to separate non-European taxpayers from their money, preferably without alerting them first.
Listen what the president of the World Bank said yesterday (full interview in the link above):
If you think this sin is unique to the World Bank, you may also think again. The current debate about ECB intervention is similar. Those who need the bailout and/or those who will not be responsible for the losses are trying to convince the German leaders to force the ECB into financing Italy, Spain, and the others in violation of its own charter. Why not? they say, the ECB can print money and buy the bonds. Is that it? Yes, if it works. However, if it doesn't...
Or have they? Someone said that politicians never change, only voters do. They don't want to fund the EFSF? No problem, we have the IMF. Never mind that the IMF is supposed to intervene as a lender of last result to bridge liquidity gaps during a currency crisis (Europe does not have a liquidity but a solvency problem and there is no currency crisis at this point). The objective, as with all of these plans, is to separate non-European taxpayers from their money, preferably without alerting them first.
Listen what the president of the World Bank said yesterday (full interview in the link above):
The U.S. administration, in discussions with lawmakers, “will want to make sure that actually the taxpayer isn’t doing a bailout of Europe,” Zoellick said. “And I think the mechanisms through the IMF and others certainly can do that.”If the IMF lends money to Italy and Italy defaults, the U.S. taxpayer is on the hook for about 20% of the losses. Mr. Zoellick, like a good politician, excludes the possibility of default in order to make his solution look risk-less, it is not.
If you think this sin is unique to the World Bank, you may also think again. The current debate about ECB intervention is similar. Those who need the bailout and/or those who will not be responsible for the losses are trying to convince the German leaders to force the ECB into financing Italy, Spain, and the others in violation of its own charter. Why not? they say, the ECB can print money and buy the bonds. Is that it? Yes, if it works. However, if it doesn't...
Germany has reason to be cautious. In the event that Italian, Spanish and other bonds had to be written down the way that Greek bonds were, Berlin would have to pay the most to recapitalize the bank. That would be tantamount to a backdoor bailout, a transfer of money from German taxpayers to cover the debts of other states without parliamentary approval.The ECB is prohibited from financing governments directly because the Germans made that clause a condition of their participation in the Euro. The Germans demanded that clause because they knew this day would come. Whether or not they decide to pay the Spanish and Italian debts it is up to them. However, it would be nice if they were first consulted by the politicians. Unless, of course, the politicians don't believe in democracy.
Thursday, November 10, 2011
More From Those European Free Markets
Italy borrowed 5B euros from the market today. How? They sold 1 year bonds (called bills). Although the identities of the buyers are not disclosed, it is a fair bet that most of the bonds where placed in Italy with the local banks who in turn get financing from the ECB. Incidentally, if this mechanism seems familiar, it is because Spain did the same last week.
In addition to providing liquidity to the banks, the ECB also intervened in the market buying existing Italian debt. Why doesn't the ECB buy the debt directly from Italy? Because their charter prohibits lending money to the governments directly. So the banks lend the money (via bonds) and the ECB lends to the banks by buying the same bonds, or others.
In addition, it is interesting to see that the rate of 6.09% was higher than the 4.5% Greece paid when they placed their bills. Naturally, the financial press continues to parade the myth that these rates are freely determined by buyers and sellers by continuing to report that the auctions are oversubscribed.
The truth is that neither Italy, nor Spain, Greece, Ireland or Portugal have a free functioning debt market any longer. Even if the auctions continued to be scheduled and reported the investors who used to buy these bonds are either too scared or bankrupt.
caveat emptor
In addition to providing liquidity to the banks, the ECB also intervened in the market buying existing Italian debt. Why doesn't the ECB buy the debt directly from Italy? Because their charter prohibits lending money to the governments directly. So the banks lend the money (via bonds) and the ECB lends to the banks by buying the same bonds, or others.
In addition, it is interesting to see that the rate of 6.09% was higher than the 4.5% Greece paid when they placed their bills. Naturally, the financial press continues to parade the myth that these rates are freely determined by buyers and sellers by continuing to report that the auctions are oversubscribed.
The truth is that neither Italy, nor Spain, Greece, Ireland or Portugal have a free functioning debt market any longer. Even if the auctions continued to be scheduled and reported the investors who used to buy these bonds are either too scared or bankrupt.
caveat emptor
Wednesday, November 9, 2011
What Does The Stock Market "Know?"
According to the experts in the financial industry the stock market is an powerful resource allocator that discounts that discounts future events. Whether it goes up or down it is, allegedly, always predicting something. Thus, like modern day Delphic Oracle, we are supposed to decipher the prophesies about the future contained in the daily fluctuations of the Dow Jones Index. Also, like its ancient Greek counterpart, the Dow Jones Index is never short (no pun intended) of willing interpreters to guide the general public through the intricate language of the prophet.
An alternative theory, held by a tiny dissident minority, is that the stock market is nothing but the sum of beliefs held by those willing to buy and sell stocks. In other words, if you believe stock X will go up, you buy it and if you think it will go down you sell it. The consensus can be right or wrong like in any human endeavor.
Although we see many examples of this on a daily basis, we'd like to point out the behaviour of the American stock market yesterday (November 8th, 2011) and today in the face of the "Italian crisis" (the name is totally arbitrary).
The market was down yesterday for most of the day. An unbiased observer, looking at Italian bonds trading with a yield of 6.50% would have concluded that: (1) nobody, save for the ECB, wants to lend money to Italy, (2) this is bad for the markets/world economy, (3) the stock market reflects this. However, as European markets began to close the US market began to firm up, ending the day in positive territory. As the interpreters were quick to point out (here is an example from CNN Money, other publications said the same)
Except that the interpreters of the Dow Jones Oracle already said Berlusconi's resignation was an issue. So they had to come up with something creative and cryptic to fit the bill. This is what Bloomberg said:
Amazingly they call this information. If it was on any other topic, this kind of nonsense would not be tolerated by any reasonable reader. Go figure.
An alternative theory, held by a tiny dissident minority, is that the stock market is nothing but the sum of beliefs held by those willing to buy and sell stocks. In other words, if you believe stock X will go up, you buy it and if you think it will go down you sell it. The consensus can be right or wrong like in any human endeavor.
Although we see many examples of this on a daily basis, we'd like to point out the behaviour of the American stock market yesterday (November 8th, 2011) and today in the face of the "Italian crisis" (the name is totally arbitrary).
The market was down yesterday for most of the day. An unbiased observer, looking at Italian bonds trading with a yield of 6.50% would have concluded that: (1) nobody, save for the ECB, wants to lend money to Italy, (2) this is bad for the markets/world economy, (3) the stock market reflects this. However, as European markets began to close the US market began to firm up, ending the day in positive territory. As the interpreters were quick to point out (here is an example from CNN Money, other publications said the same)
Stocks had been seesawing Tuesday as the fate of Italy's prime minister hung in the balance, but they moved firmly higher after the Italian president's office confirmed that Berlusconi will step down. He is expected to resign following the approval of a new budget law that is currently making its way through parliament.Today the markets opened down with the news that Italian bonds were trading lower (i.e. higher yields) which would have led and unbiased observer to conclude that: (1) nobody, save for the ECB, wants to lend money to Italy, (2) this is bad for the markets/world economy, (3) the stock market reflects this.
Except that the interpreters of the Dow Jones Oracle already said Berlusconi's resignation was an issue. So they had to come up with something creative and cryptic to fit the bill. This is what Bloomberg said:
...and Silvio Berlusconi’s offer to resign as prime minister triggered questions about who will lead Italy out of its crisis.So now Berlusconi's resignation is bad for the stock market.
Amazingly they call this information. If it was on any other topic, this kind of nonsense would not be tolerated by any reasonable reader. Go figure.
Sunday, November 6, 2011
About Those Greek Politicians...
So you think the turmoil in Greece may result in something different? Think again. It turns out the Greek politicians are apparently picked like actors in a Mexican TV soap. Either they come from the same family, or they are related by some other strange coincidence. I wonder if after calling each other dangerous they get together to watch Olimpiakos vs. Panathinaikos?
George (Yorgos) Papandreu is the son and grandson of prime-ministers. Antonis Samaras, the leader of the opposition who refuses to join him in a coalition government was his roommate in college.
Konstantinos Kamaralis, the previous prime-minister, also comes from a political dynasty as his uncle founded the party.
Because these guys also inherit the given names of their predecessors, the records of the Greek parliament read like a Garcia Marquez novel. Incidentally, Greece has the world record for most years in default since independence. About 50% of the time since 1821 (click for reference)
There are other families like the Mitsotakis themselves related to the Venizelos (the current finance minister is allegedly not related to these which would be in itself astounding event.)
The true enemy of a free market is the monopoly.
George (Yorgos) Papandreu is the son and grandson of prime-ministers. Antonis Samaras, the leader of the opposition who refuses to join him in a coalition government was his roommate in college.
Konstantinos Kamaralis, the previous prime-minister, also comes from a political dynasty as his uncle founded the party.
Because these guys also inherit the given names of their predecessors, the records of the Greek parliament read like a Garcia Marquez novel. Incidentally, Greece has the world record for most years in default since independence. About 50% of the time since 1821 (click for reference)
There are other families like the Mitsotakis themselves related to the Venizelos (the current finance minister is allegedly not related to these which would be in itself astounding event.)
The true enemy of a free market is the monopoly.
Thursday, November 3, 2011
European Market Manipulation, Today's Episode: Spanish Treasury Bonds
The process of celebrating every successful auction of government borrowings is by now a familiar feature of financial markets. The more financially stressed a treasury is, more they celebrate those oversubscribed (technically more demand than supply) auctions.
Today, the Spanish treasury successfully borrowed a few billion euros in the markets. As is now customary, the financial press pointed out that the auction was oversubscribed which surely signals that the free markets have a lot of confidence in Spain's ability to repay its debts. Never mind that:
In case this story rhymes with something you may have read, here is another one about Greece also borrowing cheaply. (With apologies for we have now decided to cross the threshold or arrogance and quote ourselves).
Today, the Spanish treasury successfully borrowed a few billion euros in the markets. As is now customary, the financial press pointed out that the auction was oversubscribed which surely signals that the free markets have a lot of confidence in Spain's ability to repay its debts. Never mind that:
- The rates continue to go higher
- Many large investors are selling all their Spanish holdings (click here for an example we could only find in Spanish about Norway's US$500 billion+ fund reducing their Spanish debt)
- The EFSF has been recently rumored to maybe be enlarged to...buy Spanish debt
- The ECB is publicly in the markets...buying Spanish debt
In case this story rhymes with something you may have read, here is another one about Greece also borrowing cheaply. (With apologies for we have now decided to cross the threshold or arrogance and quote ourselves).
Tuesday, November 1, 2011
Daily Double Talk From Europe
The surprising announcement by the Greek prime minister, Papandreu, is causing all sorts of disruptions in the Euro-space-time continuum.
What did the guy do? He had the audacity to suggest the Greek people should vote and decide for themselves if they like the deal. Leave to the politicians to praise the virtues of democracy when they win but decry its inefficiencies when they lose (and they haven't even lost yet).
In any event it is interesting to read what they are saying if only to identify who is not to be trusted. Here are my highlights:
If you owe the bank a thousand dollars, you have a problem, if you owe one million, the bank has a problem (still valid even if the amounts need to be indexed by inflation).
What did the guy do? He had the audacity to suggest the Greek people should vote and decide for themselves if they like the deal. Leave to the politicians to praise the virtues of democracy when they win but decry its inefficiencies when they lose (and they haven't even lost yet).
In any event it is interesting to read what they are saying if only to identify who is not to be trusted. Here are my highlights:
The plan, designed to aid Greece and stem the wider debt crisis, is “more necessary than ever today,” they [Merkel and Sarcozy] said in a joint statement issued in Berlin and Paris. Germany and France “are convinced that this agreement allows Greece to return to lasting growth” and want to draw up a road map for locking in the second Greek bailout.Translation:" Don't you see? We did it all for you! Why do you want to throw away your future by ignoring our selfless advice" ( The German and French bankers stare quietly from behind the curtain).
“We fully trust that Greece will honor the commitments undertaken in relation to the euro area and the international community,” European Council President Herman Van Rompuy and European Commission President Jose Barroso said in a joint e- mailed statement that acknowledged Greece’s move.Subtitle: "What can we say? If these guys decide to pull the plug, they will come after my country [Portugal] next [Barroso] you guys are next in line behind Italy and Spain. This is why we do not have a government in Belgium [Van Rompuy]. Nobody can call a referendum to ask our voters if they want to pay."
The Greek prime minister’s personal and government popularity have plunged as cost-cutting measures have sparked a wave of social unrest. The Greek leader announced a confidence vote yesterday that will conclude late on Nov. 4. The referendum would probably be held after the details of the European accord are worked out.No kidding. Bondholders want austerity, voters do not. Papandreu has been, so far, working for the former while telling the latter that it is really for their own good. If the voters decide their interests are no longer aligned with those of the creditors, they will find a way to repudiate the debt. At that moment, they will choose a politician that represents that point of view and there is little that EU or the bankers can do about it.
If you owe the bank a thousand dollars, you have a problem, if you owe one million, the bank has a problem (still valid even if the amounts need to be indexed by inflation).
Monday, October 31, 2011
Greece Ready To Roll The Dice On Democracy?
We do not know anyone who professes to be against Democracy. Cliches about the wisdom of crowds are ubiquitous in most cultures. Whether the desires of the masses coincide with those of their leaders, however, is a different story.
Whether because he is tired and wants to wash his hands in a Pilatean gesture or because he believes his own rhetoric, Georgios Papandreu has apparently decided to ask his people whether they approve the latest bailout package (and the corresponding austerity measures). Although we consider predicting the outcome of such a complex even to be a fool's errand, we'd like to point out that:
(1) the European constitution failed when the French voters, much to the surprise of their politicians, rejected the proposal.
(2) It was the Argentine middle class, tired of the austerity measures, and not the IMF, who eventually pulled the plug in their debt crisis.
Whether because he is tired and wants to wash his hands in a Pilatean gesture or because he believes his own rhetoric, Georgios Papandreu has apparently decided to ask his people whether they approve the latest bailout package (and the corresponding austerity measures). Although we consider predicting the outcome of such a complex even to be a fool's errand, we'd like to point out that:
(1) the European constitution failed when the French voters, much to the surprise of their politicians, rejected the proposal.
(2) It was the Argentine middle class, tired of the austerity measures, and not the IMF, who eventually pulled the plug in their debt crisis.
Friday, October 28, 2011
Liar, Liar...
Really, this is a tragic cartoon for Spain. Unemployment ("Paro" in spanish) rose to a record high in the third quarter of 2011 (4.978.300 people are out of work, an astonishing 21.5% jobless rate). A total of 144,700 jobs were lost in the quarter. But now it comes the funny/tragic thing: the Labor ministry, Valeriano Gómez, said that the reason behind the increase in unemployment was "consequence of the adjustment in public workers jobs". But information coming from the same agency (INE) that released the numbers tells a different story: Spain counts 3.220.600 public workers, 3.100 more then in the second quarter. Worse than that, there are 44.700 more new public workers than a year before. Adjustments? Liar, liar...
http://www.elmundo.es/elmundo/2011/10/28/economia/1319817847.html (link in spanish)
Thursday, October 27, 2011
The Power Of Illusion
As much as we like to believe we are rational beings, humans are most easily fooled by mass events. Like our bovine brethren, we tend to run with the crowd. For weeks now, the world has patiently awaited for the statement coming out of the so-called European summit. Even though, the constraints can be easily understood by anyone with even a rudimentary knowledge of mathematics, the powerful belief that the authorities will do something kept everyone waiting for "the" solution. The politicians, master manipulators as they are, obliged by releasing an ambitious plan to solve not only the Greek crisis but the potential Spanish, Italian, and maybe French crises as well. Lost in the celebration is the fact that the same question remains: who pays for the losses?
1) According to the statement the banks will write down 50% of their Greek sovereign holdings in a voluntary deal (we assume this includes the ECB which will need to be recapitalized again). The same deal they couldn't complete with a 20% haircut. According to bloomberg the banks agreed to sign off under the threat of Greek insolvency. We will patiently have to wait to see how many actually participate on the exchange which, don't forget, is voluntary.
2) If the banks lose money on the Greek bonds, they will have to raise capital. This means issuing shares (incidentally, bank shares are up today which means many still don't understand MORE shares, ceteris paribus, means lower prices per share) either in the public markers or, God forbid, from their local governments. Is Monsieur Sarcozy ready to bite that bullet? He wasn't last week, so it is reasonable that, with the pressure gone, either the banks or the the French government will try to dodge this one again during the not-so-public details phase.
3) How about leveraging the EFSF? The credit of this vehicle is already below that of Germany which means is no longer considered AAA by potential borrowers. The more debt they issue, the less so. European dreams of Chinese and Brazilian money coming in to save the day are just that. The Chinese may buy a symbolic amount, but not more. (Here is an article detailing Sarcozy's conversation with Hu Jintao, see if you can spot any numbers).
4) Finally, what about the reforms and long-term prospects for the weak economies of Europe?
1) According to the statement the banks will write down 50% of their Greek sovereign holdings in a voluntary deal (we assume this includes the ECB which will need to be recapitalized again). The same deal they couldn't complete with a 20% haircut. According to bloomberg the banks agreed to sign off under the threat of Greek insolvency. We will patiently have to wait to see how many actually participate on the exchange which, don't forget, is voluntary.
2) If the banks lose money on the Greek bonds, they will have to raise capital. This means issuing shares (incidentally, bank shares are up today which means many still don't understand MORE shares, ceteris paribus, means lower prices per share) either in the public markers or, God forbid, from their local governments. Is Monsieur Sarcozy ready to bite that bullet? He wasn't last week, so it is reasonable that, with the pressure gone, either the banks or the the French government will try to dodge this one again during the not-so-public details phase.
3) How about leveraging the EFSF? The credit of this vehicle is already below that of Germany which means is no longer considered AAA by potential borrowers. The more debt they issue, the less so. European dreams of Chinese and Brazilian money coming in to save the day are just that. The Chinese may buy a symbolic amount, but not more. (Here is an article detailing Sarcozy's conversation with Hu Jintao, see if you can spot any numbers).
4) Finally, what about the reforms and long-term prospects for the weak economies of Europe?
- Even if the 50% haircut goes through, Greece will have an unsustainable debt to GDP of more than 150% and will remain under life-support from Europe for the foreseeable future. Since they are still in the euro, they will not regain competitiveness. Thus, it is unlikely that things will get better for the Greeks which may decide to give up anyway.
- Contrary to press releases, Italy has not committed to any meaningful reforms. If they do commit, the first effect will be higher unemployment which the population is unlikely to support and will make the fiscal situation worse.
- Spain is still mired in quasi-recession and continues to run a current account deficit. The fiscal cuts touted by Sarcozy are mostly based on not paying some bills and other accounting gimmicks.
- Ireland, the poster child of self-sacrifice and fiscal rectitude is still suffering 14% unemployment and has yet to return to the public markets.
Friday, October 21, 2011
The Lies We Were Told About Greece
As the europoliticians meet this weekend to argue over who will pay for the recapitalization of the French banks ("Europe" say the French, "France" say Germany and Holland) there are a few reports regarding the situation in Greece circulating on the internet. For instance, this one posted in Alphaville, discusses not only the current situation but the fact that even after 50% haircut the Greek debt to GDP ratio would be 120% in 2015. If it goes down from there it is presumably because the projection expects some kind of Greek miracle after that. After all, predicting the Greek economy in 2015 is already a foolish exercise.
It is interesting to remember that, not too long ago, we were told that "Greek was not Argentina" (true, Argentina's debt to gdp ratio was only 55% in 2001) just like we were then told that Portugal is not Greece and Spain is not Portugal. Someone forgot to point out that neither Greece nor France are Germany, but we digress.
What is obvious at this point is that
It is interesting to remember that, not too long ago, we were told that "Greek was not Argentina" (true, Argentina's debt to gdp ratio was only 55% in 2001) just like we were then told that Portugal is not Greece and Spain is not Portugal. Someone forgot to point out that neither Greece nor France are Germany, but we digress.
What is obvious at this point is that
- the Greek people are not better off than 12 months ago and there is no plan to fix their problems.
- The discussion over who pays to recapitalize the French banks who lent all that money to Greece clearly illustrates that the whole show (the bailouts, the EFSF, the ECB changing rules, a summit every 6 weeks, etc) is for the benefit of the politically astute French and maybe German banks (and bankers) and not for the benefit of the citizens of Greece, Portugal or any of the affected countries.
- None of the predictions made by the IMF, the European governments and/or the ECB regarding Greece have come true. In fact, every time they take a look, they find a worse than expected situation. Yet, somehow, they keep making bold predictions with reckless abandon which are duly parroted by the friendly press.
- The last bailout plan agreed in July (less than 3 months ago) was a cruel joke. Beginning with the 50billion (euros) in privatization revenues.
- The European stress tests (there were 2 already) were a total waste of time. Dexia, which was recently taken into receivership by France and Belgium, passed with flying colors.
Emerging markets suffer significant contagion from the Eurozone crisis
According to this article, Europe has lent a total of USD 3.4 trillion to developing nations, triple that of the US and Japan institutions combined. In other words, approximately 80% of total loans to emerging markets come from Europe.
These charts show that foreign, and especially European banks, have a considerable presence in emerging markets. You can find other interesting graphs that further illustrate this concentration, here and here.
The data makes it clear that a crisis of any degree in Europe will have devastating consequences for emerging markets in terms of funding. Profits repatriation will also increase considerably as European banks try to maintain some kind of profitability.
Yet another reason for emerging market underperformance year to date.
For more detailed information go to the BIS quarterly review.
Caveat Emptor
Source: BIS, RBCCM
The data makes it clear that a crisis of any degree in Europe will have devastating consequences for emerging markets in terms of funding. Profits repatriation will also increase considerably as European banks try to maintain some kind of profitability.
Yet another reason for emerging market underperformance year to date.
For more detailed information go to the BIS quarterly review.
Caveat Emptor
Thursday, October 20, 2011
If You Cannot Kill The Messenger At Least Shut Him Up
We have never been fans of the rating agencies. Not only are they usually late with their analysis but they are often reluctant to call a spade-a-spade (France is AAA but the US is not? who are they kidding?). In fact, one can say that the gigantic explosion in debt over the past 30-years has been fueled by a misplaced comfort in agency ratings. For instance, it is unlikely that the German banks would have bought billions of Greek debt had it not been because S&P and Moody's gave the issuer an investment grade rating. Whether it was an American CBO (those of sub-prime fame) or the European PIIGS, the ratings gave everyone cover to distribute or buy with other people's money. The borrowers were too happy accepting the ratings so long as the bonds could be placed.
The truth, it has been said, is the first casualty in war. Thus, it seems that the formerly democratic governments of Europe have decided to go to war against the rating agencies by banning their opinion on European creditworthiness. As it is often the case, this move will likely backfire as no-information usually means worst case scenario analysis. In addition, fiduciary agents (e.g. portfolio managers) will either be restricted by contract or choose avoid buying/holding any unrated bonds (who wants the career risk?). In other words, not only will the politicians make the situation worse, but they will lose whatever credibility they have left.
George Orwell would be proud.
The truth, it has been said, is the first casualty in war. Thus, it seems that the formerly democratic governments of Europe have decided to go to war against the rating agencies by banning their opinion on European creditworthiness. As it is often the case, this move will likely backfire as no-information usually means worst case scenario analysis. In addition, fiduciary agents (e.g. portfolio managers) will either be restricted by contract or choose avoid buying/holding any unrated bonds (who wants the career risk?). In other words, not only will the politicians make the situation worse, but they will lose whatever credibility they have left.
George Orwell would be proud.
Tuesday, October 18, 2011
Daily Nonsense From Europe
What do you do when you cannot afford to pay your debts? You blame the speculators.
The European Union, emulating the failed American measures from 2008, has discovered the Holy Grail to solve the debt crisis: banning short-sellers in bank shares and buyers of Credit Default Swaps against selected governments.
As you may know, a short seller is someone who borrows financial instruments (e.g. stocks or bonds) and sells them in the expectation that he will be able to buy them back a lower price and return them to the seller for a gain. In other words, the short-seller expects the instrument to go down in price. Politicians hate short sellers as these often uncover problems before everyone else. The accounting fraud at Enron, for instance, was discovered by short sellers months before the regulators or the rating agencies even suspected that anything wrong was afoot. Had it not been for those speculators, it is conceivable that more people would have lost money investing in Enron stocks and bonds.
Similarly, a CDS is an insurance policy against default. For example, if you owned Greek bonds, you could buy an insurance policy (the CDS) against a Greek default, which is now extremely expensive. One can also buy the CDS without owning the bonds which is akin to short-selling.
Naturally, if you are, for example, Sarcozy pretending that France is a first rate power with a AAA-rated credit, just like Germany. You hate to see those pesky speculators betting on the fact that you are not. Unfortunately, for monsieur Sarcozy, most speculators do not reside within the confines of the European Union but in countries like Switzerland where the politicians couldn't care less about who speculates on what.
C'est la vie.
The European Union, emulating the failed American measures from 2008, has discovered the Holy Grail to solve the debt crisis: banning short-sellers in bank shares and buyers of Credit Default Swaps against selected governments.
As you may know, a short seller is someone who borrows financial instruments (e.g. stocks or bonds) and sells them in the expectation that he will be able to buy them back a lower price and return them to the seller for a gain. In other words, the short-seller expects the instrument to go down in price. Politicians hate short sellers as these often uncover problems before everyone else. The accounting fraud at Enron, for instance, was discovered by short sellers months before the regulators or the rating agencies even suspected that anything wrong was afoot. Had it not been for those speculators, it is conceivable that more people would have lost money investing in Enron stocks and bonds.
Similarly, a CDS is an insurance policy against default. For example, if you owned Greek bonds, you could buy an insurance policy (the CDS) against a Greek default, which is now extremely expensive. One can also buy the CDS without owning the bonds which is akin to short-selling.
Naturally, if you are, for example, Sarcozy pretending that France is a first rate power with a AAA-rated credit, just like Germany. You hate to see those pesky speculators betting on the fact that you are not. Unfortunately, for monsieur Sarcozy, most speculators do not reside within the confines of the European Union but in countries like Switzerland where the politicians couldn't care less about who speculates on what.
C'est la vie.
Monday, October 17, 2011
How Banks Make Money
Citicorp reported earnings this morning. Would you believe that in the middle of this malaise they managed to surprise on the upside? How did they manage to do that? Better loan management? More credit card transactions? (gasp) Better cost management? None of the above. The answer is ....higher credit risk from....Citicorp!
Really, you can't make this stuff up. It turns out that the same banks who argue that loans, mortgages and other "complex" instruments cannot be marked-to-market (i.e. use independent prices as opposed to those dreamed up by the banks) have no trouble marking down their own debt and reporting the difference as profit.
Take a look at the earnings report as posted on Yahoo finance. The second paragraph of the press release reads
This is our banking system America. No wonder they do not have any credibility.
Really, you can't make this stuff up. It turns out that the same banks who argue that loans, mortgages and other "complex" instruments cannot be marked-to-market (i.e. use independent prices as opposed to those dreamed up by the banks) have no trouble marking down their own debt and reporting the difference as profit.
Take a look at the earnings report as posted on Yahoo finance. The second paragraph of the press release reads
Third quarter revenues included $1.9 billion of credit valuation adjustment (CVA) reflecting the widening of Citi’s credit spreads during the third quarter. Excluding CVA, third quarter 2011 revenues were $18.9 billion, 8% below the prior year period and 8% below the second quarter 2011. CVA increased reported third quarter earnings by $0.39 per share.What this means in plain English is that Citicorp reported $1.9 billion of gains because their own credit was priced lower by the market (half their earnings were due to this adjustment). Say what? Say Citi owes $3 trillion dollars. Say the market believes they are more likely to go bankrupt, the debt, naturally, is worth less (because fewer investors want it), Citi gets to say it owes less and book the difference as a gain. The worse they do, the higher their chances of going bankrupt, the less the debt is worth, the more they make.
This is our banking system America. No wonder they do not have any credibility.
C R I S I S
Crisis, as the Chinese say, is a composition of characters that represent both danger and opportunity - a combination of the elements of risk and reward. These elements will play themselves out differently in every crisis depending on each individuals financial position, expectations and point-of-view.
From a philosophical stand point, every crisis should be interpreted as an opportunity for change, for re-evaluation and re-assessment, for improvement and evolution...
How can there be change without friction,without stimulation?
When there is no friction, there is no need to improve, leading to idleness and sloth. Friction shows us that there is always a space for new ideas, new forces that can continually nourish society by maintaining it in its original state of a constant creative disequilibrium. Evolution necessitates a certain trial and error. Without the tension of a constant disequilibrium, the game becomes fixed and there is no real growth. Only when the social and economical fabric is disorganized, one can efficiently question it and uncover ever more subtle possibilities of new ways to act. Friction will eventually makes society grow vigorous and resilient.
The current "modus operandi" of the developed world in the conduction of economic policy has been to smooth out the edges of every downturn. The process, of providing a constant and ever-lasting backstop to every economic cycle, not only limits the trough, but also substantially caps the peak.
Psychologically, this action only serves to: punish the prudent instead of the reckless by promoting moral-hazard; to socialize the losses and privatize the gains; to reinforce political hubris and short-termism; to stimulate investor complacency and laziness; to confuse business sentiment, confidence and investment considerations - simply because economies kept on life support (ultra low interest rates for extended periods of time) send the wrong signals.
Today, the ideas at the center of all macroeconomic thought, were written over 70 years ago by John Maynard Keynes. Policy makers in major developed economies are clinging desperately to this acceptable macroeconomic theory.
Note that I purposely left acceptable and theory in italics. Acceptable because it is the theory that most eloquently maintains the "status quo". As Yogi Berra once said, "in theory, there is no difference between theory and practice. In practice, there is."
At the highest levels of intellectual thought and discussion, there will always be equally convincing arguments pro and against...
Friday, October 14, 2011
Spanish Cost Cutting Measures
As you have probably heard, S&P downgraded Spain's credit last night to AA. So? you ask. AA is still a pretty good credit, better than that of most American largest banks, for instance. S&P cited high unemployment (20%+) and weak growth prospects.
Our sacrosanct markets, however, are pretty sanguine about the whole thing because Spain is allegedly making progress towards cutting their deficit from almost 10% in 2010 to 3% by 2013 (and zero by 2020). Even the WSJ, which carries a piece today (you need a subscription to read it) about how unlikely it is that Spain will meet its 6% deficit target for 2011, is hardly sounding any kind of alarm because they take the government numbers at face value.
The facts on the ground, however, are quite different. Those who bother reading the Spanish papers on a regular basis, know that the Spanish government has simply resorted to that time honored austerity strategy of ignoring the bills that come due. According to an article in Expansion the Spanish public sector has accumulated 20 billion euros of unpaid bills in 2011 (about 2% of GDP). In other words, not only are they are nowhere near meeting the deficit target for this year, they have made little progress compared to last year.
The sad thing is that none of the mainstream English-language publications (FT, WSJ, The Economist, etc) seem to bother to check the local press (perhaps they cannot find qualified Spanish speakers?) which perpetuates the myth of Spain's cost cutting progress. No wonder when they storm comes our policy makers claim that "nobody could have known."
Our sacrosanct markets, however, are pretty sanguine about the whole thing because Spain is allegedly making progress towards cutting their deficit from almost 10% in 2010 to 3% by 2013 (and zero by 2020). Even the WSJ, which carries a piece today (you need a subscription to read it) about how unlikely it is that Spain will meet its 6% deficit target for 2011, is hardly sounding any kind of alarm because they take the government numbers at face value.
The facts on the ground, however, are quite different. Those who bother reading the Spanish papers on a regular basis, know that the Spanish government has simply resorted to that time honored austerity strategy of ignoring the bills that come due. According to an article in Expansion the Spanish public sector has accumulated 20 billion euros of unpaid bills in 2011 (about 2% of GDP). In other words, not only are they are nowhere near meeting the deficit target for this year, they have made little progress compared to last year.
The sad thing is that none of the mainstream English-language publications (FT, WSJ, The Economist, etc) seem to bother to check the local press (perhaps they cannot find qualified Spanish speakers?) which perpetuates the myth of Spain's cost cutting progress. No wonder when they storm comes our policy makers claim that "nobody could have known."
Wednesday, October 12, 2011
Global Bankers Propose A New AIG To Erase Their Mistakes
Remember AIG? It used to be a AAA-rated American-based global insurance company. They sold, among other things, life insurance using actuarial strategies that assume that it is unlikely that many of their insured die at the same time. AIG was a profitable and solid company until they had the brilliant idea of insuring bonds. Bonds, they said, are just another kind of risk which we could insure using the same principles. So they sold insurance against default on billions of bonds and made a lot of money collecting premia, until the bonds began to default. At that time, the company was wiped out and would have disappeared had it not been for the intervention of the NY Fed, under Tim Geithner, who basically paid all claims against AIG in full.
Fast forward to 2011, the European banks and insurers are up to their eye-balls on European sub-prime, aka PIIGS' bonds, and are looking for a way to pass the bill to their governments without taking any losses that may jeopardize their bonuses. Enter, Allianz, a respected German insurer with access to the government (just like AIG ). Allianz has proposed to turn the EFSF into a pan-European AIG. This time, however, to save the annoying step of going to the central bank, directly with public money. Thus, the EFSF would insure the bankers against default so that they can continue to do their patriotic duty of buying high yielding Greek bonds without fear of loss. The high yield, naturally, they get to keep as earnings.
Could this work?
It all depends on who you are. It may work for the banks as they will live to fight another day and continue to pay themselves in the meantime. Greece et al, will continue to service enormous amounts of debt while remaining uncompetitive for the foreseeable future.
Europe? funny you should ask. The stronger credits in Europe will assume de-facto the liabilities of anyone insured by the EFSF. The liabilities, as it is usually the case in financial engineering will NOT show up anywhere, so the unsuspecting public will not see them until, one day, they become due...like AIG.
Fast forward to 2011, the European banks and insurers are up to their eye-balls on European sub-prime, aka PIIGS' bonds, and are looking for a way to pass the bill to their governments without taking any losses that may jeopardize their bonuses. Enter, Allianz, a respected German insurer with access to the government (just like AIG ). Allianz has proposed to turn the EFSF into a pan-European AIG. This time, however, to save the annoying step of going to the central bank, directly with public money. Thus, the EFSF would insure the bankers against default so that they can continue to do their patriotic duty of buying high yielding Greek bonds without fear of loss. The high yield, naturally, they get to keep as earnings.
Could this work?
It all depends on who you are. It may work for the banks as they will live to fight another day and continue to pay themselves in the meantime. Greece et al, will continue to service enormous amounts of debt while remaining uncompetitive for the foreseeable future.
Europe? funny you should ask. The stronger credits in Europe will assume de-facto the liabilities of anyone insured by the EFSF. The liabilities, as it is usually the case in financial engineering will NOT show up anywhere, so the unsuspecting public will not see them until, one day, they become due...like AIG.
Thursday, October 6, 2011
Let's See, What Can We Ask In Exchange For Our Vote?
No matter public pretenses, the European bailouts hinge on Germany's support. The Germans, however, given their History, like to pretend that the EFSF is a European endeavor, which also suits the French who like to pretend they are Germany's equal partner even if the credit market says they are not.
The consequence of this elaborate theater piece, is that the EFSF is beholden to the whims of all 17 countries in the eurozone. If one country says no, the EFSF is not unanimous and ceases to be a European endeavor, never mind if the only approval needed is that of the Bundestag. By our count, Greece, Ireland, Portugal, Spain, Italy, Belgium, and France, as as actual or potential recipients, are automatic votes, which leaves the process in the hands of smaller, fiscally sound, countries like Finland and Slovakia.
Nothing is free in politics and approving the EFSF can be no exception. Recently, Finland extracted a collateral concession from Greece in exchange for the approval of their tiny contribution. Now, it is Slovakia's turn. Rest assured, though, that the likelihood of a positive vote is high, the advantage of being small is that, unless you are incredibly greedy, the price you extract looks affordable to the other party.
The consequence of this elaborate theater piece, is that the EFSF is beholden to the whims of all 17 countries in the eurozone. If one country says no, the EFSF is not unanimous and ceases to be a European endeavor, never mind if the only approval needed is that of the Bundestag. By our count, Greece, Ireland, Portugal, Spain, Italy, Belgium, and France, as as actual or potential recipients, are automatic votes, which leaves the process in the hands of smaller, fiscally sound, countries like Finland and Slovakia.
Nothing is free in politics and approving the EFSF can be no exception. Recently, Finland extracted a collateral concession from Greece in exchange for the approval of their tiny contribution. Now, it is Slovakia's turn. Rest assured, though, that the likelihood of a positive vote is high, the advantage of being small is that, unless you are incredibly greedy, the price you extract looks affordable to the other party.
Wednesday, October 5, 2011
Let The Poor Save The Rich And The Taxpayer Save The Banks
The IMF was organized as supranational bank. In essence, it is supposed to be unbiased. Human nature, however, is hardly ever unbiased. For decades the IMF defended sound fiscal principles and open markets. Of course, one thing is for a group of European and American bureaucrats (the IMF is dominated by these groups by design) to impose an austerity program in Uruguay, demand that the Ivory Coast get their house in order, or recommend open competitive markets to Indonesia. It is quite another however to challenge the politicians at home.
So it should come as no surprise that this morning Mr. Antonio Borges, head of the IMF's Europe Program and a citizen of a country that is already on an IMF-lead bailout plan, proposed that the rest of the world (you, me, and the taxpayers of all countries belonging to the IMF) join in the folly of buying bonds from the rich European countries who have already spent the funds raised by such bonds on their expensive life-styles.
Being an financial engineer himself, Mr. Borges further proposed to borrow money to buy the bonds in a special purpose vehicle, which is Wall Street's parlance for we don't want to have to show this on our balance sheet because the losses will be huge.
In essence, the IMF will use money from the world over to support the spending of a half-dozen of the richest countries in the world. Not only that, Mr. Borges' plan will allow the banks from another half-dozen rich countries to avoid recognizing the losses for the bonds they willingly purchased for over a decade. When Spain, Italy, and the rest finally restructure their debt (didn't the IMF said a year ago Greece had a temporary liquidity problem?) the IMF, and not the European banks who made the mistake of lending so much money to Italy and Spain, will be left holding the bag.
Why? Because as George Orwell once wrote "Some animals are more equal than others"
So it should come as no surprise that this morning Mr. Antonio Borges, head of the IMF's Europe Program and a citizen of a country that is already on an IMF-lead bailout plan, proposed that the rest of the world (you, me, and the taxpayers of all countries belonging to the IMF) join in the folly of buying bonds from the rich European countries who have already spent the funds raised by such bonds on their expensive life-styles.
Being an financial engineer himself, Mr. Borges further proposed to borrow money to buy the bonds in a special purpose vehicle, which is Wall Street's parlance for we don't want to have to show this on our balance sheet because the losses will be huge.
In essence, the IMF will use money from the world over to support the spending of a half-dozen of the richest countries in the world. Not only that, Mr. Borges' plan will allow the banks from another half-dozen rich countries to avoid recognizing the losses for the bonds they willingly purchased for over a decade. When Spain, Italy, and the rest finally restructure their debt (didn't the IMF said a year ago Greece had a temporary liquidity problem?) the IMF, and not the European banks who made the mistake of lending so much money to Italy and Spain, will be left holding the bag.
Why? Because as George Orwell once wrote "Some animals are more equal than others"
Make 'em stop...
Nothing like a bear market/uncertainty/volatility/lack of political will, to bring out people suggesting the simple solutions to solve all of the worlds problems...
Think it started with Mr. Martin Wolf, then Mr. Paul Krugman, then Mr. Paul McCulley (ex-PIMCO) - all widely respected and renowned economists/financial market commentators - who started out with the talk that its once again "time to think the unthinkable and start printing again"...
They base their analysis, or "arguments on standard textbook macroeconomics", as one of them said.
I will not place myself in favor or against their argument here, as their infallible textbook logic will surely overwhelm me. But I will suggest that all of these so called leaders and macroeconomic commentators need a good dose of humility, they need to say "we just dont know"...this time.
"We just don't know", respects the law of unintended consequences, which is what happens when a simple system tries to control a complex system - contrary to popular belief, macroeconomics, is a complex, evolving, high-feedback, incentive-driven system."
Any simple solution, such as, to start printing again = more monetary and/or fiscal stimulus, or spending just for the sake of spending and easing just for easing's sake, will only create increasingly negative unintended consequences - artificially inflated economic rebounds fueled by speculative financial asset rallies.
We all know how those end...
Couldn't find a better way to end this with Einstein's definition of "insanity: doing the same thing over and over again and expecting different results." Or as Yogi Berra noted, "in theory, there is no difference between theory and practice. In practice, there is."
CAVEAT EMPTOR
Think it started with Mr. Martin Wolf, then Mr. Paul Krugman, then Mr. Paul McCulley (ex-PIMCO) - all widely respected and renowned economists/financial market commentators - who started out with the talk that its once again "time to think the unthinkable and start printing again"...
They base their analysis, or "arguments on standard textbook macroeconomics", as one of them said.
I will not place myself in favor or against their argument here, as their infallible textbook logic will surely overwhelm me. But I will suggest that all of these so called leaders and macroeconomic commentators need a good dose of humility, they need to say "we just dont know"...this time.
"We just don't know", respects the law of unintended consequences, which is what happens when a simple system tries to control a complex system - contrary to popular belief, macroeconomics, is a complex, evolving, high-feedback, incentive-driven system."
Any simple solution, such as, to start printing again = more monetary and/or fiscal stimulus, or spending just for the sake of spending and easing just for easing's sake, will only create increasingly negative unintended consequences - artificially inflated economic rebounds fueled by speculative financial asset rallies.
We all know how those end...
Couldn't find a better way to end this with Einstein's definition of "insanity: doing the same thing over and over again and expecting different results." Or as Yogi Berra noted, "in theory, there is no difference between theory and practice. In practice, there is."
CAVEAT EMPTOR
Tuesday, October 4, 2011
About Those Efficient Markets
One more time the equity market does an about face from after spending most of the session in negative territory (after a dismal performance yesterday) as of 3:15pm EDT it looked like losing session again. Even the mighty iPhone couldn't save the market this time. Allegedly investors (that catch-all phrase for anyone daring to buy shares) had decided that the economy was slowing down, Europe had too much debt and Bernanke is out of bullets. Financial journalists ready for happy hour, had already written their negative wrap up pieces....
And then, out of nowhere, like the cavalry in those politically incorrect westerns, came the rally.
What is a financial journalists to do? Well, look for facts to justify the move, naturally.
So our friends at Bloomberg produced a quick piece that explains why stocks went up. It says about some guys in Europe who are beginning to consider the possibility that one day they may try a solution for their under-capitalized banks (why they probably will not implement until they run of all other options.) Hey, it's a story.
In order to make it credible, one can always add the all-purpose bargain hunting to the explanation.
And then, out of nowhere, like the cavalry in those politically incorrect westerns, came the rally.
What is a financial journalists to do? Well, look for facts to justify the move, naturally.
So our friends at Bloomberg produced a quick piece that explains why stocks went up. It says about some guys in Europe who are beginning to consider the possibility that one day they may try a solution for their under-capitalized banks (why they probably will not implement until they run of all other options.) Hey, it's a story.
In order to make it credible, one can always add the all-purpose bargain hunting to the explanation.
"...valuations at the cheapest level since 2009 lured investors..." [which apparently all waited until 3:15pm and didn't bother to keep buying at higher valuations?]The most likely scenario is that the market just corrected from an oversold (i.e. too many sellers at once) condition. Sadly, that story, however true it might be, not only doesn't excite anyone but also discredits the markets as illogical. See below the 2-day chart for yourself and decide.
Bernanke Finds A Brick Wall And Pushes Ahead
Our esteemed chairman is currently displaying his wisdom in Congress. He just said that the Fed is ready
Defending his latest policy he said that Operation Twist
How about the actual economy?
There is nothing more dangerous than a powerful man (there are no checks, short of impeachment, on the Fed chairman) who has fallen prisoner of a theory (economics is hardly an exact science). Either he is lying or he believes the nonsensical proposition that he can reignite growth by driving record low rates even lower. At this point, we hope he is lying. The alternative is scarier.
"...to take additional steps to boost U.S. growth..."Which implies that he chooses not to boost growth at this time? Does he think the economy is growing too fast?
Defending his latest policy he said that Operation Twist
“should put downward pressure on longer-term interest rates and help make broader financial conditions more supportive of economic growth than they would otherwise have been,”Which is a masterful display of sophistry since otherwise have been refers to an alternative reality that can never be measured. For instance, I could say that broader financial conditions are exactly the same as they would be without Operation Twist and Bernanke cannot prove that I am wrong (I can assure you that I am wrong since nothing is ever exactly the same to an alternative reality). Furthermore, the conditional should, at the beginning of the statement ensures that Ben wins the argument anyway.
How about the actual economy?
“The recovery from the crisis has been much less robust than we had hoped,”Wait! I thought his policies were working. If they haven't worked, how does he know future ones will work? Also, "hoped" is not exactly what we call hard science, either he knows or he doesn't. Which one is it?
'...Housing, which had been a “significant driver of recovery from most recessions” in the U.S. since World War II, is now among industries contributing to the “slower-than-expected rate of expansion,” Bernanke said....'Thanks to whom? Will Bernanke ever acknowledge that the Greenspan team, which included Ben as well as Tim Geithner, pumped the housing market to the point of exhaustion? Also, did he actually think housing would lead this "recovery?" (The potential answers to that one are right down scary)
There is nothing more dangerous than a powerful man (there are no checks, short of impeachment, on the Fed chairman) who has fallen prisoner of a theory (economics is hardly an exact science). Either he is lying or he believes the nonsensical proposition that he can reignite growth by driving record low rates even lower. At this point, we hope he is lying. The alternative is scarier.
So You Think You Know How Much Your Country Owes?
Think again. Let this be a continuous lesson to those who think public finances are 100% transparent. We are constantly bombarded with glib calculations about the size of public debt and its ratio to the GDP of the home country. Except countries cannot help but to take on the debt of well-connected private enterprises. Whether they do it for the good of the people or to cover their own past mistakes is irrelevant. Once a bank like Dexia (France/Belgium) is bailed out, it debts become obligations of the state. Ireland, for instance, had the lowest debt/gdp ratio in the eurozone until they decided to bailout those black-holes they call banks in 2008.
Which is why it is useful to know that countries like France, Italy, and Spain have banks and other politically connected institutions with debts that, when taken cumulatively, exceed the GDP of the host country.
This article makes an attempt to illustrate the problem. Beware, however, of taking the numbers as precise. Macro aggregates are notorious for their large accounting errors and apple-to-oranges comparisons. In addition, they are manipulated by many (all?) governments.
Which is why it is useful to know that countries like France, Italy, and Spain have banks and other politically connected institutions with debts that, when taken cumulatively, exceed the GDP of the host country.
This article makes an attempt to illustrate the problem. Beware, however, of taking the numbers as precise. Macro aggregates are notorious for their large accounting errors and apple-to-oranges comparisons. In addition, they are manipulated by many (all?) governments.
Monday, October 3, 2011
You Ignore Math At Your Peril
Wouldn't you know? The Greeks decided that 3 months was not enough time for a Hail Mary Pass and admitted they will not meet the deficit target for this year. Without even batting and eyelash they also promised a new-new-new austerity plan for next year. This time, they really-really believe they will be able to implement the Houdini-model to achieve high growth while imposing draconian austerity.
The Greeks, among other things, are responsible for inventing politics. Whether or not they invented that unique political ability to deny reality with a straight face in front of thousands of people we do not know. In any even, the same politicians, not only Greek, who told us two years ago that the way out of the crisis was to increase government spending are now telling Greece the opposite. They are also telling the rest of us to stay calm because it will work.
The simple fact is that the government does not operate under the same rules as the private sector. An individual or a company can save without hurting their revenue. In general, when the government tries to save aggressively, the economy slows down, when the economy slows down, tax collections go down. Thus, depending on the sensitivity of all this variables, trying to reduce the deficit may paradoxically increase it instead.
Guess what, that is what happened to Argentina. That is what seems to be happening to Greece, and, even though we do not hear about it everyday, is what is happening to the other countries (you know who they are).
The reason we are subject to this nonsense is that the politicians do not want to acknowledge that the level of debt is too high. It was already too high in 2005 when nobody cared. The money has already been spent and and lost. No amount of financial engineering can modify reality.
The Greeks, among other things, are responsible for inventing politics. Whether or not they invented that unique political ability to deny reality with a straight face in front of thousands of people we do not know. In any even, the same politicians, not only Greek, who told us two years ago that the way out of the crisis was to increase government spending are now telling Greece the opposite. They are also telling the rest of us to stay calm because it will work.
The simple fact is that the government does not operate under the same rules as the private sector. An individual or a company can save without hurting their revenue. In general, when the government tries to save aggressively, the economy slows down, when the economy slows down, tax collections go down. Thus, depending on the sensitivity of all this variables, trying to reduce the deficit may paradoxically increase it instead.
Guess what, that is what happened to Argentina. That is what seems to be happening to Greece, and, even though we do not hear about it everyday, is what is happening to the other countries (you know who they are).
The reason we are subject to this nonsense is that the politicians do not want to acknowledge that the level of debt is too high. It was already too high in 2005 when nobody cared. The money has already been spent and and lost. No amount of financial engineering can modify reality.
Saturday, October 1, 2011
If Spain Is The Model We Better Run For The Hills
Once upon a time most journalism was local. It was easy then. Journalists spoke the same language as their readers and, more importantly, their sources. If and English paper wanted to publish a story about Spain, they would ask the Spanish correspondent to write one and translate it.
Then, a big globalizing cloud came in the horizon. Established newspapers had to compete not only with each other but with independent free-lancers on the internet. The Financial Times, allegedly a leading financial newspaper, recently published an article ( Italy should look to Spain for inspiration) suggesting that Italy should emulate Spain in their cost-cutting efforts.
We do not not whether the author, Mr. Tony Barber, has ever visited Spain or, at the very least, bothers to read the Spanish newspapers online. As we have noted before, Spain's so-called cost-cutting efforts are based on such time-honored accounting gimmicks like deferring government payments until they can be moved into the next fiscal period or getting forced financing from the Pharmacies (link in Spanish). Not to mention that the so-called Reestructuracion de Cajas Mr. Barber extols, has happened in name only as the critical phase of taking losses and raising enough capital to make them viable has yet to happen.
Mr. Barber, like many of his colleagues, seems to be guided by the Efficient Market Religion. Thus, he offers the following as divine proof of the superiority of Spain's cost cutting efforts:
The fact is that both Italy and Spain are very sick countries. Spain, by virtue of its complicated political structure, may look better to naive journalists who can't bother with Spanish sources to investigate were the bodies are buried. However, with 20% unemployment, a financial system clogged with real estate loans marked at par (original value, i.e. without loss reserve), and lack of central control of the autonomias (regional governments), looks hardly as a model to emulate.
Then, a big globalizing cloud came in the horizon. Established newspapers had to compete not only with each other but with independent free-lancers on the internet. The Financial Times, allegedly a leading financial newspaper, recently published an article ( Italy should look to Spain for inspiration) suggesting that Italy should emulate Spain in their cost-cutting efforts.
We do not not whether the author, Mr. Tony Barber, has ever visited Spain or, at the very least, bothers to read the Spanish newspapers online. As we have noted before, Spain's so-called cost-cutting efforts are based on such time-honored accounting gimmicks like deferring government payments until they can be moved into the next fiscal period or getting forced financing from the Pharmacies (link in Spanish). Not to mention that the so-called Reestructuracion de Cajas Mr. Barber extols, has happened in name only as the critical phase of taking losses and raising enough capital to make them viable has yet to happen.
Mr. Barber, like many of his colleagues, seems to be guided by the Efficient Market Religion. Thus, he offers the following as divine proof of the superiority of Spain's cost cutting efforts:
Now investors perceive Italy to be at greater risk than Spain (and Cyprus has leapfrogged them both). The spread between Italian and Spanish 10-year government bond yields stood on Thursday at about 51 basis points, or 0.51 percentage points.We may forgive Mr. Barber who, most probably, has never bought or sold a bond for believing that investors reflect their opinion in such impeccable manner. The fact, however, is that the markets are far from clear with regards to their opinion of whether Italy or Spain is more likely to go bankrupt. As an example, the credit of Intesa San Paolo (an Italian bank which will almost certainly fail if the Italian government were to fail) currently trades at a better rate than that of the Italian government, an anomaly that has persisted for years.
The fact is that both Italy and Spain are very sick countries. Spain, by virtue of its complicated political structure, may look better to naive journalists who can't bother with Spanish sources to investigate were the bodies are buried. However, with 20% unemployment, a financial system clogged with real estate loans marked at par (original value, i.e. without loss reserve), and lack of central control of the autonomias (regional governments), looks hardly as a model to emulate.
Wednesday, September 28, 2011
Meanwhile In Spain...
Once upon a time, treasury auctions were boring affairs. The Spanish treasury, for instance, would announce they needed to borrow a billion euros and the banks would place bids for their own account and either hold the bonds to maturity or resell them to their clients. The clearing price and interest rate at the auction were buried on page 23 of some obscure publication.
Naturally, that has all changed with the advent of the credit crisis. Now, everyone watches the auctions in order to gauge whether or not the market is willing to finance the Spanish treasury and at what rate. Also, being of the utmost interest, the clearing rate and size of each auction are now prominently displayed in all financial journals.
The question at this point is, who has the risk appetite to buy Spanish (or Italian) bonds and why? Do they have a different view of the Spanish economy that allows them to accept a 5% annual return at a time when some think Spain may be in default in a few years?
The answer seems to be neither. What seems to be happening instead (click here for a link in Spanish)
is that the Spanish banks have discovered a new way to make free money. They basically get loans from the ECB at 1% which they use to buy Spanish debt yielding 5%, thus, earning the difference.
So the next time you read that Spain (or Italy, or Portugal) raised money at an auction and that the demand was better than expected, or that the ECB is not buying government bonds, remember that money is fungible. The ECB is designed to lend to the banks who need it. Whether the banks decide to reduce or add exposure in the process is their problem and no Spanish regulator will ever chastise a bank for buying Spanish debt, no matter the scenario.
Charles Ponzi would be proud.
Naturally, that has all changed with the advent of the credit crisis. Now, everyone watches the auctions in order to gauge whether or not the market is willing to finance the Spanish treasury and at what rate. Also, being of the utmost interest, the clearing rate and size of each auction are now prominently displayed in all financial journals.
The question at this point is, who has the risk appetite to buy Spanish (or Italian) bonds and why? Do they have a different view of the Spanish economy that allows them to accept a 5% annual return at a time when some think Spain may be in default in a few years?
The answer seems to be neither. What seems to be happening instead (click here for a link in Spanish)
is that the Spanish banks have discovered a new way to make free money. They basically get loans from the ECB at 1% which they use to buy Spanish debt yielding 5%, thus, earning the difference.
So the next time you read that Spain (or Italy, or Portugal) raised money at an auction and that the demand was better than expected, or that the ECB is not buying government bonds, remember that money is fungible. The ECB is designed to lend to the banks who need it. Whether the banks decide to reduce or add exposure in the process is their problem and no Spanish regulator will ever chastise a bank for buying Spanish debt, no matter the scenario.
Charles Ponzi would be proud.
Only in Spain
Is like a joke but a bad one. The last to join the charade was Artur Mas, President of La Generalitat (Catalonia Autonomous Government). From "El PaÃs": "The Catalan government has slashed staffing levels at hospitals and reduced services, an on Monday proposed that healthcare workers accepted a 50-percent cut in their Christmas bonus. The budgets for education and social services have also been shaved. The measures announced on Tuesday include a two-month freeze in transfers to private-public care centers for the retired and other groups with special needs". Imagine this, if payments for the elderly and special needs groups are openly delayed, what we can expect is happening to other not-so-socially-sensitive bills? Four months delay? Six month delay? Is has been said that Spain´s budget deficit targets have been met only for the practice of kicking the can down the road which, translated into Spanish, means delaying most of payments due to the private sector at least by two months. In other words, how easy is to comply with your targets when your annual payments schedule only have 10 months... See what happens next year when those unpaid bills from 2011 have to be incorporated in 2012 budget... By the way, Catalonia has much to risk if it doesn´t meet the deficit target and so its credit ratings are further downgraded: on November will have to roll-over 3.15 billion euros in "Patriotic Bonds" @ 4.75%...
A Moment Of Sanity: Germany Rejects Geithner's Advice
This past weekend sec. Geithner, one more time, propose a leveraged solution for a leverage problem. This time, he tried to convince the Germans to allow the bailout fund, which they guarantee, to borrow in the markets (with German credit) to buy even more Italian and Spanish bonds. The German response? See below:
"I don't understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense,"It seems Geithner not only continues to see the world exclusively through the banker's eyes ("save US or else") but has yet to see a financial engineering solution he doesn't like.
Monday, September 26, 2011
Extra Extra!!! High Derivative Concentration
There is an excellent news by the folks at zerohedge.com, showing that contrary to popular opinion, the derivative exposure of US banks has actually increased since the prior economic crisis of 2008. Now the top 5 banks (JPM, CITI, BAC, GS and HSBC) account for 96% of the total outstanding derivative exposure!
So after a massive financial and economic crisis, what do banks do? as expected, they get bigger and riskier...
Here is a much more detailed link of the OCC's (Office of the Currency Comptroller) latest quarterly report on bank trading and derivatives activities.
So after a massive financial and economic crisis, what do banks do? as expected, they get bigger and riskier...
Here is a much more detailed link of the OCC's (Office of the Currency Comptroller) latest quarterly report on bank trading and derivatives activities.
Saturday, September 24, 2011
Tim Geithner Wants The Whole World To Go Japanese
Do you remember the original TARP? It was supposed to be a fund to buy toxic assets from US banks. As it often happens in politics, by the time it was implemented it did anything but and was used to recapitalize the banks in favorable terms using government money to buy equity without forcing anybody to take losses on their past loans. It was a gentlemen agreement of sorts, which allowed the banks to come back strong even if it did nothing for the broader economy. Adding insult to injury, many large banks purchased even more of the same toxic assets they were supposed to sell. Since they never clean up their balance sheets they never looked to expand it by making new loans.
Tim Geithner, our esteemed secretary of the Treasury, was a major supporter of the idea that helping the banks helps the economy. Except that helping the banks, as most things in economics, may mean different things to different audiences. For instance, a pre-packaged bankruptcy may help the bank clean up its balance sheet without impacting the debt, thus, avoiding a Lehman-like crisis. It does, however, wipe out the equity and prefer equity, which is what the executives running said banks own. You can already guess who prefers which solution. Geithner, if you do not know already, consults the top executives of the same banks he bailed out on a permanent basis.
Now, apparently, it is Geithner's time to help European bank(er)s (Earlier on Thursday, U.S. Treasury Secretary Timothy Geithner voiced optimism that Europe would devote more of its own resources to backstop euro area governments and banks under stress). Again, the story is as simple or as complicated as you want to make it. The European banks own some toxic assets. Whether they are real estate loans in Spain, Italian government debt in Italy, or Greek bonds and loans in France, it doesn't matter. The fact is that all of these banks are currently reporting these assets at values far above fair prices (yes, Virginia, bankers do that on a regular basis and get away with it). As it is usually the case, they do not want to take the losses unless they have to which means they won't take the losses unless they are forced by a regulator or go bankrupt, whichever comes first.
Given past performance, you can be sure that Mr. Geithner is NOT advocating that the banks are forced to clean up their balance sheets. So any plan of his, will involve some form of free money (government guarantees, mispriced equity warrants, etc) that allows the banks to avoid writing down the losses. As you can see, with American and Japanese banks (yes that is exactly what they did in the 90s), this preserves the (zombie) bank while condemning the rest of the economy to a Japanese like "recovery."
Capitalism needs failure as much as it needs success. The Japanese have been trying to absorb the mistakes they socialized in the early 90s and they are still trying. Apparently, we are on our way to doing the same.
Friday, September 23, 2011
CEO of worlds largest copper mining company says copper prices may have hit bottom...
WHAT ELSE COULD HE HAVE SAID??? REALLY???
here is the link
makes me think of what Robert McNamara once said:
"Never answer the question that is asked of you, answer the question that you wished had been asked of you"
here is the link
makes me think of what Robert McNamara once said:
"Never answer the question that is asked of you, answer the question that you wished had been asked of you"
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