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.
Monday, November 28, 2011
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).
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