Showing posts with label Crisis euro zone. Show all posts
Showing posts with label Crisis euro zone. Show all posts

Monday, July 30, 2012

30/7/2012: Grazie, Sig Draghi?

So Mr Draghi made some serious sounding pronouncements last week. The markets rallied. Over the weekend, more serious sounding soundbites came out of Mr Juncker. The markets... oh... still rallying? And thanks to both, Italy had a 'Successories'-worthy auction today am:

  • Italy 5 year CDS fell 20bps to 478 (lowest since early July) prior to the auction
  • 5 year bond sold at yild 5.29 (against 5.84 in previous) with bid/cover of 1.34 (down on 1.54 achieved in previous auction) and maximum allotment of 2.224bn out of 2.250bn aimed
  • 10 year 2022 5.5% bond sold at 5.96% yield (previous auction 6.19%) and bid/cover ratio of 1.286 (against previous 1.28) with allotment of 2.484bn out of 2.5bn planned.

Grazie Sig Draghi?

Now, wait a sec. Yes, there's an improvement. But on less than €4.7bn of issuance... and Italy needs are:

(Source: Pictet)

And hold on for a second longer:

  • Italy's net debt financing cost was at 4.721% of GDP in 2011 with debt/GDP ratio of 120.11% which implies effective financing rate of 3.931%
  • Of course, a single auction does not lift this up in a linear fashion, but... if Italy had troubles with 3.9%, should we not be concerned with 5.29%?
  • Let's put it differently: Italy's GDP grew in 2010-2011 by 1.804% and 0.431% respectively. Over the same period of time, Italy's government debt net financing costs went from 4.236% of GDP to 4.721% of GDP. This year they are set to rise to over 5.36% of GDP as economy is likely to contract ca 1.9-2.0%.
So maybe (I know, cheeky) cheering the current yields is a bit premature? Eh?

Monday, January 9, 2012

9/1/2012: Week opener: Merkozy continuing to ignore Greek realities

Today's meeting between Sarkozy and Merkel is being framed in the context of continued pressures across the euro area (see report on the meeting here). More ominously - within the context of the euro area leadership duet ignoring the latests warning signs for Greece.

Per Der Spiegel report, IMF has changed its analysis of the Greek rescue package agreed in July 2011 in-line with IMF changes in forecasts for Greek economy in the latest programme review in December 2011. Specifically, IMF lowered its forecast for growth from -3% to -6% GDP.

Der Spiegel cites IMF internal memo in claiming that the Fund is viewing existent Greek programme (including to 50% 'voluntary' haircut on Greek bonds currently under negotiations) as insufficient to stabilize the Greek economy and fiscal situation. The Fund is, reportedly, considering 3 possible options to alleviate the latest set of growth pressures:

  • New austerity measures for Athens - a measure that in my view will only exacerbate immediate pressures on Greece and will lead to dangerous destabilization of political situation in the country, leading to even more second order adverse effects on growth (e.g. prolonged strikes and rioting);
  • Deeper haircuts on Greek debt held by private institutions - in my opinion this will lead to more contagion from Greece to euro area banks and sovereigns and should be, instead complemented by writedowns of Greek debt held by the ECB, to match existent private sector arrangements;
  • Increase in the euro zone bailout funds - in my view, this measure is currently outside the feasibility envelope for Europe and, if attempted, will lead to increased cost of euro area borrowing and have a knock on effect of higher cost of lending to countries currently in the Troika programme. It is also important to note that the EFSF head Klaus Regling is aiming to raise EFSF guarantees to foreign investors to 30%, thus reducing the leverage ratio from 4-5 times to 3 times. This will lower EFSF's theoretical borrowing capacity even further.

The IMF note reports are effectively matched by the statement from the senior Germany Finance Ministry adviser made Saturday, who tole the Greek press that a 50% haircut on Greek debt will not be enough to restore sustainability to Greek fiscal dynamics.

In effect, three of out three IMF 'options' cited will exacerbate the crisis, not resolve it. And there is no Option 4 on the books.

Thursday, December 22, 2011

22/12/2011: Europe's policy errors

By now, you have figured it out - I am a big fan of my old UofC professor, John Cochrane. And in this latest article (here) he delivers even more real common sense.

Defaults:

"Conventional wisdom says that sovereign defaults mean the end of the euro: If Greece defaults it has to leave the single currency; German taxpayers have to bail out southern governments to save the union.
This is nonsense. U.S. states and local governments have defaulted on dollar debts, just as companies default."

Cochrane is correct. Orange County, CA - size ca 1/2 Ireland - has defaulted before and so... no end to the State of California or to the Feds and, crucially, no bailout. New York went bust in 1975, Cleveland in 1978. Fitch did a study in 1999, updated in 2003, that shows 2,339 cases of municipal bonds defaults in the US for 1980-2002 totaling USD32.8 billion. And guess what: no bailouts and yet the dollar still exists. Fitch estimated cumulative default rate for 1980-1986 issuance of 1.5%m cumulative default rate for 1987-1994 issuance of 0.63%, average recovery rates were around 63-64%, consistent with standardized CPD pricing practice of 40% haircut. This is not to say that defaults are costless or easy, but there is no ex-ante intrinsic reason for the common currency to implode were a country like Greece - expected by all to default - to restructure its sovereign debts.

Bailouts:
"Bailouts are the real threat to the euro. The ECB has been buying Greek, Italian, Portuguese and Spanish debt. It has been lending money to banks that, in turn, buy the debt. There is strong pressure for the ECB to buy or guarantee more. When the debt finally defaults, either the rest of Europe will have to raise trillions of euros in fresh taxes to replenish the central bank, or the euro will inflate away."

Correct again: latest LTRO allocation of €489bn this week, with €235bn of this being lent in excess of the banks covering shorter-term ECB debt is the case in point. ECB's hope is that the banks - already sick from overloading with low quality sovereign debts on their balance sheets - will use €235bn to buy more sovereign debt. This, of course, will help ECB to cut back its own purchases of Government bonds and to, thus, pretend that 'the market' for sovereign debt in Europe is somehow being repaired. The madness of this 'solution' is that it creates even greater link between ECB, banks and sovereign debt - the very cause of the crisis contagion. You can see an excellent, albeit a bit politically-correct piece on this in the Economist (here).

And to correct for the 'politically correct' bit - here's my view of LTRO: In a nutshell, the ECB will lend the banks unlimited money at 1% so they can buy PIIGS+Belgian+French debt making 2-6% margin as pure profit and benefiting from capital gains in the process. As bonds prices firm up on the back of these purchases, banks collateral deposited with ECB will also improve in value, allowing them to borrow even more. This positive correlation between banks borrowings from ECB and their profits gains will continue until in 3 years from now the entire pyramid collapses - the banks will have to repay ECB funds, prompting massive sales of bonds. And in the mean time, there will be no lending in the real economy, as banks funding will be tied into financing Government spending and banks will continue to deleverage out of real assets. This makes LTRO an equivalent of an RX to a drug addict for unlimited supply of free opiate.

As Cochrane puts it:
"Sovereign default would damage the financial system, however, for the simple reason that Europe has allowed its banks to load up on debt, kept on the books at face value, and treated as riskless and buffered by no capital. Indebted governments have been pressuring banks to buy more debt, not less.

As banks have been increasing capital, they have loaded up even more on “risk-free” sovereign debt, which they can use as collateral for ECB loans. The big ECB “liquidity operation” that took place yesterday will give banks hundreds of billions of euros to increase their sovereign bets. Bank depositors and creditors have figured this out, and are running for the exits.

...By stuffing the banks with sovereign debt, European politicians and regulators are making the inevitable default much more financially dangerous. So much for the faith that regulation will keep banks safe."



Fiscal Union:
"More fiscal union hurts the euro. Think of Poland or Slovakia. ...A common currency without a fiscal union could have universal appeal. A currency union with a bailout-based fiscal union will remain a small affair."

"Europeans leaders think their job is to stop “contagion,” to “calm markets.” They blame “speculation” for their troubles. They keep looking for the Big Announcement that will soothe markets into rolling over another few hundred billion euros of debt. Alas, the problem is reality, not psychology, and governments are poor psychologists. You just can’t fill a trillion-euro hole with psychology."

Conclusion:

"The euro’s fatal flaw then wasn’t to unite areas with differing levels and types of development under one currency. ...Nor was it to deprive governments of the ephemeral pleasures of devaluation. Nor was it to envision a currency union without fiscal union.

Banking misregulation was the euro’s fatal flaw [emphasis is mine]. Sovereign debt, which can always avoid explicit default when countries print money, doesn’t remain risk-free in a currency union. Yet banking regulators and ECB rules continue to pretend otherwise.

So, by artful application of bad ideas, Europe has taken a plain-vanilla sovereign restructuring and turned it into a banking crisis, a currency crisis, a fiscal crisis, and now a political crisis."

And then,
"When the era of wishful thinking ends, Europe will face a stark choice.

  1. It can have a monetary union without sovereign defaults. That option means fiscal union, accepting real German control of Greek and Italian (and maybe French) budgets. Nobody wants that, with good reason.
  2. Or Europe can have a monetary union without fiscal union. That would work well, but it needs to be based on two central ideas: Sovereigns must be able to default just like companies, and banks, including the central bank, must treat sovereign debt just like company debt.
  3. The final option is a breakup, probably after a crisis and inflation. The euro, like the meter, is a great idea. Throwing it away would be a real and needless tragedy."
I agree.