11/5/16: 7+1 Steps Guide to Greek Crisis Madness

Greece is back in the news recently with yet another round of crisis talks and measures. Here's where we stand on the matter.

After another Eurogroup 'talks' this week, Greek Government is back to drawing up a new set of 'measures' to be presented to the Parliament. These 'measures' are, once again, needed for yet another Eurogroup agreement of yet more loans to the country.

The madness of this recurring annual spectacle that the EU, the Greeks and the IMF have been going through is so apparent and so predictable by now, that anywhere outside Greece itself it is simply banal.

The scenario is developing exactly along the same lines as before:

1. Greeks are running out money
2. Greek loans funds are not being remitted by the EU because of the 'lack of progress on 'reforms' which were never progressed since the Bailouts 1.0 & 2.0.
3. Greek Government insists that no more 'reforms' can be imposed onto the Greek economy because there is already no economy left due to previously imposed 'reforms'
4. IMF threatens to walk out and European authorities become 'doubtful' of Greek commitments to 'reforms'
5. European authorities and Greece get into a room to hammer our (3) as a precondition for (2) both of which are necessary to avoid Greek default and are thus required to prevent (4).
6. Greece agrees to more 'reforms', gets more loans, none of which have anything to do with actually supporting Greek economy
7. Greek government declares another 'victory' on the road of the country 'exit from an era of creditors', whilst creditors become ever more committed to Greece.
8. Within 6 months, (1) repeats anew...

And this is exactly what has been happening over the recent days.

Government partner Panos Kammenos has already heralded “Greece’s exit from an era of creditors" this week in the wake of the promises by Greece to implement new round of 'reforms' aimed at placating the EU and the IMF into providing fresh credit to Greece. The target date for Greek Government putting its tail between its legs for the umpteenth time is May 24th when the Eurogroup is supposed to meet to decide on the next round of debt financing for Greece.
What are the latest 'reforms' about?

1. New privatization fund (because previous one did nada, zilch, nothing) to sell state assets (with hugely inflated expected valuations) to investors (read vultures) to generate funds (that will fall grossly short of) required to pay some debt down.
2. New rules for working out non-performing bank loans (foreclosure & bankruptcy reforms) because under (1) above, vultures, sorry 'investors', ain't getting enough.  
3. Load of new taxes (levying coffee, fuel and even web connections, for a modern economy cannot exists in the vacuum of knowledge taxes).
4. Automatic cuts to fiscal spending should the Government breach targets on fiscal deficits assigned under 2015 'deal'.
5. EUR5.4 billion in fresh budget cuts.

In return, Tsipras is getting Eurogroup's usual waffle.

The IMF (that actually holds more central position between the Greek and the EU corners) will probably be allowed to excuse itself from underwriting Bailout 3.0 agreed last Summer. This will load full Greek bailout cost onto the EU institutions - something that Europe is happy to do because the IMF has become a realist thorn in the hopium filled buttocks of European 'policymaking'. IMF will, of course, rubber stamp the Bailout 3.0 programme by remaining an 'advisory' institution (sort of like Irish Fiscal Council - bark, but no bite). In exchange, it will get European funds to repay IMF loans and will walk away from the saga with bruises, but no broken nose. Rumour has it, Germany will accept this role for the IMF but only if Greece agrees to become Europe's holding tank for refugees (it's an equivalent of Turkey Compromise with Athens that will make Erdogan livid with jealousy).

Tsipras will also receive another promise from the EU to examine Greek debt relief. By now, everyone forgot that the EU already promised to do so four years ago (see last page, 2nd paragraph in Eurogroup statement from November 27, 2012 and reiterated it in August 11, 2015 Bailout3.0 agreement). Thus, Tsipras will be able to put a new 'certificate of a promise' (written in French or German or both, for better effect) onto his cabinet wall, while being fully aware that a promise from the EU is about as good as a used car salesman's assurances about a vehicle's transmission. The only chance any sort of relief will be forthcoming is if the IMF amplifies its rhetoric about Greek debt 'sustainability', which may happen at the next G7 meeting next week, or may not happen for another six months... who knows?

Meanwhile, the saga rolls on. Protests in Greece - 'Everyone'sOutraged', are greeted by the markets as 'Things Are Going Swimmingly' just as IMF's team is shouting 'The Patient's Dead, You Morons!' while Germans are saying first 'Nothing's Happening' and a week later changing their minds to 'Things Are so Good, We'll Have a Deal' to the solo of a Greek official singing 'We've Been Half Dozing' and a chorus of EU leaders erupting with a jubilatory 'Lalala'.

Remember: we are in Europe! Mind the gap... with reality.

11/5/16: U.S. Economy: Three Charts Debt, One Chart Growth

In his recent presentation, aptly titled "The Endgame",  Stan Druckenmiller put some very interesting charts summarising the state of the global economy.

One chart jumps out: the U.S. credit outstanding as % of GDP

In basic terms, U.S. debt deleveraging post-GFC currently puts U.S. economy's leverage ratio to GDP at the levels comparable with 2006-2007. Which simply means there is not a hell of a lot room for growing the debt pile. And, absent credit creation by households and corporates, this means there is not a hell of a lot of room for economic growth, excluding organic (trend) growth.

As Druckernmiller notes in another slide, the leveraging of the U.S. economy is being sustained by monetary policy that created unprecedented in modern history supports for debt:

And as evidence elsewhere suggests, the U.S. credit creation cycle is now running on credit cards:

Source: Bloomberg

And the problem with this is that current growth rates are approximately close to the average rate of the bubble years 1995-2007. Which suggests that in addition to being close to exhaustion, household credit cycle is also less effective in supporting actual growth.

Which is why (despite a cheerful headline given to it by Bloomberg), the next chart actually clearly shows that the U.S. growth momentum is structurally very similar to pre-recession dynamics of the 1990 and 2000:

Source: Bloomberg

Back to Druckenmiller's presentation title... the end game...

10/5/16: Debt, Government Debt, Glorious Debt

It's a simple headline, really, for a single chart:

But it says so much... peace time and monetary financing and printing presses and private sector QEs and on and on... as the 'economic recovery measures' roll out, the old staple of Government debt is going up. Austerity or none, growth is weak. Yet, Governments are borrowing at rates that are simply beyond control.

In simple terms: we have deteriorating fundamentals (interest rates at nil or negative, but growth nowhere to be seen) and we have continuously mispriced risk. If this ain't a bubble, what is?..

7/5/16: Households Over-Indebtedness in the Euro Area

An interesting assessment of Italian household debt levels in the context of over-indebtedness by D'Alessio, Giovanni and Iezzi, Stefano, (paper “Over-Indebtedness in Italy: How Widespread and Persistent is it?”. March 18, 2016, Bank of Italy Occasional Paper No. 319. http://ssrn.com/abstract=2772485).

Using the Eurosystem’s Household Finance and Consumption Survey (HFCS) the authors also compare the over-indebtedness of Italian households with that of other euro-area countries (Ireland, as usual, nowhere to be found, presumably because we don’t have data).

Here is a summary table for euro area households over-indebtedness:

Several things can be highlighted from this table:

1. There is severe over-indebtedness in Spain (14.1%) and Slovenia (10%); serious over-indebtedness in the Netherlands (8.8%), Luxembourg (8.4%), and Portugal (8.2%)
2. Demographically, those under 50 are the hardest hit. This would be normal, if the incidence of higher debt amongst younger generations was consistent with demographic profile of the country (younger countries - more over-indebtedness amongst younger generations). This is not the case. 
3. Overall, worst cross-country over-indebtedness problem occurs in 31-40 age group - the group of the most productive households who should be able to fund their debts from growing incomes.
4. In 9 out of 13 countries covered, highest or second highest level of over-indebtedness accrues in “University Degree” holding sub-population.
5. Self-employed are disproportionately hit by over-indebtedness problem compared to those in employment.

In simple terms, the above evidence can be consistent with sustained, decade-long transfers of wealth (via debt channel) from younger and middle-age generation to older generation (>50 years of age). System of taxation that induces higher volatility to incomes of self-employed compared to those in traditional employment might be another contributing factor.

8/5/16: Leverage and Management: Twin Risks or Separate Risks?

A new paper “How Management Risk Affects Corporate Debt” by Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach (NBER Working Paper No. 22091 March 2016) looks at the role management risk (uncertainty about future managerial decisions) plays in increasing overall firm-wide default risk.

Specifically, the paper argues that “management risk is an important yet unexplored determinant of a firm’s default risk and the pricing of its debt. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover.”

The authors also show that a “similar pattern but of smaller magnitude occurs around CFO turnovers.”

Overall, “the increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management.”

Which means that leverage risk and management turnover risk can be paired.


In some detail, as authors note, “firm’s default risk reflects not only the likelihood that it will have bad luck, but also the risk that the firm’s managerial decisions will lead the firm to default”. In other words, while leverage risk matters on its own (co-determining overall firm risk), it also runs coincident and is possibly correlated with management turnover risk. “Management risk occurs when the impact of management on firm value is uncertain, and, in principle, could meaningfully affect the firm’s overall risk.”

This is not new. Empirically, we know that management risk is “an important factor affecting a firm’s risk. However, the academic literature on corporate default risk and the pricing of corporate debt has largely ignored management risk. This paper evaluates the extent to which uncertainty about management is a factor that affects a firm’s default risk and the pricing of its debt.”

Using a sample of primarily S&P 1500 firms between 1987 and 2012, the authors “characterize the way that the risk of a firm’s corporate debt varies with the uncertainty the market likely has about its management. The basic pattern is depicted in [the chart above]… The announcement of a CEO’s departure is associated with an increase in the firm’s CDS spread, reflecting an increased market assessment of the firm’s default risk. The CDS spread declines at the announcement of the successor, and further declines during the new CEO’s time in office, approximately back to the pre-turnover level after about three years.”

Quantitatively, the effect is sizeable: “the 5-year CDS spread is about 35 basis points (22% relative to the sample mean) higher when a new CEO takes office than three years into his tenure. Spreads on shorter-term CDS contracts exhibit an even larger sensitivity to CEO turnover and tenure. Spreads on loans and bond yield spreads also decline following CEO turnovers. These patterns occur regardless of the reason for the turnover; changes in spreads following turnovers that occur because of the death or illness of the outgoing CEO are not economically or statistically significantly different from changes in spreads in the entire sample.”

Dynamically, the results are also interesting: the process of risk pricing post-CEO exits is consistent with information updating / learning by markets. “The observed decline in default risk over tenure potentially reflects the resolution of uncertainty about management and hence a decline in management risk. …Bayesian learning models imply that if the changes in spreads around CEO turnover occur because of changes in management risk, then when ex ante uncertainty about management is higher, spreads should increase more around management turnover and decline faster subsequently. Consistent with this prediction, our estimates suggest that the increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of uncertainty there is about the new management. For example, the increase in CDS spreads at the announcement of a CEO departure when the firm does not have a presumptive replacement is almost three times as high as when there is such an “heir apparent.” The revelation of the new CEO’s identity leads to smaller declines in spreads prior to the time when he takes over if the new CEO is younger than if he is older; presumably less is known about the young CEOs ex ante so less uncertainty is resolved when they are appointed. But once a younger CEO does take over, the market learns more about his ability from observing his performance, so the spreads decline faster.”

Fundamentals that may signal CEO quality ex ante also matter: “…when the CEO has an existing relationship with a lender before he takes his current job, the lender is likely to know more about the CEO’s ability and future actions, leading to lower management risk. Consistent with this argument, we find that the sensitivity of interest rates to the CEO’s time in office is 39-57% lower for loans in which the CEO has a prior relationship with the lender compared to those without such a relationship. This relation holds even if the CEO is an outsider and the relationship was built while he worked at a different firm, so the existence of the relationship is exogenous to the credit condition of the current firm.”

What about cost of debt and risk pricing? Some nice result here too: “Since uncertainty about management is likely to be idiosyncratic rather than systematic, it theoretically should not affect a firm’s cost of debt (i.e., the expected return on debt). Accordingly, firms should not adjust the cost of capital they use for capital budgeting purposes because of management-related uncertainty. In addition, since variation in management risk appears to be relatively short-term, it is unlikely to affect firms’ long-term capital structure targets. However, since management risk increases the volatility of cash flows, it should increase the demand for precautionary savings. Consistent with this idea, we find that firms facing higher management risk tend to have higher cash holdings. In particular, cash holdings decline with executive tenure, but only for firms for which management risk is likely to be high.”


Overall, an interesting set of results - highly intuitive and empirically novel. One thing that is missing is control for quality of governance within the firms, e.g.
- CSR
- ERM
- Board and C-level quality metrics
Avenue for future extension of the study…

5/5/16: Macro Hedge Funds: Neither a Hedge, Nor a Fund...

Having written recently about the trials of Hedge Funds sub-sector (see http://trueeconomics.blogspot.com/2016/05/4516-talent-is-problem-but-so-is.html), it's worth posting this neat chart from Investcorp showing 12-mo rolling median return to macro strategy HFs:

Yeah, it is ugly. And it has been ugly since around 2012, and structurally non-pretty since the end of the Global Financial Crisis.

But the really, really ugly thing is that the chart above shows that macro hedge funds are now (over post-GFC period) pro-cyclical (or at least not countercyclical), in other words, they hedge nothing macro on the macro downside risks and do not perform well on macro upside. It is as if someone on purpose decided to create a strategy that underperforms the market on positive trends and fails to hedge the market on downside trend.

Any wonder everyone is running out of the hedgies barn?..

5/5/16: Eurocoin signals significant euro area growth slowdown in April

Updating time series analysis for Eurocoin, a leading growth indicator for the Euro area economy issued by CEPR and Banca d’Italia.

In April 2016, Eurocoin reading stood at 0.28, down from 0.34 in March 2016 and marking the lowest reading since March 2015. In other words, leading growth indicator for the euro area is now at its lowest reading in 12 months. Given previous 1Q preliminary growth estimate at 0.6% (q/q growth) from the Eurostat, current level of Eurocoin suggest quarterly growth slowdown to around 0.4%. Since April 2013 (when Eurocoin turned positive for the first time in the recovery cycle), the indicator has been averaging 0.319, which implies April reading is substantially lower than average growth activity over the last 36 months.

Charts:

Charts below highlight impotency of the ECB's traditional policy framework:

5/5/16: THE 2016 Rankings of Irish Universities in one chart

Updated Times Higher Education rankings for top 5 Irish Universities for 2011-2016:

No Irish Uni in top 100 for the 5th year running. Two Irish Unis in top 101-200, for the 5th year running and no new additions to that club.

No comment, but UK folks are concerned about their performance:  http://www.bbc.com/news/education-36203613.

4/5/16: Canaries of Growth are Off to Disneyland of Debt

Kids and kiddies, the train has arrived. Next stop: that Disneyland of Financialized Growth Model where debt is free and debt is never too high…

Courtesy of Fitch:

Source: @soberlook

The above in the week when ECB’s balancehseet reached EUR3 trillion marker and the buying is still going on. And in the month when estimates for Japan’s debt/GDP ratio will hit 249.3% of GDP by year end

Source: IMF

And now we have big investors panicking about debt: http://www.businessinsider.com/druckenmiller-thinks-fed-is-setting-world-up-for-disaster-2016-5. So Stanley Druckenmiller, head of Duquesne Capital, thinks that “leverage is far too high, saying that central banks and China have allowed for these excesses to continue and it's setting us up for danger.”

What all of the above really is missing is one simple catalyst to tie it all together. That catalysts is the realisation that not only the Central Banks are to be blamed for ‘allowing the excesses of leverage’ to run amok, but that the entire economic policy space in the advanced economies - from the central banks to fiscal policy to financial regulation - has been one-track pony hell-bent on actively increasing leverage, not just allowing it.

Take Europe. In the EU, predominant source of funding for companies and entrepreneurs is debt - especially banks debt. And predominant source of funding for Government deficits is the banking and investment system. And in the EU everyone pays lip service to the need for less debt-fuelled growth. But, in the end, it is not the words, but the deeds that matter. So take EU’s Capital Markets Union - an idea that is centred on… debt. Here we have it: a policy directive that says ‘capital markets’ in the title and literally predominantly occupies itself with how the system of banks and bond markets can issue more debt and securitise more debt to issue yet more debt.

That Europe and the U.S. are not Japan is a legacy of past policies and institutions and a matter of the proverbial ‘yet’, given the path we are taking today.

So it’s Disneyland of Debt next, folks, where in a classic junkie-style we can get more loans and more assets and more loans backed by assets to buy more assets. Public, private, financial, financialised, instrumented, digitalised, intellectual, physical, dumb, smart, new economy, old economy, new normal, old normal etc etc etc. And in this world, stashing more cash into safes (as Japanese ‘investors’ are doing increasingly) or into banks vaults (as Munich Re and other insurers and pension funds have been doing increasingly) is now the latest form of insurance against the coming debt markets Disneyland-styled ‘investments’.

4/5/16: Talent Is a Problem, But so Is Financial Services Model

When it comes to talent, hedge funds tend to hoover highly skilled and human capital-rich candidates like no other sub-sector. Which means that if we are to gauge the flow of talent into the general workforce, it is at the Wall Street, not the Main Street, where we should be taking measure of the top incoming labour pool. And here, Roger, we have, allegedly, a problem.

Take Steven Cohen, a billionaire investor hedge fund manager of Point72 (USD11 billion AUM). The lad is pretty good thermometer for ‘hotness’ of the talent pool because: (a) he employs a load of talented employees in high career impact jobs; (b) he tends to train in-house staff; (3) he operates in highly competitive industry, where a margin of few bad employees can make a big difference; and (4) courtesy of the U.S. regulators, he ONLY has his own skin in the game.

Cohen was speaking this Monday at the Milken Institute Global Conference about how he is "blown away by the lack of talent" of qualified incoming staff, saying that it is ”not easy to find great people. We whittle down the funnel to maybe 2 to 4 percent of the candidates we're interested in… Talent is really thin."

His fund hires only approximately 1/5th of its analysts and fund managers externally, with the balance 4/5ths coming from internal training and promotion channels.

The sentiment Cohen expressed is not new. International Banker recently featured an article by a seasoned Financial Services recruiter, who noted that “…many firms are finding it hard to attract the right candidates—and also failing to comprehend the true cost of finding the “right hire”” (see here: http://internationalbanker.com/finance/financial-services-need-put-culture-centre-organisations/).

Some interesting insights into shifting candidates preferences and attitudes and the mismatch these create between the structure and culture of Financial Services employment can be gleaned from this article: http://chapmancg.com/news/thought-leadership/2015/08/three-way-mirror-global-talent-challenges-in-financial-services. In particular, notable shifts in candidates’ culture with gen-Y entering the workforce are clearly putting pressure on Financial Services business model.

2015 study by Deloitte (see here: http://www2.deloitte.com/global/en/pages/financial-services/articles/gx-talent-in-insurance.html) summed up changes in Generational preferences for jobs in a neat graph:

And the business graduates’ career goals? Why, they are less pinstripes and more hipster:

In simple terms, it is quite unsurprising that Cohen is finding it difficult to attract talent. While supply of graduates might be no smaller in size, it is of different quality in expectations (and thus aptitude). Graduates’ expectations and values have shifted in the direction where majority are simply no longer willing to spend 5 years as junior analysts working 20 hour days 7 days a week in a sector that does pay well, but also faces huge uncertainties in terms of forward career prospects (to see this, read: http://linkis.com/constantcontact.com/9JrQd).

Which means, High Finance is in trouble: its business model does not quite allow for accommodating changing demographic trends in career development preferences. Until, that is, the tech bubble blows, leaving scores of talented but heavily hipsterized graduates no other option but to bite the bullet and settle into one of those 5-years long bootcamps.



NB: Incidentally, recently I was a witness to a bizarre conversation between a graduate and a senior professor. A graduate - heading by her own admission into a Government sector job in international policy insisted that the job requires her to be entrepreneurial, 'almost running [her] own business’. The faculty member supported her assertion and assured that she teaches students how to run their own businesses in courses she provides on... international diplomacy and policy. Not surprisingly, neither one of the two ever ran a business.

The hipster haven ideals of ‘we are all so creative, we can run a business from our college dorms’ run deep. And they are not about the blood and sweat of actually running a business, nor the risk of going into the world penniless and earning nothing for years on end while the business is growing. Instead, entrepreneurship for the young is all about perceived fun of doing so.

There will be tears upon collision with reality.

3/5/16: U.S. Recovery: It's Poor, Judging by Historical Comparatives

Recent research note from Deutsche covering the U.S. economy posted an interesting chart on the U.S. growth dynamics since 1980:

The note, of course, makes the point about volatility of the GDP growth in the current recovery not being out of the ordinary. But the average rate of growth in the chart above is.  Which means one little thingy: the average rate of growth is structurally lower in the present episode than in the previous three post-recession recoveries. And that is before we look at the peak-to-trough falls in GDP during the recession which was more dramatic than in any previous recession plotted in the chart. Average rate of growth in the current recovery falls outside the -1STDEV range for two out of three previous recoveries.

So here we have it: recovery is not robust. Not even strong. It is, quite frankly, very poor.

3/5/16: Banks Have Way Bigger Problems Than Low Interest Rates

Almost not a day goes by without someone, somewhere in the media whingeing about the huge toll low interest rates take on banks profitability. This is pure red herring put forward by banks' analysts that have an intrinsic interest in sugar-coating the reality of the banking sector failure to adapt to post-GFC environment.

In its international banking sector review for 2015, McKinsey & Company research (see here: http://www.mckinsey.com/industries/financial-services/our-insights/the-fight-for-the-customer-mckinsey-global-banking-annual-review-2015) briefly tackled the pesky issue of banking sector profit margins and their sensitivities to current interest rates environments.

Here’s what McKinsey had to say on interest rates ‘normalisation’ and its impact on banks’ margins:

Source: McKinsey & Co

Do note that 2.3 bps Return on Equity uplift in the case of Eurozone banks is in basis points, on top of 2014 ROE for Eurozone banks of 3.2%. Which would push ROE to 5.5% range.

Here are the conclusions: “In our analysis, however, even if rates rise broadly – a big if – banks will not do as well as many expect; margins will not jump back to previous levels. Much of the benefit will get competed away, and risk costs will likely increase, especially in economies where the recovery is still fragile. …On average, banks in the Eurozone and the U.S. would see jumps in ROE of about 2 percentage points, but these gains would still not lift returns above COE (Cost of Equity). And as the “taper tantrum” of 2013 showed, the reaction of markets to a change in central bank policy is far from clear; unforeseen problems could easily overshadow any gains from a rate rise.”

So to sum this up:

1) Let’s stop whingeing about poor banks squeezed by low interest rates: these banks face zero or even negative cost of funding which subsidies their unsustainable business model; the same banks are also benefiting from a massive monetary subsidy (low interest rates reduce loans defaults and prolong cash extraction period for the banks prior to loan default materialisation);
2) Even if interest rates are ‘normalised’, the banks won’t be able to cover the cost of equity through their normal operations; and
3) The real reason banks are bleeding profits is because they are incapable of reforming their business models and product offers and are, as the result, suffering from challengers taking chunks out of traditional banks’ most profitable business strategies.

But, more on this in my forthcoming article for the International Banker.