Abe-nomics, Bazookas and Cognitive Dissonance

In modern social psychology, cognitive dissonance is the feeling of discomfort when simultaneously holding two or more conflicting cognitions: ideas, beliefs, values or emotional reactions in your mind at the same time. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by altering existing cognitions, adding new ones to create a consistent belief system, or alternatively by reducing the importance of any one of the dissonant elements.

Source: Wikipedia

Following last week’s announcement by Bank of Japan Governor Kuroda that it will “do anything it can” to get Japanese inflation up to 2%, JPMorgan said in a communication that the Japanese, European and U.S. central banks are now in the same camp when it comes to monetary stimulus. The JPM economist who provided that assessment is undoubtedly well-remunerated, being in the regular habit of taking obscurantist developments and putting them in language that his less erudite bosses find comforting, easy to understand and easy to pass on as Gospel to the bank’s clients and investors.

In fact, based on actual statements made recently by these various central banking institutions, it seems that nothing could be further from the truth.

In January, Bloomberg blared the headline “Bernanke Dissatisfied With Growth Will Press on With QE Pace”. The Fed seems to be expecting growth and NOT inflation to be the result of its QE program.

Based in his recent comments ECB Governor Draghi is also focused on pushing a form of QE in the hopes that Euro-Zone Growth can recover to a more stable and higher growth path.

However, in contrast, the BOJ is hoping for inflation, and not growth. The specifics are simply that Governor Kuroda announced plans to double the BOJ’’s monthly bond purchases and achieve 2 per cent annual inflation within the next 2 years. This follows the smaller-sized, though entirely similar, expansionary policy that in the last two years has caused the Yen to fall almost 20 percent against the majors. Only the Venezuelan Bolivar and Malawian Kwacha have fallen by more over the same period.

The reality is that over the last 4 years one of the most enduring fictions promulgated by the authorities and their handmaidens on 19^th Street, is that central bank money printing and central government pump priming will act together to generate self sustaining growth in the economies hit by the Global Financial Crisis. This is an elaborate fantasy on which we have commented before.

There is in fact no amount of funny money and deficit finance that can steer things back onto a sustainable path unless the obstacles to growth and recovery are removed. All of the serious economic research and actual economic history that we have reviewed supports this central truth.

And now we have evidence that the world’s central bankers do not even agree on what it is possible to achieve through QE.

Is it inflation or is it growth??

This is like asking you if the objective of your exercise regimen is to gain more muscle or more fat and you actually believe that you can achieve either by following the same plan.

The real reason for the QE being pursued in the various economies of the G7 and the Euro-Zone is that Government finances in certain key countries are hemorrhaging and that this is interfering with the ability of certain Governments  to even keep up the pretence that financing requirements can be funded in the normal course.

As such the latest BOJ announcement is a sign of weakness and cause for concern rather than renewed hope. The markets which rallied on the news have got it wrong.

Source: The Japan Times

Beyond this, there are additional problems and concerns specific to the just announced Japanese policy update. For example

• Financial Policy. THis latest policy wheeze is nothing more than another salvo in an ongoing currency war. Therefore it is only likely that Japan’s trading partners will pressure the Government there to slacken their efforts to weaken the Yen in order to preserve their own growth prospects. This could lead to international tensions over economic policies;
• Monetary Policy Flexibility. The BOJ has been expanding its QE more aggressively than either the the FED and ECB, burdening its balance sheet with riskier assets and making even the possibility of an exit from this policy nothing more than a wistful fancy;
• Investor and Consumer Behavior. The QE policy distorts price signals; obscures the risk and risk/reward properties of investments; penalizes savers at the expense of borrowers (The Government being the biggest with the biggest interest tab. See above.) and encourages mal-investment;
• Starting Point Risk. This policy does not sufficiently take into account the very serious structural problems in the Japanese economy which have hampered growth and resulted in deflation. These include, most importantly the failure to properly remediate weakness in bank balance sheets, the effects of an aging population, including waning tax receipts; and the fact that Japan already has the largest (and effectively unsustainable) debt load on the face of the planet;
• Re-entry Risk. Monetary Policy implementation is a very uncertain process and the transmission mechanisms and relationships are not stable or predictable in even the medium term. There is no plan, no way to reverse what is being proposed, not in Japan, not in Europe and not in the US. If these policies do act on inflation and money demand drops as the policymakers wish, then it may trigger a self reinforcing bout of price  inflation that (a) will be hard to control; (b) will cause a variety of easily anticipated economic problems, and (c) very likely create new unanticipated problems, stresses and conflicts relating to the policies of competitive devaluation that are being pursued.

Of course we are sure that the policy wonks at the BOJ (and the FED and the ECB) are completely aware of the dangers and problems regarding their policies and of which we write. It is just that they cannot muster the intestinal fortitude, leadership and political will to opt for a solution that does not amount to a combination of bargain basement wallpaper, cheap glue and a snappy sales patter.

Therefore, at this juncture it is of only one thing we can be certain: if there is a limit to “safe money printing” (as if this term is not an oxymoron in and of itself), then the current set of central bank incumbents seem dead-set on finding it.

“…nobody is qualified to wield unlimited power.”

Friedrich von Hayek, The Constitution of Liberty, 1960

Posted in Bank Loans, Banks, Crisis, EU, Fed Policy, IMF, Restructuring, USA | No Comments »

The Limits to Austerity

“An emphasis by bankers on the collateral value and expected value of assets is conducive to the emergence of a fragile financial structure.” Hyman Minsky, Stabilizing an Unstable Economy (1986).

More than 25 years ago the famed American economist Hyman Minsky postulated that financial stability would be weakened when lending in the economy became excessively dependent on the value of the underlying collateral rather than the income-earning potential of those same assets. In recent years his theories, this one included, have been vindicated by real world examples time and time again – the most obvious instance of a credit system run amok and dependant on rising asset prices was Japan in the Postwar period – everything was linked to real estate. They are still sweeping that one up….and even after more than twenty years of failure, most people in that economy remain oblivious to the incompetence of their bankers, policymakers, and government officials that led the country into the abyss.

Today in Europe (and elsewhere) we are witnessing the compounding of policy mistakes made not so much strictly in advance of the recent GFC (Global Financial Crash) but in the months and years since its sudden onset in 2008. These mistakes centre on a belief by the authorities that everything would be all right if collateral values just picked up, and their unshakeable conceit that what they have done and what they are doing to remediate the damage done by the crisis in this way is safe, efficient and correct.

In the face of it all, job prospects, particularly for Europe’s youth have worsened; plant closures have run apace, workers benefits have suffered, pensions and social services have been cut; yet the European economy remains stuck in neutral.

Last week for example thousands of workers again took to the streets to demand an end to the austerity measures that have seen a number of European countries wracked by social, strife, high unemployment, and despair. Most of the Euro-zone economies have remained mired in slow or negative growth mode for almost three years. With 26 Million out of work across the EU and the Eurozone registering its sixth consecutive quarter of negative growth, ordinary people are coming to the obvious conclusion : “….these policies do not work”.

In January, even the IMF got into the act by proclaiming that its austerity-based policy prescriptions may have been erroneous and could in fact be making things worse.

So its fairly easy to conclude that last week’s EU summit wasn’t exactly a warm and fuzzy family barbeque type of scenario. In fact the most recent set of meetings was probably the 250^th get-together involving politicians and government officials since the crisis began.   All of these jamborees have passed without a positive, workable solution to the crisis being tabled, much less implemented.

Last week was no different: Again, the usual platitudes were served up; accompanied by the usual hand-wringing from Europe’s brightest and best minds. No specific policies were discussed much less adopted that would have been aimed at steering away from austerity; and, importantly, there was no nod from  Germany and its po-faced representatives that they would in fact countenance such proposals if they were in fact seriously put forward.

The Vatican that is not the only Global Institution that is stuck in a rut!!

Artist: Jeremy Nell, The New Age, South Africa  -  3/15/2013

Moreover, we have said from the beginning that pursuing austerity policies in an effort to right the ship was a VERY long shot at best. In fact this interview from 2010 sums up our views on this matter quite neatly. In the intervening period since that segment aired it has also become obvious that there are a number of headwinds that are blunting the impact of aggressive expansionary policies. These factors are additional important reasons why the economies of the European countries (as well as those of the US, Canada, Japan) cannot seem to find any traction in generating growth significantly above “stall speed” despite the policy impetus:

• Government Debt loads have increased a lot and this has reduced policy flexibility while eating up revenues of cash strapped Governments;
• Rapidly developing demographic factors promise to chew up Government finances at both ends: lower tax revenues as people retire accompanied by higher pension, social assistance and health-care payouts;
• Basel III capital rules and other regulatory requirements are contractionary;
• Austerity has prompted significant increases in rent-seeking behavior and tax evasion;
• Financial repression has cut savers’ incomes and contributed to yawning pension shortfalls.
• There is more…….in fact the biggie is:

…….The Restructuring Deficit

For some time now it has been obvious that there have been no real attempts made to recognize, write down and remediate losses that occurred in the immediate wake of the GFC. In fact the entire focus of the policy response has been to avoid doing just that and to instead try and engineer a re-appreciation of collateral values in the economies so that investors, lenders and other creditors can see their asset exposures skate back onside.

“No Pain” is the Objective.

“Financial Repression” is the Name of the Game.

Unfortunately, these policies are not only delivering “Max Pain” for everyone but the creditors; they are risking the welfare and social peace of today’s generations of Europeans.

Under capitalistic forms of economic organization, Banks must ordinarily be held accountable to deal with their distressed credits promptly and the public balance sheet must not be used to subsidize bad risk decisions nor to prop up zombie companies at public expense and to the ultimate detriment of employees, taxpayers and other more efficient and productive entities.

However, this departure from the norm in order to favor creditor interests is exactly what has been happening.

These policies of Financial Repression have been followed before. The most obvious examples are failed communist states many of whom had to abandon the experiment over twenty years ago with the fall of the Berlin Wall and more recently, hyperinflationary Zimbabwe. Some examples in the developed economies include New Zealand in the late 1970’s / early 1980’s before the 1984 collapse and Germany in the immediate Post WWI “Weimar” period. In every instance, the outcome of these episodes was negative. Today, the Europeans (and  North America and Japan) are conducting policies of Financial Repression in a variety of formats.

The negative effects of these policies include restrained GDP growth, distorted asset markets, a drag on productivity, hidden credit risks, moral hazard, risk of higher inflation, misallocation of resources, destruction of savings, financial contagion and a de facto “theft” of market share and profitability from successful, non-zombie businesses. This has been accompanied in the austerity countries and many others in Europe (e.g. the UK) by rapid increases in debt levels.

Rising levels of debt may not be the only cause for alarm; particularly when one considers that they are accompanied by a single-minded focus to raise asset and collateral values. In those situations, (such as now) financial structures can become extremely precarious. This is because leveraged asset positions may not always generate enough spread revenue to either service or repay the debt. As a result, and according to Minsky, the financial system can become increasingly vulnerable to what would otherwise be relatively innocuous events, such as a small rise in interest rates or a decline in asset prices.

Italy 10 Year Bond Yield

As just one example in this regard, please note that prior to EMU, Italian bond yields were in the range of 11% and the Italian Treasury quite happily financed their deficits without any concerns. To compare, in today’s market a sustained rise in Italian yields above 6% would spell “Game-Over” for their economy – and for that of Europe.

Fascism on the Rise

A further non-trivial concern is that ominous storm clouds are forming over the European political landscape in reaction to the authorities’ tin-eared and single-minded focus on the solutions, inappropriate as they are, that they have been pursuing with vigor but with so far, none of the intended effect. Because of this, mainstream political parties are under pressure in many major Euro-zone countries. In Greece the far right parties’ membership comprise most of the police and security forces and have been rising in the polls. The Jobbik fanatics in Hungary are proposing a roll-back in social freedoms inconsistent with the EU Charter. Spaniards are trying to cope with secession risks and extremely high youth unemployment. The rise to prominence of Beppi Grillo’s Party in the recent Italian elections is being soft-pedaled by the mainstream media with the byline that “he is a comedian”. He is anything but. A cursory look at his website reveals hundreds of Anti-Semitic comments, diatribes and attacks while, at the same time, it shows him to be singing the praises of the fanatics that are running Iran, looting its Treasury, oppressing its people and exporting terrorism. Grillo’s party looks to be next in line to govern Italy.

It is worth remembering that Hitler and Mussolini were both elected by folks who didn’t want austerity

Unfortunately it seems that for now, the Brussels crowd is happy to be dancing on the edge of the volcano and, that nothing can convince them to take a less risky and saner path to recovery.

Posted in Bankruptcy, Crisis, EU, IMF, Loan Losses, Restructuring | No Comments »

La Ligne Maginot

The Maginot Line, named after the French Minister of War André Maginot, was a military defensive construct consisting of a deep line of concrete fortifications, tank obstacles, artillery casements, machine gun posts, and other defenses, which France constructed along its borders with Germany and Italy, during the interwar period between WWI and WWII.

Military experts extolled the Maginot Line as a work of genius, believing at that time that it rendered France impregnable against invasion from Germany. In the event, while the fortifications successfully acted to dissuade direct attack, they were completely ineffective from a strategic military standpoint. This obvious defect was laid bare at the beginning of WWII when the German Blitzkrieg easily outflanked the Maginot Line by moving through the Ardennes forest and Holland, completely sweeping past the heavily defended fortifications and conquering France in less than six weeks. Although constructed at huge public expense and using the best minds and materials available at the time, the Maginot Line has heretofore become emblematic of any plan or announced remedial strategy that people hope will prove effective but instead fails miserably.

When Lehman Brothers was sent to the knacker’s yard by its street rivals at Goldman Sachs and Morgan Stanley following closed door sessions with Government officials during the summer of 2008, the Best Minds on Wall Street and Constitution Avenue thought that they were protected from the fallout of a mega credit event by their risk management models and counterparty legal arrangements that included margin requirements, collateral postings and mark-to-market protocols. In fact with all major counterparty banks in place and able to continue functioning as market participants, the effect of the mega crash could have been contained, minimized and worked out. Before Dick Fuld and his management team was sent to the proverbial gibbet, the preponderance of derivatives contracts and exotic securities positions could have been settled out in a reasonably orderly fashion over time. However, with Lehman out of the way, the “netting” of derivatives and other exposures between institutions could no longer take place and someone had to step in to buy up the toxic waste that resulted from the abrupt halt to the “pass the hot potato game”. With Lehman out of the loop, the toxic waste had to end up on “someone’s” book.

The consequential effects of the secondary detonations in the securities and derivatives markets in the US following the demise of Lehman unleashed a wave of re-rating of sovereign risk which fell primarily onto the Europeans, who more than a decade ago had abandoned their treaty-bound commitments to fiscal probity and restraint in order to consummate a flawed monetary union riddled with institutional shortcomings and massive governance problems. “Someone” had to prop up Government Finance in the Euro-zone in order to give the pretence that things were still manageable or all of the banks there would have gone down the gurgler.

The “someone with the hot potato” in the US is the Fed which since the event has been mainly concerned with somehow papering over the losses, minimizing them, and possibly inflating them away. In Europe, the “someone” is the ECB which has under the prodding of its client institutions been stretching out the remediation process in order to dragoon the taxpayers of the various Euro-zone countries to shoulder the load of bailing out greedy banks and their profligate government clients.

The story of the Global Financial Crash is far from over. Nothing has been solved; and as we have repeatedly stated in our interactions with the public through speaking engagements, or on TV, or in the press, the policies that have been implemented so far have simply narrowed the degrees of freedom for future policy steps while at the same time increasing the likelihood of negative unexpected consequences being visited on markets (potentially with a heretofore unseen ferocity).

There are therefore still a few more chapters to play out in this unfolding narrative.

The present chapter opened around three weeks ago when, after a sleepy summer where nothing much happened, ECB President Draghi announced that he was going to do “whatever it takes” to save the Euro-zone and support the bond markets of all the deadbeat Euro-countries through central bank purchases of bonds (something that only a year ago had been definitively ruled out). At the time, most pundits fell into line and proclaimed that this “brilliant” move had effectively ended the crisis and all risk assets rallied sharply.

Since then, reality has set in. In fact, Draghi can no more proclaim to have unlimited resources to solve Euro-Crisis that he can claim to be able to solve world hunger. As we have said repeatedly in the past the democratic fact is that voters in the affluent Euro-core are not going to go for what these solutions imply. Moreover as the ECB expands its balance sheet “without limit” the credit quality declines and the risk profile of the ECB shareholders correspondingly increases. The expansion at Europe’s Central Bank is off-set with a deterioration of the national credit quality of the nations so that the entire construct sets itself up for the possibility of being further downgraded. We pointed this obvious flaw in this strategy out on the air around a year ago.

To complicate matters further, most securities analysts have been paring back earnings forecasts and published data has turned rather negative. In fact over 80% of the world’s manufacturing capacity is now in contraction.

On this side of the pond we were treated to Dr Bernanke going “All-in” with his open-ended commitment to print money through QE3 (an event that we have been predicting since QE1 was announced ). Without belaboring all of the issues, we have with Mr Bernanke’s implied claims that he knows better that the markets what interest rates should be and how capital and lending flows need to be directed at a particular point in time; let us just examine a small example of his fatal conceit that we have drawn from the speech he gave yesterday in Indianapolis.

“The securities that the Fed purchases in the conduct of monetary policy are held in our portfolio and earn interest. ……. Ultimately, the securities held by the Fed will mature or will be sold back into the market. So the odds are high that the purchase programs that the Fed has undertaken in support of the recovery will end up reducing, not increasing, the federal debt, both through the interest earnings we send the Treasury and because a stronger economy tends to lead to higher tax revenues and reduced government spending.(Page 7)”

While Dr Bernanke so glibly proclaims that “the securities held by the Fed will mature or will be sold back into the market” as if this operation was some kind of benign voodoo magic with no real-world consequence, we would ask the good Doctor what will happen to the issuing institutions whose securities are “maturing” on the Fed’s books? Won’t these notes have to be re-financed to support asset positions or ongoing activities at the borrowing institution? Who will conveniently show up to buy this re-issued paper in the amounts that the Fed has so done in the past, and, more importantly, at what price?

This is debt management 101.

In deference to the esteemed Fed Chairman, we will only ask one more question that flows from this fantastical description of his policy: If this is the magic bullet, and printing money actually reduces debt painlessly as you so describe, then why have we ever bothered with trying to do things any other way?

Now, after having read his speech yesterday and having managed to regain cognitive equilibrium, we offer on sober reflection that the ECB and Fed policy announcements boil down to acts of desperation that are now, so shortly after being introduced, becoming obvious to the markets. Market participants know that all they have to do is wait for the cracks to appear before pouncing and bleeding the central bank players for significant trading profits.

The bottom line thus is that all Draghi and Bernanke did with their “Big Bazooka” announcements is buy some time, much in the same way that the French Military planners bought some time in constructing the Maginot Line before the German Military planners found a way to beat it. The only question is, “How much time have they bought?” Our expectation is that within a few short months, the ECB and Fed policies will again fail to prove equal to the task. Unfortunately the two biggest central bank players in the world have gone “All-in” on a policy which amounts to an ill-advised high stakes game of poker with the markets. There can be no retreat now.

This is the worst position a gambler can be in because it exposes their strategy to significant event risks and unanticipated outcomes.

The next card that is dealt could in fact blow the hand that they are jointly holding completely out of the water.

Postscript: A little known fact is that the Maginot Line and the Federal Reserve Building in Washington DC were both completed in the same year: 1937, during a period in history when failed financial policies and regional hostilities were driving the world towards catastrophe. In the just two short years following, there ensued an outbreak of general hostilities that led to WWII which brought with it global privation, outbreaks of disease, the directed mass extermination of ethnic groups, the mentally challenged and LGB populations; the first detonation of nuclear devices over heavily populated areas, the forced resettlement of hundreds of millions of people and the death of tens of millions.

Posted in Bankruptcy, Banks, Crisis, EU, Fed Policy, Gambling, IMF, Loan Losses, Restructuring, Sovereign Debt, USA | No Comments »

There is No Altruism Between Nations

Somebody should have referred to the title quote before the EMU was launched on a hope and a prayer only 13 short years ago. Yesterday we were again interviewed on the Euro-crisis as that event took another turn for the worse and continued its torturous progress towards what now seems increasingly likely – an uncontrolled dissolution of parts of the Grand Experiment.

Today we heard that Euro politicians are drafting federal plan to save the Euro-zone, that Moody’s has downgraded 28 Spanish banks, that a fellow named Yannis Stournaras has been named as Greece’s new finance minister, but also that the Greek Deputy Shipping Minster has resigned. And…wait, let’s not forget that Silvio Berlusconi has just thrown his hat into the ring to be Italy’s next Minister of Finance…You win some, you lose some.

Hope now fixes on the upcoming Euro-zone meetings this week. Euro-zone finance ministers are expected to hold a conference call tomorrow to discuss Spain and Cyprus’s requests for financial help, and there will inevitably be a lot more posturing ahead of the EU Summit scheduled for this Thursday and Friday

Again there are calls for Germany to take on the mantle of leadership and somehow bail everyone out. So far the Germans have been balking at calls for an end to the austerity push, to support the unification of fiscal policies and the issuance of jointly guaranteed Eurobonds and for the creation of an EU-wide deposit insurance mechanism. The problem with this view, that if only Germany were to change its stance, and then everything could be easily solved, is that it is naive in the extreme.

As I mentioned during the interview, even if Germany were to agree to all of these Grand Plans, the structural imbalances that gave rise to the crisis in the first place will not be resolved, economies will not resume growing, and a new crisis will rear its head in short order. Quite simply the periphery countries have a productivity disadvantage relative to Germany and also have uncompetitive wage structures relative to the Northern Europeans. This cannot be easily “patched”.

Moreover, we also know that in order for Germany to agree to such modifications to its membership in the EMU, it requires the Government to hold a public referendum on all of these changes. We also know that an overwhelming majority of Germans are not in favor of these new policies which see them subsidizing the zombies. (In fact, a recent poll showed that 69% of Germans want the Greeks out of the Euro)

Isn’t it time for the leadership of Europe to start talking about solutions that are actually possible instead of fantasizing about magic bullets?

Isn’t is time for the Europeans to stop the madness of throwing vast sums of money at what is in effect a bad trade?

"Quick operator, gimme the number for 911!!"

What Europe has needed from the very beginning is a reckoning and write down of the bad debts. They are on the books and won’t go away no matter how many policies are changed and how many bailouts are doled out. This “avoidance of loss recognition” has been the central aim of the bailout policies from the beginning. As we can now easily see, clinging to this strategy is causing a worsening of the loss position, causing a loss of confidence and contagion and promises to only increase the eventual size of the financial hole. This is being pursued nonetheless in the faint hope that the losses can avoided or pushed onto third parties that had no hand in manufacturing the crisis in the first place.(The taxpayers of other countries and future generations)

The only certainty that we now see regarding this miserable state of affairs is that there will be massive losses and that the eventual bill when it comes due will be much, much larger than it would have been two years ago when there was still a chance to nip this thing in the bud. Let us hope that that is where the similarities of our present condition with the 1930’s will end.

Posted in Bankruptcy, Banks, Bond Market, Crisis, EU, Restructuring, Sovereign Debt | No Comments »

The “Restructuring Deficit”

Financial Repression is being implemented by Monetary and Financial Authorities in many developed economies. The specific measures range from overt manipulation of traded markets, acquisition of toxic assets at off-market prices, an aversion to implementing needed restructuring of bankrupt entities, through to indirect forms of intervention such as we are witness to in Canada. The short term consequences of these types of policies include restraining economic growth, employment and productivity. Longer term consequences include inducing a greater predisposition towards inflationary policies by the monetary authorities, loss of competitiveness, moral hazard, below potential GDP growth and depressed rates of capital formation.

The Canadian Experience

In Canada so far our Central Authorities have refrained from overtly intervening in markets as noted above. That job has been left to the Crown Corporations. The Economic Action Plan announced in 2008 provided the Crowns with additional capital and a mandate to use that capital to support Small and Medium sized businesses in Canada (SMEs). Since then the Crowns have made no secret of their extended mandate.

Thus, one need not look far to find evidence of this “stealth bailout”. In Canada we have seen rapid increases in personal bankruptcies that mirror the weakness in the jobs picture and the cost-cutting efforts of many firms desperate to remain in business. Also, the number of personal bankruptcies has escalated rapidly, consistent with the scale of job losses in the early stages of the GFC. However, on the business side of the coin, the situation in Canada reflects the perverse nature of this stealth bailout. This is the fact that since the onset of the GFC the business bankruptcy statistics are not telling a tale of undue financial stress. In fact, the latest twenty four months of data show that the incidence of corporate failures in Canada has actually gone down! The data show that there were 38% fewer bankruptcies coast-to-coast in the year to October 2011 than  2007 just prior to the GFC.

The “Pig in the Python”

At the same time according to the chart, at the peak in 2010 there waa an almost foufold increase in Gross Impaired Loans (GIL) in Canada. In 2011 the GIL numbers were still almost three times higher than in 2007 and prior to the GFC. Yet, corporate bankruptcies have gone down! Moreover, if you speak to them most insolvency professionals report that business has been at it lowest ebb that they have seen over their entire careers! A number of Canadian restructuring firms have sharply cut back staff, gone out of business or have otherwise greatly curtailed their operations. Per the above-noted chart the chief cause is that the banks are not reprocessing their NPL assets in a manner consistent with past cycles and have instead been exercising extreme forbearance.

The bottom line is the fact that a large volume of restructuring that would have normally been expected to occur on the wake of the Global Financial Crisis (GFC) in 2008/2009 has simply not occurred.

Quantitative Analysis

The statistical records on corporate failures in Canada that have been maintained by the Superintendant of Bankruptcy extend back almost sixty years. The behavior of this time-series is akin to that of a step function. Historically there has always been a sharp increase in the incidence of corporate failure in the immediate aftermath of an economic slowdown or recession. This relationship has held up through numerous cycles up to, but not including the GFC. And, in looking at past cycles, the increase in the failure rates on a twelve month moving average basis was at times as high as 60% peak to trough.

The past decade has seen three distinct phases of restructuring activity in Canada. Between 2000-2003 in the wake of the Telecoms, Internet and Media bust, Canadian banks resorted to bulk sales to divest themselves of unwanted assets and distressed files. Two of the more motivated banks in this regard were CIBC and the TD. Then, between 2004-2007 the bulk of off-strategy and distressed files  were pieced out by way of bilateral loan sales to leveraged loan funds that were relatively credit and price insensitive. Both of these periods saw significant levels of activity where banks were actively repositioning credit risk in their portfolios. Following that and since 2008, and up to the present, there has been very little activity despite a sharp run up in Gross Impaired Loans balances. There has been a corresponding lack of activity in business failures and active restructuring of loan files.

To examine the history further we have used three quantitative approaches to estimate a possible shortfall in the number of business failures that have occurred since the GFC:

The first test we ran tested the null hypothesis that the distribution of failures before the GFC had the same statistical properties as the distribution of failure events following the GFC. The results here show that it is not possible to reject the hypothesis that the distributions are different. This provides some statistical support for the contention that we are in a different behavioral phase with bankruptcies and corporate restructuring in Canada now relative to what went on before the GFC.

We then used two other methods to drag some more information out of the data set. The objective of both tests was to try and determine if the level of business failures that we have experienced in Canada since the GFC is “unusually low” and is so by how much. In summary this exercise suggests that there is at present a “restructuring deficit” of between some 6,000 and 13,000 businesses that could have been expected to have gone bust in the last three years but did not (This translates into between approximately one-half to one percent of all SME businesses in Canada). Translating those figures into potential monetary exposures Recovery Partners estimates that there are at least $20 to $30 billion of loan-related charge offs and or restructuring candidates that are bottled up on chartered bank balance sheets and elsewhere.

Zombie finance works only once. At the time this strategy was implemented the expectation was that the significant stimulus that was pumped into the economy would have resulted in a fairly rapid pace of recovery. In turn this would have refloated the businesses that were underwater allowing them to return to profitability and pay down their debt. This clearly has not happened. And, it is unlikely that the old zombies will be able to pull off another rescue financing particularly if the economy continues to grind along at a low rate of expansion or if it falters and maybe another downturn works its way into the mix.

A Rising Default Environment

A number of macro-economic factors affecting credit markets worldwide, including in Canada, suggest that all credit markets are entering a rising default rate environment. Both US and Canadian consumers are beginning to exhibit substantial signs of spending fatigue simultaneously with a significant, and accelerating, renewed softening of residential real estate markets in the US — the source of a substantial portion of consumer spending and employment growth in the last decade. Moreover the widening crisis in the Euro zone has already knocked EU growth for a loop as a recession is now expected there. The inevitable contagion will likely lead to confidence problems in North America as well threatening a more protracted slowdown here as well.

Therefore, for the banks, time is running short. Further cracks are appearing in the banking system and the economy and the authorities cannot stop them from spreading. In fact our views on the Stress Tests reflect the opinion that the problems in the banking system are far from having been properly resolved. In the US, in aggregate, banks remain significantly undercapitalized. Moreover, numerous US Banks that have earlier qualified for TARP funds now have more toxic (Level 3) assets on their books than before the financial crisis began. Other areas of concern include credit cards, commercial mortgages, and of course the fact that anecdotal and other evidence continues to reflect an anemic US economy whose consumers are tapped out and who have either fallen into unemployment or under-employment in vast numbers, where a substantial portion of the housing stock is under water, and whose Government is in a deepening fiscal hole.

In Canada, the situation may be even riper for a downturn in the credit cycle, especially in the export sector. The Canadian dollar has appreciated against the US dollar by more than 40% substantially eroding profit margins for Canadian exporters. For many of the banks as well, it is a case of “they do not know what they do not know”. Quite simply this means, that because of the distortions caused by zero interest rates, the lax forbearance practices and easements in lending covenants and loan servicing, many banks cannot today reliably identify all of the zombies and at-risk obligors in their portfolios. There is thus a substantial recognition lag built into the required solution to this problem.

Should the economy slow from here or enter a recession, institutions that hold large quantities of bad or deteriorating credits that have hitherto been slow in dealing with these exposures will find themselves competing against each other to unload or otherwise cope with these problems. Moreover, to existing exposures we have to add the new zombies that will have gone to ground because of continued weakness in overall activity.

This article is an abridgment of a longer research piece written by Alex Jurshevski, Managing Partner of Recovery Partners with research assistance from David R Fine, Director Credit Asset Management at Recovery Partners and appears in the January 2012 edition of Canadian Hedgewatch

Posted in Bank Loans, Bankruptcy, Banks, Canada, Crisis, Loan Losses, Restructuring, USA | No Comments »

Frau Merkel, Just Say “Nein”!

“Was fällt, muß man nur noch stoßen”  Friedrich Nietzsche <PgDn for translation>

Dear Madam Chancellor,

This week will likely mark a critical turning point for Europe. The seriousness of the situation is underscored by the fact that this Euro-summit will also be attended by participants from the US Administration, the IMF and other third parties not normally seen at gatherings of the Eurozone political leadership.

You alone among the Euro leadership have consistently understood and have attempted to communicate that we should stop kidding ourselves that this crisis can be solved without a lot of pain.

By this point it should be clear that the tried and tested solutions for dealing with insolvency and default must be pursued. This means that Europe needs triage and restructuring, not additional “can kicking” and “monetary fakery” as some would suggest.

It also means that the “incremental” approach followed in the past 3 years has not only failed, it has become extremely counterproductive, and must be replaced by an action plan that features decisive and rapid action that will offer markets a clear roadmap to recovery.

For the negotiations that are upcoming the choice therefore is clear: you must either (1) lead Germany (and Europe) down a path of delusion and pain, submitting to the “funny money” Brussels elites who are calling for bond buying and money printing and inflicting significant cost and suffering on the peoples of Northern Europe (Germany and France being the key players) who have not over-borrowed or otherwise badly managed their economies, in order to bail out certain other nations who have done just that; all at the risk of huge expense yet with no guarantee of sustainable success; or (2), you must lay the groundwork for an orderly restructuring of the Monetary Union, which will see certain nations leave the Euro-zone (Greece, Ireland, Portugal, Spain; with Italy remaining within the EMU as a possible “Associate Member”), so that these exiting nations might catch their breath and recover. Accession plans for other nations would be put on indefinite hold.

Do not listen to the Brussels elites that believe that the problems can be papered over in the same fashion that US policymakers believe that they have done in the US. These types of gambles have never worked and inevitably have led to worse problems. It is a tacit axiom of international relations that there is no “altruism between nations” and therefore no legal, moral or ethical principle exists that would suggest the profligate countries should continue to benefit from the largesse of their neighbors at whatever the cost and without sanction. Now is the time to restructure out the countries that are not suited to, or capable of, following the fiscal and monetary discipline required as per the agreements they acceded to when they entered the Eurozone. Contrary to the advice that you may be offered by others connected to this situation, the plans for fiscal union and the role of the ECB should be sorted out after the membership structure has been adjusted. Moreover, in order to exit the crisis there is absolutely no need to add to the powers of the ECB.

There are some who say that breaking up the Eurozone would be an expensive mistake that Europe cannot afford. We say it is a course of action that Europe cannot afford not to take. There are political as well as financial reasons for this.

Following reunification Germany had a period of adjustment which was expensive, painful and lengthy. Your recent elections have shown that the German people do not want to see these sacrifices and achievements squandered. In fact, most of your neighbors are fully supportive of your policies during the recent crisis period and are looking to Germany to supply continued reasoned and reliable stewardship of this situation.

This crisis and the crisis in the United States are evidence that the West is wounded and its way of life is at risk. That means repairing (not bailing out) the financial system and insolvent countries quickly as possible. Therefore any plan that promises to restore stability at a minimum of risk and cost should be greeted favorably by all Europeans, Americans and their allies. Already too much time and money has been squandered pursuing unworkable solutions aimed at preserving some kind of idealistic and now unattainable, “status quo ante” in the Euro area.

The US should be in favor of this for that very reason, and also because a festering crisis in Europe imposes strong headwinds on the fragile growth potential in the United States, restraining activity and complicating the job of economic management there. The same is true for the UK. And the same should be true of the Euro-zone countries now under financial pressure and having to deal with austerity programs without the ability to devalue the currency that they use. In the latter case it is extremely unlikely that the austerity programs will bear fruit before a time bomb of social upheaval and popular discontent explodes and drives these nations even further into chaos.

Caption: An anti-austerity protester holds a placard with the Greek flag and swastika reading "NO to the 4th Reich" after a student parade in Athens, on Friday, Oct. 28, 2011. The student march, in commemoration of the 71st anniversary of Greece's entry into World War II, went on without major incident, but in other cities officials were heckled and in Thessaloniki, Greece's second city, a military parade was canceled. They also wrote “1941-2011 The enemy is the same”. Some shouted slogans “Germany Out from the EU”. (AP Photo/ Thanassis Stavrakis)

Europe is no stranger to currency crises. We saw enough of those throughout the 1970’s, 1980’s, and 1990’s. With the exception of the UK in the 1970’s the IMF has never before intervened in European affairs. This crisis is a European problem, and there is no strong rationale for IMF lending under the existing IMF articles. In fact the IMF does not even have sufficient resources to render any offer of assistance credible. Moreover some of the less wealthy members of the IMF would begin to register legitimate complaints about co-opting the IMF to bail out large wealthy nations. Europe has lots of money and no balance of payments problem. The Euro is a reserve currency. You and your country can do a lot to fix this problem, and using the Bundesbank, the German Treasury and the ECB, you can do everything that the IMF can do.  We are sure that the very experienced people on 19^th Street in DC understand the difference between a bad risk and a good one, know that they have scarce resources, and would welcome the chance to step aside.

Part of the costs will be the default of the Greeks, Irish, Portuguese and the Spanish and possibly the Italians, and needed bank recapitalizations in those economies and for banks in other Eurozone countries. The costs for the leavers can be estimated by looking at past crises. According to the IMF which has examined  over 100 currency and banking crises, the data show that for countries that have experienced a banking and a currency crisis (the most severe combination of adverse events) that the average output loss is about 18.8 percent, and that the average time to full output recovery is around 2.6 years. The Eurozone problem countries have already experienced these types of losses in the three years since the crisis descended upon them, but there is no recovery in sight. On the present course there is also no end game, no guarantee that the bailouts will prove successful and no estimate of the final bill.

Your national treasure will be better spent on a program of triage and recovery accompanied by the needed reforms to the EMU beyond the exit of the wayward countries. This combination of measures will deliver finite costs within a reasonably finite timeframe and, we believe, will ultimately prove politically palatable to the peoples of Europe and their neighbors.

Who knows ….if you can pull this off, one day a re-energized, institutionally more robust and better managed Euro might supplant the USD as the Number One Reserve Currency for the world.

Best Regards and Good Luck,

 

Recovery Partners

——————————————————————– 

Frau Merkel, sagen Sie einfach “Nein”!

“If you see anything that is falling, give it an extra push for good measure”  Friedrich Nietzsche

Sehr geehrte Frau Bundeskanzlerin,

Diese Woche wird wahrscheinlich markieren einen wichtigen Wendepunkt für Europa. Der Ernst der Lage wird durch die Tatsache, dass diese Euro-Gipfel wird auch von Teilnehmern aus der US-Regierung, dem IWF und anderen Menschen in der Regel nicht bei Versammlungen der Eurozone politische Führung gesehen besucht werden unterstrichen.

Sie allein unter den Euro-Führung haben stets verstanden und haben versucht zu vermitteln, dass wir aufhören sollten, uns gegenuber zu sherzen, dass diese Krise ohne große Schmerzen gelöst werden kann.

An diesem Punkt sollte klar sein, dass die bewährten Lösungen für den Umgang mit Insolvenz ausgeübt werden müssen. Dies bedeutet, dass Europa muss Triage und Schuldenumstrukturierung folgen, und nicht zusätzliche „Can kicking” und „Monetary fakery“ wie manchen würden vorschlagen.

Es bedeutet auch, dass die “inkrementelle”-Ansatz das in den letzten 3 Jahren verfolgt wurde, hat nicht nur versäumt, es hat sich extrem kontraproduktiv vorgestellt und muss durch einen Aktionsplan, der entscheidende und rasches Handeln, das Angebot Märkte einen klaren Fahrplan, um Recovery-Funktionen ersetzt werden.

Für die kommende Verhandlung ist est also klar: Sie müssen entweder (1) führen Deutschland (und Europa) auf einen Weg der Täuschung und des Schmerzes, die sich dem “funny money” Brüsseler Eliten, die für die Anleihe zu kaufen und Geld drucken anrufen und fügt erhebliche Kosten und Leid über die Völker des nördlichen Europa (Deutschland und Frankreich zu den wichtigsten Akteuren), die nicht über over-geliehen oder anderweitig schlecht ihre Volkswirtschaften geführt, um aus der Patsche helfen bestimmte andere Nationen, die genau das getan haben, alle an das Risiko von großen Lasten noch mit keine Garantie für nachhaltigen Erfolg, oder (2), müssen Sie den Grundstein für eine geordnete Umstrukturierung der Währungsunion, die unter bestimmten Ländern verlassen die Euro-Zone (Griechenland, Irland, Portugal, Spanien lag ; mit Italien noch in der EWU als mögliche “Associate Member”), so dass diese spannende Nationen könnte zu Atem zu kommen und wieder wachsen konnen. Beitritt Pläne für andere Nationen würden auf unbestimmte Zeit gehalten werden.

Mann kann nicht die heutigen Probleme mit Tapete verstecken. Diese Arten von Glücksspielen haben noch nie gearbeitet und unweigerlich zu schlimmeren Problemen geführt haben. Es ist eine stillschweigende Axiom der internationalen Beziehungen, dass es keine “Altruismus zwischen den Nationen” gibt und damit auch keine rechtlichen, moralischen oder ethischen Grundsatz gilt, dass würde vorschlagen, die verschwenderische Länder sollten weiterhin von der Großzügigkeit ihrer Nachbarn an, und ohne Sanktion. Jetzt ist die Zeit zur Umstrukturierung aus den Ländern, die nicht geeignet sind, oder in der Lage, im Anschluss an die fiskal-und geldpolitische Disziplin gemäß den Vereinbarungen sie, wenn sie in die Eurozone beigetreten erforderlich. Im Gegensatz zu den Rat, den Sie bereits vielleicht schon erhalten haben, sollten die Pläne für das Geschäftsjahr Union und die Rolle der EZB aussortiert werden, nachdem die EWU-Mitgliedschaft Struktur angepasst hat. Darüber hinaus, um die Krise zu beenden gibt es absolut keine Notwendigkeit, die Befugnisse der EZB hinzuzufügen.

Es gibt einige, die Auflösung der Eurozone wäre ein teurer Fehler, dass Europa es Sich nicht leisten kann, werden sagen. Wir sagen, es ist ein Vorgehen, dass Europa Sich nicht leisten kann, nicht zu nehmen. Es gibt politische als auch finanzielle Gründe.

Nach der Wiedervereinigung hatte Deutschland eine Phase der Anpassung, die teuer, schmerzhaft und langwierig war. Ihre kürzlichen Wahlen haben gezeigt, dass das deutsche Volk will nicht diese Opfer und Leistungen verschwendet zu sehen. In der Tat sind die meisten Ihrer Nachbarn voll und ganz hinter Ihrer Politik während der Krise Zeitraum und sind in Deutschland auf eine weitere vernünftige und zuverlässige Verwaltung von dieser Situation zu liefern.

Diese Krise und die Krise in den Vereinigten Staaten sind der Beweis, dass der Westen verwundet ist und seine Art zu leben ist in Gefahr. Das bedeutet, dass die Reparatur (nicht „Bailout“) des Finanzsystems und insolventen Ländern so schnell wie möglichpassieren soll. Daher ist jede Plan, um die Stabilität bei einem Minimum an Risiko und die Kosten wieder Versprechungen positiv von allen Europäern, Amerikanern und ihren Verbündeten begrüßt. Schon zu viel Zeit und Geld verschwendet worden verfolgt undurchführbar Lösungen zur Erhaltung einer Art idealistischen und nun unerreichbar, “status quo ante” in der Euro-Zone ab.

Die USA sollten sich für diese gerade aus diesem Grund, und auch, weil eine schwärende Krise in Europa auferlegt starken Gegenwind auf der fragile Wachstumspotenzial in der USA, einstweilige Aktivität und erschweren die Arbeit des ökonomischen Managements gibt. Das gleiche gilt für das UK. Und das gleiche sollte auch für die Länder der Eurozone nun unter finanziellem Druck und mit mit Sparprogramme ohne die Fähigkeit, die Währung abzuwerten, die sie verwenden viel. Im letzteren Fall ist es äußerst unwahrscheinlich, dass die Sparprogramme wird Obst vor einer Zeitbombe des sozialen Umbruchs und der Unzufriedenheit in der Bevölkerung explodiert tragen und treibt diese Nationen noch weiter ins Chaos.

Europa ist kein Fremder in Währungskrisen. Wir sahen genug von diesen ganzen 1970er Jahre, 1980er und den 1990er. Mit Ausnahme von ber UK in den 1970er Jahren hat der IWF noch nie zuvor in europäischen Angelegenheiten eingegriffen. Diese Krise ist ein europäisches Problem, und es gibt keine starken Gründe für IWF-Kredite im Rahmen der bestehenden IWF-Artikel. In der Tat der IWF nicht einmal über ausreichende Mittel verfügen, um ein Angebot der Unterstützung glaubhaft zu machen. Darüber hinaus einige der weniger wohlhabenden Mitglieder des IWF beginnen würde, um legitime Beschwerden über die Kooptierung des IWF zur Rettung von großen wohlhabenden Nationen registrieren. Europa hat viel Geld und keine Zahlungsbilanz Problem. Der Euro ist eine Reservewährung. Sie und Ihr Land können eine Menge tun, um dieses Problem zu beheben, und mit der Bundesbank, die deutsche Finanzminister und der EZB, können Sie alles tun, dass der IWF tun können. Wir sind sicher, dass die sehr erfahrene Leute an der 19th Street in DC der Unterschied zwischen einem schlechten Risiko und ein gutes Verständnis, wissen, dass sie knappe Ressourcen haben, und würde die Chance, beiseite zu treten willkommen.

Ein Teil der Kosten ist dass die Griechen, der irischen, portugiesischen und spanischen und möglicherweise die Italiener, Bankrott sind und auch benötigt Rekapitalisierungen der Banken in den Volkswirtschaften und für die Banken in anderen Ländern der Eurozone. Die Kosten für die Abiturienten können, indem Sie auf vergangene Krisen geschätzt werden. Nach dem IWF, die über 100 Währungs-und Bankenkrisen untersucht hat, zeigen die Daten, die für die Länder, dass eine Bank-und eine Währungskrise (die schlimmste Kombination von unerwünschten Ereignissen), die mittlere Ausgangsleistung Verlust über 18,8 Prozent erlebt haben, und dass die durchschnittliche Zeit bis zur vollen Leistung Erholung um 2,6 Jahre. Die Eurozone Problem Länder haben bereits diese Art von Verlusten in den drei Jahren seit der Krise auf sie herab erlebt, aber es gibt keine Erholung in Sicht. Auf dem gegenwärtigen Kurs gibt es auch kein Ende Spiel, keine Garantie, dass die Rettungsaktionen als erfolgreich erweisen werden und keine Schätzung der Endabrechnung.

Ihr nationaler Schatz wird besser auf ein Programm der „Triage-und Recovery“ durch die notwendigen Reformen des EMU begleitet über den Ausgang des eigensinnigen Ländern ausgegeben werden. Diese Kombination von Maßnahmen werden endlich die Kosten in einem angemessenen Zeitrahmen zu liefern und endlich, wie wir glauben, sich letztlich als politisch schmackhaft zu den Völkern Europas und ihre Nachbarn.

Wer weiß…. wenn Sie dies zu erreichen, einen Tag mit eine neuer Energie, institutionell robuster und besser verwaltet Euro könnte der USD als Nummer eins der Reserve Währung für die Welt zu verdrängen.

Mit freundlichen Glückwunschen,

Recovery Partners

Posted in Banks, Crisis, EU, IMF, Restructuring, Sovereign Debt, USA | No Comments »

Money for Nothing and Checks for Free

“Those whom the gods wish to destroy they first make mad.”   Anonymous Ancient Greek Proverb

Wow, what a crazy week. About everything that could happen did happen, except for the delivery and signing into law of a credible deficit reduction and debt control plan by the American Legislative and Executive Branches.

In the wake of that failure, investors in the US Dow Jones index rewarded President Obama on the marking of his first half century of walking on this planet by shaving 500 points or almost 5 % off of that stock market gauge. By the end of the week global bourses had shed around $2.5 Trillion of value.

The debt ceiling debacle wasn’t the only motivator behind the gloomy sentiment weighing on markets:  renewed fears that the global economy might be entering a double dip were fanned by weak purchasing reports from Germany, flattish consumption-related and employment numbers in North America, and growing doubts about the fiscal sustainability of the debt-laden laggards in Europe, now to include, most notably, Italy.

On Friday the markets looked set for another big dump following weak employment readings announced early in the  day by the US Labor Department. It is unmistakable that some foreknowledge of the reduction in the S&P US long term debt rating that was announced following the market close was given to the US Government. Therefore it is our surmise that the Plunge Protection Team swung into action to prevent another swingeing setback following on the heels of the 500 point plunge the day previous. Thus,  after a wild intraday ride, the Dow closed on a dead cat bounce, up 61.

These events prompted G-7 and G-20 country governments to convene a set of emergency consultations over the course of the weekend to discuss measures to combat the malaise sweeping global markets and to contain any contagion effect from exacerbating conditions further. The price action on several markets so far today does not engender optimism for a placid trading week ahead.

With the apparent exception of the United States and a few people here in Canada (see below) a growing realization that fiscal stresses in Western economies mean that Government spending needs to be cut back, entitlements need to be cut back, and Government generally needs to right size and reconsider its role. The bottom line is that the social safety net has become too expensive and people need to be made more reliant on their own efforts rather than rely on handouts from Governments.

It is in this context that we read an article last week in the Financial Post entitled “Only More immigrants can save Canada’s Economy” . In this piece, the author, who is associated with the New Frontier Institute, contends that in order to “save” Canada’s pension system that we need to allow immigration to reach a million people per year as an urgent  matter of policy.

What claptrap.

 Nowhere in this article is it mentioned that Canada does not have the capacity to admit that many immigrants into the country. In the last five years the amount of annual jobs growth has been well below 200,000 per annum. Where and how are we going to employ these immigrants? What of the strain on our already overstressed medical, educational and public security infrastructures? No mention. Yet the author makes reference to a recent speech by the Minister of Immigration, Jason Kenney that does clearly spell out all of the constraints and considerations involved in setting immigration policy.

Arctic Circle Cartoons 

What of recent studies that demonstrate that Canada’s immigration policies admitting as they do a few hundred thousand folks per year actually cost the public purse significant money? This is given short shrift. Ivory Tower schemes are suggested to hand over immigration policy to the provinces, magically reduce the cost of admitting immigrants and to assume away the host of logistical and social challenges implicit in this proposal, all in the name of ensuring that Canada can “fund the Baby Boom generation’s retirement obligations.”

And what of the political and social implications of such a policy? Namely that, if implemented, within one generation we effectively would be handing over electoral control of our entire country to a demographic that has no long term  relationship to this place. In exchange for what? A pension bailout that benefits a narrow slice of the population, much of which is quite well off without Government help.

The reality is that the pension deficits are real. Most pension funds are insolvent in Canada, and therefore this is a problem that requires urgent attention. The reasons for these deficits are many. Some reasons include faulty design, poor management, venal politicians agreeing to over-rich settlements with public sector unions, bad luck or bad markets, theft, fraud, perverse incentives, or the fact that some plans ail from all or a subset of the foregoing impairments. None of this however means that they should be bailed out. This makes no sense, particularly in the context of what we already know to be the case of the retirees at Nortel, Enron and numerous other companies that failed to provide safeguards for the pension obligations they had to  their retiring employees. The reality is that in any conceivable context, the prudent, economic, legally and morally correct course of action is to write down benefits in order to meet the resources extant within each of these funds and share them out to the retirees. There can and should not be a bailout unless we intend to become the next Argentina or Venezuela.

 No doubt pension reform is a large problem and one fraught with political and economic risks. However throwing away Canada’s entire future to try and paper over mistakes made by the same ”Baby Boomers” that this writing suggests need help is pure madness.

 The New Frontier website lists a number of prominent people as being part of their Advisory Board, among them Ruth Richardson, former Minister of Finance in New Zealand;  and Sir Roger Douglas, the architect of the economic reforms in New Zealand that served as a blueprint for leading the country out of the abyss of subsidies, government interventions and meddling that caused the catastrophic meltdown there in 1984. At the same time, the website is extremely coy about where it receives its funding from, leading us to surmise that it may be acting as a shill for a set of vested interests that want to bias public policy in favor of themselves rather than proposing policies that make long-term sense for Canada as a whole.

I worked under Ruth when I was managing New Zealand’s Sovereign Asset and Liability portfolios in the mid 1990’s and I have met Sir Roger a number of times. The prospect that Ruth or Sir Roger would endorse the policy recommendations as spelled out in the New Frontier article, and in the context of the commentary we provide above and as reflected in Minister Kenney’s recent remarks, is in my opinion a very low probability outcome unless there has been a massive sea change in how they view the role of Government and the constituents of effective policy. If the New Frontier Institute believes that this is not the case, we invite rebuttal, accompanied of course by the math that supports the “million immigrant a year” proposal.

 Who knows what the future might bring? Flush with a majority Government and a five year term in office ahead of him, shamefaced clarion calls for bailouts of their entitlement programs by special interests may be setting up Stephen Harper for his very own “Scargill Moment”.

Posted in Bankruptcy, Canada, Crisis, EU, Fed Policy, Restructuring, Sovereign Debt, Stock Market, USA | No Comments »

Angela Merkel’s Frankenstein

 “The astonishment which I had first experienced on this discovery soon gave place to delight and rapture. After so much time spent in painful labor, to arrive at once at the summit of my desires, was the most gratifying consummation of my toils. But that this discovery was so great and overwhelming, that all the steps by which I had been progressively led to it were obliterated, and I beheld only the result. What had been the study and desire of the wisest men since the creation of the world was now within my grasp. Not that, like a magic scene, it all opened upon me at once: the information I had obtained was of a nature rather to direct my endeavors so soon as I should point them towards the object of my search, than to exhibit that object already accomplished. I was like the Arabian who had been buried with the dead, and found a passage to life, aided only by one glimmering, and seemingly ineffectual, light.”

Mary Shelley’s  Frankenstein 1818

The passage above could easily have substituted for the press communiqué issued by the EU yesterday which laid down the agreement reached in Brussels regarding the European debt crisis and the measures adopted by lead Ministers to forestall contagion spreading from the PIIGS to other countries.

 Illustration from the “Frankenstein” edition published by Colburn and Bentley, London 1831.  Public Domain.

The nuts and bolts of the bailout package according the that document are as follows:

        – There will be new financing in the amount of EUR109 Billion for Greece;

       – Loan rates on existing debt will be cut to 3.5% from as much 5.5% for Greece, Ireland and Portugal, and maturities will be extended to 15 and as much as 30 years;

       – “Voluntary” private sector contribution to the Greek package would see creditors taking a haircut of 21 per cent. There would be no relief of this kind for Portugal or Ireland;

       – The EFSF and its successor the ESM (The EU bailout funds) will obtain new powers to intervene in national bond markets in Europe and to recapitalize banks, but only with the go-ahead of the ECB;

       – Greece will be given a “Marshall Plan” by the EU to help refloat its economy. Brussels is forming a team to help Greece administer the aid.

       – No mention was made of any need to address issues in any other EU countries or of any plans to increase the size of the bailout mechanism from the present EUR 440 Bn.

The voluntary private sector participation which will result in haircuts amounting to around EUR 37 Billion is expected to result in only a short technical default that therefore will not trigger default clauses in existing CDS contracts, thus averting the nightmare scenario.

Similar to Dr Frankenstein’s violation of every principle of medical ethics and morals involved in his grave-robbing and gruesome experimentation, by reaching this agreement the EU leadership has breached every principle on which the European Union was founded. On the kindest interpretation, this must be regarded as a measure of the desperation the EU leadership must have been feeling in the wake of recent market events and the growing levels of social unrest in a number of southern European countries.

While the intention is to provide this support only until Greece, Ireland and Portugal can re-finance themselves in private markets, the reality is that this new deal effectively gives those countries a commitment of indefinite support. What if other countries fall further into crisis and need to be bailed out? Will they end up with a Carte Blanche as well?

 The deal as announced does little to address the key issues and much of the detail appears not to have been fleshed out. The haircuts apply only to Greece, and even at that, are miles short of what the market has been signaling is really required (we estimate around 70%) and the interest rate subsidies do nothing to address the fact that they apply to mountains of accumulated debt that under the terms of the deal will not go away. How the rate fakery will play in Spain and Italy who are having to pay what the market demands is also not clear. There are now evermore committees involved in trying to operate on the patient. The extension of new powers to the managers of the bailout funds, who on their creation in early 2010 assured the markets that they would “never be used”, make them an easy mark for hedge funds who do not have to trade by committee……Watch this space.

 After the initial euphoria expressed by Dr Frankenstein, we all know how the story ends: the Monster kills a number of people in most horrible ways – including a child and Dr Frankenstein’s bride – causes the death of others, and then ends up committing suicide and dying a most horrible death in the frigid waters of the Arctic Ocean. The immoral abomination is fated to die a grisly death from the moment of its creation.

This monstrous deal will suffer a similar fate, and not too far down the road.

Posted in Bank Loans, Bankruptcy, Bond Market, Crisis, EU, Loan Losses, Restructuring, Sovereign Debt | No Comments »

Le Tigre Enchaîné

This past weekend we came across two really interesting items while reading the New York Times.

One was an op-ed by Paul Krugman that we actually happen to side with. In it, Krugman writes about the “Unwisdom (sic) of Elites” in terms of the reasons that the policies that got us into the financial mess in the US were more typically a product of narrow self interest of policy elites than demands by the public at large. It was this narrow self interest of the elites, according to Krugman, that got the US into trouble, so it is no use blaming the electorate for asking for “tax and spend” policies that pumped up real estate and the financial markets before the inevitable bust occurred three years ago.

In this connection, Krugman would do well to heed his own counsel in the matter of negotiating an exit from ruinous debt-based problems by continuing to recommend elitist solutions that pile on more debt.

…….Which brings us to the next gem that we found nestled in the pages of the venerable old paper; namely, the arrest of IMF Managing Director Dominique Strauss-Kahn at JFK Airport on charges of attempted rape and forcible confinement of a hotel chambermaid. This is not the first of such peccadilloes that have marked the career of this man. Indeed before the ink was dry on that story another woman had come forward with stories of unwelcome advances by the IMF’s top dog. Strauss-Kahn was denied bail at a hearing today.

 

The irony of this situation is not lost on many as the cartoon would indicate. It is the IMF together with its partner-in-arms, the ECB which has most strongly resisted any talk of restructuring debts for any Euro-zone countries. Today, ECB Economics Chief Juergen Stark even took to the airwaves to denounce any suggestion of restructuring as something that would inflict “massive harm” on the Euro-zone.

To us, it seems that the European authorities are again reverting to type. A year ago, the EU Sovereign Debt problem was “solved” with the creation of the EFSF (which would “never be needed” according to the ECB at the time). Then as the need for action became more obvious, massive bailout loans were forced onto a variety of countries. [The one exception here was Iceland which was all set to take on vast new debts in obeisance to the ECB and IMF until Recovery Partners addressed the issue directly with the Government there. The IMF / Nordic loan package was never closed and Iceland today is recovering albeit slowly and without the millstone of additional debt. The Icesave settlement has been pushed off as we had also earlier advised the Althingi to do.]

And, after the loan packages were doled out to the over-indebted countries, they were proclaimed healthy again by the EU honchos.

Now as the vacuity of this policy response is becoming clear, clarion calls denouncing restructuring of the debts are once again being mounted in order to avert any losses being pushed back onto the lending banks.

There is no way out of a debt problem by adding more debt to the mix. The unfortunate history here is that the IMF is an extremely creditor-friendly institution, as is the ECB. Their constituency consists in part of the largest banks in the world, and it is because of that, that these institutions are reluctant to recommend any policies that would act against the interests of these constituents, that a strict “no haircut” stance has been maintained by both.

The reality is that the debt problem in the EU is far from over. It is related as much to the lack of a framework of institutional bailout arrangements and enforcement mechanisms within the EU as it is to bad borrowing decisions by EU governments as well as bad lending decisions by Euro-zone banks. Eventually the piper will have to be paid. And, as we have observed in the past, the history of Governments under austerity succeeding in cutting back debt on a sustained basis is not encouraging. Moreover, the people of the EU have no desire to effectively become permanent tax slaves of the banks.

The impact of Mr Strauss-Kahn’s arrest on the ongoing debt talks in the EU is likely not going to have a material effect on the outcomes here. John Lipsky will do just as good a job in delivering the party line this week, and a permanent successor to Strauss-Kahn will soon be found. Over time however, the reality that some EU Governments are going to need more than just more debt and that  EU banks are going to have to take a chop and likely be restructured themselves (in certain cases) will assert itself.

Recognizing that many of the lending decisions that led to the current situation were bad is the only way that we can begin to dig our way out of this situation. The sooner that this happens, the better.

In the meantime, the important thing for those countries in debt difficulties is to ensure that they obtain timely, high-quality advice and have robust crisis management plans in place that will enable an exit from these problems with a miinimum of stress and social upheaval. 

Posted in Bank Loans, Banks, Crisis, EU, IMF, Restructuring | No Comments »

Bernanke in the Hot Seat

 “With all due respect, U.S. policy is clueless….(the problem) is not a shortage of liquidity. It’s not that the Americans haven’t pumped enough liquidity into the market.”

  Wolfgang Schauble, German Finance Minister reacting to QE2

As we saw in the lead up to the G20 meetings in Seoul this past weekend and at the meetings themselves, there is a growing chorus of discontent regarding US economic policies. Direct attacks on the Fed and its Chairman would have been unthinkable at any time in the past 30 years. Thus, while  his predecessors received the utmost in the way of deferential treatment at all times, Ben Bernanke is rapidly becoming the sad-faced “no respect” poster child for economic policies that have so far failed to live up to their advance billing and for the associated growing global economic tensions.

Just ahead of the G20 meetings, Chairman Bernanke penned an article in which he attempted to deliver an overview of the situation and the Fed’s plans for reinvigorating economic activity.  The letter is astonishing in a number of dimensions:

According to Chairman Bernanke, it seems that in spelling out Fed policy and the need for additional stimulus that the Fed intends to get the economy growing by creating false markets (ie higher prices) in the stock bond, and real estate sectors. This is short-sighted, arrogant and ill-considered even before one takes into account the fact that the man was announcing his intentions to the markets with the apparent conviction that the investment professionals who operate within them would heed his financial advice, rather than consider the logical implications of it.

Chairman Bernanke’s piece waxes eloquent, saying that the risk of deflation warrants further strong doses of liquidity: ”……… the need to achieve certain outcomes, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.” These are all laudable policy objectives, but the point is that nowhere in this article is there any mention of what the risks are of these proposals. For example, some of the second order effects of QE  and ZIRP that we know about today include:

• Liquidity leakage and consequent pressures on markets in other countries, particularly emerging economies;
• Contribution to economic imbalances and unwelcome swings in FX parities;
• Disruption of trading relationships;
• Rapid inflation of input prices and foodstuffs which falls disproportionately on low income population groups and countries and those on fixed incomes;
• Intensification of the Sovereign debt crises in other economies;
• A reverse wealth effect on consumption from the Zero Interest Rate Policy stance that hits retirees and savers.

Chairman Bernanke`s letter fails to mention other key risks of his policies including the possibility of significantly elevated inflation numbers down the road, dangers for the financability of the yawning US fiscal deficit, and a potentially unmanageable downgrading of the United States as guardian of the global reserve currency. Predictably, his explanations also fail to acknowledge the vast solvency problem in the US financial sector that needs to be urgently addressed (in ways that are markedly different from the Fed’s and the FDIC’s  “extend and pretend” approach). Not surprisingly many commentators and observers are starting to mock Bernanke and his policies.

Given the fact that there is general agreement that QE1 has been a failure; these are issues that should make the Fed and Mr Bernanke sit up and take note. As for QE2 it is hard not to observe that since the launch of this policy the stock market has lost 4% of value; bond rates in the Fed’s announced “buying zone” have backed up 40-50 basis points and the economic numbers are still expected to remain soft by the mainstream economists.

On this latter point it also helps to do the math. Even if this round of QE works and raises prices in various asset markets, then the addition to GDP through the wealth effects that Bernanke is staking everyone’s future on, will, under the best of circumstances, only translate into about an extra 0.3 to  0.7 percent of growth. This is peanuts, and certainly not an objective worthy of risking significant disruptions to achieve.

For this and other reasons best dealt with under separate cover, there is now significant opposition being mounted against the Bernanke policies. Not only did Obama and the US delegation get a bollocking from their G20 colleagues over US economic policy last weekend, several prominent FOMC members, including Plosser,  Hoenig and Warsh have spoken out against additional QE, others in the US have cautioned on Fed policy, and this week an number of prominent economists, investors and commentators issued a public letter to the Fed asking it to cease and desist on QE.

The open dissent on the FOMC and the fact that this has been taken into the public domain is extremely noteworthy. Tensions has been building between those in the Fed that regard these policies as the only way out of the Roach Motel and those who want to chart a different course and restore some measure of transparency and sanity to US monetary policy. One immediate outcome of the second alternative, provided that the policies are well thought out and capably executed is that it would defuse the systemic risks and spill-over effects that have been accumulating in the global economy and in international relations as a consequence of ZIRP and QE.

In the present scenario Chairman Bernanke is therefore in an unenviable and weak position: There is growing conflict regarding the path he has charted and what remains of the Fed’s credibility is at serious risk. There are obvious questions to be asked regarding his competencies. His communications style shows that he has little appreciation or understanding of risk and market behaviour. He failed to spot the crisis in its early stages, saying on numerous occasions that it was limited in scope and containable. His policies have not worked and considerable international tension and opposition to his policies and their intent has been building. Not to be overlooked, prior to QE1 he also mislead lawmakers and the markets repeatedly as regards the likelihood of debt monetization by the Fed – ie the willingness of the Fed to run a QE.

In the meantime, there is scant hope of a major near term bounce in the US economy. Five million jobless on the US unemployment rolls will see their benefits run out in the next couple of months. Commodity markets continue red hot. Debt crises in a number of economies are worsening. If the Fed continues to plough on as per its policy announcement we can only expect the geopolitical picture to become even more fraught

 “Honourable Committee Members…….the dog ate my homework”

With this and other depressing information painting the backdrop for his testimony, there is very little good news that Chairman Bernanke will be able to serve up to US lawmakers in February when he is obliged to deliver his semi-annual Humphrey Hawkins testimony regarding Fed Policy. He is presiding over a giant mess that he himself helped create and now cannot get out of.

The Bottom LIne: Barring a major failure of courage and leadership within the FOMC and US Government, and from the Obama Administration  (not exactly a zero probability outcome given the personalities involved)  it is likely, but far from certain, that we could see Ben Bernanke sacrificed on the altar of political expediency or resign. In the meantime the political and economic ructions resulting from QE will continue.

Posted in Banks, Bond Market, Fed Policy, Restructuring, Sovereign Debt | No Comments »