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 »

Cognitive Dissonance*

There was a fantastic universal sense that whatever we were doing was right, that we were winning. . . .So now, less than five years later, you can go up on a steep hill in Las Vegas and look West, and with the right kind of eyes you can almost see the high-water mark—that place where the wave finally broke and rolled back.” Hunter S. Thompson, Fear and Loathing in Las Vegas

The Great Bull Market is winding down much in the same fashion as when the World moved past Hunter Thompson’s Go-Go Sixties and slipped into the stagflationary dystopia of the 1970’s. No better bellwether of this phenomenon is given today than the transformation of Facebook (Nasdaq: FB) from IPO darling to abused foster child in the few short days since the shares made their debut. Today with the Nasdaq ending flattish, Facebook moved lower for the second day and its shares are now changing hands at more than 17% below IPO levels despite frantic efforts by the dealer group to hold the line on price.

With the shares trading north of 75 on a P/E basis and earnings proving hard to grow rapidly, the Facebook IPO was probably a major disconnect with financial reality much in the same way that other disconnects are playing out across the globe.

In fact this “Facebook Flop” could be the sign of a major top.

More evidence of a “disconnect” comes from Greece. For example 75% of the population want to keep the Euro; while 75% of the population want to abandon austerity – the condition precedent the previous government bound the country to precisely in order to stay in the Euro. In a similar vein, polls in the Hellenes are still showing that more than half of the population expect a civil war there in the near future.

So, it looks like we will likely be in for some “shooting and looting” before this is over.

In what has now been framed as a debate between the supporters of the Hair Shirt of Austerity , most  notably Frau Merkel and her German countryfolk; against the Growth crowd, championed by Krugman, Obama, and many Euro countries, it is increasingly hard to maintain any confidence in the longevity of the EU in its current form; or for that matter the ability of politicians to chart a stable path to renewed prosperity.

In fact, the probable contagion impact of events that are flowing out of this policy impasse should be feared  because Europe and the US will not achieve a way out of this quagmire through either growth OR austerity, unless and until a key pre-condition for restarting those regional economic engines is met.

This is quite simply that we must have a reckoning and write-down of bad debts. Until now this has been resisted at all costs by banking and investor interests, aided and abetted by the world’s largest central banks and the IMF. Surely, the experience of Japan’s two “Lost Decades”, as an object lesson of what happens when you avoid the reckoning and write-down, should be reason enough to swallow the bitter pill and get on with the task at hand. Nonetheless Europe’s policymakers dither while patching over problems in place of applying durable solutions. What in fact was the Greek Bailout other than a mechanism to buy some time for the creditors? What was the failed effort to get Iceland to swallow its IMF-led bailout, other than a thinly-veiled attempt to hang the costs of bad bond positions on Icelandic taxpayers instead of the offshore banks that had gotten themselves burned? Why is the US Government not addressing the bank solvency problem that it has been obscuring from public view, or its structural deficit problem? Are any of these policies in any way socially sustainable beyond the very short run?

The answer is “No”.

Not surprisingly therefore, it looks like no one has confidence any longer that that the current set of plans will stick. Some are now suggesting a Greek exit (“Grexit”) as a way out coupled with a “firewall” for the rest of Europe to contain the contagion. This is fantastical thinking. In the first instance, the time window for that type of a move has long since closed – as we had repeatedly advised early on in the crisis, the best strategy would have been for the Greeks to have defaulted and negotiated a “soft exit” from the Euro some two years ago. This did not happen in time and now the terms of the Greek Bailout and the much larger size of the Greek liability make a default a very risky prospect for the Greeks, and for Europe. In the second instance the concept of a “firewall” is simply not credible in the current context. The only true “firewall”, to the extent it is possible to implement such a thing is: adherence to sound risk management, non-invasive but effective regulation, and a neutral “Hands-off” government policy posture that sets the stage for stable economic growth, development and trade.

At present, more, not less, European sovereigns are looking shaky, the EFSF/ESM bailout mechanism in Europe is unfunded and unworkable and the ECB is stretched. The recapitalization of Europe’s banks which last summer was being trumpeted to be completed by October 2011 has not progressed at all. In the US the situation is hardly different with many more insolvent banks being allowed to continue in business on the pretence that they are OK; the US economy is in “Nowheresville”, vast swathes of the personal sector suffering under some form of financial duress and the Fed is increasingly looking at a significant diminution in its menu of available policy options.

No one will be sheltered and no economy will properly recover until the rot and ruin of past excesses are carved away such that new shoots of durable economic activity can take root. This will not happen as long as there are zombie borrowers and zombie banks feeding off of the productive parts of the global economy at everyone else’s expense.

* Cognitive dissonance is a discomfort caused by holding conflicting cognitions(e.g., ideas, beliefs, values,, emotional reactions) simultaneously. In a state of dissonance, people may feel surprise, dread, guilt, anger, or embarrassment. The theory of cognitive dissonance in social  psychology 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.

Posted in Bankruptcy, Banks, Crisis, EU, Fed Policy, Sovereign Debt, USA | No Comments »

Ratings Agencies take Aim at Large Banks

Late yesterday the Moody’s Ratings agency announced that it was considering a downgrade of a number of Euro-zone, US and Canadian banks including Canada’s largest and arguably its most venerable banking institution, the Royal Bank of Canada (RBC). Readers might recall that Moody’s stripped the RBC of its Aaa rating in December 2010.

At the time this was not much of a surprise because the bank had been placed on negative credit watch earlier in that year largely due to an announcement by the RBC that it was seeking to generate a larger share of its total bottom line from Capital Markets businesses. The downgrade also occurred despite RBC having emerged from the Global Financial Crisis (GFC) relatively unscathed and in much better shape than most of its offshore competitors. Other agencies soon followed suit with their own downgrades for the bank.

The RBC is currently rated AA- by S&P and Aa1 by Moody’s. Fitch, and DBRS the other major agency and Canada’s domestic credit watchdog respectively, both peg the RBC credit quality at AA. Thus while the latest Moody’s announcement will bring their ratings assessment into line with their major competitor, it still remains above the credit assessment given by the two smaller agencies

The recent ratings action again pays reference to that fact that RBC’s announced business plans are running into strong headwinds, not in the least due to the furor over implementation of the Volcker rule, but also because the markets that it is seeking to exploit in the search for revenues are running into difficulties in the form of widening spreads, lower volumes, poor funding conditions and deteriorating investor appetite.

Other Banks under review for possible downgrades include Citigroup, Bank of America, Goldman Sachs, JPMorgan Chase and Morgan Stanley; and Moody’s said it is  extending its reviews on whether to lower ratings on Credit Suisse, Macquarie, Nomura, UBS, Barclays, BNP Paribas, Credit Agricole, Deutsche Bank, HSBC, Royal Bank of Scotland and Societe Generale. Moody’s also extended ongoing reviews for downgrades on 11 companies.

Pointing to regulatory, balance sheet and liquidity the agency said in a statement after markets closed last night: “These difficulties, together with inherent vulnerabilities such as confidence-sensitivity, interconnectedness, and opacity of risk, have diminished the longer term profitability and growth prospects of these firms”.

The Moody’s news came hard on the heels of credit downgrades for a number of Euro-zone countries including Italy, Portugal and Spain because of uncertainty over the weakening profile of economic activity in Europe and a growing credibility gap regarding the advisability of the polices being forced on debtor countries by the EU/ECB/IMF “Troika”.

Do these Announcements now make the World now “Safer” from Financial Calamity?

Nothing could be further from the Truth.

In our opinion here at Recovery Partners, this latest wheeze from the Ratings Agencies is comparable to the fevered activity of Balinese pool boys trying to rearrange deck chairs in the middle of a force-5 Typhoon.

While EU leaders have droned on for the last several years about their intentions of putting a “firewall” around the banks and nations most afflicted by the euro zone debt crisis, nothing of the sort has occurred. In fact, the recent Long Term Refinancing Operation (“LTRO”) in Europe and ongoing easements in collateral rules make a massive outbreak of contagion more likely rather than less likely because, systemic risk is increasingly becoming a function of the credit quality of the weakest banks, rather than the strongest banks. The ratings agencies’ recent focus on the stronger banks such as the RBC only serve to underscore the  point that these announcements are largely a sideshow.

As we know, mark-to-market rules have either been overtly suppressed by regulators in Europe and North America or ignored.

In fact, given the unrelenting stresses in the interbank markets in Europe and elsewhere, we are wondering whether or not we are close to an explicit “event of diktat” similar to what was recently announced by the Chinese authorities. Not widely publicized, a particular example of how bad things are is given by China, the authorities there have recently commanded the banks to roll over maturing loans to local authorities in full knowledge that they are non-performing and cannot be, and will not be, paid back even under the rosiest of scenarios because they are backed by asset positions that are largely worthless and non-income producing. In the wake of the GFC, Chinese Banks lent the equivalent of 25% of Chinese GDP to local authorities. This is not a small problem.

Having the central government tell the Chinese banks to represent (to the regulator controlled by it no less!)  that the loans are sound will not make them pay off nor reduce the eventual chop that the banks will have to take. This subterfuge only postpones the inevitable day of reckoning and contributes to further uncertainty.

A notch or two on RBC’s rating or on the ratings of similar banks is hardly an issue that anyone  should lose sleep over in the current environment. There are much, much bigger demons out there.

Posted in Bank Loans, Banks, Canada, Crisis, EU, Regulatory, Sovereign Debt, USA | No Comments »

Living in the Past

“It’s interesting to note that 20 years later we have realized — we have succeeded — in creating a more stable foundation for that economic and monetary union, and in so doing we’ve advanced political union and have attended to weaknesses that were included in the system.” Angela Merkel  9^th December 2011

The weekend headlines blared a mixture of adulation and success: “Resurgent Germany”, “Shrewd Sarkozy”, “Britain Isolated”. In fact Germany is far from resurgent, Sarkozy is more reacting to events rather than leading solutions, and Great Britain’s refusal to submit to fiscal control from Brussels is hardly a surprise given that she is not a member of the Monetary Union.

Had the agreement for fiscal union been reached prior to the launch of the Euro that would have been extremely favorable news; and the fiscal controls, had they been made to work would likely have muted the breadth and depth of the current Eurozone crisis. But alas, we are not living in 1991. It is 2011 and the promised reforms are just that: “promised”, they still are subject to debate and ratification by each member nation. And then there is the question of sanctions against members who violate the proposed fiscal rules. If the enforcement mechanisms are too stringent, no national government will ratify the fiscal proposals. If they are too lax, the agreement will be toothless and incapable of serving as a bulwark against some future crisis.

But the real story is that the proposed agreement does not address any of the urgent and important issues that the Eurozone is facing right now. These stresses threaten the continued existence of the common currency. Last week’s entire exercise, and the posturing before, during, and after therefore must be judged as a lost opportunity of significant dimensions

• None of the structural problems relating to pensions and entitlements spending in a large number of countries has been adequately dealt with;
• At last count, large European banks are undercapitalized to the tune of over EUR 120 Bn. Moody’s Investors Service downgraded the three largest banks in France on Friday and said there was a “very high” probability that the French government would be forced to step in to support them if conditions worsened.
• Fifteen out of Seventeen EU countries were placed on negative Creditwatch last week by Standard and Poors.
• Greece, Ireland, Italy, and Portugal and Ireland cannot fund themselves at economical levels. Spain is arguably close to the borderline as is Belgium. Over the next 12 months the aggregate funding requirements for these countries amount to EUR 1000 Bn.
• The  EFSF is broken and no credible mechanism yet exists to replace it. Announcement of the formation date of the ESM as being in 2012 in place of 2013 does not make money available sooner until the ESM is actually funded. No updated funding plans were announced in the wake of the recent “dud” China funding effort launched in spectacularly disastrous fashion by Klaus Regler, the EFSF honcho.
• There is no relief for countries suffering with austerity. The solution, according to Merkel and Sarkozy appears to be “More Austerity!!”. As we have said in the past, the track record of these programs is not good, and that reflects cases where countries were able to devalue their currencies. In the present scenario no “Soft Exit” from the Euro for the PIIGS and other sufferers is being countenanced by the Euro Leaders. It is only a matter of time before large scale social unrest erupts in one of these places and/or the austerity programs are abandoned.
• The IMF is washing its hands of this mess. In fact, there may no longer be any legal or politically palatable way to re-engage the IMF after this episode. Similarly, the US is adopting a hands-off approach.
• One recurring theme of this crisis in Europe (and North America) was also played out yet again in that it was obvious that there is no political will to force banks that made all of the bad bets to pay for their oversights.
• The other recurring theme is that markets have again been asked to wait “another three months” for the next installment of this sorry saga.

Looking at the list above it becomes apparent that there are actually more and deeper problems on the boil now than in the late Fall when the crisis seemed to be close to a blow-off phase.

The Euro Leaders are likely taking comfort from the fact that there has been a muted to slightly positive market reaction to the announcements of last week. The reality is that what they are really admiring is the market reaction to the efforts of the Euro spin doctors hired to generate false headlines, and not developments that are substantive and likely to contribute to renewed and durable confidence in Eurozone economic management or the Euro itself.

Being suspicious of free markets, what the current Euro Leadership does not recognize is that markets do not necessarily follow a rational path in reacting to information and do not process it in a temporally consistent and predictable manner. Recovery Partners believes that although a measure of calm has returned, it will prove temporary. This is because the ongoing failure of the Euro politicians to implement apprpriate measures with enough speed and force to counter market pressures that are threatening the Euro’s survival is risking evaporation of what remains of the opportunity to turn things around. This is the fourth kick at the can this year. Each time anyone has looked for substantive progress, they have been left wanting.

For now, the relative calm in the markets is therefore more a reflection of year end book flattening and position squaring behavior rather than a true reaction to last week’s efforts of the Euro people to fix the problems. In a sense, it appears that a “Prozac Bubble” has formed to shield the markets from bad news in what is supposed to be a happy time of year.

Unless something intervenes to prick this “Prozac Bubble”, we will have to wait until the New Year to fund out what Mr. Market really thinks about the latest Euro-wheeze. Whatever the timing, in our opinion the reaction won’t be pretty.

Happy and I’m smiling,
walk a mile to drink your water.
You know I’d love to love you,
and above you there’s no other.
We’ll go walking out
while others shout of war’s disaster.
Oh, we won’t give in,
let’s go living in the past.

Once I used to join in
every boy and girl was my friend.
Now there’s revolution, but they don’t know
what they’re fighting.
Let us close our eyes;
outside their lives go on much faster.
Oh, we won’t give in,
we’ll keep living in the past

Ian Anderson, Jethro Tull

Posted in Banks, Bond Market, Crisis, EU, IMF, Sovereign Debt | 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 »

The Canary in the Coal Mine – Part I

“Now if I tell you that you suffer from delusions; You pay your analyst to reach the same conclusions; You live your life like a canary in a coalmine; You get so dizzy even walking in a straight line”

Sting and The Police

Monday’s news of the failure of the debt ceiling negotiations in the US ahould not have come as a surprise to anyone who has followed this issue. Disheartening, sad, and ultimately dangerous to our economic well-being and Global Stability, yes, but unexpected, no. Recovery Partners was interviewed on that very topic yesterday and the full interview is avialable here in part 1 and part 2 or you can watch an abridged version on our site.

On Monday  Zerohedge posted a note on Austria, entitled “35 Seconds Of TV Air Time Explaining Why Austria’s AAA Rating Is Doomed“. Most of the discussion focused on the massive Central and Eastern European credit exposure. According to them, massive bank credit losses and a sovereign downgrade is a sure bet as well as the fact that contagion has spread to several Central and Eastern European economies.

Elsewhere on the Continent, the Sovereign obligations of Eurozone countries were getting smoked as spreads against German bonds blew out across the board.  Looking ahead at the heavy borrowing calendars for many of these countries the picture does not look good.

In related news, European stock markets dropped Tuesday after an expensive bond auction for Spain and as data showed that the U.S. economy grew at a slower pace in the third quarter than initially estimated.

Also today, IMF Managing Director Christine Lagarde said in an e-mailed statement to accompany a press release annoucing the creation of a new IMF fast-track liquidity facility. “This is another step toward creating an effective global financial safety net to deal with increased global interconnectedness.”  It is no surprise as these announcements came as Europe’s crisis threatens to spread to Spain and France. The real “non-announcement” here is that this is happening because the Euro-people have yet to implement the Bailout plans agreed to weeks ago in part because the EFSF has become non-functional and incapable of producing needed funding for cash-starved Euro-governments. This despite the recent publicly announced intentions to ramp up the EFSF to between EUR 1 and 2 Trn. How ironic it is that just over a year ago on the establishment of the EFSF, that Olli Rehn, EU commissioner, boasted that the EFSF would “never need to be used”. Now it is obvious that, apart from some half-completed bailouts, it has proven to be of extremely limited effectiveness and can no longer function.

And earlier this morning it was reported by the FT that the Chinese Banking Regulator (the CBRC) announced that the Chinese Property slump exceeded the test limits of the Chinese bank stress tests. In April, the CBRC told banks to test their loan books against a 50 per cent fall in prices, and also a 30 per cent fall in transaction volumes. In October, however, property transactions fell 39 per cent year on year in China’s 15 biggest cities, according to government data. The weaknesses in the Chinese scenarios echo earlier problems with stress testing in the EU, where regulators underestimated the potential impact of a sovereign debt crisis.

Joining the party, the Fed announced new stress tests for the top 19 US banks to take place between now and January and having the results announced by March 2012. There are six large banks that are going to attract particular focus according to the Fed press release and accompanying statements.

Watch this space.

Early Warning Systems and all That

During my time in New Zealand I remember seeing lorry loads and trainloads of sheep, cattle and pigs being packed off  to the slaughter houses and knacker’s yards. Over the time I was in that beautiful country, I observed the behaviours of these animals as the transport vehicles rumbled past and this left me with the indelible impression that these creatures somehow knew that something ominous was afoot….even though they could not read, write or understand a sentence of English, much less the road map.

 This brings to mind the OWS movement which appears to have swept the globe as a phenomemenon that defies definition. The OWS movement seems a jumble of contradictions: it professes respect for the enviroment but its activities have destroyed parkland and befouled inner cities with garbage and human waste; it professes respect and fellowship for citizens of the countries in which it staging its protests, yet it’s activities have significantly interfered with the commercial interests of small businesses and their employees, threatened passersby with violence and has otherwise commanded the attention of our law enforcement authorities to the deriment of others who might actually have benefited more from their attention at a particular time; and yet all along it professes to be able to “see the future” and is therfore justified in attempting to change that “fate” for everyone’s benefit. Moreover, in conversation, not one of the OWS protesters has been able to articulate a coherent vision, objective or group mission that all OWS protesters can agree with.

 The ultimate irony of the OWS “movement” however lies not in the paucity of substance, it lies in the fact that what little substance its demands and prescriptions contain, all seem to feature demands for exactly the wrong thing. This is quite simply that  the common thread among OWS protesters is that they are screaming for : more Government, more state control, more handouts, and generally speaking, for the Government or some other central authority to “solve” their problems. This is precisely the wrong prescription delivered at a time when the reality is that the cause of many of our challenges today is that the modern Welfare State has run out of rope, our political structures have not responded well to recent challenges and, combined with the demographic picture, that there is simply is no more “wealth” to be “spread around”. The choices Western society confronts today all revolve having to make do with less. That is the Bottom Line that the OWS is ignorant of at a fundamental level.

This “movement” in its present state will therefore likely fade away shortly and none too soon. Although the OWS folks sense that “something is wrong” in the world, they, like the animals on the way to the slaughterhouse, cannot articulate what it is they sense and fear, and, because of that and other inherent limitations, they are in no way equipped to devise strategies or action plans to avoid whatever fate awaits them, nor by the same token, to be able profess that they can render such advice to anyone else.

Given the present unsettled state of the world the real issue for clear-thinking people is: “What comes next after these “occupiers” fade into the sunset?”

For more on that, please dial in to Part II of our Canaries Blog series in 24 hours.

Posted in Bond Market, Canada, Crisis, Crminal Activity, EU, Fed Policy, IMF, OWS, Sovereign Debt, USA | No Comments »

The Brazil Trade

Quis custodiet ipsos custodes? (Who guards the guardians?)

Juvenal

It all seems to be coming down to the wire: Slowdwn in the US and Europe, downgrade of economic propects in Canada; Greece on the brink of default and financial contagion feared as a consequence. Since the onset of the Global Financial Crisis (GFC) the markets have repeatedly received asurances from the authorities that the situation was containable and under control and that the policy path set by them was appropriate. Now it seems that these assurances were misplaced. Where did it all go so horribly wrong?

The “Brazil Trade” was a joke scenario that was bandied about on many of the trading desks that I have worked on in years past. Basically the story goes as follows: you pick your trades ahead of a set of economic releases, do them in huge size and with leverage, and then buy a one-way ticket to Rio de Janeiro and go to the airport. Leave one of the traders on the trading desk to watch the screens and the blotter. After the numbers release, you phone your desk from the airport to find out what happened (yes, this storyline involves communications technology that pre-dates the Blackberry, I-Pads, and proliferation of digital news screens). If your positions go onside big time, then you leave the airport go back to the desk in anticipation of a big bonus payout, and life continues as usual. If, alternatively, you blow up, you get on the plane and live off of your previously accumulated pelf in moderate confort on the beach in Rio. (The Nick Leeson / Barings debacle in 1994 was a criminal variant of the Brazil Trade that involved a luxury yacht.)

The bottom line of the Brazil Trade is thus simple: if you win the low probability bet; you win really big and life goes on as before and is even better; if you lose, life as you know it is over because you are now a fugitive living in purgatory.

Any prudent banker or trader knows that you need to blow the bad deals and bad trades out of your portfolio before the next cycle of profit making starts. However, the entire approach to crisis management in North America and Europe over the last three years has been to attempt a short circuit of this process and to foist the impression on the markets and the public that no reckoning or adjustment was or is needed in order for life to go on as before.

And, in implementing this vision of the way out of the crisis, vast amounts of taxpayer dollars have been put at risk.

Now the strategy is starting to fray in earnest. In Europe political support for the bailout strategy is faltering, Germany appears to be positioning for Greek default, while the other peripheral countries slip closer to the edge and major banks’ share prices plummet – short selling ban or no. The resignation in the last few months of two senior ECB officials – Juergen Stark and Axel Weber (note: Weber was the heir-apparent to Trichet over Draghi) – signals deep policy divisions at the Central Bank. For the policy hawks unfortunately, these two resignations represent a victory of the bailout-supportive policy doves and, most likely, a continuation of present ECB policies.

In the US the latest wheeze in the form of the Obama Jobs Plan signals just how far removed from the reality of the markets the policymakers and politicians there are. What of the recent bust up over the debt ceiling and the stated need of the Debt Reduction Super Committee to find $4 Trillion in cuts before the end of 2011? Apparently this does not matter any more – $450 billion will be spent on extending unemployment benefits and other transfers before consideration of the funding mechanism is settled. More fundamentally, in our opinion the whole package boils down to a “potluck” policy grab bag that can only incentivize the unemployed in the US to stay unemployed. If passed by Congress, it will not achieve anything meaningful outside of an increase in the US Federal debt.

Canada is not immune. Not only are our debt levels very high by international standards, the can has been kicked down the road by the authorities here while our economy remains vulnerable to accelerating slowdowns in the US, Europe and China. There should be no question, but that the de-risking of the economy here from exposure to another major credit event must be a policy priority. For the avoidance of doubt we are not advocating more stimulus (in fact the very opposite) but more active risk management of the Zombie situation and more predictable control over government finances at all levels of public administration.

We are in this unfortunate situation because the authorities in North America and Europe never encouraged the markets to make the needed adjustments three years ago. Had they let the markets find a solution and refrained from meddling:

 The eventual price tag would have been lower and much more predictable,
 Inflation risks would be less,
 Unemployment would be lower,
 The number of sovereign, corporate and banking zombies would be MUCH LOWER,
 Sovereign debt burdens would be MUCH LOWER,
 The risks of an uncontrolled debt deflation and credit market collapse would be MUCH LOWER,
 The economies of America and Europe would be recovering.

The rapidly escalating crisis has swept the outcome of last weekend’s G-7 in Marseilles into the dustbin along with the sports pages and classified ads. This week we have more policy and political meetings in Europe; and next week we have the Federal Reserve Open Market Committee in a two day meeting down on L Street. The markets are now saying a Greek default is inevitable, other countries and buisnesses are edging closer to the precipice and yet the policymakers continue to bang the same drums.

Is anyone packed for a long trip?

Posted in Bank Loans, Bankruptcy, Banks, Canada, Crisis, Crminal Activity, EU, Fed Policy, Loan Losses, 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 »