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 »

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 II

In our last blog installment we asked, 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?”

Well, here in Toronto the OWS has been dispersed, the “Library Yurt” in St. James’ Park has been dismantled and its “defenders” bundled off; and who better to provide some insight into that question than The Right Honourable Tony Blair, the former Prime Minister of Great Britain from 1997 to 2007 and since then the Official Envoy to the Middle East for the Quartet? 

Recovery Partners attended a dinner last week where Mr Blair was the keynote speaker. A key message that he delivered was that the world is shifting very fast, and it is more interdependent and interconnected than ever before. Following that theme, he said that today’s politicians must quickly get used to the fact that they have to make “Big Decisions” and they must the right ones and make them quickly or risk losing control of the situation the West confronts today. This message ran through his entire address.

As for the situation in Europe Mr. Blair strongly advised that leaders there must recognize that the Eurozone is shifting from the “Politics of the Grand Design” to the “Politics of the Grand Plan”. It is the Grand Plan that has eluded decision-makers there. Unfortunately for Europe, however, Mr. Blair emphasized that, in this regard, the Eurozone and its leaders cannot afford to rely on a strategy that makes incremental changes that lead to incremental gains. This requires that the current Eurozone leadership realize that the crisis there is not a situation to be “managed: Today’s leaders have to take Big Decisions at an Existential and Fundamental level (which in itself is an act that risks or provokes a collapse of the system unless the right decisions and plans are implemented). The key realization here is that the single currency crisis has exposed a need for reform, it has not created that need.

Mr. Blair went on to say that the true operative timeframe now for the Euro rescue must be measured in weeks not months if the Eurozone is to be saved. This means that everyone in Brussels and in the Euorzone countries needs to get behind the Euro. In the longer term decisions need to be taken about a European Fiscal Union and Fiscal Reform. There are clear flaws in the Monetary Union Project, but for now a crisis management solution must be implemented quickly.

Everything is preferable to a breakup as the consequences are serious for both creditors and debtors therefore people on all sides of the negotiating table should be motivated to find a decision. Based on the foregoing there is simply is no “middle course” according to Mr Blair.

Similarly, the US Economy requires dramatic decisions that the Leadership there has avoided. Mr. Blair enumerated several “huge challenges” facing the US including debt levels, deficits, needed reform of the tax code, and an urgent need to rebalance the economy in favour of a more equitable division of National Income. He was unequivocal in saying that needed decisions have been deferred and have been piling up for years and these imperatives can now no longer be ignored.

As noted above Mr. Blair has spent a good deal of time since leaving office preoccupied with events and developments on the Middle East. His main message here, following from above, was that the Arab Spring, the Israeli Palestinian conflict, and Islam’s relationship to the West are all not only interconnected, they are key agenda items.

While it has become obvious that a variety of  regime shifts have going on in the Middle East, it is less obvious to note that most lack stability. In many countries modernization has outstripped to ability of the economy and population to keep up. Here, the main difference between Eastern Europe and the Fall of the Berlin Wall and what is going on in the Middle East today, is that with the Fall of Communism there was: (1) Unity among the Eastern Bloc population on what they wanted to get rid of; and, (2) unity among those peoples on their desire to adopt a Western Way of life, its aspirations and values.

Mr. Blair explained that in this regard, today in the Arab world there is no cohesion around what the population would like to structure in place of deposed regimes and dictators. Therefore it would be a huge mistake for the West to assume that people there just want to move towards a stable democracy. The simple model of modernization conveniently ignores the deep influences or tribalism and religion in many of these countries.

Therefore it is not obvious what the outcome in many of these countries will actually be. That means that unless we take strong positive action to get people into the right frame of mind that there will be problems with the transition.

Many of the regimes outside the West are quite strong and resistant to “Arab Spring” type events. They afford a measure of political stability. The folks who are a serious threat to these regimes or the status quo in those countries are usually either co-opted or neutralized

To underscore this point Mr. Blair said that many prominent people in these countries are extremely nervous about making ANY move, let alone the RIGHT move….and that this is happening throughout the region. Therefore he emphasized that we in the West we have to stay engaged with these populations. Specifically he stated that we have to assist with change, help these societies cope with modernization and at the same time, challenge them. The West needs to demonstrate that democracy is not only about a constitution and right to vote, it is also about: (1) an attitude to life, (2) freedom of expression, (3) freedom of religion, (4) freedom to work and transact in open, transparent and fairly-regulated markets, and (5) the requirement to live with tolerance and diversity.

The World no longer revolves solely around the US and Europe regarding strategies and political imperatives based around territorial interests. In fact the West must understand that the main message it must represent going forward is a Way of Life: Freedom, Democracy, Justice, and Tolerance being but some of the watchwords. Through leadership and vision we should impress upon the emerging and newly middle income economies to come to the conclusion that they would do far better to emulate the West rather than if they did something else.

Mr Blair’s remarks were warmly received and appreciated. Clearly in command of the subject matter and charismatic, he could probably have gone on for several hours. From our persepctive his address was as much an observation on the current state of affairs as it a warning to all of us that unless a more constructive approach to our problems is pursued by politicians both in Europe, North America and elsehwhere, that the consequences could be extremely undesireable.

This week financial markets in Europe remained on a knife edge and the US political class again showed that it continues to behave in a manner that is completely unresponsive to market discipline. The indicatiors on the threat board continue to flash yellow and red.

I am reminded of a luncheon I attended in Tokyo shortly after the fall of the Berlin Wall, when the then Russian Foreign Minister, Andrey Kozyrev, was asked by a member of the press how things would turn out in Russia. His response was that “No one is in full control, any one of hundred outcomes are possible and most of them are ones that people really won’t like.” As events have shown since then, it appears that the world and Russia herself has largely lucked out.

We may not be so fortunate this time.

Posted in Crisis, EU, Economy, Middle East, OWS, 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 »

Greeks ‘R Us

“Money for nuthin’ and checks for free” Dire Straits

While the world’s attention this week has been focused on the sovereign debt crisis in Europe, a time bomb planted much closer to home has continued ticking away, yet it is virtually unnoticed. That problem is the massive debt piled up by American state and municipal governments over the past several decades.

Lavish spending on social programs together with an unwillingness to even consider raising new revenues means a number of American states, most notably California, are heading down the same road as Greece and other European countries. Social programs such as EBT, which are richly satirized in this video, combined with the pillaging of the state treasury by the public sector unions have resulted in the impending bankruptcy of America’s largest state.

And nobody seems to care.

California is governed by, and for the benefit of, it’s elected and other public officials. The State legislature has gerrymandered itself into highly partisan electoral districts where the incumbents for each party are safe. They each play up to their base; the Democrats by buying people off with taxpayer dollars, and the Republicans by refusing to raise taxes in any circumstances. So everyone gets re-elected while the state slides inexorably towards bankruptcy.

Today, in 2011, the average Californian has debts of $ 78,000, and an income of $ 43,000, so blowing borrowed money is normal to them. Similar to Greece this virtual bankruptcy of the state is not a temporary situation brought on by a recession or a blip in economic activity. It is institutionalized. It is built into the way Californian power brokers run their state. It has become standard operating procedure. Overspending, openly bribing public sector unions with ever more generous pay and benefits, and refusing to raise new revenues in any and all circumstances, is the “new normal” in sunny California, home of the original Fantasyland.

As Michael Lewis points out in his new book “Boomerang”, California will spend $32 billion dollars on pay and benefits this year, up 65% over the past 10 years. Meanwhile education spending is down 5%, and health and human services payments are up only a scant 5%. Here are some example of the insanity: In California a prison guard who started his career at age 45 can retire after 5 years with a pension nearly equal to his salary. The head psychiatrist for the California prison system makes $838,706. In the meantime the state’s share of the budget for the University of California has fallen from 30% to 11 %. Tuition at the University of California has gone from $776 in 1980 to $13,218 today. “Everywhere you looked the long term future of the state was being sacrificed”, according to Lewis.

Governor Schwarzenegger tried to change things. He thought he had been given a mandate to do so. He tried working with Republicans. No dice. He tried working with Democrats. Nothing doing. He tried to sweet talk, he tried to cajole and he even tried to bully them. Nothing. So he then tried going over their heads to the people directly in a special election based on four reforms: limiting state spending, putting an end to gerrymandering of the state electoral districts, limiting public employee unions spending on elections and lengthening the time it took for public school teachers to get tenure. All four were defeated by sizeable majorities. Toward the end of his second term Governor Schwarzenegger finally managed to pass a slight tax increase by persuading four Republicans to help him create the supermajority necessary to pass the measure. Californian voters thanked these four brave souls by promptly defeating every one of them in the next election.

Closer to home things are not much better in Ontario. Over the past eight years the McGuinty government has so mismanaged Ontario’s finances that Ontario now has a budget deficit of almost $17 billion dollars and has increased the provincial debt by $100 billion to $ 235 billion. This was quite a feat considering that McGuinty created new taxes one after another and raised other existing levies.

Apparently, nobody in public life in Ontario believes that the McGuinty’s Liberal government debts will ever need to be re-paid. In last month’s provincial election barely a word was uttered by anyone about deficits, debt, and the manner in which the onus of re-payment can strangle an economy. Friday’s job loss figures in Ontario’s manufacturing sector is but one indication. Even the ostensibly “free market” Ontario PCs never mentioned that there might be a need for Ontarians to live within their means, for fear of frightening voters with the revelation that Ontario might not be able to borrow and spend in perpetuity.

As events in Greece have proven, democracy only works when citizens act in an informed and responsible manner in the best interest of the community as a whole. Grabbing as much as you can get and sticking someone else with the bill has not been a recipe for long term success. The combination of self serving and cowardly politicians and an uninformed and demanding public that insists on living in a world of make-believe in places like California and Ontario will have devastating consequences for anyone hoping to receive even basic public services in the very near future.

The recent speech by Edmund Clark, Chief Executive of the Toronto Dominion Banking Group is a laudable attempt by one of our most respected business leaders to bring these issues into sharp focus. It would be encouraging if more of our business and political leaders were to pick up on this message and become prepared to throw their weight behind a movement towards awareness and appropriate reform designed to create a sustainable fiscal path for our economy. There is literally no time to waste in trying to turn this state of affairs around, we are living beyond our means and there are no painless solutions.

Do Canadians want to see their future generations suffer from our legacy of profligacy or are we going to make the hard choices necessary to turn back the tide of self interest and greed in order to ensure that we avoid driving our society into the ditch?

If we allow the unthinkable to happen, we will only have to look in the mirror in order to see who is responsible for our miseries a few short years from now.

This Blog was written under the pseudonym of “Caol Isla” whose professional qualifications include the practice of law, two stints in the Prime Minister’s Office, Chief of Staff to two Cabinet Ministers and to two Leaders of the Opposition in Ottawa, comprising a total of 34 years of service at senior levels in the Federal Government and public affairs in Canada.

Posted in Canada, Crisis, EU, 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 »

The Summer of Discontent

 ”The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”

 F A von Hayek, “The Fatal Conceit”

 If Ronald Reagan, Milton Friedman, or even Boris Yeltsin were alive today they would be shell-shocked to witness the transformation of Western countries’ public debate and public policy in the last twenty odd years from a celebration of victory by Free Markets over Communism into an embrace of the Power of the State.

In Europe and the US, governments now own or control banks, car companies, mortgage lenders, property companies and other former private sector enterprises. On both sides of the Atlantic public policy is increasingly reflecting an interventionist, heavy handed meddling by Governments who appear mistrustful of free markets. The folks currently at the center of policy-making in Brussels and Washington also seem to believe that it is possible to legislate results, pass laws to coerce behavior and generally thwart market outcomes as it suits them.

You might think that we are living in the old Soviet Union.

Don’t like the fact that the markets are starting to question the stability of European banks? Contrive a “Stress Test to allay market fears. When that doesn’t work and bank shares continue to get hammered, outlaw short selling and talk tough like you mean it. Simple. Listen to Jean Pierre Jouvet, the head of AMF, the French Financial Markets Regulator,“They wanted to test French resistance. This is our response, as always very determined, and it will be so for all those who want to put us to the test.” We’ll see.

 

Don’t like the fact that a variety of Euro area bonds are selling off in response to justifiable market fears regarding the deterioration in sovereign creditworthiness and hence increased likelihood of sovereign default? Well, then instruct the ECB and EFSF to start buying up these credits with money that is magicked up on a keyboard. Never mind that in doing this, you (the ECB and EFSF), are asking government ciphers to match wits with the likes of Michael Sherwood and his crew at Goldman’s, Bill Gross at PIMCO and Louis Bacon at Moore Capital; and that therefore this doesn’t really stack up as a fight that the apparatchiks can ever hope to win. Never mind that in all of recorded history government schemes to manipulate traded markets have always failed. And that in their wake massive credit and trading losses have accrued to the public purse accompanid by economic upheaval.

In the United States certain politicians (Nancy Pelosi among them),  are telling voters that Unemployment Insurance actually stimulates the economy because people spend their dole checks on goods and services; and that the Food Stamp programs (Over 45,000,000 recipients being served and counting)  are similarly stimulative. In the US it is now impossible for businesses to offer free coffee and donuts to clients; Grandmas can’t make home-baked pies for church socials, and kids can’t operate a lemonade stand without risking a $500 fine, all because of new US Federal regulations and armies of regulatory brownshirts freshly hired to enforce them (employed at salaries that are roughly double what they might earn in the private sector we might add). The new rules, regulations and directives burdening US business number in the thousands. 

The budget management and deficit reduction talks among the twelve member Super Committee will be getting underway shortly South of the Border. The fireworks that we saw connected to the debt ceiling negotiations are just a foretaste of what is to come in this set of “talks”. The real negotiation is over control of the 2012 Presidential and Congressional Elections. Democrats will be looking to recover ground lost by Obama in his botched handling of the debt ceiling debate while Republicans will be looking to drive the knife home and kill off Obama’s re-election chances for good. The stage is thus set for even more of the “political dysfunction” that S&P alluded to in its recent decision to downgrade the US. And the drama will play out agonizingly slowly, but loudly, over the next several months. Not a pretty backdrop either for financial markets or for Main Street.

Through all of this the markets are starting to crumble. Most commentators have raised their forecasts of the probability of a renewed slowdown  to 1 in 3 or 1 in 2. Some, like David Rosenberg of Gluskin Sheff, are saying that slipping into negative growth is a certainty. It is undeniable that economic growth in both Europe and North America is slowing. European economies are all growing at 1% annualized or less. Japan just printed a negative quarterly growth number. The US is limping along with a raft of indicators pointing to a sharp slowdown. In only one dimension this puts at risk the entire EU/ECB strategy of kicking the can down the road and hoping that the PIIGS and other debt-laden Euro-zone countries can grow out of their problems.

It is in this environment that this weekend’s annual meetings of Central Bankers at Jackson Hole Wyoming is taking place. Last year in a decidedly more upbeat environment (recall that the mantra then was that the recovery had arrived) Bernanke hinted at the unveiling of QEII and the markets promptly took off.

With the ECB and Brussels going “All-In” to stem contagion in the Euro-zone, what can Bernanke pull out of his bag of tricks to help boost confidence and get the US economy growing again? The answer is: “Not Much”. There is no more stomach for debt-financed stimulus in the US given the need to at least pay lip service to the objectives of the Super Committee. At the same time the Administration and Congress will continue to clamor for “action” to create jobs and re-start the economy.  This means that there is huge pressure on the Fed to “do something”. And, whatever the Fed “does”, the central banks of the world must fall in line or get steamrollered.

Our view is that the Fed has already recently tipped its hand by announcing the continuation of ZIRP for the next two years. Should the data continue soft as we expect it will, we foresee that Bernanke will at some point in the next few months, also implement another round of QE. Bernanke will likely strongly hint at this in any speeches and announcements coming out of Jackson Hole. No matter that the inflation indicators already exceed policy rates in both the Euro-zone and the US, Bernanke and the Fed are pre-disposed to action, can only take action in one direction, and will do so with a determination that reflects an unshakeable belief in their ability to control the economy. In our opinion they are sadly misguided in this and further, that any possible benefit can come out of the course they have already set.

So, for the period following the meeting of super-bankers,  our  short term prognosis is as follows: Government and Central Bank balance sheets will bloat further, unemployment will stay stubbornly high, economic growth will continue to crawl along at or below stall speed, the EU will continue to try and bail out failing Euro-sovereigns, the ECB and EFSF will continue to gorge on Euro-area debt that nobody wants to own; the Super Committee will serve up a dog’s breakfast; and the Fed will goose things further.

Similar to the fading days of the old Soviet Empire, the pressures for a financial collapse are building. Expect the outcome of the Jackson Hole meetings this weekend to add to, and not to subtract from, those pressures.

Posted in Bond Market, EU, Economy, Fed Policy, USA | No Comments »

Bribery and the Board

Posted in Canada, Crminal Activity, EU, Insurance, 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”.

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