eXpress Headlines
The ECB and BOE have shown their intent with their recent aggressive balance sheet expansions and the Fed is trying hard to keep the door open for more QE even as the data in the US continues to defy the general global slowdown.
In Asia however sticky inflation in India, a desire to nail property developers to the wall in China and a belief in a post earthquake recovery in Japan have kept the big Asian central banks from providing additional easing. Even in Australia where the economy has been teetering on the brink of a recession for 6 months, the central bank has refrained from any decisive moves.
In three out of the four cases above however things may slowly be about to change.
In India, the central bank recently opened the door for considerable easing in 2012 as headline inflation comes in. The market has already heavily discounted such a move with Indian equities up about 25% since mid December 2011 and some big ticket single names such as Tata Motors up more than 50%.
Quote Bloomberg
Reserve Bank of India Deputy Governor Subir Gokarn said the monetary authority will cut interest rates once it’s confident inflation will keep slowing.“The stance now is that we have reached the peak and any further action will be toward easing,” Gokarn, 52, said in an interview at his office while discussing the rupee, the government’s budget deficit and bond repurchases. The central bank isn’t concerned about the currency’s record monthly advance in January “because in a sense it’s a correction,” following last year’s 16 percent decline, he said. Emerging-markets have stepped up efforts to shield growth from the impact of Europe’s debt crisis, with Brazil, Russia and the Philippines cutting rates in recent months.
The road is not entirely clear for easing by the RBI where two issues may still derail the central bank's intention to start an easing cycle.
Firstly, the government's budget deficit continues to increase and while borrowing to invest in infrastructure etc in India is certainly worthwhile, monetary policy may still have to lean against excessively and essentially structural deficit spending by the government. This is particularly the case as supply side constraints may mean that such deficit spending adds substantially to inflation.
Secondly, the INR may be subject to substantial weakening on a resurgence in global volatility. The Fed's USD swap lines as well as the the ECB's efforts to backstop the European banking system have so far calmed things down. Nevertheless, should another period of strong and sudden INR weakness ensue, it means the RBI would not be able to reduce the yield difference to the rest of the world in any meaningful way.
In China, the economy is now visibly slowing. Foreign exchange reserve accumulation have ground to a halt and M1 growth is negative on the year. Even if the desire to cool down excessive credit growth and nailing property developers to the wall might still constitute top priorties, the balance is shifting towards easing.
China is seen making more cuts to banks’ reserve requirements to fuel lending and sustain economic growth as the housing market cools and Europe’s sovereign-debt crisis weighs on exports.The proportion of cash that lenders must set aside will fall half a percentage point from Feb. 24, the central bank said Feb. 18 on its website. Standard Chartered Plc forecasts at least three more reductions this year, while HSBC Holdings Plc (HSBA) sees a minimum of two.
So far, Chinese authorities seem content to use the reserve requirement ratio (RRR) as the main tool to provide easing. This makes sense in a command market economy where the government can be fairly sure to control the supply side of credit through loan quotas. I think however that the calls for no interest rate cuts until mid 2012 may turn out to be wrong if China is about to slow to the extent that our leading indicators show. Property prices have fallen (or failed to rise) for some time now in China and as growth slows further, the authorities may rightfully begin to argue that their near term objectives have been achieved.
Perhaps the most interesting development this week however came in Japan where the BOJ apparently got my memo as they restarted QE.
Japan’s central bank unexpectedly added 10 trillion yen ($128 billion) to an asset-purchase program and set an inflation goal after an economic slide fueled criticism it has been slower to act than counterparts.An asset fund increased to 30 trillion yen, with a credit lending program staying at 35 trillion yen, the Bank of Japan said in Tokyo today. The BOJ also said that it will target 1 percent inflation “for the time being.”
This decision appears to have gone completely under the radar, but I think it is very significant. Two points are particularly important to emphasize. Firstly, the entire 10 trillion yen added to the asset purchase program has been earmarked to JGBs which signals the BOJ's willingness (or the MOF's orders) that budget deficits in Japan are now to be directly monetised to a much higher degree than has earlier been the case. Secondly, the BOJ has now committed itself to an inflation target (1%) and will use balance sheet expansion to reach this goal.
This is textbook QE and should be bearish for the Yen and bullish for the Nikkei, but things may not be so simple of course. Chris Wood adds to the discussion in the latest version of Greed and Fear [1].
The second point is whether the latest news is a signal to short the yen. On the face of it, it should be. But the issue is whether the BoJ Governor Masaaki Shirakawa is going to follow the previous examples of his conduct of unorthodox monetary policy; whereby he raises thequantity of the so-called asset purchase programme but does not exactly accelerate the pace ofthe buying to fulfil the programme. Thus, the Bank of Japan has so far purchased ¥10.3tn of assets since the latest programme was first announced on 28 October 2010, amounting to only 52% of the previous target of ¥20tn set in October 2011.
In other words, how serious is this inflation target and over what horizon does the BOJ intend to reach it? Only time will tell, but given the persistence of deflation in Japan I would argue that any semi-serious adherence to this inflation target would require substantial balance sheet expansion by the BOJ.
As Chris Wood aptly puts it, the move by the BOJ is merely the latest evidence of the bull market in central bank balance sheet expansion and more importantly, relative central bank balance sheet. In a world where export driven growth is seen as everyone as the way out of debt purgatory you need expand and print more than your peers. On this, I also slightly disagree with Chris that Japan does not need a weaker JPY. My own analysis suggest that corporate margins in Japan are very sensitive to changes in the Yen. But that is a discussion for another time. For now, I will agree with Chris that we have seen the beginning of a sea change in Japan, but we need to see the BOJ backing up intentions.
Ultimately though, the most significant piece of news from Asia last week was the indication from both Japan and China that they would stand ready to offer their full support for the euro zone. The idea is simple; China and Japan would use the IMF as conduit to create the only real bazooka (apart from ECB monitisation).
Quote Bloomberg (my emphasis)
Japanese Finance Minister Jun Azumi said his nation and China will work together to help Europe solve its debt crisis through the International Monetary Fund.Europe needs a bigger so-called firewall of added funding to contain the crisis, even as Greece shows some improvement in solving its financial woes, Azumi told reporters in Beijing yesterday after meeting Chinese Vice Premier Wang Qishan. Azumi, who met Chinese Finance Minister Xiu Xuren during his visit, also said he asked China to make its currency more flexible.“We shared the view that Europe needs to make more efforts to create a bigger firewall,” Azumi said. “We also agreed to act together as the IMF will probably ask the U.S., Japan and China” to help boost its lending capacity.
This would indeed be global monetary relief from Asia.
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[1] - I cannot reproduce the whole piece, only select quotes.
I have been enjoying myself in the Austrian Alpes last week and hence the lower output. Here is my look though, of a number of notable news stories and contributions.
Global Liquidity
Benoît Cœuré, Member of the Executive Board of the ECB has penned a speech (and argument) on global (excess) liquidity. Izabella likes it and I agree with her that it is a good piece. I am not sure though that it is that much different than the Savings Glut argument put forward by Bernanke, but I may be missing the fine print (i.e. need to read it more carefully). The biggest problem I have is that he assumes that the lack of safe government (i.e. AAA rated assets) is cyclical and due to market failure or other "temporary" factors. Izabella interprets it as follows,
What’s the solution to this vicious liquidity circle? Simple, says Cœuré. The euro area needs to regain its role as a global supplier of safe assets. Something which could be achieved by a) ensuring that Eurozone countries have become fiscally sound and b) diverting excess liquidity from other zones back into “programme countries” by way of the IMF.
I disagree. The failure of euro zone economies and indeed large parts of the OECD edifice in general to provide "safe haven" assets is deeply structural and tied to population ageing. Unfortunately, there is little prospect that the euro zone economies will be able to supply AAA rated securities for a long time and herin lies the rub. Of course, if we are talking euro bonds, but then again. I will believe it when I see it.
Japan and the currency wars
A recent Bloomberg article suggested that Japan has been "secretly" selling JPY to try to stem the tide and force through depreciation of the Yen.
Japan used so-called stealth intervention in November as the government sought to stem yen gains that hammered earnings at makers of exports ranging from cars to electronics.Finance Ministry data released today showed Japan conducted 1.02 trillion yen ($13.3 billion) worth of unannounced intervention during the first four days of November, after selling a record 8.07 trillion yen on Oct. 31, when the yen climbed to a post World War II high of 75.35 against the dollar. The currency’s strength has eroded profits at exporters such as Sharp Corp. and Honda Motor Co., just as faltering global growth undermines demand.
Open market operations to sell domestic currency are so old school. Didn't they get the memo in Japan? In a world where all major central banks are either at or very close to the zero bound, it is central bank balance sheet expansion (quantitative easing) that matters. On this note, both Japan and the Fed are being left decisively behind by the ECB and BOE (at least in the past six months). Of course, even the usage of "standard" measures in Japan is being contested and as long as this is the case, the Yen will continue to strengthen.
Don't bet on deflation with the current team of global central bankers
Elsewhere, I am wondering where all the deflation, let alone disinflation, is. I am a sworn deflationist and I believe in the main thesis of the deleveraging/depression/deflation crowd. However, I have the utmost respect for the inflationist bias of global central banks and with the current batch of policy makers at the helm, deflation is a very remote risk.
The latest data show that inflation in China recently quickened as well as producer prices in the UK increased in the week that the BOE announced another round of QE. Of course, this is not all clear cut. Chinese real M1 (YoY) recently moved into negative territory for the first time since 1996 and in the UK, it is noteworthy that core inflation (ex food, beverages, tobacco and petroleum) came in noticeably lower in January.
I will change my views on the basis of changing data, but I am beginning to think that the bout of global headline disinflation we are expecting as a result of the global slowdown will reverse itself much, much quicker than many (including me) have expected. Arguably, we still need decisive easing in emerging markets and QE3 from the Fed, but it is more a matter of when and not if this happens and as such, global central bankers remain fully committed to creating inflation.
The main problem so far for those arguing for strong central bank action (including me) is the absence of nominal growth in output in excess of consistently rising headline inflation. Could this be a result of doing too little, perhaps, but at the moment stagflation remains the best way to describe our current economic situation and thus inflation in all forms is a drag on growth. Should the genie finally come out of the bottle in the form of consistent wage increases central bankers may find that they got more than they bargained for even if the alternative is equally painful.
The Greek experiment is about to end
Greece remains the main talking point and also the only thing that appears to prevent equity markets ripping to new highs. Greece is bankrupt and while I understand that the patience of the rescue committee will run out at some point, I am astounded that anyone expects this hideous experiment to end well. Greece will see its fifth year of contraction this year and for what? A membership of a currency union that does not work anyway?
We are told by the Troika, the EU and the IMF that failure to reach a deal would be catastrophic and thus that Greece has no way out but to take the medicine. However, Greece has a real choice and the stronger she is pushed the more obvious the end result is. Internal devaluation and decades of austerity don't work; not in Greece and not elsewhere. This remains the KEY issue that the euro area politicians and the ECB have not understood. The social fabrics of society won't stand the pressure and strain. Textbooks tell us that the cure is simple when you can't devalue, but practical experience have now shown otherwise.
I am neither on the Greeks' nor the IMF/Troika's side, but I simply point out the obvious destiny of current events; failure! Even if Greece manages to appease its creditors with austerity, the end result in terms of Greek macroeconomic balances is still unsustainable and thus the underlying problems will not have been solved.
The ECB and the IMF will likely face significant drawdowns on their Greek bondholdings regardless of whether they use such drawdowns as "carrot" for Greece to push through austerity measures. This is what the establishment has not yet understood.
MF Global investigation fails to uncover illegal activity?
Megan McArdle has an amazing article suggesting that the investigation on the failure of MF Global is finding it difficult to uncover anything illegal.
Megan quotes a piece from Reuters (no link available)
Lawyers and people familiar with the MF Global investigation of the firm that was run by former Goldman Sachs head Jon Corzine say that even though the hunt is still on to find out whether or not officials at MF Global intended to pilfer customer money in a desperate bid to keep the brokerage from failing, the trail at this point is growing cold.
This seems very odd to me even if I have not followed the aftermath in detail. I completely agree with the sentiment expressed by Megan.
I don't understand how this could be true. To be clear, I am not saying that it couldn't be true-only that I don't understand how such a thing could have happened. There is more than a billion dollars missing from supposedly segregated client accounts. I understand that it was chaotic, but what kind of chaos causes you to accidentally move money out of money that any moderately sophisticated compliance system should have automatically flagged for approval?
While my professional responsibilities are confined to the smooth running of a macro research product I sit in an office, and work, with asset managers and ever since the failure of MF global I would imagine that their general level of concern has increased. This is understandable. If your main counterparty as an asset manager (i.e. your prime broker) essentially decides to steal your deposits and/or allocate them to losing trades against the principle of segregated accounts, it really does not matter what you do. No matter the tightness of the shop run on the asset managers' end, he will face significant and perhaps even fatal losses.
Obviously counterparty risk is as old as finance itself and any decent asset manager today will deal with more than one broker and even have a strategy on how to manage counterparty risk. Ultimately though, mutual trust between asset managers and their prime brokers is a commodity which has been severely impaired by the MF Global failure and this is an issue for all players in financial markets.
Dealing with vintage data in economic forecasts using instrument variables (wonkish!)
A recent note from the George Washington University points to an interesting study from Warwick University on the forecasting of data vintages in the context of US output and inflation forecasts. The problem is as follows;
Consider a simple benchmark autoregressive model that a forecaster might use to forecast an economic variable yt. In order to estimate the parameters to be used for the forecast, typically the forecaster will obtain the most recently updated data on yt (i.e. the vintage of yt available at that time) and estimate the model using those data. However, the data in this single time series may in fact be coming from different data generating processes. The data some time back in the series have gone through monthly revisions, annual revisions, and perhaps several benchmark revisions. The most recent data, however, have been only “lightly revised,” as Clements and Galvão term it. Therefore, Clements and Galvão argue that the data in a single vintage are of“different maturities.” Forecasters may want to forecast future revisions to data as well as exploit any forecast ability of data revisions to improve forecasts of future observations. In their article, Clements and Galvão suggest that a multiple-vintage vector autoregressive model (VAR) is a useful approach for forecasters working with data subject torevisions. This comment discusses the importance of taking revisions into consideration and compares the multiple-vintage VAR approach of Clements and Galvão to a state-space approach.
This is a significant issue but remember; if the following holds, we need not worry too much about it.
If the revisions are unpredictable and the early data are efficient estimates of future data, then we may not need to be concerned about the different vintages.
Most economists assume that the statement above is true and simply force through their model. Being a great believer in practical usability when it comes to empirical economics, I would argue that in most cases this will not cause too many problems in most cases. However, a growing body of evidence suggest two important issues to consider. Firstly, revisions are predictable and thus provide important ex-ante information which should be incorporated into the the forecast. Secondly, even if revisions are unpredictable, the manner in which data is revised may itself provide important information on future data readings.
I agree, but the problem is potentially much more severe. Another issue then concerns that situation where you try to forecast Y(t) as a function of X(t) where both variables may be subject to revisions. Normally, we would solve this issue by restricting X(t) to variables where revisions are minimal (or absent alltogether). One way to do this is to use market based data (market prices, closing values of securities etc) which are, by definition, not revised. However, in the context of the e.g the classical leading indicators framework pioneered by Geoffrey H Moore, this issue re-emerges X(t) is cast in the form of real economic variables (themselves potentially subject to revision).
We have replicated and refined many of the LEIs described by Moore et al and applied it to various economic data series with specific fitting of a time series regression in each case. However, such an approach may still suffer from vintage data issues (as described above. One solution that I been thinking about is to imagine two forms of right hand variables. X(t, economic) and X(t, market based); if the latter is unrevised it might be possible to find an instrument for X(t, economic) (final revision!) using a variation of X(t, market based). This would, in my opinion, constitute an elegant way to solve the issue of data revisions in your explanatory variables.
In practice, you could also try to replace Y(t, economic) with Y(t, market based), but this is probably too a-theoretical and ad-hoc.
Global stock markets are up about 10% since the beginning of the year, volatility has collapsed, US economic data continue to defy even the mild slowdown proponents and the ECB seems to have backstopped the European banking system.
Yes, my dear reader. This is how quickly you move away from the apocalyptic abyss and back to normal. My base case is that we are close to excess complacency in equity markets and a sell off is overdue, but it is exactly also under these circumstances (where smart money start to hedge) that the market may deliver one final run up to get everyone and the postman in before hosing everyone.
In the short term, one of the only remaining stumbling block in the form of the ongoing default proceedings in Greece seem to be no match for the ongoing positive animal spirit of the equity market. Only a week ago, we got news that talks in Greece had stalled, but most recently we have been reassured that talks are back on track.
The main niggle on the first occasion appeared to be what kind of interest rate that investors would get on their new bonds and thus, ultimately, the loss of face value currently said to be 50% but also, by some, claimed to be as high 62.5%. Another issue would be whether Greece would pass legislation that forces investors to participate in the debt swap if a majority of investors agree to the PSI terms. This was specifically being discussed in the context of a particular group of investors holding both CDS contracts and the underlying bond and who would maximize their payout on the former by forcing through a hard default.
None of the terms seems have changed massively in the past week, but time is running out with March the 20th set as the final deadline as this is when Greece would otherwise have to make a payment of 4.5 billion-euro ($18.7 billion) on maturing debt. The general consensus is that if no agreement is reached, this date would mark the hard default. The reason for the optimism is then that we are very close to full surrender in the form of a 90% participation rate of creditors and, we are told, it is only a matter of time before the final 10% agrees.
The details reported so far are as follows;
Quote Bloomberg (21 Jan 2012)
The parties are near an initial agreement under which old bonds would be swapped for new 30-year securities carrying a coupon that would begin at 3.1 percent, reach 3.9 percent and go as high as 4.75 percent, Athens-based newspaper Proto Thema reported on its website yesterday, without saying where it got the information.
The desired macroeconomic outcome of all this is obviously well advertised. In 2020, Greece is supposed to have a government debt to GDP ratio of 120% and presumingly some form of growth that would allow this level of debt to stay stationary or perhaps even decline over time.
Let me be clear absolutely clear here. Within any conceivably realistic macroeconomic model, there is no way that Greece can reach a stable debt level with moderate growth under these conditions. Under the interest rate scenario noted above (let us with a average interest rate of 3.8% on the new debt) the nominal interest rate would still be substantially higher than the growth rate of the economy. The only way, the nominal debt level could then be kept stationary is by forcing the fiscal balance into surplus. However, the problem is that this affects the denominator in the debt/GDP calculation by sucking out demand (growth) from an economy already structurally impaired (within a currency union and all that).
The implications are obvious I think . The promises of stability that the PSI currently holds (even if it comes with considerable pledges of IMF money) are bound to disappoint.
First act of several to come
First of all, let us be clear. Despite, politicians' mortal fright to use the D-word and the media's acceptance of this fact on the basis that CDS contracts are not activated under the PSI, this is a stone wall default [1]. Anyone, who bothered to take merely a scant look at the history of sovereign defaults will see that the current Greek situation fits well within the framework. Indeed, the proposition that this is not a default because CDS contracts are not activated is ludicrous since in the vast majority of sovereign defaults, the debtor country begins negotiations with creditors well before the actual default is forced upon it. The fact that insurance contracts bought to protect a creditor involved in such negotiations have now been rendered useless says more about the nature of the our modern financial system than it does about the definition of a sovereign default.
Hence, we come to the real nature of this game.
The deal which now seems to be close to completed by no means closes proceedings. It is very likely in my opinion that private creditors who are currently the only ones being forced to take a haircut due to seniority of the IMF and the ECB will face a near 100% loss on their holdings. The argument is simple. Given the amount of debt held by the ECB and the IMF and the fact that these two institutions are senior debt holders the debt held by private creditors becomes juinor debt and thus the tranche which takes the first (and in my opinion likely complete) loss in the event of a default.
Of course, once we reach this point the issue of CDS contracts will rear its head yet again since if a 50-60% haircut can be considered voluntary anything beyond this becomes very difficult to characterize as such. Any rating agency would find it difficult not to classify further losses as a default and thus begins the fun in earnest. And then comes the ECB and IMF's share. It will be politically dynamite if the ECB had to print on the liability side to cover losses on the asset side on Greek sovereign debt [2] or if the IMF had to ask its contributors for extra cash to cover for losses on loans made out to Greece or any other economy. Obviously, much will be done to prevent this, but just look at the numbers of Greece's economy and you will see that it is not that outlandish, especially if Greece opts to stay in the euro zone. Finally, Greece only represents the starter here. Any deal agreed in Greece will be ardently watched in Ireland and Portugal who will feel they are entitled to the same deal with their private creditors.
Most tragedies have several acts, twists and turns. Investors should expect no less from the one currently being played out in the European sovereign debt markets.
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[1] - I know that the legal smarty pants will wade in now noting that default is only used when a payment is missed, but fact of the matter is that sovereign debt restructurings and defaults throughout time have always been a long process. Claiming that the Greek situation is different because it is allegedly voluntary and CDS contracts not activated is pathetic in my view, nothing less really.
[2] - In practice the ECB could do nothing and see its balance sheet shrink with the amount lost on the asset side (i.e. reduce lending to the banking system (delevering) with the amount lost on the bonds). However, in the event of a large loss beyond provisions (if any) it is likely that the ECB would "need" to credit reserves with the amount lost on Greek bonds (hence printing money) it would do this by increasing open market operations (the LTRO essentially) on the asset side. I mention the liability side first though since the mechanism would essentially be deleveraging. Whenever a bank takes heavy losses on loans it usually responds by raising capital AND reducing lending. Since the ECB can't really issue debt in the same way as commercial banks, it would need to either reduce lending OR if that is not possible issue liabilities to match the loss of which it is, as a central bank, free to do at its lesure.
Edward Hugh has a brilliant analysis of recent events in the eurozone and especially how banks are leveraging the liquidity provided by the ECB to "cleanse" their balance sheet of bad assets and essentially exchanging these for freshly minted euro deposits at the ECB. I think we should be very clear what is going on here; this is essentially a covert recapitalisation of the European banking system and the ECB is in every sense of the word acting as a lender of last resort.
Here is the relevant part;
Another area where the transfer of liquidity doesn’t show up as a change in aggregate excess liquidity is when banks offload their wholesale liabilities to other EuroArea banks and refund via the ECB. Here again, if they do it smartly, they can even earn a bit of “quasi carry” in the process, by buying back their debt at well below face value from those who are anxious to exit the periphery, and then refinancing at the ECB without writing down the underlying asset. This could be termed a liability “write down”, and again the procedure earns the bank a nice bit of income which can subsequently be used to help the recapitalisation process. Take the Portuguese Bank BPI (the country’s fourth largest), which is making public tender offers to buy back its debt. If all concerned tender their bonds to BPI, BPI will pay something short of €1.5bn cash to investors. Mortgages which were previously sitting in one of their SPVs will return to their balance sheet, and ECB money will now be on the other side financing them allowing significant profits (and capital) to be reported. In this particular tender the smallest discount is 35% and the largest is 65%. Investors may initially balk at the offer, since they will nurse a heavy loss (equal, naturally, to BPI´s profit) but ultimately they will probably be only too happy to be able to walk away from Portugal, and with some cash in their pocket to boot. Iberian banks were already aware of the benefits of this kind of restructuring during the 2009-2010 liquidity wave, and went about quietly repurchasing their bonds (bank capital, securitizations, senior bonds) on a selective and private basis at a discount. Much of their reported profits in those years in fact came from either the ECB carry trade or this kind of transaction. So when we read that another Portuguese bank – Banco Espirito Santo – has just had €1 billion of debt guaranteed by the Portuguese state (a sovereign which can’t itself go to the markets) it isn’t hard to imagine that the process going on in the background is something similar to that seen in the BPI case, and that the debt is being guaranteed so it can go over to the ECB to be posted as collateral. The National Bank of Greece has been doing something similar. They recently offered to buy back some €1.5 billion in covered bonds and preferred securities,offering 70% of face value for the covered bonds and 45% for the preferred hybrids. As the bank itself says, “The purpose of the offers is to generate core Tier 1 capital for the group and to strengthen the quality of its capital base….The offers would generate a gain for the group.” And Italian banks would seem to be doing something similar, since they issued around €40 billion in government backed bonds specifically to take to the ECB. The bonds are held by the banks themselves and stay on their books to maturity, their only purpose being to provide collateral for use at the ECB. In fact Italian banks took something like €116 billion from the LTRO, or almost 25% of the total. Perhaps this is why Unicredit CEO Federico Ghizzoni and other European top bankers met ECB officials in Frankfurt back in November, to discuss new rules for collateral. In Spain securitised mortgages sitting on the balance sheets of the bank-ownedFondos de Titulizacion de Activos could also be recycled in this way (here’s a complete list, although note that these Funds are regulated by Spain’s CNMV and not the Bank of Spain, which is why their presence is relatively unknown and people are able to accurately say that the central bank has been very strict on SIVs, since they weren’t their responsibility). That something like this may be happening, with the ECB “buying into” public and private Euro Periphery debt while investors are discretely getting out is suggested by this report in Bloomberg: The euro is losing the relationship with riskier assets that underpinned the currency in 2011 as the deepening sovereign debt crisis reduces the creditworthiness of even the biggest economies in the region. The 17-nation currency has fallen 8.7 percent against the dollar since October, while the Standard & Poor’s 500 Index has gained 3.4 percent, and the correlation between the two dropped to 58 percent from a record 91 percent in November, according to data compiled by Bloomberg. The euro had moved almost in lockstep with investments linked to growth, including stocks and the Australian dollar, since January 2011. This decoupling is taking place as European Central Bank President Mario Draghi cuts interest rates and promises banks unlimited cash for three years to rein in soaring borrowing costs for governments… Strategists also anticipate more losses as the US economy improves while the euro zone shrinks, driving international investors away from the region’s assets. So if the first two objectives were to help the struggling sovereigns, and enable the commercial banks to refinance their debt, then to some extent these objectives have been met. But what about the third objective, moving credit on the periphery to get the real economy moving again? Well, here the ECB’s measures are likely to have far less effect, and indeed what effect they do have may be in some way a mixed blessing, since the banks seem far more worried about demonstrating they have an adequate level of core capital than they are about participating in solutions to real economy problems.
Another area where the transfer of liquidity doesn’t show up as a change in aggregate excess liquidity is when banks offload their wholesale liabilities to other EuroArea banks and refund via the ECB. Here again, if they do it smartly, they can even earn a bit of “quasi carry” in the process, by buying back their debt at well below face value from those who are anxious to exit the periphery, and then refinancing at the ECB without writing down the underlying asset. This could be termed a liability “write down”, and again the procedure earns the bank a nice bit of income which can subsequently be used to help the recapitalisation process.
Take the Portuguese Bank BPI (the country’s fourth largest), which is making public tender offers to buy back its debt. If all concerned tender their bonds to BPI, BPI will pay something short of €1.5bn cash to investors. Mortgages which were previously sitting in one of their SPVs will return to their balance sheet, and ECB money will now be on the other side financing them allowing significant profits (and capital) to be reported. In this particular tender the smallest discount is 35% and the largest is 65%. Investors may initially balk at the offer, since they will nurse a heavy loss (equal, naturally, to BPI´s profit) but ultimately they will probably be only too happy to be able to walk away from Portugal, and with some cash in their pocket to boot.
Iberian banks were already aware of the benefits of this kind of restructuring during the 2009-2010 liquidity wave, and went about quietly repurchasing their bonds (bank capital, securitizations, senior bonds) on a selective and private basis at a discount. Much of their reported profits in those years in fact came from either the ECB carry trade or this kind of transaction. So when we read that another Portuguese bank – Banco Espirito Santo – has just had €1 billion of debt guaranteed by the Portuguese state (a sovereign which can’t itself go to the markets) it isn’t hard to imagine that the process going on in the background is something similar to that seen in the BPI case, and that the debt is being guaranteed so it can go over to the ECB to be posted as collateral.
The National Bank of Greece has been doing something similar. They recently offered to buy back some €1.5 billion in covered bonds and preferred securities,offering 70% of face value for the covered bonds and 45% for the preferred hybrids. As the bank itself says, “The purpose of the offers is to generate core Tier 1 capital for the group and to strengthen the quality of its capital base….The offers would generate a gain for the group.”
And Italian banks would seem to be doing something similar, since they issued around €40 billion in government backed bonds specifically to take to the ECB. The bonds are held by the banks themselves and stay on their books to maturity, their only purpose being to provide collateral for use at the ECB. In fact Italian banks took something like €116 billion from the LTRO, or almost 25% of the total. Perhaps this is why Unicredit CEO Federico Ghizzoni and other European top bankers met ECB officials in Frankfurt back in November, to discuss new rules for collateral.
In Spain securitised mortgages sitting on the balance sheets of the bank-ownedFondos de Titulizacion de Activos could also be recycled in this way (here’s a complete list, although note that these Funds are regulated by Spain’s CNMV and not the Bank of Spain, which is why their presence is relatively unknown and people are able to accurately say that the central bank has been very strict on SIVs, since they weren’t their responsibility).
That something like this may be happening, with the ECB “buying into” public and private Euro Periphery debt while investors are discretely getting out is suggested by this report in Bloomberg:
The euro is losing the relationship with riskier assets that underpinned the currency in 2011 as the deepening sovereign debt crisis reduces the creditworthiness of even the biggest economies in the region. The 17-nation currency has fallen 8.7 percent against the dollar since October, while the Standard & Poor’s 500 Index has gained 3.4 percent, and the correlation between the two dropped to 58 percent from a record 91 percent in November, according to data compiled by Bloomberg. The euro had moved almost in lockstep with investments linked to growth, including stocks and the Australian dollar, since January 2011.
This decoupling is taking place as European Central Bank President Mario Draghi cuts interest rates and promises banks unlimited cash for three years to rein in soaring borrowing costs for governments… Strategists also anticipate more losses as the US economy improves while the euro zone shrinks, driving international investors away from the region’s assets.
So if the first two objectives were to help the struggling sovereigns, and enable the commercial banks to refinance their debt, then to some extent these objectives have been met. But what about the third objective, moving credit on the periphery to get the real economy moving again? Well, here the ECB’s measures are likely to have far less effect, and indeed what effect they do have may be in some way a mixed blessing, since the banks seem far more worried about demonstrating they have an adequate level of core capital than they are about participating in solutions to real economy problems.
While I would, in general, be hesitant in taking anything from Zero Hedge at full face value I think the following story on Unicredit adds flavor to this by providing further evidence on the points Edward mentions above.
The story is clearly speculative but gets backing from Edward's accout above. The following seems to be a part of the general process which in itself is, in my view, absolutely mad.
Banks in weak countries have been issuing debt, getting a government guarantee, and then posting them as collateral at the ECB. There are examples of this for Greek banks for sure, but my understanding is it has also been occurring in Portugal and Ireland. It is the only way banks in Greece (and the other countries) can raise money.
The article then goes on to make this more alarming point (but really does not have evidence to back it up) that it appears that about €40 billion of the first LTRO was done by Italian banks (Unicredit?) that issued bonds to themselves and got a government guarantee, and then posted this asset as collateral for liquidity through the LTRO.
So, here is how I understand it.
Unicredit issues a 3m bill and gets a government guarantee so that whoever chooses to buy this bill knows that it will be backed by the sovereign (after all, this is still better than the bank even if the two are joined by the hip). The only problem is that it is being issued to itself with a permanent guarantee from the government.
From an accounting perspective this must be close to illegal in any meaningfully lawful jurisdiction, but I defer to experts here of course. The issue here is not then that the sovereign is guaranteeing a liability of a bank, we have seen this plenty of times and it is indeed the only way that some financials can issue debt, but rather that the bond never gets marketed to third party buyers.
It is absolutely astonishing that this 3m bill is then being posted as collaterall at the ECB. But you must understand that it has to be posted as such as far as I can see since you can't hold your own liabilities. So, the banks posts a bond issued to itself and posts it at the ECB and get freshly minted fresh euros credited to its bank account at the ECB. After the process, Unicredit still has the bond as a liability but instead of the same bond on the asset side (which is impossible) it has a deposit asset with the ECB.
If this is true, and the ECB is agreeing to this I must admit that it amounts to a serious bout of banking follies in the European banking industry.
One point that I have been shouting from the proverbial roof tops in my research, to partners and colleagues is that 2012 may well be the year when all major central banks will be conducting both conventional and unconventional monetary easing at the same time. I think this is a very strong testament not only to the severity of the ongoing debt crisis in the developed world, but also to the propensity of central banks to choose inflation as the desired route to recovery. We need not initially discuss whether they are deploying the proper set of policies or even whether such policies represent moral hazard or a ponzi scheme on government debt.
The main thing is to realise that this is an unprecedented global monetary experiment.
My message to investors in 2012 would then be not to underestimate this inflation bias by part of global central banks. Inflating your way out of too much debt won't work in the long run without considerable defaults and/or economic stress (hyper inflation). Events since 2008 are ample evidence of this, but the simultaneous inclination to create inflation and debase your currency (to generate more inflation and exports) by all major central banks will continue to exert a profound effect on asset prices and the global economy.
In so far as goes the idea that an investors' interest in asset prices is conditioned on return and volatility we can say that central bank policy will affect both. Financial assets will certainly benefit from excess liquidity, but the unravelling of too much debt through inevitable defaults and the central bank policies themselves will generate volatility. Whether the combination of such volatility and return means that you should stay out of the market entirely is a question for the individual investor.
From a macroeconomic point of view, the downbeat assessment remains however that it is difficult if not impossible to paint a picture of where sufficient growth is going to come from and on the investment side of things, the higher level of volatility will tend to shake the foundation of investors even if money is to be made for short periods of time.
Most attention has been centered on the ECB, whether the 3y LTRO represent QE and whether the continuing rejection to buy government bonds outright means that the ECB is a laggard among global central banks (see this excellent report by Hinde Capital for additional analysis relative to the points below).
750 Billion USD, and counting ...
Europe remains the center of the global debt crisis, a role the continent has now decisively taken over from the US which stood at the forefront in the initial phases of the crisis in 2008. Apart from the almost endless summits and meetings among government officials the significant measures continue to be the ones coming from the ECB.
In my view, the European interbank market is virtually dead and dusted, and the ECB and the Fed are now effectively the only thing between Europe's banks and large scale failures. Since early September 750 billion USD worth of liquidity has been provided to the European banking system of which 100 billion sits on the Fed balance sheet through USD swap lines.
Who will bet against the final 3y LTRO auction to take this beyond one trillion USD?
Spanish and Italian curves are now nicely steep again after a brush with inversion which obviously was one of the main objectives even if it was always debatable whether banks would buy government bonds with the liquidity taken up at the ECB.
The question is; how do you unwind all this? 750 billion USD to roll short term liabilities with the ECB and the Fed seems to me to be one of the biggest gamble in monetary history.
While the BOE and the Fed have been transparent in their QE efforts and the BOJ never really having left the zero bound the ECB has been more covert. However, it is my contention that with the expansion of the securities market programme (SMP) in 2011 to buy considerable amounts of government bonds (1) as well as the 3y LTRO the ECB is now fully engaged in quantitative easing.
I base this on two points.
The ECB will of course vehemently deny this but investors should understand that such denial is mainly out of political reasons. When Draghi unveiled the ECB’s attempt to backstop the crisis in Europe by offering full allotment liquidity on a 3y basis, the market was disappointed because the central bank president also reiterated that the ECB would not step up its purchases of government bonds.
I think that the ECB will be forced into a much more direct and active role where unsterilized purchases in the primary market (monetisation) will be needed, but I fully appreciate the political issues. We are currently in a delicate situation where new governments in most of the involved countries are saddled with forced mandates to impose austerity. It is very difficult for all parties involved to push this agenda if the ECB had stepped up a full backstop. Moral hazard risks are consequently paramount here.
As such, investors must content with the ECB’s attempt to shore up the European banking system which is no little feat given the bank rollover schedule in 2012 as well as new Basel II regulation which will further impair already shaken balance sheets. The ECB’s initiatives then follows the steady deterioration of conditions in the European (indeed global) banking system which initially culminated in the coordinated action by global central banks to supply dollars through Fed swap lines and which found its European answer in the ECB’s decision to provide unlimited liquidity yet again.
The problems look ominous for European banks and the global financial system in general. No matter what, European financial institutions will have to delever significantly which will spread its tentacles wide and far due to the high penetration by European banks in emerging markets (Eastern Europe in particular).
Behind the scenes however, significant ink has been spilled to debate and speculate on to the exact significance of the ECB’s liquidity operations.
John Hempton for example suggests that the ECB’s policy move is an open invitation to play the carry trade game using almost free liquidity to buy higher yielding government bonds.
Well the Euro fix is in. Whether it works - that is another question. But the fix is this: European banks can borrow unlimited amounts for three years to buy Euro government debt. The debt often yields 5 percent. The money costs 1 percent.
I agree that the incentives are certainly there for the banks to play this game especially in the context of government bonds as zero risk weighted assets. The problem is that many European banks have spent more than a year and two stress tests to get rid of substantial amount of peripheral government debt (which do not count as zero risk weighted assets according to Basel III) and as such weak governments are unlikely to benefit from this.
The flip side of this is that most of the liquidity taken up by banks go straight back to the ECB at the deposit facility which is now standing higher than at any time between 2008 and 2010.
Quote Reuters
The euro zone banking system starts the new year awash with record levels of liquidity but few signs that institutions are prepared to lend to each other, leaving money markets frozen.Most of the near half trillion euros of three-year funds borrowed from the European Central Bank in the last week of 2011 have made their way back to the ECB's overnight deposit account.
The Reuters piece goes on to argue that most of the liquidity will probably go to aid the large refinancing need banks face in 2012 and thus effectively as a replacement for a non-functioning interbank market that would normally be able to roll this financing. If this does nothing to solve the problem of sovereign insolvency and illiquidity it will work wonders through the fact that banks won't act as a drag on their respective sovereign's balance sheet as long as the ECB is involved.
I would note though that even though the liquidity is mainly reflected in reserves held at the ECB, it still represents excess liquidity as noted by Danske Bank.
Some market commentators have argued that the first 36 months long-term refinancing operation (LTRO), in which banks took EUR490bn in total, has so far not worked as planned because the extra liquidity has simply been placed on the deposit facility at the ECB. However, this argument is false.The sharp increase in outstanding open market operations (MRO+LTRO) increases excess liquidity (defined as open market operations plus recourse to the marginal lending facility minus autonomous liquidity factors minus reserve requirements) and this excess liquidity shows up as deposits at the ECB in just the same way as it did in 2008-10.
However, nothing is easy and despite the fact that collateral can be posted for liquidity the sovereign is still on the hook as my friend Edward Hugh points out.
Banks are being encouraged to keep rolling over what are basically NPLs by financing them at 1% at the ECB (foreclosing on them in Spain and keeping the property on the books may cost something like 8% in comparison). But the ECB isn't assuming the risk here, the national sovereign implicitly is, and is getting in deeper by the day.
This is certainly true by the letter of the law but one has to wonder whether the ECB will ever get paid back here. I mean 3 years is an awful lot of time. The ECB can roll these loans as long as need be (it has already effectively been rolling bank funding since 2008) while maintaining the figue leaf that it is not funding sovereigns. This may be true, but it is effectively funding the sovereign's banks and postponing the day of reckoning which is bank failures or nationalisation or both.
If the ECB is then forced take a hit on the collateral or the loans themselves, it will need to create the money to pay for these loans by printing euros. This sounds as a plan to me except that it does not solve the funding risks of governments which may or may not be able to ask their banks for help. The likely answer is that they won't be unless the ECB and EU decide to wield the ultimate weapon of financial oppression which would be to penalise reserves over a given level with negative interest rates at the same time as banks would be forced, through regulation, to hold government bonds.
But Edward makes another interesting point;
Looking at the Greek PSI, what they would try and do (if all this gets that far, I mean if the Euro holds together long enough in this Byzantine world) ) is load up the private sector share of the haircut, and keep the ECB as untouchable official sector. At the limit they can use ELA to keep the banks afloat while the sovereign restructures and then recapitalises. (...) Why would any ex Eurozone third party want to be counterparty to anything which might end up being subordinated to ECB exposure later on down the line. The more I think about it the more it seems to me that the 3 yr LTROs might end up choking the European banking system to death.
Looking at the Greek PSI, what they would try and do (if all this gets that far, I mean if the Euro holds together long enough in this Byzantine world) ) is load up the private sector share of the haircut, and keep the ECB as untouchable official sector. At the limit they can use ELA to keep the banks afloat while the sovereign restructures and then recapitalises.
(...)
Why would any ex Eurozone third party want to be counterparty to anything which might end up being subordinated to ECB exposure later on down the line. The more I think about it the more it seems to me that the 3 yr LTROs might end up choking the European banking system to death.
It is difficult to disagree on the gist of this point, namely that the ECB is digging itself a very big hole. If banks can exchange under water assets at the ECB for a deposit asset at the ECB (albeit with a negative carry) the ECB is running the risk that it becomes the sole counterparty of bad assets in the euro zone in which case seniority will mean very little.
The Greek situation is a good example. Private creditors face an almost certain 100% wipeout exactly because they represent such a small tranche of the total stock of debt. In such a situation the asymmetric relationship between subordinate and senior debt holders mean that the latter essentially become equity holders. But once subordinate creditors are wiped out the turn comes to the senior debt tranches and the further the ECB goes along the road of providing full allotment liquidity the higher will be its implicit direct claim on assets of all sorts of qualities.
In conclusion, it is my view that the ECB is now the only thing between the economy and widespread bank failures, but I also concur that the consequence of this is a permanent outsourcing of the interbank market in Europe to the ECB's balance sheet and, quite possibly, Fed's USD swap lines.
(1) - Even if such purchases have been fully sterilised.
Hello everyone. Here is to a Merry Christmas and a great new year. As you might have noticed, posting has been a little less frequent this year, but such is life when work comes in the way. We are working on some very interesting initiatives at Variant Perception regarding blogs and online presence which will allow me to post more content here.
For now though, have a great Christmas weekend.
best
Claus
I normally do not mix business and pleasure but in this case they are such a close match that I think an exception is warranted. The small independent macro research firm I work for is consequently in the process of restructuring its website and is opening up its Trusted Sources which was previously restricted to clients. VP Trusted Sources is a collection of content providers and their content that we deem to offer high quality and value adding financial and macroeconomic analysis worthy our own, investors' and other researchers' time.
Obviously, skilled and hardened readers of econ blogs would point out that the last thing the internet needs is another information aggregator. I would agree, and even in the world of economics and finance there are already considerable aggregators and umbrella sites which collects and gathers information.
However, and biased as I naturally am, I would argue that the VP Trusted Sources blows most of the other"passive" information aggregators in the financial industry away. I would point to three reasons for this.
1. We provide macroeconomic and financial news in its most pure format and if you are a consumer of such information you will be extraordinarily well served. This is high powered macroeconomic news, from one passionate macroeconomic researcher to another.
2. The VP Trusted Sources is essentially a custom made/all inclusive macroeconomic RSS reader. You don't need to create one; we have done it for you.
3. Its versatility. the VP Trusted Sources hub can be used either as the equivalent of a financial/economic Arts and Letters Daily or as a fast and efficient way to learn about a given topic.
I would particularly emphasize the balance between blogs, news and bank/investor research (1) which means that the VP Trusted Sources becomes a potentially very valuable gateway for information. You will also note that each entry (referring back to an original article) has both primary and secondary tags. I dare you to do research on a specific/generic topic where the VP Trusted Sources cannot lead you to instant and valuable information which will make your life easier.
Well, I think that this must be enough self-promotion for one day. Since it is free I encourage you to have a look and if you don't like it, feel free not to return. If you do, tell all your macro friends and fellow macro geeks about it.
(1) - Obviously some links will lead to walled content as some providers may not give free access to their content, but the vast majority of links goes to free resources.
The rumour mill is grinding particularly fast at the moment. Germany and France seem to be working on the famous nuclear solution, Spain plays tough on outsiders, the IMF is rumoured to be preparing an aid package for Italy not to mention Hungary and Austria (just like Belgium) has entered the rating agencies' cross hair.
So, what to believe?
I don't know, but it is interesting that Reuters are now reporting France and Germany to be in an agreement on a fast track move towards fiscal union as well as allowing the ECB to aid sovereigns more forcefully (i.e. unsterilised intervention).
I want to see this before I believe it. Germany is certainly sending conflicting signals. Yet, this may be because they are truly unsure how long they can play this game of chicken with the rest of Europe. Clearly, Merkel has a point in refusing to issue euro bonds and/or letting the ECB step in since the periphery needs to put their house in order or at least show a credible plan to balance the budget. This is essentially quid pro quo as Merkel knows that Germany needs to pay in the end.
But there is a rub. One issue is surely the fact that public finances across the eurozone are unsustainable but another is how these economies are going to achieve anything near the growth needed not to collapse (default) anyway.
We keep on coming back to two main points.
1) It was clear for all that pain was coming in the periphery already in 07/08 and that this would be a substantial period of negative growth/deleveraging consolidation.
2) But the question was always whether such pain could be administered from within the euro zone. We are steadily coming to the conclusion that this is not possible and Germany knows this. But the solution is not clear since jettisoning the euro would have grave implications for the EU too and therefore there is a very strong lock-in mechanism here which it is difficult to get out of.
Finally, there is always the risk that one or many of the Southern European economies will simply "get" enough and make some quick and devastating decisions. It is important to understand my point on this.
I am sure it would be catastrophic for Greece or another country to leave by their own accord and do a messy default, but at some point the rest of Europe and the market will simply corner whatever government that might be in place and they will start taking their own independent decisions.
I note that there are calls for the new government in Spain to play "hardball" with Germany. In this situation, Germany has a distinct interest in just letting the market squeeze the periphery, but of course the rest of the "core" is getting dragged down too and the whole banking system is now at risk of a major liquidity/solvency crisis. In this sense, I only agree conditionally with Felix Salmon:
El-Erian is very good at explaining the problem which needs solving: "Europe must still stabilize its sovereign debt situation. But this is now far from sufficient. Policymakers must also move quickly to contain banking sector frailties, and do so using a more coherent approach to the trio of capital, asset quality and liquidity." It seems to me, though, that sequencing matters here. Liquidity is — always — more important than capital/solvency. Give an insolvent bank enough liquidity, and it can live indefinitely. Remove liquidity from a bank, and it dies immediately, no matter how solvent it might be or how high its capital ratios are. And as for asset quality, we’re pretty much talking a zero-sum game here: when the banks’ dubious assets are the sovereign’s liabilities, the real solution is inflation, not nationalization.
El-Erian is very good at explaining the problem which needs solving:
"Europe must still stabilize its sovereign debt situation. But this is now far from sufficient. Policymakers must also move quickly to contain banking sector frailties, and do so using a more coherent approach to the trio of capital, asset quality and liquidity."
It seems to me, though, that sequencing matters here. Liquidity is — always — more important than capital/solvency. Give an insolvent bank enough liquidity, and it can live indefinitely. Remove liquidity from a bank, and it dies immediately, no matter how solvent it might be or how high its capital ratios are. And as for asset quality, we’re pretty much talking a zero-sum game here: when the banks’ dubious assets are the sovereign’s liabilities, the real solution is inflation, not nationalization.
I agree that liquidity is a key issue at the moment in the euro zone banking system, but let us not kid ourselves. Europe has not had a functioning interbank market since 2008 and we are just now seeing the accumulated effect of this.
I just read a big and very detailed BC report on deleveraging among EZ banks and I am extremely concerned. It is clear to me that not only sovereigns are battling with solvency issues but so are many banks and the extent to which they are fighting it means that they will have to cut lending and asset growth substantially. As such, I am afraid that the problems in the euro zone are beginning to resemble a widespread solvency problem both amongst banks and sovereigns, a combination which, to boot, will feed off each other. Especially Eastern Europe are going to have big problems in 2012. They are going to see an almost complete stop of credit flows through the banking system due to parents cutting cross border lending.
I think that we will see a wholesale and government driven process of bank nationalisations and restructuring in the next 6 months in the euro zone. I also think that most southern european economies are ultimately facing both public and private insolvency issues which will need balance sheet write-offs to get solved. It seems to me that, as so many times before, euro zone politicians are once again getting caught out by reality.
(see source of image at end of post)
I have recently spent a few days in New York talking to clients as well as sneaking in a bit of marathon watching and a visit to the Guggenheim museum. Flying across the big pond also means that there is plenty of time to catch up on movie watching. I opted for the action pack on the way out and went for a bit more intelligence and depth on the way home.
I especially liked the last movie I saw, the Adjustment Bureau (The AB), starring Matt Damon (David Norris) and the lovely Emily Blunt (Elise Sellas). The AB is an interesting metaphor on the idea of fate and the extent to which you are your own master or whether there is grand plan that we are all bound to follow. The movie works mainly because of the interaction between David and Elise. Especially the second chance meeting (in the bus) between Elise and David after the latter had been riding the same bus for 3 months to try to see her convinced me that these two persons are meant to be with each other. Any grand plan that the illusive Chairman and his caseworkers are trying to enforce in order keep these two people from being together is surely unfair and wrong.
The premise and drive of the movie then becomes Damon (David Norris) and Blunt's (Elise Sellas) fight against the fate imposed on them by the Adjustment Bureau. And I would argue that anyone with but a shred of romantic fiber will be cheering for David and Elise on this one.
Does this sound familiar? I think it does and as I thought about the movie I realised that it mimics the attempt by eurozone policy makers to force through a grand plan of monetary cooperation despite obvious signs this is not working.
Enter Monti and Papademos. You could hardly find a better expression of the EU's attempt to keep things according to plan than the appointment of two eurocrats as leaders of Italy and Greece respectively. On the face of it, you would think that their appointments have been a success. Both have recently won approval in parliament for pushing through just about any agenda that their new government may see fit.
Italian Prime Minister Mario Monti won a final parliamentary confidence vote, granting full power to his new government after pledging to spur growth and reduce debt in the euro-region’s third-largest economy. (...) Greece’s new government unveiled a budget for 2012 with a deficit shortfall dropping by almost half, thanks to pension and wage cuts and a Greek debt swap that will slash interest costs. (...) The fiscal plan, which will be approved by the Greek Parliament before a meeting of European Union leaders in December, is designed to regain the confidence of creditors and secure resumption of international financing. Prime Minister Lucas Papademos, appointed last week, is racing against a three- month deadline until elections to secure international loans and avert a collapse of the economy.
Italian Prime Minister Mario Monti won a final parliamentary confidence vote, granting full power to his new government after pledging to spur growth and reduce debt in the euro-region’s third-largest economy.
Greece’s new government unveiled a budget for 2012 with a deficit shortfall dropping by almost half, thanks to pension and wage cuts and a Greek debt swap that will slash interest costs. (...) The fiscal plan, which will be approved by the Greek Parliament before a meeting of European Union leaders in December, is designed to regain the confidence of creditors and secure resumption of international financing. Prime Minister Lucas Papademos, appointed last week, is racing against a three- month deadline until elections to secure international loans and avert a collapse of the economy.
Look a little closer however and you will see that the market is still calling the shots as focus has swiftly shifted from Italy and Greece over to Spain where borrowing costs last weeks reached all time highs. It seems that as one hole is plugged and the plan put back on track another problem emerges and throws it off track again.
In Greece and for all the talk of Papademos preventing collapse, it is important to emphasize that he is there mainly to manage a default process.
The Greek government started talks with banks on the terms of the voluntary debt swap that is part of the country’s international bailout agreement, the Finance Ministry in Athens said.The debt swap -- part of a second rescue package for Greece -- aims to put the country on a path to cut its overall debt load to 120 percent of gross domestic product by 2020. The discussions in Athens are expected to take weeks to conclude, a European official said today on condition of anonymity.
120% in 2020 while probably realistic is still too high for Greece and the issue of non-paying CDS will continue to complicate matters. The point is not so much the obvious issue that a 50% haircut can never be considered voluntary, but two additional factors. The first is that there is still considerable risk of Greece sliding back even with Papademos at the rudder and as the ECB have rejected to participate in any restructuring with its bonds (implicit seniority) any further haircut will have to fall on private creditors. Thus, any further haircut from this point and we are looking at a near full wipeout. Secondly, if the sovereign CDS market turns out to be a red herring, it is likely to lead to a sharp repricing of all exposed sovereign risk as potential buyers will realise that the only real insurance they have is to pay a lower price (i.e. demand a higher yield). Let me re-emphasize. Putting together a deal that gives banks a 50% "voluntary" haircut so that CDSs on Greek debt are not activated only to string together, on the same meeting, a deal to allow the EFSF to issue CDSs on Italian and Spanish debt is amazing to me.
In Italy, trend growth is essentially 0% if not negative and if you factor in the government's proposals for austerity from here to 2015, the debt snowball will be difficult to avoid. It is unlikely that Italy's new government will provide stability as the task facing them is impossible without financial help. Italy is likely to be asking for support at some point and here it is quite unlikely that the IMF or EFSF will be able to step in. This leaves the ECB which is already being forced into the fray by market conditions pushing up Italian yields.
There is strange focus on primary surpluses in Italy and the fact that the country managed to bring in the debt to gdp ratio in the 1990s due to ongoing primary surpluses. At the moment the point is obviously that it is exactly the high interest rates/low growth environment which is choking of growth. Eliminating interest rates from the analysis makes no sense at all. A simple rule of thumb states that if your nominal growth rate is below the weighted average nominal rate of interest on your debt, then the debt snowball will roll. Obviously, fiscal austerity undermines growth and thus exacerbates the debt snowball. Frontloading fiscal austerity when yields are rising and growth is going down will end in a vicious circle a la Greece.
A severe credit crunch is developing in Europe with Morgan Stanley estimating the total shrinkage of eurozone banks' balance sheets to the tune of 1.5 to 2 trillion euros. This is between 15% to 20% of eurozone GDP (2010 values).
There are three components here.
I am not getting paid by the European Banking Association. I am merely trying to convey the idea that when you ask banks to take a significant hit on the asset side at the same time as they remain unable to adjust the liability side a credit crunch is exactly what you end up with.
Especially Eastern Europe is important as the region faces significant roll over and financing risk in 2012. Hungary and Ukraine will need to start paying back the IMF loans and Hungary faces, to boot, significant funding risks in the banking sector. Hungary is in a very tight spot because the foreign banks are essentially shutting down lending due to the fact that Hungary has pushed through a deal which allows homeowners to pay back CHF mortgages at a, for them, favourable exchange rate.
Hungary is essentially caught in a vice which perversely forces the central bank to raise interest rates in times of volatility to protect the currency and thus foreign currency borrowers as well as to help keep inflation in check. Whether the central bank will move in with aggressive interest rate hikes (as e.g. the 300bp hike in 2008) is debatable and outright intervention probably more likely. The sad irony about Hungary's situation is that just as the country faces the pressure of paying back the first installment of IMF loans received at the initial phases of the crisis, there is talk about the fund coming back in. Details are sketchy at this point, but e.g. Morgan Stanley suggests that such talk may already be ongoing.
In addition, Romania and Latvia will come off the IMF/EU taps and return to market based financing which will further put strains on supply even if these economies are small. Essentially, many economies and corporates in CEEs have pushed forward financing to 2012 in hope of better times. The problem is however that the good times seem to be somewhat further away than initially expected and any economic agent having postponed tough financing decisions to 2012 in hope of relatively more calm markets is about to be disappointed.
Adjustment Needed?
We are then back to square one with ECB bond buying and the Franco/German disagreement about this very question representing the main issue which holds back markets. It is furthermore important to emphasize the underlying current here in terms of global credit markets as a whole. Almost all credit spreads are widening and wholesale funding markets are virtually non functioning which means that banks, especially in Europe, remain dependent on the ECB's funding window more than ever.
In practice, the ECB is already buying considerable quantities of Spanish and Italian bonds, and this will continue until there is a credible plan on the table for a eurozone wide recapitalisation of the banking sector.
For the chairman and the case officers it gradually becomes clear that it is too difficult to keep David and Elise from seeing each other and the archives are consulted which reveals an interesting fac. In earlier versions of the plan, Elise and David were meant to be together and it is concluded that this is probably one of the reasons that the plan keeps deviating from course.
As a result, the case officer originally tasked with keeping David and Elise is taken off the case and Thompson, aka the Hammer, is brought in to handle David's "adjustment". As he confronts David with the irreversibility of the plan he conveys the ultimate arrogance of an architect unwilling and unable to deviate from the original set course. In this sense, Thompson displays the same inflexibility as European politicians in their claim that the world would unravel if the plan is not strictly followed.
As Dan accepts Thompson's argument that he and Elise are not meant to be with each other if only because Thompson promises to destroy Elise's dancing carreer he leaves Elise and all seems lost. Yet, in the frantic closing stages of the film as David takes a final leap of faith running the risk of being "reset" we learn that the idea of adjustment is a double edged sword. Things can be adjusted according to plan, but the plan itself can also be adjusted.
There are very good reasons why events keep on deviating from plan in the eurozone and it is misleading when we are told that it would be a disaster if the status quo is not maintained in the eurozone. Indeed, it would be a disaster if it is. There is plenty of evidence and good arguments as to why the eurozone in its current setup was always going to fail and why considerably adjustments would need to be made as we moved forward. Such adjustment were never made however and all we we were told was that the convergence would happen by default as time passed.
I am not, and have never been, advocating a break-up of the eurozone, but it seems to me that obvious decisions are being avoided because they are deemed to conflict with an underlying plan that I find it difficult to see the meaning of. An adjustment is needed in Europe and like with Dan and Elise, the adjustment should be to the plan itself.
Source of image are http://moviescreenshot.blogspot.com/ and Universal Pictures. All pictures above are courtesey of http://moviescreenshot.blogspot.com/ and Universal Pictures and specifically this entry. The Adjustment Bureau is produced by Universal Pictures.
Germans are euphoric these days—compared to the dour mood that prevailed for nearly two decades when real wages declined in a stagnating economy with high unemployment. This new optimism is joyriding the powerful German export machine and appears to be impervious to the nightmarish scenarios playing out at the periphery of the Eurozone. And now, Germans have something else to be euphoric about: a housing bubble.
By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)
The National Association of Realtors' January 2012 existing home sales statistics show an annualized 4.3% monthly increase in total existing homes sales from December. Annualized gives what the yearly level and rate would be if the current month's rate was applied to an entire year. The change in existing home sales from this time last year was 0.7%.
graph: TMTGM
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Meet Roberta Karmel, an unassuming law professor. Meet Professor Karmel's answer to finally break up the big banks.
Another financial crisis, a prolonged recession, or changing political ideologies could cause a re-examination of the status quo and lead to a decision to break up the big banks. If that should happen, policy makers could well take another look at the Public Utility Holding Company Act of 1935 as a model for accomplishing such a breakup over a limited time span of, say, seven years. The political mood is already shifting. The 1980s mantras -- government regulation as problematic, free-market competition as an unquestioned good, financial engineering as worthwhile innovation and finance as more important than commercial and industrial enterprise -- are now being reconsidered. This could lead to a more responsible balance between government, finance and industry. Dodd-Frank, despite its length and complexity, is only the beginning of real regulatory reform. It's a continuation of the complexity of already overly complex financial and regulatory systems. What we need is a simple regulatory scheme to create a simpler banking system.
Yet another deal, yet more austerity. The Financial Times has the most detailed terms of the latest Greek bail out. We've dug out some details as well.
Here's the money shot. Greece's GDP is expected to shrink by 17% when comparing economic output from 2009 to 2013. That is not a recession. Greece is in a depression.
Gez, why not just invade, rampage and pillage the nation? Must all war be economic these days?
There was a leaked internal document which says Greece will never get out of this debt and shrinking GDP means....more bail outs.
There are new revelations on the 50 state mortgage fraud settlement. From The Financial Times:
A clause in the provisional agreement – which has not been made public – allows the banks to count future loan modifications made under a 2009 foreclosure-prevention initiative towards their restructuring obligations for the new settlement, according to people familiar with the matter. The existing $30bn initiative, the Home Affordable Modification Programme (Hamp), provides taxpayer funds as an incentive to banks, third party investors and troubled borrowers to arrange loan modifications.
A clause in the provisional agreement – which has not been made public – allows the banks to count future loan modifications made under a 2009 foreclosure-prevention initiative towards their restructuring obligations for the new settlement, according to people familiar with the matter.
The existing $30bn initiative, the Home Affordable Modification Programme (Hamp), provides taxpayer funds as an incentive to banks, third party investors and troubled borrowers to arrange loan modifications.
The settlement is estimated to be $40 billion. The fines are only $5 billion of this, which implies U.S. taxpayers are on the hook, not the banks, for $30 billion. So instead of getting any justice that using people's homes, their shelter and main life investment as a gambling chip and paper chase game is wrong, once again we get to pay for financial folly while banks pocket the cash.
Naked Capitalism has put up a top 12 list of things wrong with the foreclosure fraud settlement. Here's reason #1:
Sorry speculative traders in commodities, the Fed actually did a just say no on more quantitative easing. The FOMC meeting minutes for January 24-25th were released last week and some speculative commodities traders still seem to be in denial land.
The FOMC money quote:
The Committee also stated that it is prepared to adjust the size and composition of its securities holdings as appropriate to promote a stronger economic recovery in a context of price stability. A few members observed that, in their judgment, current and prospective economic conditions--including elevated unemployment and inflation at or below the Committee's objective--could warrant the initiation of additional securities purchases before long. Other members indicated that such policy action could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run. In contrast, one member judged that maintaining the current degree of policy accommodation beyond the near term would likely be inappropriate; that member anticipated that a preemptive tightening of monetary policy would be necessary before the end of 2014 to keep inflation close to 2 percent.
Welcome to the weekly roundup of great articles, facts and figures. These are the weekly finds that made our eyes pop.
The never ending invasion into our privacy knows no bounds. We just saw Google ignoring browser privacy settings and even when you delete cookies, flash cookies and even use proxy servers, you're being tracked. For those who have strong boundaries this is just irritating as hell. It's also stupid in terms of statistics. One percent, which is the typical dismissed exception of these profiling algorithms, equates to 3 million people in the United States.
Think Occupy Wall Street has dribbled to the oblivion of political history? Think again. It seems an offshoot of the OWS movement, The 99 Percent Working Group, Ltd., a non-profit, came up with the 99% Declaration and National General Assembly. They published a PETITION FOR A REDRESS OF GRIEVANCES and are organizing delegates, complete with voting rights, to ratify their platform. Yup, a real specific platform and agenda. They even bought a commercial.
The January Consumer Price Index, which measures inflation, increased 0.2%. From a year ago, CPI has risen 2.9%. Below is the graph for CPI's monthly percentage change.
Core inflation, or CPI minus food and energy also increased 0.2% for January. Core inflation has risen 2.3% for the year. This is the highest yearly increase in core inflation since 2008. Core CPI is a Federal Reserve inflation watch number. Below is the graph for the year core inflation change.
The January 2012 Residential construction report showed Housing starts increased 1.5% from December's revised 689,000, to a level of 699,000. December housing starts were revised significantly, from 657,000 to 689,000. January 2012 is now 9.9% above January 2011's 636,000 housing starts. Housing starts increase was due to apartments, 5 units or more of one building structure, which increased 14.4% in one month. Single family housing starts declined, -1.0%, from December 2011.
Below is a graph of housing starts going back to 1960. One can see how badly the bubble burst on residential real estate.