The Coming of an Economic Firestorm? [View article]
Dave, I read the link and fell into a nihilistic stupor. Kidding aside, here is an excellent companion piece written by Gavyn Davies who lays out the likely paths of a breakup of the EMU should it come to pass, which is looking increasingly likely. http://tinyurl.com/7x3...
The Coming of an Economic Firestorm? [View article]
Interesting discussion here but I think it’s important to distinguish between gross exposure and net exposure.
From the EBA stress tests conducted last summer available data infers that the 20 largest European banks were exposed to PIIGS private and sovereign debt to the tune of $ 4.5 trillion gross.
According to the BIS data, total global cross-border exposures to the five PIIGS countries totaled $4.1 trillion at the end of the first quarter of 2010. Sovereign debt exposure (public sector) is rather small compared with the other categories of debt, such as non bank private sector debt and other indirect exposures, including derivatives (financial insurance contracts), guarantees extended and credit commitments.
Importantly, though, the European banking sector held 89 percent of the PIIGS' direct exposure ($2.7 trillion). However, the banking sector in some European countries is much more exposed than the banking sector in other European countries to debt issued by the PIIGS.
All or most of gross exposure, however, is offset through the purchase of CDS and other hedging techniques which dramatically reduces the level of gross exposure to a net level which is probably a better measure of exposure conditional upon counter party risk. The logic is that bilateral netting, as the principle behind this argument is called, should always work - no matter the market, and that counterparty risk, especially when it comes to hedges, should always be ignored because banks will always honor their own derivative exposure.
Obviously that this failed massively when AIG had to be bailed out, to preserve precisely the tortured and failed logic of bilateral netting was completely ignored, after all things will never get that bad again, right? Well, wrong. Because the argument here is precisely what the exposure is when the chain of netting breaks, when one or more counterparties go under.
So when HSBC reports thats "The bank’s net investments in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain fell 33 percent to $5.5 billion, from $8.2 billion in June." keep in mind counter party risk.
Since first responding, I have tried to catch up on some reading and in the course of doing so have read various weekly letters I either receive or subscribe to, including Mauldin's Thoughts From the Frontline.
In this week's issue Mauldin devotes much time to German contingency planning for a possible default by Greece, which I previously commented on, and a UBS paper examining the process and estimated costs of a country (rich or poor) the leaving the eurozone. The numbers are huge.
Were Greece to leave the zone it's likely it would default on a minimum of 50% of its sovereign debt and possible as much as 75% to 90%. Since we have seen the 50% figure frequently in the context of Greece remaining in the zone, I'm inclined to believe in the higher estimates. Additionally, Greek's GDP could contract by as much 40% to 50% in the first year according to UBS.
It's my guess German financial officials are busily developing alternative economic scenarios and working out likely financial costs for each outcome, understanding that in the long term their interests are best served by preserving all of most of the zone but in the near term decisions must be guided by maximizing the return on finite resources. It's crunch time.
The following is from Mauldin's letter:
Welcome to the Hotel California Such a lovely place Such a lovely face They livin’ it up at the Hotel California What a nice surprise, bring your alibis
Last thing I remember, I was running for the door I had to find the passage back to the place I was before “Relax,” said the night man, “We are programmed to receive. You can check out any time you like, but you can never leave!”
- The Eagles, 1977
You can disagree with the UBS analysis in various particulars, but what it shows is that there is no free lunch. It is not a matter of pain or no pain, but of how much pain and how is it shared. And to make it more difficult, breaking up may cost more than to stay and suffer, for both weak and strong countries. There are no easy choices, no simple answers. Like the Hotel California, you can check in but you can’t leave! There are simply no provisions for doing so, or even for expelling a member. The costs of leaving for Greece would be horrendous. But then so are the costs of staying.
The data I quoted is for the first quarter while what you cite is for the second quarter which is more current and better illustrates the precarious conditions within Greece.
With each day there is mounting concern that Greece will default and Germany is now preparing for that eventuality by preparing a Plan B under which banks would take 50% haircut on Greek debt should Greece not receive additional tranches from the second bailout due to breach of contract and failure to make promised spending cuts, institute labor market reforms and sell public assets.
I have no sympathy for Greece but I do believe the austerity measures are so severe that they will bring about serial economic contractions which will reduce tax receipts, deepen the deficit and lead to fresh calls for further cuts. We can already see this playing out as Greece’s economy is simply as mess. GDP growth is minus 5.5%; debt to GDP is 160%; and the fiscal deficit is in the 8% to 9% range. All of this is leading to further calls for spending cuts and growing doubts whether Greece can be saved with some viewing the country as a black hole in which money is wasted and vaporized.
Greece must either default or leave the eurozone and these are precisely the measures being discussed within the inner circle of policy making. Der Spiegel reports:
German Finance Minister Wolfgang Schäuble, who is reportedly doubtful that the country can be saved from bankruptcy, is preparing for the possibility of Greek insolvency. Officials in his ministry are currently reviewing scenarios for handling such a situation, exploring what it might mean for the rest of the euro zone. Under the first scenario for a Greek bankruptcy, the country would remain in the euro zone. Under the other, Athens would abandon the common currency and reintroduce the drachma.
Volker Bouffier, the governor of the state of Hesse, which is home to Germany's financial capital Frankfurt, is a member of Chancellor Angela Merkel's conservative Christian Democratic Union (CDU) party, as is Schäuble. Bouffier is now urging that the possibility for countries to leave the euro zone be created quickly. Current European Union treaties provide no provisions for a country to abandon the currency.
"If the savings and reform efforts of the Greek government aren't successful, then we need to ask the question of whether we need new rules to make it possible for a euro country to leave the currency union," Bouffier told SPIEGEL.
Weekly Market Drivers: It's All About the Bondholders (Not Greece), Stupid [View article]
I think you are right and were it only Greece the EU and ECB may be taking a different course. But this is not the case and the involved parties are desperately searching for time and money under the delusion banks will build larger capital buffers and that neighboring peripherals (Italy, Spain and Portugal) will reduce their respective structural debt burdens.
An additional perspective, is that the EU and ECB are frantically seeking a means to hold together patchwork of countries together as a union when none of the essentials for a union are in place. The design of the EMU was flawed at the outset as the EMU has never fully satisfied the conditions for an optimal currency area: Synchronized economic activity and growth rates; a high level of labor and capital mobility; fiscal federalism allowing the fiscal risk sharing of idiosyncratic national shocks; and a significant degree of political union. Instead it’s a patchwork of seventeen countries with a shared monetary policy but different languages, different cultures, different ethics and different fiscal and budgetary policies. It’s an illusion of a union.
The only real solutions are massive debt restructurings and/or a break up of what is clearly proving to be a dysfunctional union. But politicians and bureaucrats have vested interests which they place above the public good; officials never want to admit mistakes; and bureaucrats do not want to lose their jobs as they are equipped to do little else.
So the obvious solution is to paper over fundamental solvency problems with more liquidity, piling debt upon debt. This keeps the EMU alive and conveniently protects the interest of rentiers and financiers and imposes upon the public the costs of the inherently flawed union and all of the debt being issued to keep it afloat until it implodes.
Weekly Market Drivers: It's All About the Bondholders (Not Greece), Stupid [View article]
Interesting article.
Most of the chatter and noise last week was about the final tranche of the original bailout package of 110 billion euro which now appears to be a done deal. Late last week the IMF agreed to extend its portion of of the 12 billion euro loan notwithstanding that Greece is technically in default of the original agreement having failed to institute all of the promised reforms.
This will buy a bit of time but the larger battle will be over the second bailout package which will be 105 billion to 150 billion euro or more, which will simply buy more time by kicking the can down the road. Notwithstanding Merkel's backing down from insisting that bondholders take a haircut, the private sector will be asked to make "voluntary" concessions in the form of maturity extensions along the lines of the Vienna initiative.
With bonds rated as junk, 18% on five years bonds, entrenched corruption and a totally dysfunctional economy dominated by unions and gilds and a culture of entitlement its most unlikely Greece will get its financial house in order and revive what could be generously be described as moribund economy. Assuming the second package is extended, most believe it will take Greece through 2012 or maybe into 2013 when the same problems will resurface when Greece will be unable to rollover its debt.
It's at this point Greece is likely to formally default on its projected sovereign debt of around 500 billion euro. Given the toxity of the PIIGS debt and the unlikelihood of meaningful reform inside of Spain, Italy, Portugal and France, the risks of contagion must be viewed as being very high.
So now what are we going to have in Basel III? Four layers of capital: two levels or Tier I capital, a conservation buffer and a counter cyclical level. In all it was proposed that total capital be 9% of assets but under industry pressure this has been watered down to 8%.
Under the agreement the new Tier 1capital ratio is increased to 4.5 per cent, more than double the current 2 per cent level, plus a new buffer of a further 2.5 per cent. Total capital plus the conservation buffer must equal 8%
All of this being built upon Basel II, which contained constructive language but also contained “pillars” or recommendations about how supervisors should evaluate activities and risk of individual institutions to see if there should be extra capital requirements against complicated securitisations or other assets not fully understood. Pillars, while useful, are not mandatory and are subject to prudential and regulatory discretion.
So in addition to diluting down the originally proposed 9% capital rule and allowing implementation of capital standards through 2018, Basel III will inherit many of the pillars of Basel II …..a repository of all things good under an intelligent regulatory system……..but risks inaction because no nation wants to act first against its banks and suffer a competitive disadvantage. Additionally, Basel III is silent on too big to fail and has few provisions, if any, to deal with bad assets.
While on paper Basel III is an improvement over Basel II, if what is agreed to is not enforced it’s likely to have little practical impact. Had we aggressively enforced the clauses and pillars of Basel II we could have easily averted the past and continuing financial crisis.
The Coming of an Economic Firestorm? [View article]
The Coming of an Economic Firestorm? [View article]
From the EBA stress tests conducted last summer available data infers that the 20 largest European banks were exposed to PIIGS private and sovereign debt to the tune of $ 4.5 trillion gross.
According to the BIS data, total global cross-border exposures to the five PIIGS countries totaled $4.1 trillion at the end of the first quarter of 2010. Sovereign debt exposure (public sector) is rather small compared with the other categories of debt, such as non bank private sector debt and other indirect exposures, including derivatives (financial insurance contracts), guarantees extended and credit commitments.
Importantly, though, the European banking sector held 89 percent of the PIIGS' direct exposure ($2.7 trillion). However, the banking sector in some European countries is much more exposed than the banking sector in other European countries to debt issued by the PIIGS.
All or most of gross exposure, however, is offset through the purchase of CDS and other hedging techniques which dramatically reduces the level of gross exposure to a net level which is probably a better measure of exposure conditional upon counter party risk. The logic is that bilateral netting, as the principle behind this argument is called, should always work - no matter the market, and that counterparty risk, especially when it comes to hedges, should always be ignored because banks will always honor their own derivative exposure.
Obviously that this failed massively when AIG had to be bailed out, to preserve precisely the tortured and failed logic of bilateral netting was completely ignored, after all things will never get that bad again, right? Well, wrong. Because the argument here is precisely what the exposure is when the chain of netting breaks, when one or more counterparties go under.
So when HSBC reports thats "The bank’s net investments in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain fell 33 percent to $5.5 billion, from $8.2 billion in June." keep in mind counter party risk.
Greece: The First Of The Dominoes? [View article]
In this week's issue Mauldin devotes much time to German contingency planning for a possible default by Greece, which I previously commented on, and a UBS paper examining the process and estimated costs of a country (rich or poor) the leaving the eurozone. The numbers are huge.
Were Greece to leave the zone it's likely it would default on a minimum of 50% of its sovereign debt and possible as much as 75% to 90%. Since we have seen the 50% figure frequently in the context of Greece remaining in the zone, I'm inclined to believe in the higher estimates. Additionally, Greek's GDP could contract by as much 40% to 50% in the first year according to UBS.
It's my guess German financial officials are busily developing alternative economic scenarios and working out likely financial costs for each outcome, understanding that in the long term their interests are best served by preserving all of most of the zone but in the near term decisions must be guided by maximizing the return on finite resources. It's crunch time.
The following is from Mauldin's letter:
Welcome to the Hotel California
Such a lovely place
Such a lovely face
They livin’ it up at the Hotel California
What a nice surprise, bring your alibis
Last thing I remember, I was running for the door
I had to find the passage back to the place I was before
“Relax,” said the night man, “We are programmed to receive.
You can check out any time you like, but you can never leave!”
- The Eagles, 1977
You can disagree with the UBS analysis in various particulars, but what it shows is that there is no free lunch. It is not a matter of pain or no pain, but of how much pain and how is it shared. And to make it more difficult, breaking up may cost more than to stay and suffer, for both weak and strong countries. There are no easy choices, no simple answers. Like the Hotel California, you can check in but you can’t leave! There are simply no provisions for doing so, or even for expelling a member. The costs of leaving for Greece would be horrendous. But then so are the costs of staying.
Greece: The First Of The Dominoes? [View article]
The data I quoted is for the first quarter while what you cite is for the second quarter which is more current and better illustrates the precarious conditions within Greece.
Greece: The First Of The Dominoes? [View article]
I have no sympathy for Greece but I do believe the austerity measures are so severe that they will bring about serial economic contractions which will reduce tax receipts, deepen the deficit and lead to fresh calls for further cuts. We can already see this playing out as Greece’s economy is simply as mess. GDP growth is minus 5.5%; debt to GDP is 160%; and the fiscal deficit is in the 8% to 9% range. All of this is leading to further calls for spending cuts and growing doubts whether Greece can be saved with some viewing the country as a black hole in which money is wasted and vaporized.
Greece must either default or leave the eurozone and these are precisely the measures being discussed within the inner circle of policy making. Der Spiegel reports:
German Finance Minister Wolfgang Schäuble, who is reportedly doubtful that the country can be saved from bankruptcy, is preparing for the possibility of Greek insolvency. Officials in his ministry are currently reviewing scenarios for handling such a situation, exploring what it might mean for the rest of the euro zone. Under the first scenario for a Greek bankruptcy, the country would remain in the euro zone. Under the other, Athens would abandon the common currency and reintroduce the drachma.
Volker Bouffier, the governor of the state of Hesse, which is home to Germany's financial capital Frankfurt, is a member of Chancellor Angela Merkel's conservative Christian Democratic Union (CDU) party, as is Schäuble. Bouffier is now urging that the possibility for countries to leave the euro zone be created quickly. Current European Union treaties provide no provisions for a country to abandon the currency.
"If the savings and reform efforts of the Greek government aren't successful, then we need to ask the question of whether we need new rules to make it possible for a euro country to leave the currency union," Bouffier told SPIEGEL.
Weekly Market Drivers: It's All About the Bondholders (Not Greece), Stupid [View article]
An additional perspective, is that the EU and ECB are frantically seeking a means to hold together patchwork of countries together as a union when none of the essentials for a union are in place. The design of the EMU was flawed at the outset as the EMU has never fully satisfied the conditions for an optimal currency area: Synchronized economic activity and growth rates; a high level of labor and capital mobility; fiscal federalism allowing the fiscal risk sharing of idiosyncratic national shocks; and a significant degree of political union. Instead it’s a patchwork of seventeen countries with a shared monetary policy but different languages, different cultures, different ethics and different fiscal and budgetary policies. It’s an illusion of a union.
The only real solutions are massive debt restructurings and/or a break up of what is clearly proving to be a dysfunctional union. But politicians and bureaucrats have vested interests which they place above the public good; officials never want to admit mistakes; and bureaucrats do not want to lose their jobs as they are equipped to do little else.
So the obvious solution is to paper over fundamental solvency problems with more liquidity, piling debt upon debt. This keeps the EMU alive and conveniently protects the interest of rentiers and financiers and imposes upon the public the costs of the inherently flawed union and all of the debt being issued to keep it afloat until it implodes.
Weekly Market Drivers: It's All About the Bondholders (Not Greece), Stupid [View article]
Most of the chatter and noise last week was about the final tranche of the original bailout package of 110 billion euro which now appears to be a done deal. Late last week the IMF agreed to extend its portion of of the 12 billion euro loan notwithstanding that Greece is technically in default of the original agreement having failed to institute all of the promised reforms.
This will buy a bit of time but the larger battle will be over the second bailout package which will be 105 billion to 150 billion euro or more, which will simply buy more time by kicking the can down the road. Notwithstanding Merkel's backing down from insisting that bondholders take a haircut, the private sector will be asked to make "voluntary" concessions in the form of maturity extensions along the lines of the Vienna initiative.
With bonds rated as junk, 18% on five years bonds, entrenched corruption and a totally dysfunctional economy dominated by unions and gilds and a culture of entitlement its most unlikely Greece will get its financial house in order and revive what could be generously be described as moribund economy. Assuming the second package is extended, most believe it will take Greece through 2012 or maybe into 2013 when the same problems will resurface when Greece will be unable to rollover its debt.
It's at this point Greece is likely to formally default on its projected sovereign debt of around 500 billion euro. Given the toxity of the PIIGS debt and the unlikelihood of meaningful reform inside of Spain, Italy, Portugal and France, the risks of contagion must be viewed as being very high.
Basel III: My Quick Analysis [View article]
Under the agreement the new Tier 1capital ratio is increased to 4.5 per cent, more than double the current 2 per cent level, plus a new buffer of a further 2.5 per cent. Total capital plus the conservation buffer must equal 8%
All of this being built upon Basel II, which contained constructive language but also contained “pillars” or recommendations about how supervisors should evaluate activities and risk of individual institutions to see if there should be extra capital requirements against complicated securitisations or other assets not fully understood. Pillars, while useful, are not mandatory and are subject to prudential and regulatory discretion.
So in addition to diluting down the originally proposed 9% capital rule and allowing implementation of capital standards through 2018, Basel III will inherit many of the pillars of Basel II …..a repository of all things good under an intelligent regulatory system……..but risks inaction because no nation wants to act first against its banks and suffer a competitive disadvantage. Additionally, Basel III is silent on too big to fail and has few provisions, if any, to deal with bad assets.
While on paper Basel III is an improvement over Basel II, if what is agreed to is not enforced it’s likely to have little practical impact. Had we aggressively enforced the clauses and pillars of Basel II we could have easily averted the past and continuing financial crisis.