The Financial Times indicator is looking more and more reliable: when the pink paper starts playing at the top of its form, the wheels are about to come off.
The most troubling aspect of the Standard & Poors downgrade of Greece to junk and Portugal’s downgrade came in its release. It isn’t just that Greece looks increasingly likely to default. As we have said, it seems like a certainty; the fiscal cuts required by its austerity program are arguably the deepest in modern times.
The real problem is that the losses on default are likely to be far steeper than is typical for sovereign borrowers. From S&P’s press release:
The outlook is negative. At the same time, we assigned a recovery rating of ‘4′ to Greece’s debt issues, indicating our expectation of “average” (30%-50%) recovery for debtholders in the event of a debt restructuring or payment default”
Yves here. Those who called Greece a subprime borrower were more correct than they knew. One of the factors that made subprime losses so devastating has been the high loss severities.
The real risk here is to Eurobanks. They ran with even higher leverage ratios than US banks, they are believed to have recognized less of the losses thus far on their books than their US peers. Even worse, readers report that the major dealers (and the Eurobanks were part of this cohort) are carrying toxic assets at prices that are vastly above likely long-term value. Eurobank exposure to Greece is over $190 billion, and total periphery country exposure is roughly $900 billion.
In the subprime crisis, many pundits and the Fed itself thought the losses would be contained, unaware that for every $1 in BBB subprime bonds, another $10 in CDS had been written, and that many of these exposures sat with highly levered firms, namely insurers and dealers, who were not able to take much in the way of losses. The gross level of exposures looks much worse here and the banks most at risk have not done much (save take government handouts) to rebuild their balance sheets.
So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU’s erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on.
The VIX posted its biggest one-day increase since 2008 but its level of 22 is positively tepid compared to crisis norms. Portugal, whose total debt to GDP is higher than Greece’s, is under pressure as bond spreads continue to widen. Hungary’s premier-in-waiting stated that the country, which was bailed out last year, will not be able to meet IMF fiscal targets and should widen its deficit even more to stoke growth. Traders went into risk-aversion mode, with emerging market and junk bonds also suffering. And as we mentioned, quite a few people in London expect a significant devaluation of the pound after their elections.
A further source of trouble is political. If the euro continues on its expected slide and the pound is devalued, the dollar’s strength will put a major dent in the US ambitions to increase exports. Moreover, the rise in the greenback relative to other currencies will no doubt make China much more reluctant to revalue the renminbi against the dollar.
Japanese markets are down over 2% at this hour, with the rest of Asia faring better.
Update 1:30 AM, 4/27: I somehow missed the article by Ambrose Evans-Pritchard of the Telegraph, who argues that the ECB will have to use the nuclear option of market intervention to buy up government bonds.
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Greeks don’t even pay their property taxes for crying out loud. Moreover, the government can’t force them to do so!
How is it possible to get any other outcome than a default?
Hi Francois. One of the main reasons Eastern Europeans don’t pay taxes is because for generations they were abused by their governments. Most people think Eastern Europe is socialist, but in fact they are closer to an anarchist society. Their relationship with the government is like a game of cat and mouse and in general they are highly cynical about politics and governance. This, in my view, is the biggest threat to the US: gen X and Y will find out the government stole their future… no Social Security left, huge debts to pay off, jobs gone, Medicare bankrupt… you get the picture.
I am more than willing to suffer a decrease in my standard of living if it helps punish the a-holes whose debt-fueled consumption brought on this crisis.
You are so right! This is a time-bomb which is going to provoke a critical re-evaluation of the social contract (they are going to realize that the financial system isn’t working for them AT ALL!)
I believe the current credit-creation mechanisms are heading for a death spiral because of the unsustainable imbalances its inherent biases provoke.
Couldn’t agree more!
Any time governments decide that accountability is for everyone but them and their cronies, (Hmmm! Our beloved US elites circa today, anyone?) the social contract is stretched to the breaking point.
And that has always and invariably meant big, big trouble down the road.
That said, the peculiar situation in Greece is a sight to behold; not having even a central registry of properties (!!) is mind boggling, to say the very least.
“A further complicating factor is political. If the euro continues on its expected slide and the pound is devalued, the dollar’s strength will put a major dent in the US ambitions to increase exports.”
But of course, we don’t need to increase exports. A little simple home-first economics and things heal up. Keeping our market to ourselves (for a limited time, if that’s the flavor of your politics) would be the simplest, surest, and best remedy for an impoverished middle class dragging a nation’s economy down. While this would have to be imposed by ungamable statute law rather than clever fiscal manipulation, it would still raise the tide far more than the fantasy foreign customers.
“But of course, we don’t need to increase exports. A little simple home-first economics and things heal up. Keeping our market to ourselves (for a limited time, if that’s the flavor of your politics) would be the simplest, surest, and best remedy for an impoverished middle class dragging a nation’s economy down. While this would have to be imposed by ungamable statute law rather than clever fiscal manipulation, it would still raise the tide far more than the fantasy foreign customers.”
Are you saying that the US should impose trade barriers, raise import taxes on finished goods and similar actions?
If so please see: http://en.wikipedia.org/wiki/Smoot%E2%80%93Hawley_Tariff_Act
Here is an excerpt from Wiki: ‘The Smoot-Hawley Tariff or Hawley-Smoot Tariff (P.L. 71-361, officially named, the Tariff Act of 1930)[1] was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels.[2] The overall level tariffs under the Tariff were the second-highest in US history, exceeded only (by a small margin) by the Tariff of 1828.[3] The ensuing retaliatory tariffs by U.S. trading partners reduced American exports and imports by more than half and contributed to the severity of the Great Depression.’
I an not saying your suggestion (assuming it is your suggestion) would not work, for the situation today is not as it was at the beginning of the great depression…but trade barriers do not normally solve more problems than they create.
I suggest that balance of trade is about the only solution to the soverign debt problems that continue to crop up around the world. Soverigns were forced to balance trade under the gold standard but under fiat currency regimes soverigns simply print more currency. The outcome of printing ever more fiat is huge balance of trade overhangs and soverigns that borrow too much by issuing ever more credit and selling ever more soverign debt to pay for imports that they cannot afford.
The solution imo is for mercantilist nations to stop over producing and exporting in an attempt to get a ‘leg up’ on their trading partners. The current mercantilists soverigns need to focus on trade balance.
If the IMF really wants to move toward a more harmonious world economy then they should addresse the balance of trade issues before they reach the critical stage that currently exists. Real economic hardships to populations caused by poorly managed soverign economies often lead to wars…Something that should be completely off the table since the invention of nuclear weapons, not that wars ever solved problems except for idle defense manufacturers.
The Smoot-Hawley situation was a little more complex than what we usually understand. The impact of the tariff did not have significant overall change on imports – it changed the composition of imports as it was designed.
The huge reduction in trade came when the dollar was devalued by FDR in 33 – there was an immediate multiplier effect on the tariffs far in excess of the original tariff rates, in effect halting imports and stifling trade. The tariffs should have been recast at the same time.
“The huge reduction in trade came when the dollar was devalued by FDR in 33 – there was an immediate multiplier effect on the tariffs far in excess of the original tariff rates, in effect halting imports and stifling trade. The tariffs should have been recast at the same time.”
Yes, you are correct…but the tarriffs were not recast so we cannot say with absolutel certainty that if the tarriffs were recast the great depression would not have happened. That is a problem with economics…there are no lab trials, no testing of hypothesis. We are living in an economic experiment now and we have no idea of the outcome.
Remember this one from Ben ‘subprime has been contained and will not spread to the greater economy’
Will we hear next that ‘the European economic problem has been contained and will not spread to the rest of the world economies’?
If I had my druthers I would prefer Glass Steagle be restored, not Smoot Hawley.
I’ve been thinking on your point about Smoot-Hawley, and I’m not 100% sure that it would play out the same time this time. I apologize for my following twisty logic, and am happy to have smarter people decimate it.
In S-H days the Americans were an exporting juggernaut and they were the “emerging market”, right? We put up tariffs in order to REMAIN an exporting juggernaut. The resultant trade war decreased trade overall, but since we exported more than imported it significantly reduced our exports.
But now were the importing juggernaut, with our currency pegged to mercantilist nations that are exporting juggernauts. Because of this our currency can’t “float” as it “should” which would aid and abet our balance of trade problems.
In theory, then, a trade war would REDUCE trade again, reducing imports AND exports… but this time would it not reduce imports more due to the fact that we are such an importer?
it seems to me that there isn’t even a theoretical way for us to improve our balance of trade unless we see one of three things
-a cultural refusal by American populace to buy non-American (like what the Japanese people do)
-tariffs
-revaluation of the pegged mercantilist currencies.
I see no other way to do this.
ON a side note: one major problem with a trade war would be OIL prices for us.
Positively the smartest thing said about Smoot-Hawley on any message board ever. Trade wars do lead to beggar thy neighbor policies, but some neighbors are in a better position than others. Right now, we don’t produce most of the consumables that our population requires. However, in China, they don’t consume many of the products that they produce. Which is worse? Rising prices at home as manufacturers return to the U.S. to make our manufactured goods, or massive unemployment in China as they suddenly realize they haven’t built a sustainable middle class?
The best outcome is obviously gradual adjustment, but right now that’s not possible, so instead America is engaged in gradual decline. Something will give soon, and the consequence will probably be a Smoot-Hawley type law, either in Europe or in the United States.
Perhaps the European Union will split into two parts:
The EU
and
the PIIGS,
which form a group and be known as
The PU
CreditAnstalt part deux, baby!
But Yves, Larry Kudlow said today that Greece was not a big deal and “perversely” (his word) long term bullish because it signaled the end of the Euro social program party!
Yves has this exactly right. The danger is both contagion and the interconnections. PIIGS’ problems are not just theirs. They also belong to the Eurobanks and I agree the state of those banks and their exposures seem to have escaped real scrutiny. And there are also the downstream consequences. Who will Germany and the Netherlands export to when the PIIGS’ economies are thrown into recession/depression?
As with the US-China relationship, there are no white hats or black hats. There are just parties who are all connected to each other. Germany and the Netherlands can’t segregate themselves from the PIIGS fallout. What hits the PIIGS will hit them through the banks, through exports, and through chaos in the euro. The worldwide march to depression is now less driven by economic factors than the political failure to react appropriately to them.
“the political failure to react appropriately to them.”
What real alternatives are here but kicking the can down the road? This is what they will try anyway. I am absolutely on the fence if they should succeed in that. Rolling all loans to all the PIIGS will not be enough – you have to fund their banking systems/capital flight (within one currency!!!) at the same time. It would be even more expensive in two or three years as I do not see the underlying problems get solved anyway and anyhow.
Besides this, you are right. If you ad the bad bank debts, France, Germany and Netherland budgets are not looking sustainable either. Add at least 400 bn Euros of bank losses to Germans deficit (let´say 70 bn) – capitalize it over 5 years, and you still double it. Not even mentioning all off-balance sheet gimmicks….
As crises always are, this crisis is also an opportunity. As this is a systemic crisis, so the system which produced the problem, namely a debt/consumption/eternal GDP growth-based money system, needs to be tackled at its roots.
Money is just a tool for enabling economic activity. We can design it how we want. MMT offers a very interesting angle on money creation and money functionality. This, combined with something like 100% reserve banking, would take a lot of the heat out of finance generally. There are also other money-types, as considered by Bernard Lietaer, that offer hope and sense.
The explosive (in historical terms) combination of debt-driven conspicuous consumption and debt-only money controlled by profit-driven private credit institutions must be undone. We need to make a choice between money-profit and money-wealth on the one hand, and humanity/societal health on the other. Which is more important? Which should be in the driving seat? Should money/debt/usury concerns be the overriding priority and arbiter of all, or should things like literacy, decent education, ecosystem etc take center stage?
The debate is always framed as if there were but one way of doing things. There is not, there are many, and the current model is spinning out of control. Discussing which parameter to tune while our collective hair is on fire is a waste of time and getting us precisely nowhere.
Toby,
“Free to Choose” never really meant that we were free to choose another economic system, something different – an alternative – from the current one. That idea never crossed Milton Friedman’s mind. There never was an option… MARKET TOTALITARIANISM is the only one. It offers the security of AUSTERITY – a known, tried and true strategy with predictable results/outcomes. “Perfected” in the periphery in the past 30 years or so [Chile anyone?] it is now making its way to the center.
This kind of austeritization fuses almost seemlessly with Americans’ deeply rooted religious notions of repentance for past sins. It’s time to pay up you know… And off to the slaughterhouse the sheep march in remorseful resignation. After all, it’s our own fault! We only did what we were told.
But in reality “the taxpayers’ promise to pay” is all that’s keeping the game going. So long as the looters can extract their rents from the taxpayer it will continue until there’s nothing left to loot. And there will always be something to loot unless it is outlawed.
DEFAULT is the only form of resistance that will put an end to this charade and lead to something systemically different from the security of austerity. So long as the former is kept off the table, the latter is guaranteed. Free to choose… free to choose. But do we really want to? The escape from freedom to the security of austerity is so much easier and predictable. Why think outside the box?
Younger people like you willing to think outside this box are the promise of the coming dark age. Wishing you well.
What is appalling in this story of sovereign debt is the response of EU leaders and eurocrats. This crisis is not about deleveraging banks but about unwinding Ponzi schemes.
Somebody thinks that governments may run a Ponzi scheme, which is a financial organization with liabilities and no assets backing those liabilities. The scheme can last only as long as everyone believes the debt can be paid back and investors continue to buy those assets.
http://mgiannini.blogspot.com/2009/11/you-owe-money-or-when-unthinkable-had.html
Unfortunately there are not “too safe to fail assets” and EU banks, particularly German and French ones, should stop their money creation out of thin air running high leverage ratios.
http://mgiannini.blogspot.com/2010/03/money-creation-for-nothing-or-let.html
“Eurobank exposure to Greece is over $190 billion, and total periphery country exposure is roughly $900 billion.”
Are ‘periphery countries’ Spain, Portugal and Italy?
Thanks….
Periphery often means everyone except Benelux/France/Germany.
So, rather exclusive, lots of countries peripheral, hence the 900Bn fright number.
Sorry for the ambiguous drafting. This is the PIIGS, Portugal, Ireland, Italy, Greece, Spain.
I don’t think even the IMF can come up with 900 billion.
Is Ireland a ‘periphery country’? What about the UK? I suspect they are a lot closer than we think.
Ireland is definitely periphery, being one of the ‘I’s in PIIGS. The UK doesn’t count, as it is not in the Eurozone.
The rest of the periphery (the new EU members of Eastern Europe) also owe lots of money, but are not yet in the Eurozone (though some have euro pegs).
Well, my screen is all red here in London at 8:40 in the morning. The Spanish market looks the worst (uh, no surprise there?). The 2 year greek bond has just jumped to 28% yield (from 16% yesterday). I don’t want to think of the mark-to-market losses on those…
“So the whole idea that the financial crisis was over is being called into doubt.”
Who were we trying to kid?
Now we get to find out just how badly “extend and pretend” has impaired everyone’s ability to respond. Thank God we bailed out the TBTF banks with all that money. I’m sure they’ll be climbing all over themselves to help the rest of the world out of this tough spot!
Hey, now there’s thought! These TBTF banks have just the right touch for this problem!
Why doesn’t Greece work with GS to repackage their debt into some AAA rated junk? Seems like GS has shown some real talent on that area. I’m sure S&P will re-rate Greece if GS gives them a big enough fee (and S&P “releases” the model so GS knows how to cook the numbers.)
And then the fabulous Fab can resell it to widows and orphans! (But only after the GS sales guys give it the “shitty” rating as a seal of approval!)
ouqun (above) is going to make me a deal on some Greek soccer jerseys. I plan to securitize the shipment and offer CDOs on it. I’ll cut you in for a special NC-reader price.
Act now! Mezzanine tranches are still available.
Glen,
You ask: “Why doesn’t Greece work with GS to repackage their debt into some AAA rated junk? Seems like GS has shown some real talent on that area. I’m sure S&P will re-rate Greece if GS gives them a big enough fee (and S&P ‘releases’ the model so GS knows how to cook the numbers.)”
I suspect that might have already been done.
Even though Deutsche Bank didn’t play the leading role in originating “kamikaze” mortgage loans and packaging them into “suicide” bond products—-products designed to fail so that it or its clients could take short positions against them—-it certainly played a major role.
I think there is an excellent possibility that Goldman and Deutsche Bank did the same thing with “kamikaze” sovereign debt that they did with “kamikaze” mortgage debt.
The real trick will be, if there is a credit event, to get the German (or other) taxpayers to pay off on Goldman’s and Deutsche Bank’s short bets against sovereign debt, just like the US paid off on Goldman’s short bets against mortgage debt.
If the loan exposure is $900 billion, and there are 10x as many CDS as the underlying loan amount, we’re talking $9 trillion of derivatives. Something tells me that Goldman and Deutsche Bank are heavily on the winning side of these wagers, and that their counterparties will not have the money to cover.
The widows and orphans that Goldman and Deutsche Bank sell the “suicide” bond products to are only the intermediate victim—-small potatoes. The ultimate mark is the taxpayer.
The real trick will be when Greece defaults, and the banks all go to collect on their shorts only to find the counterparty is broke. So they’ll go to the people of Europe, declare the end of the world, and collect on their bet that Europe would implode from the very people that got imploded!
It’s a classic!
There will have to be some fancy footwork to avoid another credit crunch, too. Greek bonds are on the verge of not qualifying for the ECB’s repo scheme: if the other rating agencies pipe up, the bonds will be junk.
http://ftalphaville.ft.com/blog/2010/04/28/213461/the-ecbs-big-greek-collateral-headache/
You could look at it another way, and interpret the goings on in Europe as a recognition of the debt problems and the covering up of losses. This will force debt to be written off, banks and investors to take the hit and adjust their risk models accordingly. So it will be no more bubble economics, off balance sheet accounting, tweaked statistics, and a clamp down on banks. Once this process has finished and it seems likely that Europe will go back into recession as a result, what sort of economic position will Europe be in? Will Europe have taken the Swedish route to tackling debt or the Japanese route and will there be an advantage to being the first to sort things out. To my way of thinking the poor value in the Euro just allows Europe to export its unemployment to areas with strong currencies.
5 years ago in the UK I was in the market for a particular moderately expensive household item and when I took into account features, quality and value for money, goods made in the US, Japan and China came near the top of the list. Last week I was looking for a similar item and was surprised to see that European and Indian manufactured goods very clearly topped the list. What did surprise me was the fact that certain US manufactured ranges had been withdrawn, some items withdrawn for re-pricing and generally US goods looked like a lot more corners had been cut to achieve price points. Once china pulls back on its stimulus I would not be surprised to see some shocking statistics coming out of the US as a result.
“The real risk here is to Eurobanks. They ran with even higher leverage ratios than US banks, they are believed to have recognized less of the losses thus far on their books than their US peers”
OK, I think the Euro banks are on to something: A Modest Proposal – Losses are Profits.
Its easy to implement – just change some computer code on the spreadsheets and make pluses into minuses, and minuses into pluses. Viola!!! We’re all rich! And all this financial stuff is all psychological. I believe I’m rich, I believe I’m rich…
“for every $1 in BBB subprime bonds, another $10 in CDS had been written”
I assume that CDSs are a zero-sum game, so who are the winners? And why can’t they just bail out the losers? Isn’t that what the PIIGS are asking Germany to do?
And to those who say that Germany can’t get by without the Eurozone as trading partners, I would point out that Germany is heavy in capital goods of a quality that few countries (Japan and Switzerland come to mind) can rival. In the mid-1980s I worked in the US at a produce wholesaler. We had giant packaging machines that could take a stream of fruit (say, oranges) and put them into net bags, weigh them, and slap on a label. They were all from Germany, and their makers (ours were by Affeldt) had no global rivals. I suspect that the same is true for many kinds of heavy machinery.
Sure, Germany will lose sales if the Euro collapses and the new Mark rises, but how many other Eurozone countries make anything at all that China, Brazil, or the Arabs would buy? At least the Germans and Dutch still have the ability to sell to the world.
If the Euro tanks to the dollar and yen, and the Chinese stay pegged to the dollar, Germany will be exporting to everybody.
We buy German machine tools for aerospace work. Fantastic quality, but even a few of the German manufacturers were starting to move production to China. Too bad, we tend avoid machine tools made in China (even if they slap a German name on it.)
You’re on to something there, but you missed the larger point. Germany makes stuff for emerging markets. The PIIGS are emerging markets. Placing that mix in a currency union necessitates an imbalance which can only be maintained if Germany is willing to continue to export the capital to finance it as China does its own.
True, the PIIGS are emerging, but not all emerging markets are equally unable to pay their bills. Germany is unlikely to go hungry.
The PIIGS can still import from Germany, only the terms of trade will change. With their newly-devalued currencies the PIIGS will be able to re-build their export sectors. France and the UK may re-learn how to compete with Germany, while the latter can deploy its capital (as you suggest) in places where it is put to work instead of in buying fancy houses.
ECB buy PIIGS bonds? Merkel will have a cow.
I’m vastly confused, The Euro is stronger against all other currencies this morning despite the abysmal outlook otherwise. I’m stupid, my apologies, I don’t get it. Any enlightenment is most appreciated. Is the the work of the currency swap kings?
Hi NS,
The workings of forex are murky, and trading in them is treacherous. In the short term, however, it seems that political uncertainty drives the euro price. If euroland is a human body and Greece is a gangrenous toe, then one might cut off the toe, saving the body (but losing a toe, a blow to one’s vanity and pride), or try to save the toe, thereby risking the entire body. What euroland will choose to do in the end is the uncertainty.
If the toe is cut off and Greece defaults, the euro will likely strengthen. If euroland goes the USA-route and bails out anyone big enough to make trouble, then look for the euro to fall to around parity with the dollar. Of course, all paper currencies are in a race to the bottom, so it’s a relative thing.
If Germany (possibly with some of its northern neighbors) leaves the eurozone, look for its new currency to vault upwards, as they’ll have shown that they are alone in refusing to print to infinity and see what happens.
If you live in Europe, I suggest saving those notes whose serial numbers begin with ‘X’ (Germany), ‘P’ (Netherlands) or ‘L’ (Finland). The thinking among ordinary Germans is that only the ‘X’ notes will be accepted for new Marks (or whatever they call it, maybe ‘Merkels’).
NS, the Euro may simply be correcting a bit after the large recent fall. As with most financial markets, what you read in the news has usually already been priced into the market by the time you’ve read it, via inside information, speculation and risk aversion.
Very kind and my thanks to both Captain Teeb and Jonny for clarifying, makes sense.
We live in very interesting times.
>>I assume that CDSs are a zero-sum game, so who are the winners?<< You assume that both parties to the transaction record the transaction in the same manner. In many OTC derivatives transactions, I suspect both sides book profits, the employees get bonuses, the bonuses are spent, the firms capital is gone, and the taxpayers are f*cked.
The US markets are still slightly down as the market continues to think that this European problem will be contained. I can think of at least 5 problems that should make the markets go down more
1. Lower US exports to Europe because of a lower Euro
2. No potential appreciation of the yuan to the dollar
3. Lower European demand because of even weaker European growth making for a case for even weaker US exports
4. Potential risk of similar debt downgrades for other countries like Italy,UK and Japan
5. Potential debt downgrade of US itself
I for one can’t wait for the motocross racing season to kick into full gear. Our bikes have been packed up and garaged for the offseason, but it’s time to get them out there. We have alot of work to do on some of the bikes, and its gonna take some time, but like we do each year, we upgrade several of the systems, and make our supercrosser bikes better than they were the season before. Ride hard – or go home…
“If you live in Europe, I suggest saving those notes whose serial numbers begin with ‘X’ (Germany), ‘P’ (Netherlands) or ‘L’ (Finland). The thinking among ordinary Germans is that only the ‘X’ notes will be accepted for new Marks (or whatever they call it, maybe ‘Merkels’).”
The mainstream press are picking up on this difference. See:
“Serial numbers may hold the key if euro falls apart”
mailonsunday.co.uk/money/article-1270294/Serial-numbers-hold-key-euro-falls-apart.html
I can think of at least 5 problems that should make the markets go down more
this is very interesting. I don’t know if this is true but I could not verify this story from another news source.
Israel buys 13 Greek islands..
http://www.gpexaminer.com/?p=32