The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be...
This is a trick question, for the fates of many European countries are now inextricably tied by what appears to be a poorly conceived methodology of handling diverse political and economic entities under a single currency without a truly authoritarian governing body. Basically, it's the old American saying, "Too many Chiefs and not enough Indians". If one member faces a harder landing, chances are that several others will follow. When I first started this series, a few pundits accused me of being sensationalist. I assume their weren't studying the numbers. It's funny how a few days can bring so many to your side of the table. Now it is becoming much clearer that this is more of a pan-European issue than a pan-Hellenic one.
The printer of the world's reserve currency had a problem selling debt. How well do you think the EMU members will be able to hawk their record trillions of (now apparently obvious to all) relatively stressed debt? Well, Europe's Economic Recovery Almost Stalls as Germany Unexpectedly Stagnates as the IMF Joins EU, ECB in Pledging Support for Greece. This is an extreme blow to the credibility of the Euro. Just a year ago, (silly) pundits were speculating that the Euro would replace the dollar as the world's reserve currency, and now the IMF is coming to a EMU members aid just has it has third world and emerging countries.
This is part 3 of my Pan-European Sovereign Debt Crisis Series. See The Coming Pan-European Soverign Debt Crisis and What Country is Next in the Coming Pan-European Sovereign Debt Crisis? for the first two parts.
Much of the analysis that I have seen fails to put enough weight on the bad loan/NPA issue in each country's respective banking system, which essentially is the cause of most of the countries' particular malaise to begin with. I have thrown together a crude, rudimentary chart to put this into perspective...
When comparing these sovereigns using metrics that encompass more than the usual suspects, you get a clearer picture. The bank bailouts were expensive, arguably too expensive. It may have been better to let them fail in the market and nationalize them. Notice how the nations with the highest NPAs are doing the worst. In addition, one should remain cognizant that the "extend and pretend" game has allowed hundreds of billions of "phantom" NPAs to roam free in each of these countries' GDPs unrecorded. I believe there may be some surprises left in quite a few of the German banks. We will probably see if I'm right over the next few quarters. See German Recovery Stalls Unexpectedly in Fourth Quarter:German gross domestic product showed no growth in the final quarter of last year, official data showed on Friday, leaving Europe's largest economy on a weak footing going into 2010.
All one really has to to is follow the banking losses. They are deeply concealed in the Spanish banks, but are now coming home to roost (From Bloomberg: BBVA Fourth-Quarter Profit Plunges 94% to $44 Million on Asset Writedowns). As was illustrated by Speigel online below:
National deficits have increased in many countries belonging to the European common currency.
Even Speigel states: European Union Sees Threats to the Euro - Late last year, it became fashionable to predict the dollar's demise. This year, however, shaky state finances within the European common currency zone have many worried about the future of the euro. Even the EU thinks the monetary union could be in danger.
Notice how all of the big deficits also have big bank NPA chunks as a percent of their GDP? I warned of this just over a year ago, focusing on Spain and their busting housing boom. See The Spanish Inquisition is About to Begin... and the original forensic report and macro analyis of Spain's housing bust from January of 2009, Reggie Middleton on the New Global Macro - the Forensic Analysis of a Spanish Bank Wednesday, 28 January 2009 (paying subscribers may download the BBVA forensic analysis, whose subject matter is now quite timely). In this post I made clear that BBVA had considerable problems, Spain was heading down and to quote from the actual post, "Those of you who attended the BoomBustBlog Boat rides should have heard me express my opinions that I believed the Pound, Euro and oil would all head sharply southward."
Below are excerpts from an excellent article on Spain from the blog "A Fistful of Euros":
The impact of the stimulus package can also be seen in the seasonally adjusted unemployment numbers supplied to Eurostat by the Spanish Statistics Office (INE). Unemployment (which hit 19.3% in September - see chart below) has been rising continuously since mid 2007, but the sharpest increases were registered during the fourth quarter of 2008 and the first quarter of 2009.
It is very hard to see any real difference in the trend rate of increase between the second and third quarters of 2009, and we should expect this trend job attrition rate to continue until it once more accelerates under the impact of either the government being unable to continue funding the stimulus, or the banking sector having a financial crisis (possibly induced by someone being forced into trying to sell some of the housing units they are accumulating only to discover that there are no buyers, since the market is effectively dead)...
That is to say, credit is once more starting to flow freely round the French economy, while here in Spain banks continue to accumulate reserves, lending generously to the government, while money for struggling small companies and for young people looking to buy homes is hard to find. What is more, if we look at the chart below (which was prepared by Dominique Barbet and Martine Borde for PNB Paribas) we will see that the stock of unsold new homes - which was in any event never very high in France, maybe 100,000 in the spring - is down by 20% as sales steadily pick up again, while here in Spain we continue to play a guessing game to decide just how many (more than a million surely) such properties there are here, and the number is growing, not declining, since real new sales to private individuals (as opposed to newly completed properties contracted two years or so ago, or exchanges between developers and banks) are almost non existent at this point. Everyone knows prices will fall further, and are waiting for them to go down...
Then on Friday we had the key piece of information, which confirmed what many of us already suspected, since Markit PMI data for October retail sales made plain the presence of very divergent trends across the Eurozone, with ever more robust growth in France contrasting with falling sales in Germany and Italy. As Jack Kennedy, economist at survey organisers Markit Economics said "While the sense of growing optimism should be treated with some caution - it appears the increase in sales was also supported by widespread discounting and the continuation of the government's car scrappage scheme - the outperformance of France relative to Germany and Italy offers further evidence that it is France that is leading the Eurozone recovery."..
And here, with this very outperformance comes the problem, since the ECB policy rate will be set to target average eurozone inflation, which will certainly be lower than inflation in France, and possibly significantly lower. Which means the ECB policy rate will be below the one which the French economy will, in reality, need...
Between 2000 and 2008 the structural dynamics of the Eurosystem were different from now. Spain was the "exceptional student", with above-average growth, and inflation which was consistently over the Eurozone average, and for long periods above the ECB policy rate. This had the consequence, of course, that French inflation was nearly always below the average. Now things have changed. We are coming out of recession with a eurozone divided into three groups. French growth is becoming robust, while Germany and Italy are dependent on exports and just keeping their head above water. Spain, on the other hand, fails to recover and continues to contract. This is what makes the current situation critical, since starting in 2010 France will have an inflation rate over the EU average, and in all probability over the ECB interest rate. Which means that if something isn't done, and soon, to force the situation in Spain, and produce a recovery, France will have negative interest real rates during a sharp economic rebound, with all the risks that that implies...
Only last Wednesday Norway became the first western European country to raise interest rates since the start of the financial crisis after its central bank reported finding "signs of renewed growth" in the global economy. Central bankers from across the global, from Washington, to Sydney, to Delhi and to Oslo are all now busily telling us they are going to take increasing account of future accelerations in asset prices in an attempt to avoid repeating policy mistakes that are presumed to have inflated two speculative bubbles in a decade - and left the entire Spanish economy in a lamentable state. If France had its own monetary policy I have no doubt La Banque de France would be itching to follow the Norges Bank and raise rates, but there is one small problem, La Banque de France has no capacity to decide on monetary policy in this way, and herein lies the heart of what is now Europe and the ECB's greatest dilemma.
While denied by the EMU members, it appears to be without a shadow of a doubt that fractures are showing in the monetary union. The Euro was not well concieved. It gets worse. The stresses to the Euro will also come from well outside of the European Union. Many of the Euro countries have significant exposure to central and eastern European countries who are significantly more fragile than the one's mentioned above. This exposure will easily daisy chain through Europe if it were to ignite. Well, the CEE countries primary trading partners are in the Eurozone, and as the Eurozone slows down, the chances of CEE issues increases. That will be the subject of my next Pan-European Sovereign Debt Crisis post and I will have several specific banks on a detailed watchlist for paying subscribers to download, which should help you ahead of the curve.
As I stated in parts one and two of this series, although Greece is in bad shape, it is a drop in the bucket in comparison to the problems abound in the other countries.
- Paying subscribers can download a tear sheet on all Spanish banks investigated here: Spanish Banking Macro Discussion Note 2010-02-09 02:48:06 519.40 Kb).
- Paying subscribers can also download the 11 page tear sheet featuring 7 Italian banks worth noting, including one with a 100% ratio (meaning the bank has more non-performing assets than it has equity = insolvency!) Italian bank here: Italian Banking Macro-Fundamental Discussion Not 2010-02-09 17:00:40 792.07 Kb.
In the news:
We have some sell side guys stealing ideas from my blog :-)
Government Bailout May Damage Corporate Credit Quality Feb. ...
... Credit-default swaps insuring against losses on company bonds in Greece, Portugal ... underlying securities or the cash equivalent should a company fail to adhere ... - 2010-02-11
The inevitable "vig" to be paid on pushing out these sovereign bonds:
Pays Investors Premium on 10-Year Bond Sale (Update2) Feb ...
... cash equivalent should a company or country fail to adhere to ... The spread on Portugal's new bonds should narrow ... to Harvinder Sian, a senior bond strategist in ... - 2010-02-10
in 'Lose-Lose' Deal on Greek Bailout, Jen Says (Update1) ...
... unions in Greece and other PIIGS countries now know they are too big to fail. ... extend a financial lifeline to Greece at a summit tomorrow sent bond yields to ... - 2010-02-10
With all of the needs for sovereign debt issuance, the private sector will most assuredely get crowded out. This is probably worse than it sounds, since most banks are still coddling significant hidden losses and NPAs (even though many are reporting profits and paying bonuses), hence will not be lending anytime soon. There will be no recovery without available credit, and if there was ample credit supply available (which there really is not) the sovereign nations will be soaking it up anyway.
From part two of the Pan-European Sovereign Debt Crisis:
Let's examine exactly how much debt we are talking about and when...
The weaker Eurozone countries will start flooding the market with sovereign debt rollovers starting THIS MONTH. It remains to be seen whether Germany will backstop Greece, but if they do how can they avoid backstopping Spain, Portugal and Italy. The Spanish and Italian backstops will be particularly tricky since there are bank NPAs hidden in their whose extent has been purposely kept a big mystery. Reference the NPA as a percetn of GDP chart above. If Germany doesn't backstop these countries then it's left up to the IMF and their goes the credibility of the Euro. If Germany does backstop the countries, then their goes those Bund rates! An interesting conundrum, indeed.
The near term debt issuance is simply the tip of the iceberg here. According to Merrill Lynch, we have trillions of nigh unwanted sovereign debt to deal with (by way of Zero Hedge):
Borrowers Face More Costs on Debt Talk, Deutsche Bank Says ...
... Dubai World, which is in talks to reschedule $22 billion of debt, failed to present ... is in the process of raising $750 million in an Islamic bond sale and may ... - 2010-02-10
to Pay Higher Yields at Government Debt Auctions (Update1) ...
... Contagion' Asia's 10 largest local bond markets declined ... Vietnam failed to sell 1 trillion dong ($54 ... 80 billion rupees ($1.7 billion) of bonds maturing in ... - 2010-02-09
Rate Room Limited by Greek Contagion Risk, Banfi Says Feb. ...
... The country failed to qualify for the switchover because of a ballooning budget deficit ... s woes are part of a fiscal crisis that has roiled bond markets across ... - 2010-02-09
Bond Risk Surges on Sovereign Woes (Update1) Feb. 5 ...
... on growing concern that governments will fail to close ... swap indexes are benchmarks for protecting bonds against default ... securities if a borrower fails to meet ... - 2010-02-05
Gain on Deficits in Europe, Losses in US Payrolls Feb. ...
... risk." Treasuries climbed yesterday, pushing 30-year bond yields down ... The economic numbers failed to alleviate ... tying $81 billion of notes and bonds next week ... - 2010-02-05
... 20 million euros in damages for failing to accept ... Junk Sales Halt Company bond sales in Europe have ... demand to own European investment-grade bonds was unchanged ... - 2010-02-05
Borrowing Costs Jump at Three-Year Note Sale (Update2) Feb ...
... The bonds of some of the weakest economies in the euro region tumbled in the past two months on concern governments will fail to meet their debt commitments. ... - 2010-02-04