Greece Is Toast
Several web sites have been reporting that there is 'market chatter' about an imminent Greek default, which we can confirm: There is such chatter (in fact, it has been going on for some time) and it should be pretty obvious why. The hasty departure of the 'troika' from Athens on September 5 – before it could give its placet on the Greek government's failing efforts to rein in its deficit – was like waving a red flag in front of traders.
Ever since, Greek government debt has been in an unrelenting free-fall. Today the yield on the Greek one year government note shot up to nearly 98% again after a brief pullback on Thursday. Five year CDS spreads on Greece increased by over 400 basis points on Friday alone, adding approximately 'one Italy' and ending the day at a new record high of over 3,500 basis points. This means it now costs nearly $3,5 million per year to insure $10 million in Greek government debt.
An intraday chart of Greece's one year government note yield as of Friday. At 98% it confirms that there is little hope of avoiding a default – click for higher resolution.
Another confirmation was brought to our attention by a friend, namely that there are rumors that Germany is preparing to shore up its banks when the fall-out from a Greek default hits.
„Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said.
The emergency plan involves measures to help banks and insurers that face a possible 50 percent loss on their Greek bonds if the next tranche of Greece’s bailout is withheld, said the people, who spoke on condition of anonymity because the deliberations are being held in private. The successor to the German government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks, one of the people said.
The existence of a “Plan B” underscores German concerns that Greece’s failure to stick to budget-cutting targets threatens European efforts to tame the debt crisis rattling the euro. German lawmakers stepped up their criticism of Greece this week, threatening to withhold aid unless it meets the terms of its austerity package, after an international mission to Athens suspended its report on the country’s progress.
Greece is “on a knife’s edge,” German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7, a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament. „
Since it is not up to Greece, but rather to Germany whether more good money is thrown after bad before the inevitable default occurs, we take these rumors as an indirect confirmation that the Greek bailout just died. As we noted yesterday, there are a number of insurmountable problems the bailout strategy faces: for one thing, the Greek government cannot fulfill the conditions of the bailout. The Greek economy is in depression, and tax revenues are accordingly plummeting. 'Austerity' is not a bad thing per se, but it has to be accompanied by measures that ensure that investment in production is once again seen as potentially fruitful. Greece would at a minimum have to rescind 90% of the bizarre thicket of EU imposed regulations, which it can not legally do. For another thing, Finland seems unlikely to back off from its demand for collateral – and this, as we noted previously, automatically sinks the deal as well, as the IMF would then lose its preferred creditor status. Moreover, Finland's government is thinking about pulling out of the rescue altogether if it does not get collateral, which would likewise kill the bailout deal.
Greece's default is proper and necessary: it makes no sense to prop up unsound credit and force tax payers into even more involuntary servitude on behalf of creditors who underestimated the risks they have voluntarily taken.
In short, the default will be a salutary event. It will remind people that lending money to governments is not without risk. That perhaps they would do better by taking their chances with the financing of wealth-generating production in the private sector rather than relying on income that governments ultimately obtain by coercion.
After all, you wouldn't finance the mafia either, would you? Even if it had an AAA rating.
The big question is now what comes after the default. In a way, the default may be interpreted as a positive event by the markets, as it would remove a point of great uncertainty that has plagued the markets for quite some time. On the other hand, there may be collateral damage that is as of yet hard to foresee. We are referring to the fact that contagion may manifest itself in unexpected ways, most likely via the banking system.
Not surprisingly, the growing expectation of a Greek default has once again hit European markets hard, and bank stocks were hit especially hard. Concurrently, CDS spreads on banks exploded into the blue yonder on both sides of the pond.
“Anxiety about the latest flare-up of Europe’s debt crisis is also driving up the cost of insuring against the default of European banks.
Those most directly affected by Greek sovereign debt are taking it the hardest. BNP Paribas’s 5-year CDS spread is up 10% this morning to about 261 basis points, according to Markit data. Credit Agricole’s spread is up 8% to 270 basis points, and Soc Gen’s is up 9% to 353 basis points.
Here at home, Bank of America’s CDS spread is up 7% to about 349 basis points, though still about 40 basis points away from its record high. Citi is wider by about 6% to 236 bps. J.P. Morgan is about 5% wider, to about 130 bps.
Goldman Sachs is wider by about 7% to 241 bp, and Morgan Stanley is 6% wider to 326 bp.”
The stocks of European banks thought to have large exposure to Greece fell sharply, but even the banks not directly exposed to the baleful influence of collapsing Greek debt values saw their share prices wilt further. Below is a brief chart overview:
Societe Generale is a big French bank with quite a bit of exposure to Greece – it has crashed to a new low. Note that the recent moves in the stock are quite large percentage-wise – click for higher resolution.
Anyone who thought that the stock of Italy's largest bank Unicredito couldn't go any lower just found out that it still can go even lower after all – click for higher resolution.
It doesn't help you if you're big and German as long as the word 'bank' is part of your name. Deutsche Bank's stock continues to crash – click for higher resolution.
RBS – almost back at its lows. Being British and practically not exposed to Greece at all is no help either. The worry is of course that wherever Greece goes, Ireland may eventually follow. That would be bad news for UK based banks indeed – click for higher resolution.
The EuroStoxx bank index. Well, there is strong support at about 82 points (the 2009 low), followed by even stronger support at zero :) – click for higher resolution.
Our own index of bank CDS (which is an unweighted index of CDS on BBVA, Deutsche Bank, SocGen, BNP Paribas, Intesa SanPaolo, Unicredito, and Monte dei Paaschi di Siena) continues to reflect the growing worries over euro area banks as well.
Euro bank CDS as of the close on Thursday – today it once again jumped to even higher levels – namely to a new high of over 364 basis points, as can be seen on the long term chart below – click for higher resolution.
Our index of CDS on seven major euro area banks, weekly. It could soon stand at twice the level it inhabited during the 2008/9 crisis – click for higher resolution.
Stark, Raving Mad, Resigns
Today's beating of European markets with the ugly stick took a turn for the worse when German ECB board member Jürgen Stark resigned, allegedly for 'personal reasons'. Stark came inter alia to attention when he accused 'Anglo-American interests' (meaning, hedge funds based in Connecticut or London and certain political circles) to be behind the plunge in peripheral European sovereign debt and the associated notion that the euro might fail (apparently it was the fact that the euro was seen as a contender to replace the dollar at least in part as the 'reserve currency of choice' that was ascribed by Stark as the motive behind this).
A friend remarked to us today: 'Stark, raving mad, resigns' and we decided to use that little word play as the title of this paragraph.
Stark is a well-known hawk, so you may wonder why his resignation was interpreted as a negative for 'risk assets'. The reason is that his resignation reveals that there is indeed a deep rift within the ECB. Stark, like former BuBa president Weber before him, was a vocal opponent of ECB intervention in the bond markets of peripheral sovereigns, and indeed, not-so peripheral ones as well. In this, he represented a position that is broadly approved in German economic and political circles. 'Stark' is by the way the German word for 'strong'. A good name for a monetary policy hawk.
Former German ECB board member Jürgen Stark, his mien appropriately stern.
(Screenshot via tagesschau.de)
As Reuters reports, there seems indeed to have been a 'bond buying row':
“European Central Bank Executive Board member Juergen Stark is resigning his post in what sources say is a protest against its policy of buying bonds to help troubled euro zone debtor states.
The news highlights the size of the split at the ECB over the bond-buy plan and the extreme tension between its policymakers, who have been at the center of the policy response to the euro zone debt crisis.
Stark is one of the most experienced policymakers at the ECB, a young institution whose president, Jean-Claude Trichet, retires next month and hands over to Italian Mario Draghi, whose country is embroiled in the euro zone debt crisis. Stark and Bundesbank chief Jens Weidmann both opposed the ECB's decision last month to reactivate its bond plan following a 19-week pause. The bank decided to buy the bonds of Italy and Spain after they came closer to succumbing to the debt crisis.
The ECB has faced sharp criticism in Germany for buying bonds – a move many here see as taking the bank into the fiscal arena and threatening its core role of fighting inflation. The ECB confirmed Stark would be the second German policymaker to leave the bank this year after Bundesbank chief Axel Weber quit in February – a move also spurred by his opposition to the bond program.
"This is remarkable," said Manfred Neumann, emeritus economics professor at Bonn University and former thesis adviser to Bundesbank President Jens Weidmann. "Stark held the same view of the bond-buying as Axel Weber and the current Bundesbank president. It is a position that all the Germans have. This is a sign of huge problems within the central bank. The Germans clearly have a problem with the direction of the ECB."
Well, there you have it. The markets apparently didn't like the news of the resignation at all, as evidenced by most European stock markets closing right at their lows of the day, and indeed right on the precipice in technical terms. However, it appears that Stark will be replaced with the 'more pragmatic' (read: less principled) Jörg Asmussen, currently Germany's deputy minister of finance.
“German Deputy Finance Minister Joerg Asmussen will replace Stark on the ECB's six-member Executive Board, a source familiar with the plan said.
"Asmussen will be more pragmatic," Bert Ruerup, former head of the 'wisemen' council of economic advisers to the German government told Reuters. "I don't think that he will fight as openly. This may calm down when the EFSF gets the power to buy bonds. I'm surprised at the timing, why Stark would step down now," he added.
Meet the mother of all ugly charts, Germany's DAX index. This seems to be a new closing low and our 'running correction to be followed by more downside' idea continues to be confirmed. German stocks are cheap, but they could become cheaper – click for higher resolution.
Italy's MIB: subjected to yet another righteous pasting – click for higher resolution.
The CAC-40 in Paris has now entered into a 'who's uglier' competition with the DAX, but has avoided making a new closing low by a mere hair – click for higher resolution.
Greece's Athens General Index. We think it will become a buy after the government defaults, although one should perhaps first wait a bit and see if it decides to reintroduce the drachma – click for higher resolution.
In the meantime, a plan to force bond holders euro area banks to actually take some losses has been shelved in favor of continuing 'extend and pretend' (presumably because that has worked so exceedingly well thus far). This could of course also be a hint that the eurocracy is slowly but surely coming to terms with the fact that Greece's coming default is simply inevitable. As Bloomberg reports:
“The European Union is delaying proposals for senior bondholders of failing banks to take losses because the measures may spook investors at a time of market turbulence and they need more work, according to two people familiar with the situation.
Michel Barnier, the EU’s financial services commissioner, will unveil draft legislation on the measures in October at the earliest, said one of the people, who declined to be identified because negotiations on the proposals are continuing. The bondholder plans are part of broader proposals for orderly closure of failing lenders that the European Commission, the 27- nation EU’s executive arm, had intended to present this month.
World leaders in the Group of 20 nations are seeking to agree on measures to wind down failing lenders without the need for public bailouts. Current market circumstances mean the commission has to be careful about when it presents the proposal, the people said.
“The pricing of bank debt spiked” in January when the commission published a preliminary version of its plans, the said in a published on its website today. It is “uncertain” whether a move to a so-called bail-in regime in which senior bondholders would financially contribute to bank wind downs “has been fully priced in at this stage,” the BBA said.
Banks including Citigroup Inc. and Goldman Sachs Group Inc. have said that including writedowns for senior bondholders as part of the measures may make it more expensive for banks to attract funding.”
The ECB press conference on Thursday (you can watch the video of it here) was as always quite interesting and contained an impassioned impromptu speech by Jean Claude Trichet defending the ECB on the grounds that it has 'delivered price stability' as it is mandated to do. He noted that the ECB has often resisted political pressure and intends to continue to do so.
The problem with this is of course that the so-called 'price stability' policy is itself erroneous and quite dangerous. Read our previous essay 'The Errors and Dangers of the Price Stability Policy' to see why this is so.
Something else we have come across: an 'ECB hawk-o-meter' published by Reuters. With this you can check which ECB board members are seen to be 'hawks' and which ones are considered 'doves'.
Krugman Likes Obama's Stimulus Speech – Uh-Oh
Since Paul Krugman is quite enamored with both Thursday's 'stimulus' speech by president Obama and Charles Evans' 'hair on fire' proclamation arguing for more monetary pumping that was delivered on Wednesday, you can be 100% certain that both are very bad ideas. If you wavered before, this should remove all doubt. Mish has written a withering critique of Obama's plan which looks at it in some detail.
Here are a few snips from Krugman:
“I was favorably surprised by the new Obama jobs plan, which is significantly bolder and better than I expected. It’s not nearly as bold as the plan I’d want in an ideal world. But if it actually became law, it would probably make a significant dent in unemployment. “
Well, no, it probably wouldn't, and if it did, then it would turn out that temporary relief has once again been bought at the cost of a never-ending economic malaise. Just like last time – but perhaps that has been too long ago for Krugman to remember. Oh, wait, we forgot. Last time the government 'didn't spend enough'.
“O.K., about the Obama plan: It calls for about $200 billion in new spending — much of it on things we need in any case, like school repair, transportation networks, and avoiding teacher layoffs — and $240 billion in tax cuts. That may sound like a lot, but it actually isn’t. The lingering effects of the housing bust and the overhang of household debt from the bubble years are creating a roughly $1 trillion per year hole in the U.S. economy, and this plan — which wouldn’t deliver all its benefits in the first year — would fill only part of that hole. And it’s unclear, in particular, how effective the tax cuts would be at boosting spending.
Still, the plan would be a lot better than nothing, and some of its measures, which are specifically aimed at providing incentives for hiring, might produce relatively a large employment bang for the buck. As I said, it’s much bolder and better than I expected.”
It should be no surprise that Krugman is aghast at tax cuts, since his first instinct is always 'free market bad, government intervention good'. If it were up to him, we'd labor under the US version of GOSPLAN already. Everybody would have a job, in a drab gray prison not worthy of a human existence. Of course he is right that these tax cuts will probably not work as intended, if for the wrong reasons. As we noted yesterday, tax cuts that are not accompanied by a commensurate decrease in government deficit spending are completely useless. However, the main point here is that Krugman labors under the utterly mistaken Keynesian notion that employment creates economic growth.
It is exactly the other way around – economic growth creates employment. As always, Krugman is putting the cart before the horse, and so is Obama for that matter.
As to Evans' proposal to go down the road to Weimar, Krugman hasn't heard anything more gratifying in a long time apparently. But not to worry, he seems resigned to the fact (prematurely as we believe) that Evans' proposals won't be implemented.
“As Mr. Evans pointed out, the Fed, both as a matter of law and as a matter of social responsibility, should try to keep both inflation and unemployment low — and while inflation seems likely to stay near or below the Fed’s target of around 2 percent, unemployment remains extremely high.
So how should the Fed be reacting? Mr. Evans: “Imagine that inflation was running at 5 percent against our inflation objective of 2 percent. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.”
But the Fed’s hair is manifestly not on fire, nor do most politicians seem to see any urgency about the situation. These days, the best — or at any rate the alleged wise men and women who are supposed to be looking after the nation’s welfare — lack all conviction, while the worst, as represented by much of the G.O.P., are filled with a passionate intensity. So the unemployed are being abandoned.”
The problem is of course two-fold. For one thing, the Fed is the engine of inflation. To mandate that the very engine of inflation should 'keep inflation low' is utterly non-sensical. If we really wanted inflation to be low, we would simply abolish the Fed – presto, problem solved.
For another thing, the Fed can not 'create employment' either. It can in fact do absolutely nothing to spur the wealth creation that is necessary to create new employment. Its policies achieve the exact opposite, as distorting the natural interest rate can only lead to capital malinvestment, bubbles and the associated capital consumption. It is absurd to expect the central bank to be able to 'create jobs', just as it is absurd to believe that the 'president can create jobs'.
The one societal achievement that can and does indeed create jobs is the free market. The free market however is despised by Paul Krugman, even as he is surrounded by and partakes of its fruits.
The US stock market has meanwhile decided after the low volume bounce on Wednesday to resume going in the direction of the main trend, which indicates that a near term break of the August lows can still not be ruled out. Our can not yet be dismissed, but it has also not yet been confirmed – a break of the August lows would furnish such confirmation. Evidently the stock market was slightly less impressed by Evans and Obama than Paul Krugman was.
The SPX, daily as of Friday's close. We can still not rule out that a bigger down wave is on its way – click for higher resolution.
Euro Area Credit Market Charts
Below you find our usual collection of charts of CDS spreads, bond yields euro basis swaps and a few others. Prices in basis points, prices and price scales color-coded where applicable. Nothing has changed as of yet – the market tensions remain in full flower. Note that now that CDS on Greece are art a new all time high of 3025 basis points, CDS on Portugal's debt have also begun to shoot up again and very quickly to boot. This shows that the risk of 'contagion' remains elevated. We can not rule out that Greece's coming default may be followed by a very chaotic period in the markets, as market participants try to gauge the unknown risks and exposures that are out there. 'Sell first, ask questions later' could easily remain the order of the day.
5 year CDS on Portugal, Italy, Greece and Spain – a concerted move to new highs – click for higher resolution.
5 year CDS on Ireland, France, Belgium and Japan – for some reason this one was only updated until Thursday, we will include a new update that includes Friday's action in the next post – click for higher resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for higher resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – still building triangles, normally a continuation formation – click for higher resolution.
5 year CDS on Romania, Poland, Slovakia and Estonia – ditto building triangles, with several already breaking out to new highs – click for higher resolution.
5 year CDS on Saudi Arabia, Bahrain, Morocco and Turkey – also as of Thursday's close (all were slightly higher on Friday) – click for higher resolution.
10 year government bond yields of Ireland, Greece, Portugal and Spain – Greek yields at a new high – click for higher resolution.
10 year government bond yields of Italy and Austria, UK gilts and the Greek 2 year note. The Greek two year note now resides at a hefty 57% yield. Italian yields turning up again after Thursday's brief pullback – and the 'safe haven' (hahaha) yields continue to be chased lower – click for higher resolution.
5 year CDS on germany and US, and the Markit SovX Index of CDS on 19 Western European sovereigns – as expected, this index has now broken out to new highs – click for higher resolution.
The three month, one and five year euro basis swap – once again going deeper into negative territory. The bank funding crisis continues unabated – click for higher resolution.
Inflation adjusted yields – still drifting lower as 'inflation expectations' (they should be renamed 'future CPI expectations') are knee-capped by plunging risk asset prices – click for higher resolution.
5 year CDS on the 'Big Four' Australian banks (as of Thursday's close) – the release of better than expected GDP data has produced a little bit of profit taking in these, but we believe that the collapse of the Australian housing bubble has very likely already begun – click for higher resolution.
Via CLSA's 'Greed & Fear', an index of Australian house prices. It sure looks like 'bubble trouble' is on its way – click for higher resolution.
The VIX is right at the monthly resistance level that demarcates the 'crash zone' – this looks very dangerous for the market – click for higher resolution.
The US 10 year note yield at a fresh multi-decade low – click for higher resolution.
The US dollar likes the chaos – click for higher resolution.
Charts by: Bloomberg, Stockcharts.com, Bigcharts.com
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