Greek Rescue Signed Off, Spain to be Grilled, Germany Misses Its Own Targets, Portugal Warily Eyed – A Case of Indiscipline
Reuters informs us that the eurogroup finance ministers have now made their crosses on the Greek bailout package, after which their 'focus will shift to Spain'. As readers may recall, Spain's new prime minister Mariano Rajoy has just flipped the EU the bird, not to put too fine a point on it, by announcing that the country will miss the EU prescribed fiscal target and stressing that this was in any case a 'sovereign decision' and none of the EU's business. The always colorful Ambrose Evans-Pritchard referred to this as 'Spain's sovereign thunderclap'.
In any case, this show of Spanish debt target recalcitrance has evidently alarmed the eurocrats to varying degrees. Spain, so Reuters, is to be 'grilled' as to its change of course:
“But as Greece's financial problems shed some urgency, Spain has thrown down a new challenge. After announcing the previous government missed its 2011 budget deficit target by a significant margin, the new administration added it would not meet the agreed deficit goal for this year either.
"Spain will be subject to serious discussion today, both because of the method and the substance of their announcement," said one euro zone official involved in the preparation of the ministers' discussions.
Spain, the euro zone's fourth biggest economy, was quick to impose austerity measures to protect itself from the euro debt crisis. It planned to cut its budget shortfall to 6 percent of gross domestic product (GDP) in 2011, but reported an 8.5 percent shortfall instead. In 2012, it was to cut the deficit to 4.4 percent, according to a path agreed with EU finance ministers. But with unemployment at 23 percent and rising, Spain's new government announced earlier this month that it would aim only for a cut to 5.8 percent, while still maintaining a 2013 goal of 3.0 percent.
"They will have to be questioned, I think there are no real reasons for missing the target this year," a second euro zone official involved in the preparations said.
The European Commission expects Spain's economy to contract 1 percent this year after growth of 0.7 percent in 2011, a sharp downward revision from the last forecast of 0.7 percent growth. "The worse deficit performance in 2011 is not due to worse growth, but to lax fiscal policy," a third euro zone official said. "And catching up in 2012 is then hampered by the poor expected growth, so solutions are not easy."
Euro zone officials are worried that allowing Spain to soften this year's target would create a dangerous precedent and undermine the credibility of the European Union's recently sharpened budget rules.
It will be difficult for Spain's ministers to explain why the country should get gentler treatment than other member states. On the other hand, forcing more austerity on a country already in recession could be difficult to justify economically and Spain insists it will meet the ultimate target of bringing the deficit down to 3 percent in 2013.
"Spain will be a very difficult case," the first official said. "The 2013 deficit reduction target will have to be ensured," they said, adding that more data and clarifications were needed to decide whether the European Commission should fine Spain. The euro zone is keen for Spain to cut its deficit to show markets that it is serious about putting its public finances in order and to ease concerns that more countries will be forced to ask for euro zone emergency financing.
After two years when the EU has preached budget pain as the only cure for the excessive spending that fuelled the sovereign debt crisis, showing leniency to Spain would be tantamount to waving a red flag in front of sceptical financial markets.
The greatest danger of course emanates from the fact that the fiscal fate of Spain's government is so deeply intertwined with the country's banks now, as we have pointed out on several occasions this year. That letting Spain get away with a higher deficit is tantamount to 'waving a red flag in front of skeptical financial markets' is certainly an appropriate turn of phrase in this context. The markets can not be conned for long as is already amply demonstrated by the fact that new Greek debt is trading at 'distressed levels' according to the FT:
Greece’s new bonds, issued after its €206bn debt exchange, started trading on Monday at distressed levels, indicating that investors fear another restructuring is probable.
A series of 20 bonds with maturities of 11 to 30 years began trading and were quoted with prices of between 23 and 26.5 cents in the euro, a slight rise from Friday’s grey market.
Greece’s yield curve is still inverted with the 11-year bond yielding about 18 per cent and the 30-year bond 13.4 per cent, meaning investors are braced for more distress.
The new yields are the highest in the eurozone, ahead of Portugal, the country considered most likely to follow Greece in needing a second bailout.
Most investors remain deeply sceptical of Greece and the sustainability of its debt despite Athens shaving off €100bn, or nearly a third, from its debt burden in last week’s successful bond swap.
Strategists expect to see a wave of selling in the coming weeks, particularly as banks that committed as long ago as July to take part in the swap are finally able to cut their exposure to Greece.”
Oh well – what can one say to that but, 'duh'?
With regards to possibly imposing a fine on Spain, if it indeed pays up, one wonders how exactly that is going to help the case. Most likely all that would happen would be that its deficit would simply be increased by the height of the fine.
Meanwhile, the main instigator of the stricter 'fiscal compact', Germany, is itself missing its debt reduction targets, as Der Spiegel reports under 'Germany Fails to Meet Own Austerity Goals'. Oops!
“As she travels from one European Union summit to the next, Angela Merkel's constant mantra in recent months has been austerity, austerity, austerity. But apparently the German chancellor hasn't been quite as strict when it comes to her own country's budget.
SPIEGEL reports this week that the German government didn't reach even half of its planned savings in the federal budget. Only 42 percent of the spending cuts named by Merkel's coalition government, comprised of the conservative Christian Democrats and the business-friendly Free Democratic Party, were actually not implemented.
Calculations made by the influential Cologne Institute for Economic Research indicate that only €4.7 billion ($6.16 billion) of the €11.2 billion in austerity measures stipulated by the savings package actually took shape in 2011.
The government is also falling behind on its targets for this year. Of the originally planned €19.1 billion in savings, less than half has been implemented. For the coming year, the concrete measures that have been agreed on so far cover just one-third of the announced amount of savings. Merkel's cabinet is hoping to agree to the basic foundations of the 2013 federal budget in March.
This lapse is particularly embarrassing for the German government because the news comes just after 25 European Union member states agreed in early March to an international fiscal pact obliging them to adhere to greater fiscal discipline.”
So when are Inquisitor General Olli Rehn's minions going to ride into Germany to 'grill' the German government on this blatant failure to meet its fiscal targets? Have they packed their knee splitters, choke pears and crocodile shears already?
Prepare to be grilled, ye debt deviants and deficit sinners
While all this gross indiscipline is spreading in euro-land – as everybody should have known it would, following the LTRO's and the reduction in market pressure they helped bring about – Portugal is of course the one nation that is now getting the most attention in terms of its 'next Greece' potential. Bloomberg opines that '':
“The good news is Greece won’t default on March 20, and 10-year borrowing costs for Spain and Italy have dropped below 5 percent. The bad news is similar- maturity Portuguese bonds still yield more than 13 percent.
Portuguese 10-year debt yields 13.71 percent, down from a euro-era record of 18.29 percent reached Jan. 31 though higher than its 2011 average of 10.17 percent. Two-year rates of 12.48 percent have doubled in the past year, though they are down from more than 21 percent at the end of January.
The ECB bought short-dated Portuguese securities on Feb. 29, according to two people with knowledge of the transactions who declined to be identified because trades with the central bank are private. That ended pause of at least two weeks in the central bank’s Securities Markets Program, through which it has bought almost 220 billion euros of euro-area government bonds.
Portugal, whose government debt is junk rated at Moody’s Investors Services, Standard & Poor’s and Fitch Ratings, risks becoming the next nation to need to restructure its debt, according to Matteo Regesta, a senior fixed-income strategist at BNP Paribas SA in London. Portugal’s deficit was 4 percent of gross domestic product in 2011.
“The market doesn’t believe that Greece is a unique case,” said Regesta. “Portugal is very similar. It would be easy to try to placate and distract the attention of the bond vigilantes, if only policy makers would immediately close the funding gap, pre-empting any further pressure on the periphery. I’m afraid I don’t think that’s going to happen.”
Portugal is raising taxes and cutting spending as it fights to meet the terms of its 78 billion-euro aid plan from the European Union and the International Monetary Fund after it followed Ireland and Greece in seeking a bailout in April.
Vitor Constancio, ECB vice president and former Bank of Portugal governor, said March 8 that Portuguese austerity measures were on track and Greece’s debt swap would not need to be repeated. The following day, German Finance Minister Wolfgang Schaeuble called Greece a “completely unique case.”
Let us not forget here that Portugal's government once told us it would 'never need a bailout', an assertion it continued to stress until one day before it applied for a bailout. Similarly, Mr. Schäuble's 'Greece is unique' promise must be compared to the full-throated pronouncements uttered by various eurocrats when Greece started to wobble in 2010: 'no sovereign nation in the euro area will ever be allowed to default on its debt'. Anyone saying otherwise was branded a fool eager to lose money. And yet, here we are. So why will Portugal likely require a debt restructuring as well?
We promised we would keep our readers posted when Edward Hugh's report on Portugal becomes available – and it was posted yesterday at 'A Fistful of Euros' entitled “Portugal Gradually Shuffles Its Way Up Towards The Front Of The Debt Queue”.
Edward is based in Spain and so has a first hand view of what happens in Portugal and Spain. As we have mentioned in these pages, last year's fiscal target was met with the help of 'one off' measures that by their nature can not be repeated (most prominently the theft of pension assets). Much of what Edward relates in his report will already be known to readers of this blog, but there is also quite a bit of additional information. What is especially interesting is what he relates about the country's 'hidden liabilities'. A brief snip [note: 'SOEs' stands for 'state owned enterprises, 'PPPs' for 'private-public partnerships', ed.]:
“As in the Spanish case the government provided guarantees for SOEs, so it has contingent liabilities and might be forced at some point to take over the debt. According to IMF estimates, explicit guarantees to Portuguese SOEs (including those outside general government accounts) represented anywhere between 10% and 15% of GDP in mid-2011.
Then there are the PPPs. These are especially important in Portugal, and the value of the government’s ultimate exposure may be something like 14% of GDP. Such partnerships have been popular politically since they have the accounting advantage for governments that, as the private sector holds the debt and the state simply services it, the outsanding quantity doesn’t count as state debt for Eurostat EDP purposes. Indeed such schemes have even been marketed to government agencies on just these grounds, as I pointed out in an early post on the topic – Just What Is The Real Level Of Government Debt In Europe? (February 2010). PPPs are often used to finance infrastructure programmes, with the government paying a charge to use the infrastructure until final ownership is assumed at the end of a defined period. In the Portuguese case such “rents” amount to about 1% of GDP annually.
Then, naturally, there are the accumulated unpaid bills. According to Eurostat data Portugal had 8.8 billion Euros worth at the end of September last year, or around 5% of GDP, although note that some of this will be normal trade credit, so the Portuguese government’s own estimate of 3.5% of GDP which should be counted as debt may not be that far from the mark.
Also, banks need recapitalising, and the IMF estimate that the banking system will need funding to the tune of about 4.7% of GDP in 2012 alone.
In short, Portugal's true debt situation is a great deal worse than it appears on the surface, and the surface appearance is already bad enough (see the economic data and the debt repayment schedule we published in 'Manufacturing a Model Student').
1. The BIS on Europe's Banks
The BIS (Bank for International Settlement) has just released a report on the euro area banking system. In this report, it notes that the eurocracy's calls for increasing bank capital 'added to instability'.
As the FT reports:
“Calls by European regulators for banks to hold more capital exacerbated concerns over the health of the eurozone’s financial sector and led to fears of a squeeze in lending to businesses and households, the Bank for International Settlements said on Sunday.
The BIS, often referred to as the central bankers’ bank, said the requirement, announced last October, for the region’s largest banks to buttress their capital buffers and raise their tier one capital ratios to 9 per cent by June of this year had destabilised the system by bringing fears of a drop-off in lending and a rise in asset sales “to the forefront of financial market concerns”. The funding strains that emerged in the second half of last year had “fuelled fears that European banks would be forced to sell assets and reduce lending, thereby weakening real economic activity”, the BIS said. The new regulatory measures had “added to those fears”.
Eurozone banks sold assets and cut some types of lending, notably those denominated in dollars and those that attracted higher risk weights, in late 2011 and early 2012. The organisation’s latest quarterly review found that credit extended by eurozone financial institutions fell by about 0.5 per cent in the final quarter of 2011. However, the impact was largely offset because other lenders, asset managers and bond market investors took over the business of European banks.”
In view of the final paragraph one may well wonder what was then actually the problem? Furthermore, let us not forget that euro area banks were already deemed to be on shaky grounds by the markets well before the eurocracy finally admitted they were short of capital.
In fact, the first two bank 'stress test' farces conducted by the EBA (European Banking Authority) were widely derided as propaganda exercises designed to put lipstick on a pig – which indeed they were. Bank stocks began to crater as soon as the first 'stress test' results had been released, as investors were afforded a glimpse into some of the more obscure corners of bank balance sheets and suddenly the potential for insolvency of some of Europe's biggest banks became uncomfortably obvious.
This fact did not suddenly change when the capital calls issued by the EBA became more realistic after the third 'stress test'. All that changed was that the EBA finally acknowledged that sovereign debt issued by deadbeat governments could no longer be considered 'risk free'.
As we often point out here, a fractionally reserved banking system is always de facto insolvent anyway, as the banks can not possibly pay all, or even a sizable fraction of the money substitutes that exist in the form of deposit liabilities on their books 'on demand'. This is especially so in the euro area, where reserve requirements are now at a mere 1% (down from an equally laughable 2% previously) and the effective standard money cover of bank deposit liabilities amounted to less than 5% as of the end of last year (a number that remained roughly constant for most of the year as it were). The only thing that was 'different' last year is that the sovereign debt crisis woke many market participants up to these facts. There is in other words often a wide gulf between reality and perceptions and occasionally the gulf happens to be bridged. To state that a more realistic assessment of banks' capital requirements sparked intensified crisis conditions is really stretch, as the previous unrealistic assessments had already sparked them. Anyway, BIS reports are always interesting for the plethora of data they contain, and interested readers can download the above mentioned quarterly report here (pdf).
2. Edward Hugh's Latvia Presentation
Edward has graciously allowed us to offer a presentation of his to our readers for download. The presentation is entitled “Latvia's Demographic Future” (pdf) and deals with the economic challenges posed by demographic developments, not only in Latvia but elsewhere as well (it contains a plethora of charts and data detailing the problem of 'graying societies' in a number of European countries).
3. Financial Repression Update
We also wanted to direct our readers attention to a recent article by Carmen Reinhart at Bloomberg that updates her 'financial repression' thesis. Her article concludes:
“Faced with a private and public domestic debt overhang of historic proportions, policy makers will be preoccupied with debt reduction, debt management, and, in general, efforts to keep debt-servicing costs manageable.
In this setting, financial repression in its many guises (with its dual aims of keeping interest rates low and creating or maintaining captive domestic audiences) will probably find renewed favor and will likely be with us for a long time.”
In other words, the 'war on savers' on which we first commented back in 2008 will remain a feature of economic life for some time to come. Investors should take precautions accordingly. Below we reproduce a few interesting charts that came with the article:
Debt of developed economies over the past 112 years – we're at a record high and there isn't even a World War on that could serve as an excuse.
Real interest rates over three historical time frames.
Treasury and GSE securities outside of public sector (central bank) and intra-government holdings.
Domestic bank holdings of sovereign debt in the 'GIP' trio of insolvent euro area members
In the above context it is also interesting that US banks have increased their buying of treasury bonds by a factor of seven so far this year:
“U.S. banks bought more government and related debt in the first two months of 2012 than they did in all of last year, an endorsement of Federal Reserve Chairman Ben S. Bernanke’s assessment of the economy that’s boosting demand for bonds even with yields near the lowest on record.
Commercial lenders purchased $78.2 billion of Treasuries and securities of agencies in January and February, compared with $62.6 billion in all of 2011, bringing their holdings to $1.78 trillion, Fed data show. Deposits exceeded loans by a record $1.63 trillion last month, up from $1.17 trillion in January 2011, providing scope to buy more bonds.”
This likely partly explains why the expansion of uncovered money substitutes by commercial banks has suddenly accelerated to 23% annualized over the past quarter. Banks are evidently creating plenty of new deposits in favor of the government. Meanwhile, tax payers must probably brace themselves for the next wave of bailouts already, as it has turned out that student loans (many of which are federally guaranteed) – the by far fastest growing lending category last year – are turning out to be a bad bet indeed. According to the WSJ:
“39%: The percentage of student loan borrowers who were paying down their balances in the third quarter of 2011.
Student loan debt is surging in the U.S. — hitting $867 billion at the end of 2011, more than credit card debt or car loans — but most borrowers aren’t paying down the balances.”
An analysis by the Federal Reserve Bank of New York released this week aimed to get an idea of how many student loan borrowers were delinquent. The official figures put that number at 14%, or about 5.4 million borrowers holding some 10% of all student debt — roughly comparable to levels seen in mortgages, credit cards and auto loans.
But there’s a caveat. Student loans are special since they don’t have to be paid down immediately. If you’re currently in school, you’re adding to the debt and not paying it down. According to the NY Fed, some 29% of borrowers fall into this category. (The researchers can’t measure this directly, so they looked at borrowers who had balances in the third quarter that were higher than in the second.) Meanwhile, student loans allow forbearance periods for recent grads or in time of economic hardship. The NY Fed estimates that 18% of borrowers fall into this category, meaning their third-quarter balance was equal to the second quarter and there was no past-due balance. Taking these borrowers who don’t have to make payments out of the equation, and looking only at those who do, 27% have balances that are past due.
At the same time, the 47% of borrowers who are adding to the loans or in a forbearance period may be cause for concern. Though these borrowers aren’t in any state of default, they will have to pay back these loans eventually.”
This sure sounds like a giant train wreck waiting to happen.
Charts by: Reuters/Reinhart
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