Spain's Public Debt, Italian Shenanigans, More Fun in the Greek Sun, Open Doors Found in Germany
Spain's Debt Problems Seep Back Into the Market Mind
In another sign that the deteriorating fiscal situation of Spain is beginning to be perceived as a growing problem by market observers, the WSJ has published an article late last week on the jump in the country's cumulative public debt. While the overall level of debt is actually still low compared to most other countries in the euro area, it is the growth trajectory that raises an eyebrow here and there. Remember that Ireland had the lowest public debt-to-GDP ratio of the euro area prior to the crisis, so a low starting point means little.
According to the WSJ article:
“Spain's central bank said Friday that government debt rose to 68.5% of gross domestic product in the fourth quarter, the highest since at least 1990, as the country's budget deficit surpassed expectations.
Spain's government ran a budget deficit of 8.5% of GDP last year, down from 9.2% in 2010 but well above the 6% government target.
Debt is also expected to increase this year, as Madrid seeks to cut its deficit to 5.3% of GDP, a tough prospect amid economic contraction and weak tax receipts. Spain's government is forecasting the economy may contract 1.7% during the year. In the third quarter, Spanish debt stood at 66% of GDP. A year earlier, it was at 61.2%. Bank of Spain records, starting in 1990, show that debt had previously peaked at 67.4%.
Spain's debt remains low by European standards, and below the 87.4%-of-GDP euro zone average, according to Eurostat estimates, but it has been rising faster than in other countries as tax receipts collapsed in the wake of a four-year property bust, and government outlays soared with unemployment surpassing 23%—the highest by some distance in the euro zone.
Even though countries like Germany, France and Italy all have government debt levels significantly higher than Spain's, they also have lower government deficits.
Spain's government debt reached a low of 36.2% of GDP in 2007, after three consecutive years of budget surpluses and strong economic growth above 3%. Economic contraction in 2009-2010 and again since the fourth quarter of last year, as well as an ill-fated stimulus package after the 2008 crisis, have led to a ballooning of debt as a percentage of economic output.
Regional governments, in charge of key areas of spending like health care and education, posted debt at 13.1% of GDP in the fourth quarter, up from 12.7% in the third. Local governments, as in recent quarters, recorded a small decrease in debt, to 3.3% from 3.4% of GDP.”
We would point out here: although the market is currently cutting Spain some slack in the wake of the ECB's LTRO's, Spain's debt situation is not any better from what it was in November of last year when the market panic was at its height. On the contrary, the situation is clearly worse now, as the government had to admit that last year's deficit was higher than advertised and that this year's will again be higher than originally planned. In short, if the market was in panic in November, it would actually have even more reason to be in panic today. This underscores that the main determinant of short term financial market action are perceptions and sentiment. Facts like those cited above work to alter these perceptions over time. Just wait for the LTRO effect to dissipate, and we will likely be back at square one.
Last week it was revealed that Italy had to pay Morgan Stanley some $3.4 billion in January that it owed on account of a derivatives trade that has blown up (more precisely, an interest rate swap that went exactly the wrong way – for Italy, that is). It seems that this is only the tip of the iceberg however: Italy is in the hole by $31 billion on its various outstanding derivatives bets.
Imagine the same headline hitting in November of 2011. What would that have been worth at the time? A 50 basis points jump along the entire Italian yield curve in a single trading day?
“When Morgan Stanley (MS) said in January it had cut its “net exposure” to Italy by $3.4 billion, it didn’t tell investors that the nation paid that entire amount to the bank to exit a bet on interest rates.
Italy, the second-most indebted nation in the European Union, paid the money to unwind derivative contracts from the 1990s that had backfired, said a person with direct knowledge of the Treasury’s payment. It was cheaper for Italy to cancel the transactions rather than to renew, said the person, who declined to be identified because the terms were private.
The cost, equal to half the amount to be raised by Italy’s sales tax increase this year, underscores the risk of derivatives countries use to reduce borrowing costs and guard against swings in interest rates and currencies can sour and generate losses for taxpayers. Italy, with record debt of $2.5 trillion, has lost more than $31 billion on its derivatives at current market values, according to data compiled by the Bloomberg Brief Risk newsletter from regulatory filings.
“These losses demonstrate the speculative nature of these deals and the supremacy of finance over government,” said Italian senator Elio Lannutti, chairman of the consumer group Adusbef. The transaction may prompt regulators to push for greater transparency and regulation of how governments use derivatives, said the head of the European Parliament panel that deals with market rules.
“This latest revelation shows that we need to know a lot more,”Sharon Bowles, chairwoman of the economic and monetary affairs committee, said in an interview today. “I’m reluctant to have quite as many exemptions for central banks and countries” from transaction-reporting rules, she said.
Morgan Stanley said in a Jan. 19 filing with the U.S. Securities and Exchange Commission that it “executed certain derivatives restructuring amendments which settled on January 3, 2012” and reduced its Italian exposure by $3.4 billion. Mary Claire Delaney, a spokeswoman for the New York-based firm, declined to comment further. Officials at the Italian treasury in Rome declined to comment on the contracts.
Morgan Stanley had a gain of about $600 million in the fourth quarter related to the unwinding of contracts with Italy. That gain was a reversal of charges it took earlier in the year to reflect the risk that the country wouldn’t pay the full amount it owed, Chief Financial Officer Ruth Porat said in a Jan. 19 interview.
The $600 million gain accounted for about half the bank’s fixed-income trading revenue in the fourth-quarter, excluding a charge related to a settlement with MBIA Inc. and accounting gains tied to the firm’s own credit spreads.
As Italy’s borrowings rose beyond the 1-trillion-euro mark in the mid-1990s, the country started to use interest-rate swaps and swaptions, options to enter into a swap, to cut the cost of servicing that debt, a person with knowledge of Italy’s contracts said.
Many bonds sold at the time had maturities of five or 10 years, some paying coupons of as much as 10 percent, according to data compiled by Bloomberg. Italy used swaps to spread its payments over 30 years or more, the person said.
The country also reduced its interest costs by issuing swaptions, using the income it received from selling the derivatives to pay debts.
As swap rates, which typically track German bond yields, plunged after 2008 and option volatilities increased, Italy found itself owing its banks money on the derivatives as its bets unraveled.”
So let's see: the $3.4 billion Italy paid to Morgan Stanley represent about 50% of the sales tax increase that is supposed to help plug the yawning holes in its shaky fiscal edifice. However, that's only about 11% of the total losses on derivatives it actually has on its books at present.
You probably know already what we're going to say. Here goes anyway: you couldn't make this up.
Greece: More Fun in the Sun
As the IMF signed off on its contribution to the latest Greek bailout package, a few choice remarks hit the wires. :
The International Monetary Fund on Thursday approved 28 billion euros in funding for Greece over the next four years and IMF chief Christine Lagarde lauded Athens’s reform efforts, but Fund officials highlighted the need for further fiscal adjustment and the implementation of tough reforms to ensure the country’s recovery program remains on track.
The IMF said it would immediately disburse 1.65 billion euros as part of the deal aimed at keeping Greece financed until 2014.
In a written statement issued after the announcement of the decision, Lagarde praised the government but said further reforms and fiscal adjustment were needed. “Greece has made tremendous efforts to implement wide-ranging painful measures over the past two years,” she said.
“Greece’s priority is to undertake competitiveness-enhancing structural reforms,” she said, adding however that “significant further fiscal adjustment is necessary to put debt on a sustainable downward trajectory.”
In a conference call from Washington, an IMF official said Greece’s debt to GDP ratio was projected to drop from 165 percent at the end of 2011 to 116.5 percent by 2020.
The IMF’s mission chief to Greece, Poul Thomsen, emphasized the importance of Greece implementing labor market reforms — moving away from collective labor contracts — in order to become more competitive.
“Greece still faces a major competitiveness gap; if it doesn’t close this gap, it will continue to see a reduction in wages,” Thomsen said.
Thomsen said he hoped for an increase in tax collection but did not see any scope for further tax hikes. His deputy, Mark Flanagan, answering a question put to him by Kathimerini English Edition, said there were “problems at every step of the process.”
“It takes about 10 or 12 years to enforce tax collection, which is an eternity,” he said. He said the government had promised not to offer amnesties and they expected it to honor this.
OK, so we can probably all agree that Greece has a 'competitiveness problem' and is in urgent need of economic reform to address it. As to the '165% debt to GDP is going to become 116% by 2020', one is not sure whether to laugh or cry. The Maastricht debt limit is a 60% public debt to GDP ratio. By the way, there is actually no reason why 'debt to GDP' should be used a yardstick for anything. What has the total economic output to do with a government's ability to service its debt? In reality, tax revenues and spending are the decisive factors. However, the last sentence highlighted above illustrates nicely why all of these demands for more reform must probably be filed under 'wishful thinking'. It 'takes 10 to 12 years to enforce tax collection'? Only in Greece!
The Greek government and its bureaucracies are so dysfunctional that they can not even properly organize the looting of their citizens, a trick almost every government on the planet has really down pat. There are two things governments are usually quite good at: highway robbery (errr…getting the citzens to 'pay their fair share', lest they be thrown into prison), and annoying the hell out of everyone by giving birth to new rules and regulations as though they were a colony of yeast that's been left lying around in the sun on top of a big heap of sugar and fanned with pure oxygen.
Also via Ekathimerini we learn that the ECB is providing some oxygen as well, to the Greek banking system in this case. Now that Greek debt has been upgraded by the rating agencies after the PSI deal, the ECB 'will make at least an additional €25 billion available to lenders in Greece'. Party on dudes!
Meanwhile, Norway's sovereign wealth fund was among those who refused to take part in the Greek debt swap voluntarily. The Bloomberg report on this neatly encapsulates the problems created by the deal that the eurocracy has hailed as a 'crisis turning point'. The creation of a subordinated class of creditors means that said creditors won't be financing any peripheral sovereign debtors anytime soon:
“Norway’s sovereign-wealth fund rejected the Greek debt swap because it disagreed with the different treatment given to the European Central Bank, according to chief executive officer Yngve Slyngstad.
“It’s very important to create trust in the markets,” Slyngstad said in an interview in Oslo. “To create trust you have to stay by the rules and therefore to give preferential treatment or to give collective-action clauses retroactive use is challenging. We said ‘no’ on a principle basis.”
Greece reached its target for participation in the restructuring after using the so-called collective-action clauses to force the hand of holdouts, with investors accounting for at least 95.7 percent of the bonds taking part. The ECB was exempted from taking losses on its holdings, while the European Investment Bank was also said to be spared writedowns, according to two officials familiar with the matter.
“The whole thing has been done with a great deal of contempt for the rule of law,” said Marc Ostwald, a fixed- income strategist at Monument Securities Ltd. in London. “Long- term investors are not going to get involved with the periphery for a long time. It’s not surprising.”
Contempt for the rule of law? Just another day in the crisis! What should really not surprise anyone is that governments will unilaterally abrogate their contractual and legal duties at the drop of a hat as long as they can point to an 'emergency' that needed to be wrestled.
As we have pointed out before, the 'non-default default' of Greece certainly provided a valuable lesson for investors.
Merkel Kicks Down a Door
Bloomberg informs us that the German word for 'no' ('nein'), really means 'yes', or at least 'maybe'. Given that nowadays 'war is peace', inflation is only 'temporary', our freedom and privacy are sacred, just 'as long as we don't have anything to hide' , central banks are 'inflation fighters' and so forth, in short since a plethora of Orwellian reinterpretations of the meaning of things have become commonplace – you may well say they are the new coin of the realm – it was only a question of time before the hitherto fairly innocent and straightforward term 'no' would be reinterpreted as well.
“German Chancellor Angela Merkel left the door open to boosting the euro-area financial backstop, saying that a decision on reinforcing the firewall will be made in time for International Monetary Fund meetings next month.
Merkel said that European finance ministers have discussed “combination possibilities” for the permanent and the temporary rescue funds ahead of a March 30 meeting in Copenhagen. Ministers may decide to increase the region’s crisis fund to a total capacity of 692 billion euros ($904 billion) when they meet, a euro-area official said separately.
There you go! 'No' becomes 'maybe' and by the sound of it, it's a 'maybe' that is already three quarters of the way to 'yes'. Perhaps we should make up a new technical term for this, the 'yaybe' maybe?
Moreover, Merkel and Schäuble have evidently found a really ingenious way of saying 'yes' and 'no' at the same time:
“What’s clear is that we need to settle on a position with a view to the IMF’s spring meeting because the topic will surely come up and because there have been offers by the international community” to boost the IMF’s anti-crisis resources, Merkel told reporters in Munich today. “You can count on us setting the course by the end of March.” [YES!]
Finance ministers are weighing what to do with the temporary European Financial Stability Facility, which manages rescue programs for Ireland, Portugal and Greece, and its permanent successor, the European Stability Mechanism. Their decision, a signal of how much aid euro nations are willing to provide in a crisis flare-up, affects how much other countries will contribute to a global crisis backstop.
That figure of 692 billion euros represents the least ambitious, and therefore most attainable, proposal for expanding the 17-nation euro zone’s firewall, the official said. Other options are still on the table, with potential total capacity ranging from 500 billion euros, if ministers do nothing, to a maximum of 940 billion euros.
Merkel, speaking after talks with trade and industry representatives, reiterated her opposition to lifting the 500 billion-euro ceiling on the ESM, saying there is “no question” of expanding it. Business leaders she talked to said they don’t want an “unlimited permanent rescue fund” and she agrees, she said. That means it’s “extremely important” the limit stands.[NO!]
If the ministers do nothing, the ESM’s 500 billion-euro limit will be the firewall’s binding constraint. Available funds would be less because the EFSF has already committed 192 billion to the three bailouts under way.
Under the least-ambitious option, the ESM would be allowed to start fresh with its entire half-trillion euro capacity available for future use. The EFSF would continue to administer the programs in progress while its unused capacity would no longer be available.
Under other options, ministers might allow the EFSF’s 248 billion euros in unused capacity to remain available until at least June 2013, when the EFSF is slated to phase out. The money could be kept available until then, or it could be set aside through a political decision that ministers could revisit if needed, the official said.
Led by the U.S., major world powers have held back on increasing the IMF’s crisis-fighting resources until the euro area does more to help itself. German Finance Minister Wolfgang Schaeuble said this week that there is a “certain link” between the firewall decision and a bigger role for the IMF. [YAYBE!]
From a realpolitik standpoint this verbal balancing act is probably best translated as “we're going to do it, but need to do it in such a way that we can tell our voters we haven't done it.” That shouldn't pose too big a problem in our brave new 'war is peace' world.
Credit Market Charts
Below is our customary update of credit market charts, an end-of-week update of the usual suspects: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Prices are as of Friday's close.
We're still looking for new CDS quotes on post-PSI Greece. Obviously the old contracts have ceased trading and hence are no longer worth quoting. In the meantime we can however observe the yields on the newly issued Greek debt. Most euro area credit market charts once again looked better by the end of last week. Evidently the markets remain unconcerned for now, although there still are the first stirrings of new trouble evident in Portugal, Spain and perhaps Ireland as well. Also noteworthy is that the already elevated CDS on Ukraine's sovereign debt have enough of a bid that they refuse to follow CDS on other CEE nations on their round-trip back to 'no worries' territory.
5 year CDS on Portugal, Italy and Spain - click chart for better resolution.
5 year CDS on France, Belgium, Ireland and Japan - click chart for better resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria - click chart for better resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia - click chart for better resolution.
5 year CDS on Romania, Poland, the Ukraine and Estonia - click chart for better resolution.
Three month, one year, three year and five year euro basis swaps – use of the Fed/ECB dollar swap window has declined sharply in recent weeks, a sign that dollar funding problems in the euro area are easing further. This is not least because US money market funds are once again buying the commercial paper issued by French banks! - click chart for better resolution.
To be sure the overall amount is still small:
The 10 biggest prime U.S. money market mutual funds more than doubled their holdings in French banks in February, as lending from the European Central Bank bolstered investor confidence. French bank holdings rose to $18.2 billion from $8.8 billion in the month, according to data compiled and published in today’s Bloomberg Risk newsletter.”
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – not surprisingly, easing further as well - click chart for better resolution.
10 year government bond yields of Italy, Greece, Portugal and Spain – the yield on Greece's new 10 year bonds has declined a bit to 18.2%, and must still be considered 'distressed debt' obviously. Meanwhile we have a feeling Spain's yields may have found a low that will hold for some time - click chart for better resolution.
Austria's 10 year government bond yield, Ireland's 9 year yield, UK gilts and the Greek two year note (ignore the Greek note yields, that is a stale quote). Gilts have followed the yield on US treasuries higher, as the 'safe haven' bid leaves the market. Of course with gilts you never know…at some point the market may actually start to worry about the UK's debtberg as well - click chart for better resolution.
5 year CDS on Australia's 'Big Four' banks – a nice 'risk on' plunge, but is it justified? Australian home prices may be coming under pressure, with sales transactions tumbling (in real estate the old saying 'volume precedes price' is truer than in most markets). See 'Australia's Housing Market Creaks' at the WSJ, from whence we have extracted the next chart - click chart for better resolution.
Australia's new home sales tumble (chart via WSJ).
Lastly, the SPX, the gold-silver ratio adjusted VIX-based volatility indicator, and the gold-siver ratio. In the short term the volatility indicator seems to confirm the move in the SPX, but note that there are now longer term divergences in sight – click chart for better resolution.
Addendum: Lord, Grant me Chastity and Continence, But Not Yet
Treasury secretary Tim Geithner recently delivered a speech at the Economic Club in New York, in which he did his personal version of Augustine of Hippo's famous saying (which we often hear enunciated by Ben Bernanke as well). It basically goes, “yes, we must bring the fiscal train wreck back on track, but not yet”
We won't bore you with details from the speech, which is most highly recommended as a sleeping aid. The sentence above basically summarizes the meat of it, the rest is the usual political pablum about all the things 'we' (this is to say, the government) simply must do immediately, no matter the cost. It actually means 'the government must do', while 'we' must pay – but luckily we can always 'pay later'.
We will instead leave you with a pithy remark by Ludwig von Mises on such verbal acrobatics by politicians:
“What the doctrine of balancing budgets over a period of many years really means is this: As long as our own party is in office, we will enhance our popularity by reckless spending.”
Charts by: Bloomberg, The Wall Street Journal
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