Let's Bail Out the Irish Banks – Again!
Readers will probably be aware of the song and dance surrounding the recent resumption of the ongoing disintegration of the euro area. Still, we will reprise some of the salient features here.
It all began when the German chancellor Mrs. Merkel, who since about May this year has (not unreasonably) adopted a very stern mien, wearing a constant frown of admonishment – together with France's president Sarkozy, publicly broached the idea that bondholders of insolvent entities (read: the PIIGS) should actually take some losses here or there.
The combination of these two terms (i.e., 'bondholders' and 'losses') when enunciated by the political leader of the EU's paymaster, immediately produced – fresh losses for bondholders.
This actually shows what the markets really think about the ability of the busted peripherals to stand on their own two feet.
Alarmed by these developments, the EU's bureaucracy has sprung to life, and criticism of Mrs. Merkel has poured forth. It may be true that she is partly motivated by a desire to play to her home audience, as is alleged in this reprint of an FT article ('Euro Zone Anger at Germany Boils Over'). In that case she would be right for the wrong reasons.
Who actually did the quiet resenting we wonder? The article purports 'just about everyone'. As it is, there can be no efficient capital allocation when all and sundry keep getting bailed out at every opportunity.
However, as the article also notes, there has been a lot of back-tracking recently, in view of how the markets have reacted. We have noted previously that German market sensibilities are somewhat underdeveloped, but that begs the question, how do you get such a plan across diplomatically? This is to say in a form the markets will 'like'? It simply can't be done.
Earlier this week (Monday-Tuesday) this happened:
5 year CDS spreads on the senior debt of Anglo Irish Bank, as of Tuesday (as you will see further below, there has been subsequent 'profit taking')
5 year CDS spreads on the subordinated debt of Anglo Irish. Contrary to the senior debt, this was not guaranteed by the Irish government, and has thus always been more reflective of the true state of the bank, i.e. it's a clear indication of bankruptcy.
This has galvanized renewed action. Today the UK made conciliatory noises about being prepared to do its bit to – this is probably a result of its own banks being among those 'bondholders required to take losses'.
The term 'national interest' is usually code for every tax payer to hold on to his wallet, as it is about to be plundered again. The latest idea is not to bail out Ireland as such (since the Irish government keeps insisting publicly it is well financed until next year), but instead bail out its banking system in a separate EU action – for what must by now be the fourth bailout in a row for Ireland's banks. Why oh why not just admit that these banks are bankrupt and be done with it?
As we related at a recent presentation, in the late 15th century, the House of Medici went bankrupt – at the time, it was Europe's biggest banking corporation (you can probably guess why it went under – that's right, it engaged in fractional reserve banking). No-one even attempted to bail it out – and guess what? The world actually kept turning! Economic progress has continued to this day! Our point is simply this: it really wouldn't be the first time a big bank goes under, and one would hope it wouldn't be the last either. Failing banks are nothing new, and are nothing to be feared. The irish banks specifically are so utterly destroyed (there are estimates that up to 80% or so of their assets may be duds) that one truly wonders what the point of rescuing them actually is. It's not as though there were anything left that looks to be worth saving.
Alas, as Bloomberg reports:
Memo to Olli Rehn: in terms of the size of their respective banking systems relative to their country's economic output, the main difference between Iceland and Ireland is that the latter has an 'r' in its name where the former sports a 'c'. You bet that the 'problem is too big to manage' – it doesn't take a genius to see that. Let us stop to think here for a moment about whether or not the world is better off with or without Landsbanki and Kaupthing, which were denied a rescue. In what way is Anglo Irish (et al.) different?
Well, there is one thing that certainly plays a not unimportant role – as the German magazine Der Spiegel reports in 'Irish Debt Woes Make German Banks Uneasy':
So there you have it…the interconnectedness of the fully lent up (and thus inherently insolvent) fractionally reserved banking system is still the real reason why the bailout circus is underway. And we have abrogated the sound legal principles of the monetary deposit contract why exactly? The massive debt expansion has certainly done absolutely nothing to improve economic growth or wealth creation – it has achieved the exact opposite. If you're big on empiricism, compare economic growth during the 'deflation' of 1870-1910, or the post WW2 gold exchange standard era prior to 1971 with what happened afterward, when money and debt creation really took off. You will find that economic growth was far stronger in those prior eras. In fact, the sounder the monetary and banking system, the more real economic growth there was.
It has however enriched a caste of bank managers that have engorged themselves on bonuses for many years. The standard bromide that this is needed to 'attract and keep the necessary talent' sounds like a bad joke in view of what the banking cartel has inflicted on the global economy.
Flow of Free Money to Greece in Jeopardy
While these ups and downs in the Irish debt drama played out, an almost forgotten earlier customer of the European Bailout Union was made aware of the fact that the flow of free money is apparently tied to certain conditions.
Funny enough, it was the finance minister of Austria, Mr. Pröll, who gave the Greek bond market a little shove this week. Austria can in fact not afford to send any money to Greece. Its government has just presented a new budget brimming with tax increases (alas, no spending cuts of any consequence). The only reason why it couldn't say no is that it may one day be in need of a bailout itself. As we reported previously, Austria's banking system is in a situation that is roughly analogous to Ireland's , in that it is far too big relative to the country's total economic output. In 2008 a bank run was stopped at the very last minute. Austria's banks have vast exposure to the Eastern European nations that were formerly part of the COMECON. This is a business that is going great guns during the inflationary bubbles, but it's deadly when a deflation scare shows up.
Anyway, Mr Pröll not unreasonably remarked that while the flow of money in the direction of Greece seemed to work quite well thus far, the flow of data from Greece in the other direction, namely data confirming its adherence to certain budgetary goals, remains rather murky.
At first Reuters reported:
Then it luckily turned out that it was all just a little misunderstanding (alas, Austria is apparently hanging on to the money, misunderstood as it avers to be):
And just to be safe, we're hanging on to that money for now as well – out of context perhaps, but there it is. Of course this may just be a political ploy aimed at the Austrian domestic political market , so to speak. Anything to get people's minds off the tax hikes?
We note that Greek economic and budget statistics keep getting revised with about the same frequency as Ireland's banks require fresh bailouts. This is to say, a great deal more often than anyone would like, especially as the revisions all happen in what is generally considered the wrong direction.
The Euro Area's Survival Remains in Doubt
All in all, it remains highly questionable if the euro area in its current incarnation can actually survive. No doubt the 'political will' to keep the project intact is still great – for motives that are inherent in every large bureaucracy. Bureaucracies, as Ludwig von Mises noted many years ago, have their own dynamics – they strive to increase their power and grow. Anything that smacks of having the potential to induce shrinkage is resisted with great tenacity.
However, there are economic and political realities nobody can wish away. The inflationary boom of 2002-2007 has laid a number of economies low, as always happens in such booms. Too much scarce capital has been consumed, and nothing can be done to retroactively change this fact. Germany's proposal to let some of the risk takers bear the losses that are rightfully theirs is sound, but as can be seen, these plans falter every time the bond markets sell off.
The alternative is a bailout that could eventually mushroom into what's known as 'too big to bail' territory, and the imposition of fiscal austerity on the worst fiscal offenders seems only remotely doable from a political point of view. Unless you're the Baltics and fear Russia more than a deflationary depression, you're liable to eventually see your citizens balk.
The (admittedly very anti-EU) Telegraph reports:
The most recent charts:
1. CDS – all prices in basis points, color-coded
5 year CDS spreads on Ireland's sovereign debt, the senior debt of Anglo Irish and Bank of Ireland, and below on Japan's sovereign debt. The recent spikes to new highs have given way to a retreat now that some sort of bailout seems imminent. We still had to re-scale Anglo Irish here after the huge move earlier this week. Even complacency about Japan seems ever so slightly disturbed.
5 year CDS spreads on the remaining 'PIGS' (Portugal, Italy, Greece and Spain). The talks over Ireland have temporarily led to a pullback in this space as well, with the exception of Greece, which is suffering from Austria's reported refusal to pay until assurances about fiscal progress are forthcoming (this may of course just be a Pröllian ploy).
5 year CDS spreads on Romania, Hungary, Austria and Belgium. Not much change recently, but we are expecting a Belgian breakout on occasion. The occasion will probably prove to be ill-timed, as always happens in these situations.
The Markit SovX index of CDS on the debt of 19 Western European sovereigns – a classic pullback to test the breakout?
2. Euro Basis Swaps
3 month euro basis swap – Euro-doom, a measure of dollar funding strains in the euro area's banking system, looks slightly gloomier again after a period of respite.
1 year euro basis swap.
5 year euro basis swap.
5 year CDS spreads on Australia's 'Big Four' banks – still fairly well behaved, but you know what we think about the future of Australia's property bubble. It ain't gonna end well – and this is our seismograph.
Lastly, here's a composite chart maintained by our good friend T.R. at Citi, that shows the SPX with three indicators that are important for its performance. This is a neat way to watch out for divergences and 'early warning signs' about imminent trend changes. The indicators are the gold-silver ratio, gold-commodities ratio and a proprietary volatility indicator (it's not just a simple SPX-VIX ratio). If you look closely at this chart, you will notice that the indicators often give subtle clues.
A closing remark: you may wonder why we concentrate on CDS spreads rather than on bond yields or the often quoted spreads of PIIGS bonds over German Bund yields. First of all, they all move together anyway. However, there is another reason as well (for the same reason we like to watch positioning data in options markets) : namely, the fact that speculators can buy and sell CDS without necessarily having a position in the underlying debt securities makes this the market that is most responsive to changes in sentiment. It's the leverage inherent in the positions that is of importance here. Paying 950 bips for CDS on Greek debt is really making a statement.
Finally, note that at the recent high in the SPX, sentiment has become extremely lopsided, especially in options markets. There has been very little hedging and a lot of call buying based on QE2's promise of 'free money'.
Charts by: Bloomberg
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