Blind 'em with science
Oct. 28th, 2011 11:04 am![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksWhen all of the heavy firepower that the EU said it was firing after the Wednesday summit is analyzed, a fair proportion of it looks to be the result of blanks being fired. Cunningly, the EU has pushed out three "solutions" simultaneously, in the vague hope that the general public, at least, will not bother to read the analyses that come from, well people like me.
The three solutions produced in the wee small hours on Thursday morning were, once again, high on declarations of intent and low on details of how this intent was going to be achieved. I'll focus on one of these (the Greek haircut), not because that one is the most important – it's probably the least important of the three – but because it's the most neglected and is the one that has been most interpreted as a "real" answer.
Let's get the other two "solutions" out of the way and explain why they don't really solve anything:
1) Recapitalize the banks.
No sooner had the EU announced that the Tier 1 Capital ratio would be raised from 5% to 9% than banks such as Pohjola in Finland were announcing proudly that it didn't make fuck-all difference to them, mate, they were Finnish and they were in tip-top condition by virtually any measure you came up with, and by others such as Portugal's Espirito Santo Financial Group saying that, er, well, actually the Bank of Portugal seems to think that we are E1.487bn light, so could you investors chuck E790.7m our way, please?
As I wrote before, the paradox here is that, if the private sector (such as pension funds) decline to back the increased equity of the banks that need it most, and if the less-stable banks continue to find it hard-to-impossible to get any "term" funding (two-to-five year lending agreements), then the only logical source of funds is the Central Banks, but then you get the situation of States whose dodgy sovereign debt has caused the need to recapitalize banks issuing more Sovereign debt to help recapitalize the banks. Well, that's an interesting piece of financial engineering, but it's hardly sound.
Bloomberg observed this morning that:
Well, "warranty at the EU level" is the one thing that Germany blocked last week.When we get on to the EFSF bit, I'll argue that what we are kind of getting here are sort-of-eurobonds without calling them eurobonds. Or, rather, an EU-wide guaratnee that Germany can pretend is not an EU-wide guarantee.
The largest recapitalization problems fall most on Greece and Cyprus. Seventy banks were tested, with German banks needing just E5bn (I think France is E12bn -- but France is so opaque that it might "really" need much more than that). Spanish banks need E26.2bn and Italian banks need E14.8bn. Greece, considerably smaller in total capitalization to start with, needs to find an extra E30bn. Now, let's be blunt here, without an EU guarantee, the Greek banks have not got a hope of raising that money.
So, in the places where the recapitalization is particularly important (it's important everywhere to avoid a post-Lehman-like liquidity crisis, but it's important in Greece to stop the banks shutting their doors) it's hard at the moment to see where that recapitalization is coming from. Which is where the EFSF guarantees come in....
2) Increase the firepower of the EFSF:
As I posted on October 24, without China, the whole thing falls apart. Klaus Regling, boss of the EFSF, is in China today looking to negotiate Chinese state backing. What is not mentioned here is that this is yet another example of a eurobond without a eurobond. Any Chinese money that has already come into the euro has not, you will be unsurprised to learn, been into Italian or Spanish bonds. It's been into German bonds. And any future money that comes in will only come in if Germany basically promises to act as backstop. Promising undying friendship and eternal gratitude doesn't really cut it for the Chinese, who, for an ostensibly socialist state, are rather good capitalist bargainers. And, for a country that's determined not to be the last resort for European debt guarantees, Germany is going to be making a darned good impersonation of being the last resort for European debt guarantees.
So, the general plan is for China to bash cash into the EFSF, which Germany promises won't leave China high and dry, and those funds can be used to guarantee the new debt issued by Greece, Italy, Spain and Portugal. It's a eurobond in all but name, separated only by one level in order to give what Richard Nixon might have described as "plausible deinal".
3) The Greek haircut.
This actually appeared the least controversial matter, in that the EU was agreed on it, the EU banks agreed to it (albeit with a heavy heart) and it looked to reduce Greece's debt-to=GDP ratio to a possibly manageable 120%.
But the details are far less cheerful. For a start, I fail to see how a 50% haircut doesn't qualify as a default. By this parameter, if all the people who are owed money agree to a 99% haircut (no matter how heavy the political pressure on the lenders) then this is not a default. That is clearly bollocks.
But the argument here is that the haircut is voluntary, and it's here that some interesting numbers emerge. Although a European bank can be leant on to accept a 50% haircut (75% of Greek debtholders accepted a 21% haircut), non-European bank debtholders, or hedge funds, might not be so inclined to accept.
The European Banking Authority's latest stress tests found that European banks held E98.2bn of Greek debt. The total outstanding Greek debt is E350bn. Past emerging market restructurings done a voluntary basis were done with less than 30% haircuts.
See this comparison of the Argentinian default with the Greek "restructuring".
http://www.safehaven.com/article/16926/a-comparison-of-our-greek-bond-restructuring-analysis-to-that-of-argentina
I think the number of rejectors of a 50% haircut will be far higher than the 25% that rejected the 21% haircut (this in itself was about 30% of the non-European bank debtholders). If there is a high level of "sod off, are you taking the piss?" response, then a mandatory debt exchange would be the result. That in early 2012, when ISDA meets, would trigger the credit default swaps, which are currently being held as useless bits of paper and making many sovereign banks wonder why they bought such "insurance against default" in the first place.
++++++++
So, what's the "triumph" of the latest summit? We have a bank recapitalization that will be hard to achieve in the places that need it most, a strengthening of the EFSF that is really little more than a leap of faith and which, at 1trn euros, still only staves off the eventual fateful day, and a Greek "haircut" that actually only consists of a vague belief that people who are owed a tenner will accept a fiver in the interests of world stability.
NFC, as I believe they say.
The three solutions produced in the wee small hours on Thursday morning were, once again, high on declarations of intent and low on details of how this intent was going to be achieved. I'll focus on one of these (the Greek haircut), not because that one is the most important – it's probably the least important of the three – but because it's the most neglected and is the one that has been most interpreted as a "real" answer.
Let's get the other two "solutions" out of the way and explain why they don't really solve anything:
1) Recapitalize the banks.
No sooner had the EU announced that the Tier 1 Capital ratio would be raised from 5% to 9% than banks such as Pohjola in Finland were announcing proudly that it didn't make fuck-all difference to them, mate, they were Finnish and they were in tip-top condition by virtually any measure you came up with, and by others such as Portugal's Espirito Santo Financial Group saying that, er, well, actually the Bank of Portugal seems to think that we are E1.487bn light, so could you investors chuck E790.7m our way, please?
As I wrote before, the paradox here is that, if the private sector (such as pension funds) decline to back the increased equity of the banks that need it most, and if the less-stable banks continue to find it hard-to-impossible to get any "term" funding (two-to-five year lending agreements), then the only logical source of funds is the Central Banks, but then you get the situation of States whose dodgy sovereign debt has caused the need to recapitalize banks issuing more Sovereign debt to help recapitalize the banks. Well, that's an interesting piece of financial engineering, but it's hardly sound.
Bloomberg observed this morning that:
In 2008, the U.S. Federal Deposit Insurance Corp. gave a guarantee on bank bonds, allowing financial institutions to access markets with the backing of the government. For European policy makers to replicate the success of that program any warranty would have to be given at the EU level because the deteriorating public finances of southern states means they would struggle to back their banks, analysts said.
Well, "warranty at the EU level" is the one thing that Germany blocked last week.When we get on to the EFSF bit, I'll argue that what we are kind of getting here are sort-of-eurobonds without calling them eurobonds. Or, rather, an EU-wide guaratnee that Germany can pretend is not an EU-wide guarantee.
The largest recapitalization problems fall most on Greece and Cyprus. Seventy banks were tested, with German banks needing just E5bn (I think France is E12bn -- but France is so opaque that it might "really" need much more than that). Spanish banks need E26.2bn and Italian banks need E14.8bn. Greece, considerably smaller in total capitalization to start with, needs to find an extra E30bn. Now, let's be blunt here, without an EU guarantee, the Greek banks have not got a hope of raising that money.
So, in the places where the recapitalization is particularly important (it's important everywhere to avoid a post-Lehman-like liquidity crisis, but it's important in Greece to stop the banks shutting their doors) it's hard at the moment to see where that recapitalization is coming from. Which is where the EFSF guarantees come in....
2) Increase the firepower of the EFSF:
As I posted on October 24, without China, the whole thing falls apart. Klaus Regling, boss of the EFSF, is in China today looking to negotiate Chinese state backing. What is not mentioned here is that this is yet another example of a eurobond without a eurobond. Any Chinese money that has already come into the euro has not, you will be unsurprised to learn, been into Italian or Spanish bonds. It's been into German bonds. And any future money that comes in will only come in if Germany basically promises to act as backstop. Promising undying friendship and eternal gratitude doesn't really cut it for the Chinese, who, for an ostensibly socialist state, are rather good capitalist bargainers. And, for a country that's determined not to be the last resort for European debt guarantees, Germany is going to be making a darned good impersonation of being the last resort for European debt guarantees.
So, the general plan is for China to bash cash into the EFSF, which Germany promises won't leave China high and dry, and those funds can be used to guarantee the new debt issued by Greece, Italy, Spain and Portugal. It's a eurobond in all but name, separated only by one level in order to give what Richard Nixon might have described as "plausible deinal".
3) The Greek haircut.
This actually appeared the least controversial matter, in that the EU was agreed on it, the EU banks agreed to it (albeit with a heavy heart) and it looked to reduce Greece's debt-to=GDP ratio to a possibly manageable 120%.
But the details are far less cheerful. For a start, I fail to see how a 50% haircut doesn't qualify as a default. By this parameter, if all the people who are owed money agree to a 99% haircut (no matter how heavy the political pressure on the lenders) then this is not a default. That is clearly bollocks.
But the argument here is that the haircut is voluntary, and it's here that some interesting numbers emerge. Although a European bank can be leant on to accept a 50% haircut (75% of Greek debtholders accepted a 21% haircut), non-European bank debtholders, or hedge funds, might not be so inclined to accept.
The European Banking Authority's latest stress tests found that European banks held E98.2bn of Greek debt. The total outstanding Greek debt is E350bn. Past emerging market restructurings done a voluntary basis were done with less than 30% haircuts.
See this comparison of the Argentinian default with the Greek "restructuring".
http://www.safehaven.com/article/16926/a-comparison-of-our-greek-bond-restructuring-analysis-to-that-of-argentina
I think the number of rejectors of a 50% haircut will be far higher than the 25% that rejected the 21% haircut (this in itself was about 30% of the non-European bank debtholders). If there is a high level of "sod off, are you taking the piss?" response, then a mandatory debt exchange would be the result. That in early 2012, when ISDA meets, would trigger the credit default swaps, which are currently being held as useless bits of paper and making many sovereign banks wonder why they bought such "insurance against default" in the first place.
++++++++
So, what's the "triumph" of the latest summit? We have a bank recapitalization that will be hard to achieve in the places that need it most, a strengthening of the EFSF that is really little more than a leap of faith and which, at 1trn euros, still only staves off the eventual fateful day, and a Greek "haircut" that actually only consists of a vague belief that people who are owed a tenner will accept a fiver in the interests of world stability.
NFC, as I believe they say.
![[identity profile]](https://www.dreamwidth.org/img/silk/identity/openid.png){kind=small}
keyword ranking tool backlink service
Date: 2011-10-30 08:46 am (UTC)Focus, Birks, Focus
Date: 2011-10-30 03:46 pm (UTC)This, for some reason, worries me.
It's sort of like watching a five-tool baseball player hit the limit on all five tools in the same game. Somehow, you can sense that the game is already over...
(And no, I don't have a clue what I'm talking about this time, either. But I'm still in a state of pro-Europe trepidation.)
Re: Focus, Birks, Focus
Date: 2011-10-30 04:05 pm (UTC)PJ
Mamma Mia
Date: 2011-10-30 03:54 pm (UTC)But if the EU powers-that-bewoerdingenkraftmachten were to narrow down their aims, say, to completely shutting down the likes of Espirito Santo Financial Group and paying investors off at, say, 90c on the euro, wouldn't that actually de-leverage the upcoming catastrophe when every single bank in Europe gets their short-term funding cut off at once, needs to recapitalise at 9%, and discovers that, post Arab Spring (a side issue that I note you have not yet factored in), not a petro-dollar in existence is going to come their way?
In other words, I'm far more worried about the feedback mechanism on all this (cf Lehmans, etc) than I am about individual examples of catastrophic failure.
Greece is doomed, but surely it's not beyond the wit of Europe's central bankers (basically, Frankfurt) to mitigate the stench from tiny little economies like Portugal.
Re: Mamma Mia
Date: 2011-10-30 04:13 pm (UTC)Part of the problem is that, although there are similarities to the past, in other ways, "we have never been here before". One of these is that the global economy is much more inter-connected that it was. I mean, how DO you shut down ESFG? Portugal would never agree to this as a "solution". The technicalities of this are possible, I suppose, but the implications would be a complete global (not even EU-specific) freezing of the volatility of money. As a solution, it's even more constrictive than the pre-Roosevelt responses to the 1929 crash.
I mean, if money just stops moving altogether, you don't just get bad broke banks shutting down, you get what were good banks becoming bad banks, because banks depend on the volatility of money to generate income. You get countries that had decent tax revenues moving down the Greece route because money isn't moving around, so taxes aren't paid. The entire world of business would hit some kind of mother of all cash-flow crises.
In this sense, you have to keep at least some of the bad banks going to stop the good banks becoming bad banks.
PJ
Re: Mamma Mia
Date: 2011-10-30 04:23 pm (UTC)"Let's clear this up quickly and take the pain for a year or two" is hardly radical (although I will call it that if it makes you feel happier about your U. Cantab days). It's sodding obvious, isn't it? And it was sodding obvious in 2008, which is, let's see, -1 year away from a result.
As you keep banging on, the basic issue is that Hoi En Telei are, bizarrely, concerned with Business As Usual and making the assumption that a few sticking plasters will keep this going into the middle term, say, 2015.
Obviously it will not. Even if all three major participants (I'm including Italy purely as a courtesy) deliver, it will not.
Sorry, I'm still generalising as an institutionalised historian (yes, we're institutional as well). I'll have to think about this a bit more.
Re: Mamma Mia
Date: 2011-10-30 04:33 pm (UTC)How you "shut it down" is theoretically very simple.
You buy it.
Admittedly you'd have to get various Portuguese interests to agree, but frankly the alternative sounds even worse to me. You're not buying every single Portuguese bank; you're just taking the more worrying ones out of the equation.
Of course, you're then left with the rest of them. But you could do this at minimal cost throughout the entire EU (possibly with a warning sign over French banks, whose finances make no sense to anybody who is not a graduate of the Ecole Polytechnique), and at the very worst you'd end up like the UK, lumbered with a huge unwanted equity in various Scottish farragoes and Northern Rock and Lloyds.
I haven't seen a melt-down of UK Government finances based on that.
To extend your exuberant last sentence, I cannot see a problem with innoculating the worst of the bad banks in order to keep at least some of the bad banks going to stop the good banks becoming bad banks ...
And doesn't that sound a tiny bit like feedback?
Re: Mamma Mia
Date: 2011-10-30 05:38 pm (UTC)But, you are right in one sense. If a complete crisis is developing, this kind of mass nationalization is possible. This could be followed by compulsory mergers and job losses (that will be the hard part) and a complete restructuring of the European banking system. This probably has to come, but there's no chance of it occurring at the moment without a complete freeze-up, as far as I can see.
PJ
no subject
Date: 2011-10-30 05:50 pm (UTC)French and Italian banks are another matter. I'm looking forward to your analysis of how and when to sell these junkers short.
I still think my (otherwise absurd) suggestion that the EU should buy up the low-hanging, but not entirely Greek, fruit and then spend some time working out what to do with the resultant mess is not unreasonable. It honestly looks like reverse leveraging to me. And we could all do with a bit of that.
On the bright side, a complete freeze-up is ridiculously unlikely.
Ask yourself what the movers and shakers are going to do with their trillion after a couple of weeks or so.
no subject
Date: 2011-10-30 10:54 pm (UTC)If so, I can only hope that your characterisation of Merkel as a dull, bland, Lutheran scientist who would really like to do the right thing (as opposed to being a politician) is correct. Otherwise, it's tits up by Christmas, isn't it?
Bump That Baby!
Date: 2011-10-30 11:20 pm (UTC)De Lusignan's Revenge
Date: 2011-10-30 11:28 pm (UTC)I mean, how weird is that?