European Summary

Posted by on Nov 7, 2011 in Uncategorized | No Comments


Some new government is in the works.  It will say and do whatever it can to get the next tranche of IMF/EU money.  Somehow this is being cheered as good news.  The reality is far worse.  Greek banks issued over €6 billion of government guaranteed debt.  Who in their right mind would buy Greek bank debt guaranteed by the Greek government?  Well, no one, of course, so they post it at the ECB as collateral!  Yes, the Greek banks are able to get money from the ECB by issuing bonds guaranteed by the Greek government.  The best part is that the guarantees don’t count in the debt to GDP calculations of Greece.  I would say this borders on insanity, but it goes beyond that.  I thought the ECB sovereign positions were bad enough, but how much will they lose when Greece defaults?

And Greece will default.  The new “unity” government will do and say all the right things for now, but I think we have entered into a new phase where bankruptcy is a real option.  The EU, in their infinite wisdom, is actually hastening the process with all their threats.  The bulk of the IMF/EU bailout payments is immediately repaid to the banks of the EU, so it is not a huge direct benefit to Greece.  Suddenly, people are analyzing what a post default Greece could look like – and it is not apocalyptic.   The new Drachma, if they go that route, could be strong, especially if they default and repudiate rather than re-denominate.  The talk about creating some Eurozone rules for dealing with sovereign bankruptcy should be enough to make Greeks realize there are currently no rules, and if they just stop paying, nothing much can be done to them.

Greece is just entering a new phase, one where it is finally willing to consider all options, and what is best for Greece.


Still no actual proposal on what a 50% “haircut” for Greece is.  Dallara seems happy to comment – about the “progress” being made, but also on a wide variety of other subjects.  Some guy named Tran is being quoted frequently as well recently.  Noticeably absent is Mr. Ackerman.  Not a single quotation of his that I can find since the deal was announced.  Maybe as CEO of DB he feels it would be inappropriate to try to influence the outcome.  Maybe as the most respected senior member of the IIF who has a real job, he is trying to distance himself from their games and attempts to capitalize from the situation?  Something seems very strange here, though it has been encouraging that some banks are finally taking decent sized write-downs on their Greek exposure.

Belgium and Dexia

For a bank that was “bailed” out, the senior CDS still trades around 600 bps and the sub CDS is still over 30 points up front.  Yes, I too forgot to read the documentation of what the bailout actually was or did.  It seems the market isn’t that convinced the bailout is for real.  Is it possible that the bailout terms are actually pretty weak?  The answer is yes, and I’m just annoyed I didn’t spend more time digging for details about what has been done.


A total mess.  2-year Italian government bonds traded north of 6% yield today.  The curve is flattening, and only avoiding aversion, because there is no bid for longer dated paper either.  This is bad, and Italy was supposed to be saved by all the schemes and ploys of the EU the past month.  The Italian politicians are in denial and anger mode.  Soon they will say the right things, but the market will likely shrug that off, since absolutely no willingness or effort to change things has been in evidence.

The Italian banking sector could see another big leg down.  Italy, may be too big to fail (possibly too big to save), but at some point, some banks may have to be sacrificed.  Doing more work on this, but if the sovereign debt is yielding 6%, how are the banks going to fund themselves?  As massive holders of Italian government bonds, how will they sell assets to reduce their funding needs without eating through their capital?  It would also be a lot harder for the EU to manipulate the situation to avoid a Credit Event on banks.  More coming on this topic, but for now, everything in Italy looks bad, and the deterioration is actually accelerating.


The ECB is financing the Portuguese banks to the tune of €45.5 billion Euros.  Once again, this is separate from their sovereign debt holdings.  Maybe the ECB can get some extra money by allowing reality TV to film its investment process.  It could run between Pawn Brokers and Hoarders.  How much is Germany ultimately going to have to pay for these positions when they go bad, or will all of Europe experience hyperinflation when the ECB prints?  Portuguese 2-year bonds are trading at 80% of par to yield 19%.  The potential EFSF first loss of 25% may not be enough to encourage investors to buy new Portuguese 2-year paper, let alone 5-year paper, where the existing bonds trade below 65%.  You can get 35% first loss coverage by just buying bonds in the open market at 65.


Banco de Valencia was suspended from trading in Madrid today.  It needs about €600 million of capital.  The country has its own problems, but the banking system in Spain is feeble and they have still never accepted the losses from the property bust.  The banking system is worse relative to the sovereign than in Italy, so expect problems to materialize here first, but it is not a good sign for Italian banks either.


I wrote about that this weekend <> .  Nothing new to add since no new facts have been revealed about the bigger plans.  A new 10-year deal was priced today, cheap to the old 10-year.  It is good that they sucked it up and issued, but it is not coming at a great level, and this is still a nice straightforward note, not the 25% first loss thing they are hoping to use in the future.


So, the IMF is working to get more money out of Russia.  The best part about including Russia is any need to be politically correct, is off the table.  The Russians, if nothing else, are direct and hold a grudge.  The leaders may say a lot, and may even have a lot of money, but the average Russian is still poor, has horrible work conditions, and remembers that 25 million Soviets were killed in World War II.  There was a battle for Stalingrad, but no equivalent battle in France.  The most resistance the French put up was “Mon Dieu, no, no, you would like my neighbor’s chateau would make a much better headquarters than mine”.  The limited direct resistance is even more interesting when compared to the years of complex planning meant to stop such an invasion (Maginot Line = EFSF?).   Not only that, but the last time the French sent a short leader into Russia, it wasn’t a pleasant experience for anyone involved.  I think that also started roughly in November.  Russia may decide to do more, but I wouldn’t bet too much on that at this stage, though, they are suckers for women in high heels.  They have told her they would pledge higher membership quotas.  I am not sure if that means more money for the IMF or just Russia will pay a higher percentage of existing commitments?  If it is for more money, it will be interesting to see how congress reacts to demands for another tranche of loans/commitments.  It will also be interesting to see what the IMF is proposing.  Maybe collateral is back on the table?  Which the IMF and Russians would like, but not so sure the recipients would want to provide – remember, default isn’t that bad while bondholders have no rights, it becomes a worse option as you give the bondholders some rights.