Friday, 13 April 2012

EBF. Spain. Seasonality

There is now less than three months until the European banks have to meet EBA’s strict demands for a Tier 1 Capital of 9 per cent. I have repeatedly been highly critical of the decision to force the banks into a rapid deleveraging at a point in time when the European economies are being hit left right and centre by austerity programs. Not surprisingly Christian Clausen, President of the European Banking Federation (EBF) is also highly critical. In his criticism, he adds a couple of points that are worth noting.

His first point is that the new standards are often so weakly formulated that the banks tend to be more careful, rather than aggressive, when implementing the standards. Another point is that in order to meet new demands for net stable funding, the interbank market need to provide funding to the tune of 1.9 tn EUR, which is frankly impossible.

While I agree with some of Clausen’s views, it is worth remembering that the banks themselves created the mess that politicians are now trying to get them out of. Shame that the same politicians managed to make a mess out of the rescue mission.

I continue to be surprised about the lack of precision in the financial press when it comes to bailouts. Reading the most recent batch of comments about Spain’s economic problems, the reader would be excused for believing that Spain faced bankruptcy. It could also seem that the European bailout funds are not sufficiently large as their total volume more or less corresponds to Spain’s government debt. It is nonsense.

Greece got a debt restructuring. It means that a large proportion of the country’s government bonds were declared null and void, and new ones with a lower nominal value were issued instead.

Portugal and Ireland got what is now popularly referred to as a “bailout”. It is a credit line, established for a limited period in time, allowing the countries to cover their financing needs from other EU countries. Such credit facilities allow the countries to bypass the market, and the idea is to reduce the financing costs temporarily while the countries try to get their economic house in order,

Such a credit facility is not related to the overall outstanding debt, but to the financing and refinancing needs for the term of the facility. If it is e.g. a three year period, it is assumed that 10-year bonds will be dealt with on market terms later.  

Spain may opt for such a facility if the short term yields continue to climb. But it has nothing to do with 10-year bond yield climbing past 7 per cent, as the press has had it.

In order for a country’s debt/GDP ratio not to increase, the average yield on the outstanding debt cannot exceed the nominal growth of the GDP. That is exactly the purpose of “bail-out packages”, and explains why the interest paid on the credits are lower than market rates.

The most recent job numbers from the US came out a bit worse than expected after a number of months with better than expected numbers. While being highly interesting from a political point of view, the data are probably simply a result of the milder than normal winter in the US.

Job data are always seasonally corrected, as everybody knows that bad winter weather leads to short term layoffs. When the winter is milder than expected, fewer people are laid off. Seasonal correction mechanisms are based on several years of data and adds some jobs. The result is an overshoot. Unless you are familiar with this mechanism, you will have a tendency to adjust your forecasts upwards.

But around March, the effect of the warm winter disappears out of the statistics as the seasonal correction does not add those extra jobs in the spring. So suddenly your fresh optimistic forecasts collide with the seasonal correction mechanism. And the data disappoint. Interesting to see if we are in for more disappointments.

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