Friday, 11 May 2012

Whoops! Helicopter. Euro.

The drama of the Spanish banking sector is getting worse. The government has asked the (savings) bank sector to increase loss provisions from 54 bn EUR to 166 bn EUR to cover potential losses on loans to construction companies and developers: It would not be that bad, if it also covered potential losses from loans given to property buyers. Some estimate that making reasonable provisions for such loans would mean that the banks would have to make provisions of 270 bn EUR. That would effectively kill the sector.

Spain is rapidly approaching an Irish situation, with one important difference: the Spanish government has not been silly enough to guarantee anything. The problem is quickly beginning to look like a situation where it will be impossible for the government to bail out the banks by injecting capital. I am afraid that at some point in time it will be impossible for the government not to explore the “Swedish model”, of nationalisation without any compensation to shareholders, flotation of huge chunks of bad loans, and a later re-privatisation of healthy banks.

The good news is that EU is now clear in offering Spain an extension of the time limit to reduce government deficit to below 3% of GDP. In return Spain has to accept an “audit” of the plan to rescue the banking sector. I am not entirely sure that such a plan really exists.

Spain is a living testament to the complete misunderstanding that this crisis is about government debt. It is not it is about total leverage of the economy, public AND private. Spain and Ireland (and Denmark) had healthy government finances but a hugely leveraged private household sector as the crisis began. Healthy government finances proved to be no help.

More Whoops!
JP Morgan-Chase admitted to have lost some loose change, USD 2bn and counting, on their Prop Trade activities, i.e. speculation for the bank’s own books. Of course that old devil, mark-to-market, was to blame (together with poor risk management and failing organisational oversight). If only JPM had been allowed to book the positions at prices that suited the bank better insted of being mercilessly forced to book the positions at market prices, things would not have run out of hand.

To me it sounds as if the arrogance of the pre-2007 period is coming back with a vengeance. As they say in French “Chasser le naturel, il revient au gallop”.

The good news is that such a loss is a major setback for Wall Street’s lobbying activities, aimed at weakening the legislative efforts to curb Prop Trade, the so-called Volcker rule.

Helicopter Ben gets company
Fed Chief Ben Bernanke got the nickname early in his career because he advocated QE programmes to stave off financial crises. Now Citi’s chief economist Willem Buiter joins Ben in the helicopter. Buiter recommends even more radical easing of the monetary policy than seen so far. Buiter is not just any bank economist. He was a highly respected academic economist and a member of Bank of Englands Monetary Policy Council before taking the jump to the big paycheque in Citi. It is just six weeks ago that Buiter claimed that Spain was heading for a debt restructuring. The reason: the government is not strong enough to recapitalise the savings bank system.

Now Buiter sees that the monetary initiatives by the world’s central banks are becoming increasingly ineffective when combined with a banking system in full deleveraging mode. Add the death-by-austerity fiscal policies in Europe. Buiter suggests Central Banks to lend money directly to the private sector, circumventing the banking system.

And some good news
The Euro has been weakening recently (no, it is not really the dollar that has gained, if you measure on a trade-weighted basis), and the usual chorus of anti-EU megaphones have trumpeted that as a sign of the Euro-zone’s imminent collapse.

For those who remember my writings last year in the autumn, I am strongly in favour of a weaker currency. I am even in favour of parity with the USD. It should not happen too quickly and disorderly, though. But for sure it would help on Europe’s economic situation. As long as Europeans still find it cheap to shop in the US, there is something wrong with the terms of trade.

Wednesday, 9 May 2012

Overstepping the limits. Banks. US economy.

Overstepping limits
German member of ECB’s management Jörg Asmussen gave an interview in Handelsblatt that almost – almost - gave me sympathy for outgoing French President Sarkozy. Sarko once famously hissed at former ECB chief Trichet that as an unelected civil servant, Trichet’s role was not to decide on politics. That should be left to politicians.

Mr Asmussen, who is a career civil servant, clearly oversteps all limits for public statements from the ECB. He lectures Greece – where no government is formed. He lectures incoming French president Hollande. He gives rather precise policy designs – namely that the deadly austerity policy must be continued at any price. His only admission is that the austerity drive may be “complemented” with a growth initative. Mr Asmussen repeats the views of Bundesbank, and acts like a mouthpipe of the most conservative politicians in Germany. This is not the way for a high ranking member of the ECB to gain friends. Such a rant from Asmussen would have served him a stinging rebuke if there had not been a power vacuum in France and Greece.

Spain dodges an important decision
The Spanish government has apparently decided to yet again recapitalise a local savings bank, Bankia, created by merging 7 smaller regional lenders. The top management, including highly respected former central bank chief Rato, has resigned. The problem with giving the banks more money instead of nationalising them is that it does not solve the issue of the bad assets, in this case loans to real estate development. In the USA, the government gave money to the banks (without demanding a management change) and lifted a huge amount of bad debts off their balance sheets.

The bad news is that according to all statistics, Spanish property prices have nowhere fallen enough. More bad loans will arrive.

The Spanish banking crisis will not be solved until the government decides how to handle the bad debt. I still believe there is a simple solution: Package it and sell it in the markets. It may mean that the banks are insolvent. Some of them should then be allowed to fold.

Denmark enforces tougher rules on bad bank loans
The Danish banking sector – which started the banking crisis as one of Europe’s most fragmented – is reeling under new, tougher rules for loan provisions. After three years where dozens of local banks have gone belly up, the Danish regulator’s no nonsense approach is likely to force more bank closings. Prospective loan provisions are likely to exceed all market expectations and may push some more of the weaker banks into insolvency. Last year, tighter practices led to the first senior debt loan losses in Europe and it shut many Danish banks out of the interbank market.

It is ironical that the country which arguably is further ahead in the cleaning up of its bank sector is being punished by the financial markets. It compounds the problems of getting the economy going again. It proves the old adage: it is better to fail conventionally than to excel alone. It is better to pretend the problem of bad loans does not exist than to get it out in the open.

US need more QE??
A number of pundits are trying to change the tone of the economic debate in the US. Some disappointing economic data have created renewed doubts about the future growth. It is interesting to see the difference between perception and reality. The reality is that the US economy is chugging along with virtually all of the economic indicators pointing to continued growth. It is particularly good news that small and medium sized companies are getting more optimistic.

However, the perception is that data are disappointing. You cannot be disappointed if you did not have expectations. And we have seen everybody (and his dog) revising forecasts upwards in the past three months as the US economy recovered from a mini-slowdown in Q3 of last year. Now the growth is stabilising – and we get disappointing news in comparison to the new, more optimistic expectations. Following the time honoured practice of economists and other pundits, it could lead to 2-3 months of disappointment. Even if there really isn’t anything to be disappointed about.

Monday, 7 May 2012

European elections

The elections in Europe largely had the outcomes expected last week. However, it did not come as any great relief to the markets. What was two days ago a potential political uncertainty is now a confirmed political uncertainty. This adds to the uncertainty created by the horrible data indicated by the “Flash PMI” numbers last week. It is interesting that the uncertainty only affects the stock markets and the Euro. All other kinds of risk assets are holding up nicely. It rhymes with our perception that this is a completely normal rotation between the asset classes, driven by a readjustment of growth expectations. It is confirmed by our proprietary risk indicators, which remain low. This is not a repeat performance of the 2011 market collapse.

Hollande won the French election and will now have to face the reality. That reality is a country with high unemployment, slow growth, slow productivity growth, and a twin deficit as both government and external balances are in minus. He will not be able to fix any of that with the economic program presented during the election campaign. Rumours are also that he will face a wave of redundancies from large French companies – companies that Sarkozy allegedly leaned upon to make them postpone firings until after the elections. His first foray into the international scene will be a visit to Berlin, where he will be reminded that agreements are there to be respected.

However, the EU commissioner for economic affairs, Olli Rehn, has already indicated that the pact could be interpreted in a more flexible way – which probably means that the budget targets will stand but that the deadline for their implementation. German Finance Minister Schäuble has spoken of Hollande’s need to “save face”.

What the practical outcome will be is still uncertain. My guess is that some kind of growth initiative plus a de facto (even if not official) delay in the deadlines for cutting the budgets.

The preliminary results of the general elections pointed to a hung parliament, where the parties behind the debt restructuring agreement command exactly half of the seats in the new parliament. A motley crew of parties opposing the agreement form the other half. For the financial markets the issue will be whether this will now lead to an actual default on the reduced government debt. It is too close to call, by my impression is that a weak coalition will be formed between parties in favour of staying inside the EU, and – by extension – to respecting the agreements. It may then survive a few months.

Local elections in the German state of Schleswig-Holstein gave an important pointer to the mood among Germans voters. Chancellor Merkel’s party experienced a slight loss, The main opposition SPD gained and most of the votes came from the minority partner in the current government, the liberal FDP. Merkel’s coalition is somewhat weakened, but mainly because of the plight of the coalition partner. So far it has no practical implications for her government.

What it means
All of this will probably keep the stock markets on their toes in the short term. There appears to be two main strands of thinking out there, and the market movements can be interpreted as result of the mood prevailing at any given mood. There are those who (still) believe that it is possible to cut one’s way to growth, and those who believe that excessive cutbacks will kill growth.

So far, the latter camp has been right. While nobody contests the necessity to increase budget discipline, it is obvious that Europe’s growth is tanking because of public sector cutbacks. And a lack of funding to small and medium-sized companies. We expect that the stock markets will remain jittery in the days to come and that EUR will continue to weaken. 

Friday, 4 May 2012

A possible change to Europe's austerity

The French presidential elections on Sunday will be followed by elections to the parliament in June. So if all the opinion polls are right, France will have a new president and a new majority within a few weeks.

For Europe this could have a significant effect. Francois Hollande, who appears to become France’s next president has been very clear that he wants changes to the current “Fiscal Compact”, the code name for Europe’s German-inspired austerity programs, by which all Euro-zone member state must have cut their budget deficits to 3 per cent of GDP by 2013.

Data released this week point to a sharp downturn in the economic activity in Southern Europe and in France. Economic activity is also stalling outside the Euro-zone and unfortunately there is no other explanation than government cutbacks. All of this will eventually hit Germany, whose growth is strongly dependent on the growth in the export markets. With the rest of Europe slowing, Germany’s economy is bound to follow.

All over Europe voters are throwing out politicians who have been managing the crisis and are now connected with the austerity programs. The “hard core” of the Fiscal Compact is crumbling. The Dutch government has resigned as the far-right PVV refused to support domestic budget reductions. In Finland, the True Finns party has adopted a similar position.

This creates an interesting situation. Will Hollande cave in, faced with Merkel and Schäuble, and give up on his election rhetorics? Or will Merkel and Schäuble realise that keeping Europe on track will require that France is fully on board and that this can only be obtained by relaxing the economic policy? Most pundits expect the first.

My guess is that Germany will “cave in”.

In practical terms it could imply that the 3% budget targets will be postponed by a year or two. All kinds of EU funds will be used to provide assistance in long term financing to southern Europe. It will reach from Infrastructure funding to long term financing. Portugal and Ireland will probably be able to negotiate a 1-year extension of their bail-out loans.

All of this will happen in the face of determined resistance from the Bundesbank.

Does it sound too good to be true? Well, maybe. But Germany is not controlled by a strict economic philosophy alone. There is a political dimension to it as well, and Chancellor Merkel is a politician with strong instincts.

Having failed to explain to German voters what the packages to Greece, Portugal, and Ireland were all about, Merkel is now facing German voters fed up with “paying for Europe”. Local elections in the coming days will give an important indication of the strength of the dissatisfaction. If the results are a strong showing for the Social Democrats, Merkel will be weakened politically and will need to adopt her policies well in advance of the next national elections to be held in 2013.

The only way of getting out of that situation is to make sure that growth will resume soon. So far Germany’s leading politicians and Bundesbank have acted as if Germany alone was immune to the crisis. That perception has allowed them to treat lack of growth in the other European countries with something akin to disdain.

A combination of a crumbling Eurozone “hard core”, a sharp drop in exports and political resistance from German voters could change Merkel’s mind.

On top of that, remember that for the longer term political prospects in Europe, Germany cannot afford to alienate France. Germany needs Europe as much as Europe needs Germany.

If I am not right in assuming that growth will be back on Europe's political agenda, things could get worse than they are now. I hope I am right.