Daily News Roundup 2012: Wednesday 16 May

Good morning

The headlines:

1. The Greek President proposes a government of non-politicians after failing to form a government of useless/unpopular politicians. If the kids (read: "brats") can't agree on an interim government now (until the new round of elections next month), the mandate gets handed to either a Council of State or the Supreme Court. First off, I'd like to express amazement at how complicated the Greek political system is. Secondly, I'd like to express amazement at how prepared the Greek constitution/electoral law is for just such an eventuality. Thirdly, I'd like to express amazement by asking "have you ever in your life?" A government of non-politicians sounds like a military junta (who are undoubtedly waiting in the wings). Frankly - a military coup might be the cleanest thing here. Instant suspension from the EU. Boom. Link: Useless.
2. The Greeks are running the banks. And so it starts. For anyone that has been wondering how Greece leaving the euro will play out, it starts with the pitter-patter of Greek sandals running out the bank doors with all their money in (euro) cash to be stuffed in a mattress and planted in the fields. The Central Bank head, George Provopoulos (Greece has a Central Bank?!) has approached the president (who appears to be nought but an ineffective figurehead that has no political significance whatsover - is he a king?! Democracy, my proverbial posterior) with a "small problem, sir": that he describes as "great fear" that isn't yet, but could quickly become, "panic". He also, apparently, has a talent for understating the obvious. Link: No need to panic, sir, because it's not "panic" yet. Try "manic", you goon.
3. On the other hand, Greece is going to repay the 435 million euros that fell due yesterday. Link: That's what they're saying now!
4. Finally, in news that's not Greece-related, the US Department of Justice is about to start a criminal probe into the JPM $2 billion loss. But I thought that this was all just an "egregious error"! Sigh. And Jamie Dimon has tried so hard to self-flaggelate his way into public sympathy. But question: I'm just not sure how criminal a case you can make. Because, well, mistakes (even egregious ones) happen. And that's just, like, life in the Investment Banking world. Pass your Volked-up Rule first, DOJ, and then you can probe away usefully. Rather than engaging in (what appears to be) a PR exercise that spends lots of money that you don't have. Now that's egregious. I believe Warren Buffet calls this "throwing good (borrowed) money after bad"? Link: The DOJ wants to probe JPM.
5. Apple is releasing a new Macbook that looks even more awesome. Unlike the Wozniak, I would sell Facebook shares at any price to buy it. Link: Thinner, Lighter, Faster.

That's all for now!

Have a good day.

Daily News Roundup 2012: Wednesday 9 May

Good morning

The headlines:

1. John Taylor of FX Concepts (a hedge fund guy) says that Greece will exit the Euro this year. Link: Actually, Taylor reckons that it may be as soon as next month. Well exactly - how often can Greece actually go to the polls and fail to form a government? Given that it needs the next round of the bailout package by next month; I don't think that any of the old school crew are going to give it to them without there being some balance of power committed to the original terms. That said, the anti-austerity tide is making a general tsunami of itself in almost all of the EU - so maybe the new kids on the block will ignore the old school as being, well, old. But if that doesn't happen, the newly-unformed Greek Government will approach the IMF. And Christine Lagarde will barely pause in her tanning booth to say "Non, bitches".  And I reckon that the anti-austerity league will throw their hands up in a huff and leave. This will all be foolish - because it's going to be bloody chaotic if the Greeks "elect" to leave the Euro (read my original article on this here). But if there are political parties that believe that Greece's spending is not the core problem; then I'll bet good money (NOT) on them believing that they can handle a monetary regime change. Like hell.
2. The big traders are abandoning Wall Street in favour of Hedge Funds. Link: As they should. I've written about it here.
3. Berkshire plans $1.6 billion sale of bonds to replace maturing debt. Link: And that's how WB rolls. It's business as usual - there's some debt coming due; they're replacing it. 
4. Syriza (anti-bailout) tells the pro-bailout guys to abandon their aid pledges. If they don't, then there's no chance of forming a coalition government in Greece. The definition of "stalemate". For the record, Alexis Tsipras (the Syriza leader) phrased it this way "I expect Antonis (Samaras) and Evangelos (Venizelos) to send a letter to the EU revoking their pledges to implement austerity measures by the time they meet with me tomorrow". And that, folks, is the core of diplomacy: self-presumption. Idiot. Link: Next candidate please.
5. Senate Republicans block Obama's student loan rate freeze plan. Link: Indeed. I refer back to yesterday: student loans appear to be on the increase, but not for any obvious reason. The suspicion is that it's just become another form of state welfare, as unemployed Americans return to school (and more debt) while they're not doing anything else. Higher education is not necessarily productive: there are courses and degrees out there that amount to nothing more than thinly-veiled leisure activities. I'm sorry: but the arts tend to be hobbies that you can sometimes make a career out of; not careers that you can sometimes take up as a hobby. Subsidizing that is just not-at-all-veiled vote-mongering.
6. French and Portuguese banks lose out on Africa deals. This has given breathing space for other banks with lesser colonial links. Like the British (Standard Chartered and Barclays) and the Americans (Citigroup) and the South Africans (Standard Bank and RMB). It's a pity - because for those original banks - go where the growth is. Don't dwell on an economically-obese homeland. Link: In search of growth.
7. In South Africa, the head of Sanral has stepped down. The rand has dropped on the news. The South African National Roads Agency Ltd recently lost a case in the high court - and has been forced to delay the implementation of its e-tolling system. But for anyone driving the highways of Joburg, all the capital investment has already happened. So the debt obligations are there and someone has to pick it up. If it's not the taxpayer directly, it's be the taxpayer indirectly. The SA government will have to pick up the tab - and at that point, lower credit ratings, higher interest costs, higher future taxes. Link: The Scaredy Fat Cat jumps ship.

That's all for now.

Have a good day.

Greek CDS Exposure: Proving the ISDA and Bloomberg Wrong

According to numerous news reports, the net exposure arising as a result of Friday’s decision to declare the activation of Greek CACs a credit-default event amounts to approximately $3.16 billion (assuming that the bonds achieve no value at the ISDA auction on March 19).

Where is the data coming from?

On the same day that the ruling announcement was made, the ISDA issued a FAQ document relating to the Greek Sovereign CDS credit event. Both these documents can be downloaded at http://www2.isda.org/greek-sovereign-cds/. This document makes reference to the $3.16 billion net notional as disclosed by the DTCC (The Depository Trust and Clearing Corporation). In fact, the publication erroneously links to Table 5 of the DTCC data – the actual figure is found in Table 6. Link: http://www.dtcc.com/products/derivserv/data_table_i.php?tbid=6. Table 6 discloses the Top 1000 Reference entities for the swap arrangements (ie. the issuers of the instruments being covered by the credit default swaps). Under the heading “Hellenic Republic”, the sovereign debt gross notional is disclosed as $68,901,331,331; and the net notional is disclosed as $3,162,579,257.

What is the problem that people are having/should be having?

The problem appears to be twofold:

1. The preliminary list of bonds submitted to the ISDA for restructuring credit event consideration included issuers other than the Hellenic Republic. 
2. Is the sovereign debt exposure figure presented by the DTCC a fair reflection of economic reality? 

Problem 1: The Other Issuers on the Preliminary List

From my reading of the ISDA public announcements, the problem is as follows:

1. The preliminary list of bonds submitted for review (released by the ISDA on March 7 – this can also be downloaded from the link identified above) includes issuers other than the Hellenic Republic. No basis for the inclusion is given, nor is it required. The list is not final – rather, these are the bonds that the public has asked the ISDA to consider. 
2. It is suggested that the reason for inclusion is on the basis that many of these issues have guarantees issued by the Hellenic Republic. Given that the trigger event was the activation of CACs, one could infer that the default will only extend to those bond issues where CACs have been retroactively imposed (ie. only Sovereign Debt). 
3. The ISDA has not identified the bond issues to be affected by the default announcement: the wording is specific to the occurrence of a Restructuring Credit Event. 
4. According to the announcement, the EMEA Determinations Committee is currently in the process of reviewing the preliminary list of submitted bonds. 
5. Therefore, the magnitude of the default event will only be set after the EMEA DC formally identifies the bonds affected. 

Can impact of the other issuers be quantified?

The issuers identified in the preliminary list of submitted bonds are:

1. The Hellenic Republic 
2. Athens Urban Transportation Organisation (OASA) 
3. Attica Bank S.A. 
4. EFG Eurobank Ergasias S.A. 
5. Hellenic Railways (OSE – Organismos Sidirodromon Ellados) 
6. National Bank of Greece S.A. 
7. New Economy Development Fund S.A. (Taneo) 
8. Proton Bank S.A. 
9. Aeolos S.A. 
10. Ariadne S.A. 
11. Agricultural Bank of Greece S.A. 
12. Alpha Bank AE 
13. Piraeus Bank S.A. 

According to Mark J. Grant in his article “The Eight Hundred Pound Greek Gorilla Enters The Room” (link: http://www.zerohedge.com/news/eight-hundred-pound-greek-gorilla-enters-room) – these other bond issues are going to increase the CDS impact number up to $79 billion.

I’m not sure where that number comes from, but I’m going to assume (for this section) that the DTCC figures are correct. If they are, then with the exception of the Hellenic Republic, none of the above issuers feature in the Table 6 Top 1000 reference entities. The smallest of the Top 1000 (by net notional exposure) is Nextel Communications, with a Gross Notional of $1,649,302,354 and a Net Notional of $105,475,330. By inference, therefore, the maximum additional net notional exposure to be added by the other 12 entities identified is an extra $1.3 billion ($105 million by 12).

However, as I have previously stated, this is unlikely to be a real consideration as the triggering event is the activation of the Collective Action Clauses – an event which should have no direct default impact on government guarantees given to state-owned entity and domestic bank issues.

Problem 2: Is the DTCC’s calculation correct?
Renowned investor Jim Sinclair (JS) in an interview with King World News suggests that the real question to be asked should be: is the amount calculated by the DTCC correct? He says that the DTCC amounts calculated are only in respect of transactions taking place within the US (ie. they exclude foreign bank transactions, as well as transactions undertaken by the foreign subsidiaries of US banks). If that were the case, then we would have to look for the real information in the data presented by the Bank of International Settlements (BIS).

The latest data available from the BIS takes us up to June 2011. According to Jim Sinclair, the total CDS market approximates $37 trillion, of which over 50% must relate to Greek debt. The first figure is supposedly drawn from BIS statistics; the second is based on his 50 years of market experience.

Well, the first figure is factually incorrect (or perhaps chronologically incorrect – it’s always possible that the number referred to a different point in time). At the end of June 2011, the total outstanding CDS market, according to BIS, was $32.4 trillion (net exposure).

As regards the second, the BIS gives a breakdown of the CDS market based on reference entity sector. Of the $32.4 trillion, only $2.9 trillion actually relates to Sovereign Debt. The only other potential impact is in the sector of the CDS market held over CDO instruments, which may or may not include Greek sovereign debt issuances in default. This sector of the market constitutes a net notional $0.9 trillion. So in total: a potential exposure of $3.8 trillion.

Obviously, this is significantly larger than the $3.16 billion being used by the ISDA (over 1000 times larger). And Jim Sinclair does make a good point: the DTCC tagline for its data is that “this section provides comprehensive reports on the vast majority of CDS contracts registered in the Warehouse’s global repository” (link: http://www.dtcc.com/products/derivserv/data/index.php). Obviously, CDS contracts that are not registered with the DTCC would not be included in this data. And it certainly sounds like the DTCC captures only the US portion of the market.

As a reasonability check, compare the total of the Table 6 Top 1000 reference entities to that of the total CDS market according to the BIS figures. The total net exposure of the DTCC Top 1000 is only $1.1 trillion, compared to the $32.4 trillion of the BIS. If we say that the DTCC figures approximate the BIS figures, the balance of $31.3 trillion must then be made in reference to other issuers. Given that the Top 1000 include governments and all major corporate and parastatal bond issuers – this implies that the majority of the CDS market has been taken out against small issuers! Highly unlikely.

As a final check, one should consider what the figure of $3.16billion is implying about the global debt market. I have used Table 15B of the BIS quarterly statistics (link: http://www.bis.org/publ/qtrpdf/r_qa1203.pdf), which breaks down the Total International Bonds and Notes by nationality of issuer. Whilst this statistic uses total international bonds and notes outstanding rather than just sovereign debt, or a combination of both international and domestic debt: the point is to illustrate the proportion of the international debt market that is made up by Greek debt. 

Total International Bonds and Notes Outstanding (in US billions)
Greece	397.40
The World	27 819.70
Proportion represented by Greece	1.43%
Total CDS Net Notional Exposure (in US Billions)
CDS Net Notional Exposure (DTCC)	3.16
World Net Notional Exposure (Sovereign Debt) - from BIS	2 907.80
Proportion represented by Greece	0.11%

If we just assume that all investors were blind and equally distributed their CDS investments between countries, we would expect Greece’s net notional exposure to approximate its portion of the debt market. Even more so, we would have expected investors to flock to CDS instruments over Greek sovereign debt, given the economic fundamentals of Greece’s position (ie. you’re much more likely to buy insurance when your house is made of untreated wood and situated next to a blacksmith, than if your house is made of stone). Instead, the ISDA (and Bloomberg) would have us believe the opposite, that investors underweighted their CDS exposure to Greek sovereign debt.

Is there a reasonable explanation for underweighting?

I think that there is an argument to be made here. After all, why has a Greek default been delayed for so long? A year ago (even 6 months ago), the Euro leaders were all against causing a credit-restructuring event for fear of triggering CDS instruments and causing contagion. And now suddenly, everyone is keen for a default. Including Greece, who elected to action the CACs to top up the extra 14% of the debt – where they could have just restructured the 86% voluntary portion and gotten away with it. So the question is: why now?

I think that the delay has accomplished two things:

1. If I were speculating on Greek sovereign debt defaults three or four years ago (back when CDS instruments were cheap), I would have purchased CDS instruments over the debts issues that were falling due in the short-term – as these would have been much more likely to default (as their repayments would have fallen due sooner). By stretching out the time to default, some of the original CDS instruments will have lapsed, as Greece has managed to meet its debt obligations up and until this point; albeit with the assistance of the first bailout. And in the interim, as the market realised the Greek crisis, the spreads on Greek Sovereign CDS widened making it almost prohibitively expensive (and therefore unprofitable) to purchase more CDS instruments. Greece and the Eurozone may have faked it until they made it. 
2. The delay also gave the major banks the chance to recapitalise in anticipation of a default, and to rebalance their positions.

So perhaps the ratios sound about right.

Conclusion
Either way, the $3.16 billion figure is wrong. If anything, it is only the lower end of the range. What we can say is that there is definitely $3.16 billion of net exposure – but that it seems to only represent the US exposure. The rest of the world’s net exposure is floating somewhere in the $2.9 trillion of the BIS statistics.

Leaving the Euro: Such a Cost

At the time that I'm writing this, the Greek Government is split over the bailout package requirements, and Evangelos Venizelos (the finance minister) is trying desperately to appease the Troika (the European Commission, the ECB and the IMF) whilst still asking for more time.

But the Troika is irritated. Time is running out. And various people in varying positions of authority are beginning to say menacing things like "the Euro can survive without them". Oi vey. When it stops being "our" problem, and it becomes all about "those guys", it really begins to sound like the unity is gone.

Which is only a step away from saying that they should bugger off.

So, the question that we should be asking is: why has Greece not left already? 

The answer, quite simply, is that it will be cheaper for them to stay. According to Chancellor Merkel, the cost of Greece leaving the Euro would be "incalculable". That is literally true - there are too many variables at play. But UBS analysts have come up with an economic estimate: when there are many variables at play, analysts just come up with a range.

So, to that end, I'm going to summarise the economic costs that will likely arise should Greece leave the Euro (horribly plagiarised from the UBS report - although I suppose that it's not really plagiarism once I acknowledge that fact). If you're interested in reading the full UBS report, the link is here.

To begin, I need to point out that there is no legal option for Greece to leave the European Monetary Union (EMU). There is no clause for it in any of the treaties - precisely to discourage any one country from leaving the EMU.

There is also no clause in the treaties that would permit the expulsion of Greece from the EMU. The only legal option for expulsion is an amendment to the Maastricht Treaty. In order for the treaty to be amended, there would have to be unanimous consent from all 27 countries, including the country being expelled. And even were Greece to agree to its own expulsion, many of the countries are required to take the amendment back to their people for referenda to take place. So extremely unlikely then within the necessary time-frame.

Which means that the only option available for Greece is secession. According to the UBS report (and common sense), this will come with five core economic costs:

1. Default on Domestic Debt
2. Collapse of the Domestic Banking System
3. Departure from the EU
4. Trade, Tariffs and Protectionism
5. Civil Disorder

Default on Domestic Debt

Once Greece leaves the Euro, it will need to adopt a new currency (let's assume it goes back to the drachma). The next obvious question is: will the sovereign debt (currently denominated in Euro) be converted into drachmas or remain denominated in Euro? 

If the bonds are re-denominated into drachmas, that would constitute a default. Remaining euro-denominated would mean that the debt would have to be paid using Euros earned through trade flows - which are not going to be sufficient. I mean - they're not sufficient now, and if you consider point 4 below, it makes it even less likely. Default on Euro-denominated debt is therefore virtually certain. 

That said, even if Greece stays in the EMU, default is virtually certain.

The costly part of secession would be corporate default. If the government changes back to the drachma, the private sector will no doubt be forced back as well - which means that they will default in the same way. Even if not forced, the private sector would still be earning in drachmas, trying to pay off euro-denominated debt. And given the monetary and fiscal stress that Greece is experiencing, the drachma would immediately, and drastically, devalue against the Euro. Ergo: corporate default.

Corporate default = bankruptcy proceedings.

Bankruptcy proceedings = many firings and domino effects (as one company goes, so this puts strain on its creditors, who may also go bankrupt, and so the cycle continues).

Collapse of the Domestic Banking System

In order for the drachma to function, domestic bank deposits would have to be re-denominated into drachmas. As the UBS analysts point out - there are a range of questions that arise here. Would the only accounts affected be euro-denominated? Would it only apply to bank accounts belonging to Greek residents? And foreign branches of Greek banks?

But in any case, long before the denomination takes places, there would be bank runs. Any account-holder would be foolish not to withdraw their full funds in Euro-cash immediately - and either place it into a foreign bank account, or hide it in a mattress. Could the bank runs be curbed? Possibly - by imposing withdrawal limits during the transition, or by making the re-denomination a shock event (ie. a re-denomination without warning). But the former runs the risk of civil unrest, and the latter is practicably impossible. At the very least, bank officials in-the-know would seek to self-preserve - and in doing so, their actions would become a warning.

Also at a regional level, given the ease with which the suspicion of secession can initiate bank runs, the collapse of the Greek banking system is quickest way for contagion to spread to its European neighbours.

Departure from the EU

This almost goes without saying - to secede from the EMU is to secede from the EU. The UBS report does not attempt to quantify this cost - which makes me think that it is more qualitative. Obviously, there are trade repercussions, which will be dealt with below. But in my mind, the biggest implication here, apart from trade, is that Greece would lose access to EU financial assistance.

Trades, Tariffs and Protectionism

Given point 1, the secession would make Greece reliant on its trade flows for self-financing. But secession would also leave it without a trade agreement with Europe - which encompasses most of its trading partners.

At the same time, the devaluation of the drachma may give a temporary competitive advantage - but the European Commission has specifically stated that it would "compensate" for any movement in the new currency. This could be accomplished by a trade tariff being imposed on Greece equal to the advantage created by the devaluation.

So trade would likely collapse.

Civil Unrest

The risk of civil unrest would already be high during the transition with the panic and tension of a banking sector collapse. In fact, civil unrest seems to be a real risk at the moment. If the Greeks lose access to their bank accounts, that may well be the final straw.

But also, immediately after the transition, I would think that Greece would begin the process of monetizing its debts. The Government would still need to fund its current expenditure. And given the default, and the state of the taxation system, the easiest and most immediate source of financing would be money creation. It is highly unlikely that the Greek people would take this calmly.

Political Cost

Then there is the political cost, which cannot be quantified. With secession and fragmentation, Europe would lose her voice on the international stage.

In Conclusion

Without considering the impact of civil unrest and the political cost, the UBS analysts conservatively estimate that Greece withdrawing from the Euro will cost her citizens between €9,500 and €11,500 per person in the first year, and between €3,000 and €4,000 per person in subsequent years. In contrast, the cost of bailing out Greece, Italy and Portugal altogether, assuming a 50% haircut on debtors, would cost the German population "little over €1,000 per person, in a single hit".

So Greece.

She must stay.

Daily News Roundup 2012: Tuesday 7 February

Good morning

I woke up this morning to the news on BBC that a famed South African singer has resurrected from the dead after a fancy funeral in 2009. He was apparently captured by zombies, imprisoned in a cave, and forced to eat mud to survive. The family have told everyone that it's him. The crowd that gathered for his unveiling near his home village was pushed back by police with water cannons. Crazy? Perhaps. Sometimes, I am reminded that cultural prejudice is a tough one to overcome: one man's faith is another man's fairytale. But still - I eagerly await the DNA test results. And I can't help but think that the family could do with some liquidity injection. http://www.bbc.co.uk/news/world-africa-16905521.

The headlines:

1. In entirely unsurprising news, the Greeks are delaying http://www.bloomberg.com/news/2012-02-06/papademos-meets-creditors-as-sacrifice-looms-for-greece-to-stay-in-euro.html. Every morning, this gives me an opportunity to harp on a little more. If you've read the article, and are wondering why the Greeks need to legislate job cuts (surely SURELY you could just fire the excess?) - the answer to that question is constitutional. Article 103 of the Greek Constitution: Item 2: "No one may be appointed to a post not provided by law"; Item 4: "Civil servants holding posts provided by law shall be permanent so long as these posts exist", and dismissal requires "a decision of a service council consisting of at least two-thirds of permanent civil servants". http://www.hri.org/docs/syntagma/artcl120.html#A104. Once employed by the State, Greeks are effectively constitutionally entitled to always be employed by the State. It's absurd. How much of the labour force is actually employed in the public sector? Most journalists seems to say about a third. A really good article on the Greek public sector employment appeared some time ago in the Economist: http://www.economist.com/blogs/charlemagne/2010/03/empathy_short_supply.
2. American farmers are planning to plant their biggest crop since 1984 in order to take advantage of high prices. I can't help thinking that farmers do well for themselves. They sell their crops long before they plant them. And then they take out weather insurance on the crop. Gone are the days where you worried too much about the rain. Perhaps we should all go to Iowa to plant soybeans. http://www.bloomberg.com/news/2012-02-07/farmers-plan-biggest-u-s-crop-boost-since-1984-led-by-corn-commodities.html.
3. The markets are still quite excited by the Glencore-Xstrata merger. The combined company is set to be the biggest zinc, lead and thermal coal exporter in the world. http://www.blogger.com/blogger.g?blogID=6352522737625176777#editor/target=post;postID=3969027086030403289. I would guess that there is also excitement because the merger season for an industry always seems to start with one big deal. 
4. The American states are almost all signed on to a mortgage accord between themselves and the five banks involved in the talks. I keep reading these articles and still not quite understanding what the point of the accord is. But it seems to revolve around the banks agreeing that they did things wrong, and setting "requirements for how the banks conduct foreclosures, provide mortgage refinancings for underwater borrowers (people who owe more on their mortgages than their homes are worth) and both fund loan principal reductions and make payments to states and borrowers who lost their homes to foreclosure". But everyone can still sue the banks. I come back to my theory about Americans in election years. http://www.bloomberg.com/news/2012-02-06/banks-in-mortgage-deal-are-said-to-demand-new-york-mers-lawsuit-be-dropped.html.
5. Randgold is talking about expanding into Congo. After 2011's 259% increase in profits, I'm sure they need to spend the money somewhere. And that's my "Africa is the place" punt. http://www.abndigital.com/page/news/top-business-stories/1163100-Randgold-eyes-Congo-prospects-as-profit-soars.

Happy Tuesday.

Daily News Roundup 2012: Friday 3 February Addendum

Read this article on the magic Greek statisticians:

http://www.bbc.co.uk/news/world-europe-16834815

I have underestimated the BBC. I owe them an apology.

Thanks to @ddendum on Twitter for pointing this out.

Your twitter handle is @mazingly @pt....

Daily News Roundup 2012: Wednesday 1 February

So, the news that I'm reading:

The Eurozone Debt Crisis

• Greece one step away from Debt Deal (Associated Press via CNBC) link: http://www.cnbc.com/id/46205601 
• Europe's Central Bank can't fix "dysfunctional" EU (CNBC) link: http://www.cnbc.com/id/46205597
• What happens if Greece defaults? (CNBC) Link: http://www.cnbc.com/id/43425042?slide=1 Slide 11 is frankly unnecessary. 
• Portugal Pressures ECB to Halt Contagion (Bloomberg) Link: http://www.bloomberg.com/news/2012-01-31/portugal-as-greece-pressures-ecb-to-halt-contagion-prompting-nascent-bulls.html

The key points:

1. Everything mostly continues unchanged. Greece is still close to a deal, but not there yet.
2. The Greek deal will not be enough to make her debt sustainable. Even if there is a 70% haircut.
3. Germany is still irritated.
4. France is still telling everyone that they'll only ratify the new Fiscal Treaty after elections (ie. once Sarkozy has been replaced - that seems to be the general idea...)
5. Journalists still keep writing misleading headlines like "Greek Debt talks continue as EU signs new treaty". From what I can tell, that treaty is still unsigned and unratified. The best we can talk about is general agreement to agree.
6. Portugal is the new Greece. 
7. People (important ones) think that the EU is dysfunctional: the Southern countries (and, for some reason, Ireland) have one code of fiscal discipline (debatable use of the word "discipline") where the Northern countries have another (less debatable use). No big surprises there.
8. I found an interesting slide show on CNBC: "What happens if Greece defaults?". Although I felt that Slide 11 was frankly unnecessary. Link:  http://www.cnbc.com/id/43425042?slide=1 

The Golden Cross

• Stocks form "Golden Cross" (CNBC) link: http://www.cnbc.com/id/46203721 When the 50-day moving average crosses the 200-day moving average - considered a bullish signal. Issue with technical chartists.

The key point:

1. The Golden Cross is a trend observed by technical chartists: when the 50-day moving average crosses above the 200-day moving average. It's considered to be a bullish signal, mainly because it means that the average share price (that's more or less what an index is) over the last 50 days is now higher than the average over the last 200 days. Higher short-term averages over long-term averages sounds like the markets are picking up.
2. I'm just not sure why everyone is so excited. Generally speaking, technical chartists are dismissed as not having predictive power. 
3. It's interesting that the markets seems to be recovering, but the technical chartists then take it a step further and say that we can now reasonably expect a bullish market (an 81% chance) because that's what has happened historically.
4. Many academics consider this an incorrect assumption for a number of reasons (including a number of quantitative academic studies). But mostly, in my mind, the problem is the oranges and apples story. There is a mismatch between the underlyings: the historic data was generated in a period that had definitively different economic characteristics to today's. We are not the same fruit anymore.

The Republican Nomination

• Mitt Romney wins Florida Primary (Associated Press via CNBC) link: http://www.cnbc.com/id/46212222

I'll admit that I don't really understand the nomination process. Everyone runs around collecting delegates in various states, all in the lead-up to a convention. Anyway - I read it because I like the word "caucuses" - and I'm interested to see if the Republicans will nominate a candidate with a name like Newt Gingrich. He sounds like a character out of Harry Potter. But I suppose it worked for the Democrats with Obama. 

If politics had technical chartists, they would be predicting Newt Gingrich for the win on that basis alone.

Sorry - that was a bit mean. 

The US Housing Market Saga

• Treasury Investigates Freddie Mac Investment (The New York Times via CNBC) link: http://www.cnbc.com/id/46201587 Freddie Mac is a mortgage giant. Pressure from the Obama administration to forgive some of the principal for mortgage-holders whose principal exceeds the value of the underlying house (election year) - ease refinancing, and participate in debt forgiveness programs. Under investigation for investing in "inverse floaters" in 2010 - effectively giving them exposure to the interest component of mortgages. At the same time, Freddie Mac has barriers in place to prevent refinancing. 
• Foreclosures draw Private Equity as US sells homes (Bloomberg) Link: http://www.bloomberg.com/news/2012-01-31/foreclosures-draw-private-equity-as-u-s-selling-200-000-homes-mortgages.html

The key points:

1. Firstly, this is hugely interesting. I'm going to have to write a series of posts on the US Housing Market because it's both fascinating and important on a number of levels (it did, after all, trigger a crisis).
2. The Freddie Mac (the Federal Home Loan Mortgage Corporation) is a US government-sponsored enterprise that is intended to expand the credit available to home-owners (the topic of a future post).
3. The Freddie Mac has been under pressure recently from the Obama administration to ease refinancing for mortgage-holders, and participate in debt forgiveness programs. It is, after all, an election year. 
4. The background to this story is that after the housing market crashed, some investors were left with principal amounts to repay that exceeded the value of their properties (to be honest, for many, this was the case before the crash as well). So the Obama administration would like to forgive some of the principal for these home-owners; and also to permit them to refinance the mortgages at the new lower interest rates being pushed by the Treasury. ("Refinancing a mortgage" essentially means that you can take out a new mortgage at the lower rates of interest, and use those proceeds to pay off the old mortgage at the higher rates of interest, with the net effect that you pay less interest).
5. Freddie Mac has been actively resisting both the refinancing and the principal forgiveness - arguing that it does not make economic sense.
6. It turns out, however, that Freddie Mac has been investing in "inverse floaters". Basically, an "inverse floater" is a financial instrument that has higher values when mortgage-holders pay higher rates of interest (ie. when they're not permitted to refinance). 
7. It all smells a little like vested interest.

The US Credit Rating

• S&P warns of cuts; Another US downgrade coming? (CNBC) link: http://www.cnbc.com/id/46202656 

The key points:

1. The issue is health-care costs. As these go up, so the spending pressure increases.
2. The interesting question being raised is whether a US downgrade will make a difference. After all, the dollar was still a safe haven after its downgrade in August 2011. It actually strengthened.
3. According to the economist interviewed in the article, it seems that Ratings Agencies have a very short term view. If you project out any healthcare and pension costs, there should be no AAAs at all.

Dodd-Frank

• Citigroup opposes applying Dodd-Frank to Municipal Bond Market (Bloomberg) Link: http://www.bloomberg.com/news/2012-01-31/citigroup-joins-msrb-to-oppose-applying-dodd-frank-law-to-muni-bond-market.html

The key points:

1. The Dodd-Frank is to the Subprime Crisis what Sarbanes-Oxley was to the Enron crisis.
2. We should all know more about it. 

Other

• CNBC has a special "coverage" section on the Porn Convention 2012. Link: http://www.cnbc.com/id/45292339/

The key points:

1. The Adult Entertainment industry is a $14 billion industry, despite being under threat from piracy and legislation.
2. Like the Tobacco industry, most users repeat.
3. Would you invest in a listed Adult Entertainment conglomerate? Ethically, maybe not. But morals aside? Forgive the pun - but yes, you'd probably want to have a closer look...

Daily News Roundup 2012: Tuesday 31 January

It's important to start something new on the last day of the month. So I've been up for a bit, abused my iPad slightly, and I've decided on a hierarchy of news applications:

1. Bloomberg - obviously. However, Bloomberg is quite technical, and assumes a fair amount of pre-knowledge for anyone interested in doing this on their own.
2. CNBC - what a legendary news station. I recommend this one. All the essential stuff is covered. And it's really well-explained.
3. BBC - I've left out. I think Bloomberg and CNBC had it covered.

The Headlines that caught my eye:

Emerging Markets

• Emerging Markets post Bigger Gains than the US so far (CNBC). link: http://www.cnbc.com/id/46191756
• Starbucks to enter India (Reuters via CNBC) link: http://www.cnbc.com/id/46196917
• Tata Global surges after venture with Starbucks (Bloomberg) link: http://www.bloomberg.com/news/2012-01-31/tata-global-surges-after-venture-with-starbucks.html
• Asia Stocks, Oil Rise on Greek Debt Talks (Bloomberg) link: http://www.bloomberg.com/news/2012-01-31/asian-stocks-oil-rise-on-greek-debt-swap-talks-progress-aussie-advances.html

I'm not sure if it's come through, but I'm an emerging markets fan. The media tends to turn all our focus toward the financial woes of Europe and the United States - and we end up forgetting that there is literally a whole New World of investment opportunity. A New World that seems quite capable of sustaining itself (if it had to) without Europe and the US. For example, the trade flows between China and Africa have grown at record pace; and now, China is the biggest trade partner for most African countries (including South Africa I'm told - although I stand to be corrected).

As the US and Europe struggle, we're seeing Emerging Market funds post higher returns and large multinationals driving their products and franchises into the economies of Asia, Africa and Latin America. The Indian Economy, for example, is expected to generate economic growth of around 6.5% in 2012 - during an expected global recession! The thing to point out (in my mind) is that the debt markets of these economies are relatively unsophisticated - and many of these cultures have historical biases against debt and borrowings. This leaves them relatively-hedged in a financial 'world' that is struggling with its debt.

Europe

• EU Nears Confrontation Over Greek Rescue (Bloomberg) link: http://www.bloomberg.com/news/2012-01-30/eu-nears-confrontation-over-greek-rescue-as-portugal-poses-looming-threat.html
• Most Banks Tightening Credit to Europe - Fed Survey (Reuters via CNBC) link: http://www.cnbc.com/id/46192914
• Greek Bondholders May Face 70% 'Haircut': Source (The Associated Press via CNBC) link: http://www.cnbc.com/id/46191869
• Jim Rogers: No One Leaves the Eurozone This Year (CNBC) link: http://www.cnbc.com/id/46186447

I'm just a big fan of Jim Rogers' attitude: "I would love for them to say that OK it's a disaster and for banks and shareholders to say they'll take big losses. Everything would collapse and I would buy all the euros I could and all the stocks I could, but I don't think that is going to happen." Perhaps he's exaggerating to keep off all the speculators.

The key points:

1. Portugal seems to be heading in the same direction as Greece. Its bond issues have a "junk" status credit-rating, and credit-default swap spreads (that is, the cost of insuring the bond issues) imply around a 70% chance of default.
2. As the headline implies, US banks are withholding credit to their European counterparts.
3. 1 and 2 are strong signs that contagion would take place should Greece default.
4. Greek debt negotiations are still continuing - and the EU is increasingly frustrated by Greece's lack of success, and its failure to implement enough fiscal measures (ie. just not austere enough). Apparently, Germany suggesting a fiscal overseer, which basically would have put Greece under curatorship - but it seems that everyone reacted with shock.
5. The EU summit is set to ratify a new Fiscal Treaty (it was agreed on in December last year - but it still needs to be ratified) which is meant to act as a safeguard against further fiscal problems by imposing penalties on governments whose fiscal deficits exceed set limits (I think I read 3% of GDP).
6. EU leaders appear to be admitting that austerity is not enough to take Europe out of the fiscal crisis. This is quite interesting - as it marks a change in stance for a number of the more conservative countries, Germany being the most prominent. And honestly, it just makes sense: if I was facing bankruptcy, slowing my spending would not be enough. I'd probably have to take on a second job. And maybe sell off some assets. 

America (The United States thereof)

• Why Even 20-somethings Are Worried About Retirement (CNBC) link: http://www.cnbc.com/id/46146242

This was interesting because I think it demonstrates why it's necessary to have some kind of formal finance taught in schools. I think this will be a future blog post. 

• Jim Rogers: I Would Not Buy Facebook (CNBC) link: http://www.cnbc.com/id/46186936

Just because Jim Rogers had a lot to say yesterday. But agreed - buying hot stocks has been shown to be a bad buy. Much better to buy underrated stocks with good fundamentals.

• US Treasury Forcing Mortgage Principal Forgiveness (CNBC) link: http://www.cnbc.com/id/46193915

The reason that the US lost its AAA rating was because of its high fiscal deficit (very bad), as well as its bad asset book (after the subprime crisis, the bailout of the mortgage agencies, banks and insurance companies involved the US government taking on their bad assets). Now there is a plan to write these off (this is an election year, after all). I'm just concerned that decisions made during an election year tend to be short-sighted. But we shall see.

• Blackrock's Doll says Feds' QE3 is unlikely (Bloomberg) link: http://www.bloomberg.com/news/2012-01-31/blackrock-s-doll-says-fed-s-qe3-is-unlikely-in-contrast-to-pimco-s-gross.html

Quantitative Easing is always of interest to me - it comes back to the Inflation post: Quantitative Easing is just another term for monetizing debt. In measured and managed format, a relaxed monetary policy can stimulate an economy. But then a government walks the very fine edge of perception. Interestingly, the US Fed does not release official money supply data. This does make it hard to form expectations of future inflation - I would guess that's part of the reason for not disclosing those figures.

Post-script

• CEOs of Barclays, HSBC may keep bonuses (Bloomberg) link: http://www.bloomberg.com/news/2012-01-31/barclays-s-diamond-hsbc-s-gulliver-may-escape-hester-s-zero-2011-bonus.html

This is just linked to my post from yesterday. I'm sure Mr Hester will be planning a move soon - to a bank that's not state-backed.

Contagion. And Why Greece is Contagious

So. That last post.

Some people were irritated.

In the aftermath, I was called a wolf in sheep's clothing (amongst other things); and the post was called "a rehash of selective information" "which offers no conclusive suggestions as to how to resolve the situation" and "was lacking in certain fundamental areas".

Which I found to be a bit unfair. Firstly, you're not really discrediting the argument by calling it names. And secondly, you can't attack an argument by attacking the person making it. The debating phrase in my head is "the ad hominem fallacy".

Also, to be frank, if patriotism requires me to be blind and sheeplike, then the wolf accusation is a compliment. After all, wolves and sheepdogs are not so different. Shun me if you wish; but I like to think that it's the wolves, not the sheep, that do well in a crisis.

In any case, I was sent a video link that offered an alternative viewpoint (Peter Economides - "Rebranding Greece"). If anyone is interested, you should youtube it - it's worth seeing a different perspective. Essentially, Mr Economides suggests that Greece has been unfairly singled out in the crisis - and that the Greeks are partly to blame for this. He argues that Greece must rebrand herself if she is to come through this. Mostly, I agree.

But I have some observations:

1. A branding solution unfortunately does not change the underlying fiscal crisis - in the same way that dying my hair dark is unlikely to help if I'm going bankrupt (even if the bank had a prejudice against blonds to begin with). While it may be necessary in the long-run - as a short-term solution, it requires more than just a change in look - we also need an internal dynamic shift to take place.
2. As an alternative to the current view that Greece has the highest default risk (a view based on Greece having the highest public-sector-debt-to-GDP ratio), Mr Economides uses a UBS analyst report on the likelihood of sovereign default. The report incorporates the public-sector-debt ratio, the loans-to-deposits ratio, and the credit-to-GDP ratio to create a quantified index of default likelihood. As a general point, incorporating the "loans-to-deposits" ratio of the private banking sector, whilst interesting, is not that relevant to longterm sustainability - it is the government that is going bankrupt. That ratio simply gives an idea of banking sector stress, which is linked to the level of reserves that the Central Bank/Reserve Bank will have available if the bankruptcy goes down today - not the underlying systemic fiscal crisis that will persist over time. From what I can see, the greatest index weighting has been placed on this variable.
3. In addition, the basis of the alternative viewpoint was a forecast generated by analysts at a bank. Using an analyst forecast to definitively dispute the actual fiscal data can be dangerous. This is not what Mr Economides is doing (he seems to be making a point about statistics and perception); but it is what some people are doing to justify their own views on the crisis.
4. Incidentally, I searched for this UBS report (the Andrew Cates' Aggregate Balance Sheet Risk Index) online - and while there is much reference to it, I could not actually find it. So, in all honesty, I am inferring some reasoning. But that said, every article I read that mentions the index includes the caveat that the index does not take into account all factors that affect the risk of default. 
5. Mr Economides states that after the Olympic Games of 2004, "we [Greece] started consuming like lunatics". This supports my original argument - although I also think that Greece would have been overboard on its spending before this. Olympic Games are not cheap to put on.
6. The human cost of this crisis is undeniable. But sadly, it is also unavoidable. Pragmatically speaking, any solution will limit rather than avoid human cost. Perhaps there is a certain hardness that comes from having lived through a real fiscal crisis - but people will survive, and will emerge stronger and more rooted in community.
7. Finally, I was never, at any point, attempting to imply that the Eurozone debt crisis is purely a Greek Debt crisis. But I do agree that it forms the focus of the media attention.

So I'm going to address that last part: why I think it is the Greek Crisis in the news, and why there is the potential for the rest of the world to interpret the Greek debt crisis as the Global debt crisis.

It is because, fundamentally, Greece has the largest relative public sector debt. We are not talking about the "likelihood of default" here - but the magnitude of the problem. And even if we were to accept the conclusions of the UBS report - that report would still lack a fundamental variable (indeed, it is the variable being pushed by Mr Economides): market perception. Regardless of whether it is justified, public perception considers Greece to be the most immediate default risk.

And that makes it the most immediate default risk. 

Two broad factors drive a share price: company fundamentals, and market perception. Two broad factors drive the cost of sovereign debt: national fundamentals, and market perception. And easily, market perception is the more dominant: because it thrives on emotion, paranoia, and our deeply ingrained animalistic instinct to stick with the herd. 

Given that, the question becomes: what is the market perception concerned with?

Answer: contagion. 

• Contagion is the spread of economic problems from one country into other countries with similar characteristics.

In this situation, a disorderly default in Greece would give rise to a contagion that would spread through the other indebted countries in the Eurozone. 

A simple series of events that we would call "contagion" could be as follows:

1. Greece defaults on its debt, triggering an immediate downgrading of its sovereign debt to junk status, as well as triggering the Credit-Default Swaps written over its bond issuances.
2. The ECB, most of the Eurozone Reserve Banks, and most international banks have Greek Debt exposure (ie. they have investments in Greek bonds). If these bonds default, it would call the credit quality of these institutions into question. There would be further downgrades in their credit ratings, and consequent increases in their cost of borrowing.
3. As the cost of borrowing increases, so the reserve banks come under further liquidity pressure. Any new borrowings will cost more; and some of their current assets would not be paying back expected cash flows (the Greek bonds in default).
4. Given the recent default, borrowers may be unwilling to buy up new debt issuances from countries with similar economic characteristics to Greece and/or they may not have the funds available to invest in them. This would cause liquidity shortfalls, and an inability of the at-risk countries to roll their debt (ie. borrow new money to pay back old loans - thereby keeping the level of debt constant).
5. These liquidity shortfalls could result in more at-risk countries going into default.
6. And so the pressure continues to build as each new country defaults, bringing about further defaults, and spreading the contagion.

So really, we're all concerned about contagion. And everyone is anxiously looking for the country that will kick it off. Which, at the moment, looks to be Greece in March 2012 (a large number of bond repayments fall due at that point - which is why everyone is so desperate for a deal before then). 

The Eurozone solution right now seems to be an orderly Greek default. If the default is orderly (ie. based on the debt negotiations) - expectations can be managed, and hopefully contagion will not spread. A disorderly default, on the other hand, will almost definitely give rise to a free-for-all. Hence the media attention.

And what, in my opinion, is the solution for Greece itself?

A miracle.

Because right now, Greece cannot earn in revenue what she already owes in debt, never mind what she intends to spend. I see one of two things happening:

1. Greece leaves the Euro, undergoes a collapse of her banking sector (bank runs are sure to happen in the period before leaving the Euro), monetizes her debt, and suffers through a period of inflation and/or hyperinflation (it will be her third experience of traditional hyperinflation); or
2. Greece suffers through the austerity program and recession in the hope that she can stay in the Euro.

Either way, there will be suffering. But austerity is controlled, whereas debt monetization is not. And at the very least, austerity may give some relief in the form of external funding from fellow Eurozone countries.

Finally, I am all for the Greek call to community. We should be rising up: rising up to help the Greek elderly. Because if the Zimbabwean experience is anything to go by, it is the elderly who bear the brunt of fiscal crisis. They are fully reliant on the State, because they are no longer in a position to react.

The Greeks must rediscover their community. If the cloud is to have a silver lining, it is the only way.

Why the Greeks are in Crisis

The world is filled with concern.

Every time I turn on Sky News, a Greek Debt negotiation is stalling. And frankly, no one should be that surprised. Having grown up in a Greek community, I can empirically say that the Hellenes are a fan of two things:

1. Their right to voice their opinion;
2. Their right to storm out when someone opposes it.

This leads to a lot of storming. And a lot of factions, in elevating levels of prejudice: 

• First, and foremost, it's the Greeks against the world. 
• Then, when we're just talking about the Greeks, it's my island against the rest of Greece. 
• Then, when we're just talking about my island, it's my village against the rest of the island. 
• Then, when we're just talking about my village, it's my family against everyone else. 
• Then, when we're just talking about my family, it's me-and-the-family-I'm-currently-speaking-to against the side of the family that I'm not speaking to. 

It's complicated. 

But I'm getting distracted, and ahead of myself. I have a bit of a personal fetish for fiscal deficits and fiscal policy. It's a bit bizarre - but thanks to my Zimbabwean heritage (I'm a Zimbabwean-Greek half-breed), I have seen some pretty exciting things happen with Fiscal Policy. And actually - now I'm a bit grateful for it - because the First World is suffering from some serious fiscal crises.

So Greece. Well, my Greek friends on facebook have a lot of theories for the current crisis. My favourites:

1. The Germans are trying to take over
2. The politicians are in the pockets of a subversive Troika
3. Greece is a scapegoat for the United States
4. Turkey wants to replace Greece in the European Union (?)
5. The Aliens are coming

Actually, I may have invented that last one. But regardless, I am constantly amazed by the number of Greeks that comment on these wall posts with "You make it all so clear" and "I see it now". I shake my head, roll the eyes at the sky, and start a facebook fight with:

"I'm sorry - but the Greeks had it coming".

At which point, the argument descends into fierce rhetoric and the casting of genetic aspersions. But I think that I may have the data on my side (always assuming that the data sources aren't also part of the shadowy conspiracy to destroy Greece). So I went on a bit of a data search, and with the help of www.economywatch.com, I have this graph of the Greek National Deficit:

Greek Fiscal Deficit (Billions of Euros)

 A key definition:

• Fiscal Deficit: is the amount by which government spending exceeds government revenue. Or, in individual terms, it would be the amount by which my spending exceeds my salary.

In the popular press, I regularly see the period after Greece entered the Euro described as "a spending spree". Certainly, looking at the above deficit graph, it seems that the deficit was maintained (and even reduced) leading up to 2000 (Greece's entry to the Euro). After that, Greece springboards deep into an ocean of deficit, somersaulting briefly in 2005, and coming out of that nicely into swallow dive. 

And how does one dive into deficit? One of three ways:

1. You get worse at collecting taxes (a salary cut - or you get fired);
2. You start to spend more (there's that spree); or
3. Both 1 and 2.

Now Greece has traditionally had a history of poor tax collection. In fact - that's quite an understatement. The story is that tax evasion became a form of political protest during the 400 years of Ottoman Occupation, and the Greek people have never really abandoned the concept. After all - why pay taxes when you don't support the government in power? Although, I am a bit sceptical, because I think one would be somewhat incentivised to find a reason to complain, and thereby rationalise tax evasion.

Personally, I see this tax evasion tendency in the historical movement in the supply of money (for the pre-2000 data, I have the ECB website to thank):

Greek Money Supply (Money and Quasi Money Stock Outstanding)

If I can refer back to my "What is: Inflation, and why is it a tax" post - where governments stuggle to tax appropriately, and have limited access to further borrowings, a fiscal deficit can be financed by printing money (this process is commonly referred to as "monetising the debt"). The above increase in money supply suggests high/chronic levels of inflation. I then went to look at inflation (thanks to the World Bank for this data):

Greek Inflation/CPI (% Change)

There are high/chronic levels of inflation occurring throughout the 80s and 90s, but being brought down to below 3% by 2000 (one of the requirements for Greece entering the Euro). At this point, Greece enters the monetary union, and the inflation level begins to approximate inflation in the Eurozone as a whole. This certainly suggests that the authorities were printing money to finance their deficit while they still had control of the Greek drachma, and weren't trying to persuade the EU that they wanted in.

And then, as Greece enters the Eurozone, it suddenly has access to all this extra credit - off the back of its recent fiscal success, as well as the stability of the Eurozone. And it loses its mind (it doesn't look that hectic, but we're talking about billions of Euros):

Greek Revenues and Expenditure (Billions of Euros)

The widening gap between revenues and expenditures in the post-2000 era has to be financed somehow. And the real problem? Well, now that Greece is part of the Euro, it can no longer monetize its debt - after all, it has surrendered its monetary autonomy to the Eurozone. So it looks like we're sitting at option 2 - the spending in overdrive (hooray for the extra credit!). And if you consider her inflationary activities as a type of tax collection, Greece has now lost a key source (if not her principal source) of finance. 

Buggery.

And after the spree comes the long dark cold of austerity. And the Greeks are not happy. And I guess that's human - we like to have fun, but it's not fun to pay the cost afterward. 

Can we have a moment for the really scary part of this story? I'm going to plagiarise a projection from the latest IMF Country report (it's officially titled the "Article IV Consultation"). Greece has an aging population coupled with costly State pension plans (for example, Greek pensioners are entitled to 13th and 14th cheques every year). The IMF projection for government expenditure (driven by expected pension or "aging" costs) against revenue is the following graph:

IMF Projection of Greek Government Revenues VS Expenditure through to 2060

My question: HOW is Greece going to pay for it?

And just a small reminder - Primary Expenditure is before the cost of interest. The more Greece borrows, the higher its interest cost. That primary deficit (the gap between Revenue and Primary Expenditure) is going to be magnified by the inclusion of an increasing interest expense - as every year more has to borrowed to pay off the growing primary deficit, as well as the previous year's interest cost.

It's not sounding sustainable.

At all.

Rating Agencies and the Credit-Rating Downgrade

Last week Friday, S&P announced a credit-rating downgrade of many many Eurozone countries. Although, judging from the BBC news items, you would think that only France was affected. Also - and perhaps more concerning - one of the BBC articles had the following phrase at its tail-end, clearly a tentative bone thrown to the financially confused: "Credit ratings are used by banks and investors to decide how much money to lend to particular borrowers". 

And I had a little "not quite" moment to myself.

So, I came up with a list of definitions that need to be mentioned:

1. Debt (or Sovereign Debt) - is how a government or a large corporation borrows money. You and I would go to the bank and get a loan. Actually, I'd go to my rich uncle and beg. But these guys need a fair amount more than any bank can give, or would be willing to give (after all - given the size of the loans we're talking about - the bank would be effectively throwing all their chickens, and livestock, and their mother, into one giant basket - which sounds a little risky). But when we talk about bond issues, or treasury bills, or commercial paper (CP) - these are basically all different forms of borrowing (as a general rule of thumb - the different names usually denote the time period of the loan: bonds are longer, treasury bills and CP are very short-term). And instead of one large lender, the debt gets parcelled into smaller bonds, or notes, and sold to multiple investors. And when we say "sold", we mean that the investors are buying the rights to receive the future cash-flows of the bond. It's the same as the bank "selling" me a loan - it's "buying" the right to my future repayments.
2. Ratings Agencies - we have more than one of them. Three main ones, in fact: Standard & Poors (or S&P, as I affectionately refer to it on twitter), Moody's, and Fitch. There are others - but those are the three big boys that cause the big uproar when they change anything. Ratings Agencies are meant to be independent third parties that go and do all the background credit checks on the borrower on behalf of the investors. And because borrowers know that investors like knowing that a credit check has been done: they will pay the Ratings Agency to come in and do them, in order to make their bond issuances (loan applications) more appealing to the investing public. This does create a problem with independence, however - who is paying for the rating, and who wants a better rating?
3. A Credit Rating - is the Ratings Agency's opinion of how likely the borrower is to pay back the debt on time. It is affected by two things in general: the terms of the debt issue (how big is the issue, when are the payments due, etc), and the financial status of the borrower (affected by both their internal capabilities and their external environment). The credit rating, from what I understand, reflects how things stand at the date of the rating. Unlike a Credit Outlook:
4. A Credit Outlook - is the Ratings Agency's feeling on what will happen at the next rating review. A negative rating would suggest that the Agency realistically expects to downgrade the rating at the next review.
5. Credit risk - this is the likelihood that the borrower will default on the debt.
6. Default - this does NOT mean that the borrower goes bankrupt (although it can mean that). Generally speaking, default refers to missing a debt repayment. So if Greece is a day late in paying its next installment, it will be in default. Even though it may pay the very next day.

So what does all of this mean? And how does the rating affect anything? Well:

1. A credit rating generally affects the interest rate that the borrower will have to pay. The better the rating, the lower the interest rate. And practically, this means that if I look at two different bonds that I'm going to buy - and one is rated AAA (the least likely to default) and the other is rated AA+ (highly unlikely to default, but more likely than AAA) - and they both offer 3% interest - well then I'm going to buy the AAA! It makes no sense to take on more risk for the same interest rate. So the borrower will have to offer slightly higher interest rates in order to get me to buy the AA+ bond.
2. But more importantly: the biggest investors in bonds are large institutional investors, like pension funds. These large institutional investors are usually required to keep a large percentage of their investments in AAA bonds. And this is for good reason. Most of us invest some of our salaries in pension/provident/retirement funds every month - and those funds have to do something with the money to make it meet our requirements when we eventually retire. Pension and Provident and Retirement funds - they are the giant money-players. And because of this, they're highly-regulated by their national governments. Many of those regulations place restrictions and limits on where they can put their money - precisely because there is such high political risk at play (can you imagine how UNHAPPY a voting public would be if a pension fund crashed? It doesn't bear thinking about). So, as it turns out, the biggest investors are hyper-conservative.
3. Most borrowers are not intending to pay back their full debt any time soon. The debt "rolls" - so each time a repayment is due, more money is borrowed to pay it back. Theoretically, it's very possible for a borrower to operate at a consistent level of debt. But when credit-rating downgrades occur, it becomes more expensive and more challenging to re-finance the debt.

So in conclusion, what are we saying? When a down-grading occurs - you have to pay more (point 1) to borrow less (point 2). And then there is the ripple effect. Because you look at local banks - they take our savings and give out loans. They have to do something with all the savings and call-deposits that they receive - also highly-regulated. And they're also credit-rated so that investors have an idea of where to place their call deposits. So the banks have to be conservative and invest a large percentage in AAA bonds. Those bonds get down-graded to AA+. Well then - the bank's security was sitting in AAA bonds, those have been downgraded, and the bank's downgrade follows within the week.

What is the problem? These Ratings Agency guys - they can cause a serious liquidity problem if they get it wrong. And they do get it wrong. A lot. They managed to let the entire Subprime Crisis pass them by until it was too late. Those downgrades were spectacular when they happened. 

If I'm honest - it feels a little to me like the Ratings Agencies are extremely gung-ho about not letting the Subprime crisis repeat itself. I'm not saying that they're wrong (if you read the IMF's 2009 Article IV Consultation on Greece, for example - it's clear that them kids are properly in trouble - and the deficit projections based on an aging population and a public pension plan that includes 13th and 14th cheques are terrifying). But I am saying that they seem to be a little over-eager to downgrade wherever possible. Rather be wrong on the negative side, I guess. But still - people tend to overreact. And that can exacerbate the problem far worse than erring on the side of optimism.


And in answer to the BBC - I see what you're saying. But I think that credit-ratings are more about the interest rate the borrower has to pay, and whether an investor is legally permitted it in his portfolio, rather than the investor decision about whether he wants to lend or not. 

A Friday 13th of credit-rating downgrades.

It just happened.