Watching Europe deal with its debt crisis is like observing a knife catching competition – in slow motion. No matter how long it goes on, no matter how many times the idiot contestants see the outcome demonstrated, they all manage to express surprise or even dawning outrage when another of their digits is neatly sliced off and lands on the floor in front of them. Quelle surprise!
And I can’t help but feel we are building towards another little finale of foolishness. Portugal was downgraded only a month ago. A week ago Greece was dropped into the dim and sulfurous region of “Highly Speculative” non investment grade debt. And now Spain has been downgraded by Moody’s from Aa1 to Aa2. Aa2 is still a high grade investment. But Spain is moving down and that exposes Portugal again and brings Italy into the frame as well.
As always it is the reasons for the downgrade which are more important than the move itself. Moody’s basically laughed in Spain’s face over Madrid’s estimated costs of bailing out Spain’s gored banking system. Madrid said it would cost another 20 billion euros to shore up her banks. Moody’s said at least 40-50 billion. Which sounds bad but is only the hors d’oeurve. For the figures both Madrid and Moody come up with depend entirely on their assumptions about the broader economic outlook. And both Madrid’s 20B and Moody’s 40-50B are based on a moderate, even benign scenario. Using a moderately more stressful scenario, the funding needs of the Spanish banks quickly climbs to 110-120 billion euros.
Which brings us to the second round of European Bank Stress tests. These are the scenarios which underpin all the estimates of GDP growth or contraction, unemployment and bank losses. The first round, conducted last year, was universally derided for being more worthless than the banks it was supposedly testing. The ONLY thing tested was every one’s patience with the simpering shamelessness of the Eurocrats and sneery arrogance of the bankers who defended them. The markets treated the results with the utter contempt they deserved and downgrades ensued.
The second round of Stress Tests are supposed to confound the critics. And in a sense they are doing exactly that. No one can quite believe that the eurocrats and bankers are going to do the same again. but it seems they are. This time the banks will be tested against a whole, earth shattering 0.5% fall in GDP and 15% fall in the stock markets. That is like testing a parachute by patting it and saying, “Well it feels lovely and plump!”
Inside the bag is another matter which neither the banks nor our ‘regulators’ are willing to let us see inside. Because if we did this is what we would find. A European bank, faced with needing to show a better ratio between risky assets (in this case bonds it had bought based on dodgey loans) and capital held, decided NOT to sell or mark down the bad loans, nor indeed to raise more capital, but to do something a lot cheaper. The bank took out insurance on its poor loans in the form of CDS from a US company. But if you take a look at what capital the insuring company has, surprise surprise, it doesn’t have the money to pay up if it had too. Thanks to the indefatigable Karl Denninger at MarketTicker for that one. As Karl points out, this is the same stupidity and greed which set up the bank implosion in the first place.
But while the stressless tests are administered and no one is allowed to see what kind of improvised expolsive financial devices the banks are building, reality is leaking out. Moody’s also worried that whatever measures the Central government is taking, the regional and local governments are another story. Over half of Spain’s regional governments did not reign in their debts as they were supposed to. The reason is simple. Those regional governments are the ones who pay for lots of the services which people do not want cut.
The add in the sheer size of Europe’s over all borrowing. Just Europe’s banks, NOT including sovereign borrowing, is 2.4 Trillion euros over the next three years (till 2014) . This year Spain Portugal and Italy all have huge debts which need to be funded. Some is old debt needing to be rolled over (a long debt that was funded for a short period and now needs to be refunded – like getting a new deal on your mortgage) and some new debts that need to be paid.
These three nations all have large debts (Italy has the largest amount) and are going to be trying to attract buyers of their debt at a time when their energy costs, thanks to Libya, are heading up. Portugal is definitely being shepherded towards a punitive EU/IMF bail-out impoverishment programme. Spain is looking increasingly like it will not make it, not intact anyway. One solution which I think we will see being touted is for Spain to let American banks and funds ‘rescue’ the Cajas. What this would mean in reality is that American banks and investors would put in capital enough to keep the wheels turning, but probably NOT take on the debt load, The argument would be that Spain can’t bail them out and fund them sufficiently to make them competitive. The US banks will step up and say we can help with that in return for us now owning a chunk of the cajas. The US banks would love this as the Cajas are the well spring of deposits. The long run would be America having a huge hold on Spanish banking cash.
Of course it’s not just Europe trying to attract buyers for their debt. Just add in America’s debt needs and the total debt for sale will be $5 Trillion in just the next three years.
And before I go please remember that when people talk of bailing out a nation’s banks what it really means is bailing out the people and other banks who lent money to the bank in question. They are the people and banks really being bailed out. And those banks, the real recipients of bail out money paid to Greece, Spain, Ireland and Portugal are the German, French and British banks.
some queries..
With reference to ratings agencies downgrading sovereign debt and previous post, "The search for yield – Mr King shouts a warning":
"The same rating agencies are using the same methods to rate the same assets, bonds, debts, securities, derivatives and CDOs that they got so completely and utterly wrong before. The same ratings agencies are still getting paid for the same 'expert' ratings by the same banks who paid them off, sorry paid them, before. The same rating agencies are still claiming that their ratings should be trusted and quoted while simultaneously maintaining that their ratings are NOT guides to worth but are "just their opinion"."
I'm confused here – what's going on? They're a bunch of economic spoofers. Ok, so they are a bunch of predatory economic spoofers. Well, predatory economic spoofers whose favours can be bought at the right price. Why aren't governments paying them off to give them better ratings? Is someone else paying them to downgrade ratings? How to know when these guys are giving realistic ratings?
Sure, we all know that the balance sheets of these countries are dire right now but why are the ratings agencies allowed to dictate and direct the sequencing of the endgame?
And who or what constitutes 'the markets', because it seems to me everyone references them(governments, banks, businesses, economists, etc.) but nobody admits to being party to them. Is 'the markets' a collective cloud-like term for investor/speculators and their floating opinions something akin to individual worker bees constantly going on about the buzz of the colony as though it were something apart from themselves'?
Hello ahimsa,
Good questions. You put you finger directly to the soft spots.
The Ratings agencies do far more work and get far more of their income for banks and fundfs than they do for naitons whose bonds are fewer and their make up far clearer.
Government debts are based on fairly public metrics of employment etc. Pirvate bonds and other paper, by contrast, are made deliberately complicated and difficult to rate. Which means their ratings are also far more diffcult to understand or dispute.
I agree it does seem unlikely that teh fate of whole nations would be allowed to be, if not dictated, then certainly heavily influenced by a few comapnies who rate things. And most people assume the US and maybe the UK would just not allow dangerous downgradings to happen – after all accidents in the home are all too common. Of course, smaller nations do not have this clout. On the other hand to some extent the ratings agencies merely crystalize and formalize what pricings in the market are often already making clear.
Which brings us to your question of who exactly makes up 'the markets'. They are like 'public opinion' only, even less democratic. Markets are one dollar one vote. We're all part of 'public opinion' but none of is it on our own.
The markets are, as you say, the collective cloud. Problem is those in teh markets are less like bees and more like wildebeasts. Individually fairly stupid, herd like in mentality, easily spooked one moment and obstinately determined to run off a cliff at another. For those who know how to spook at one moment and run against the herd at another there is ample oportunity to profit from manipulating such goggle eyed imbeciles.
Most markets are 2% thought and 98% spittle flecked, group-think avarice and optimism.
Thus their mistakes tend to be very collective
Another question. Some time ago, Max Keiser, in between rants of financial terrorism and rape, suggested that the European bond markets were being manipulated by US interests as payback for France refusing Monsanto GM products (wikileaks US ambassador to France: response must be measured, targeted and sustained – the ambassador at the time was George Bush's former Texan sporting colleague). Is this possible? By painting European debt as risky would that make US debt cheaper by virture of appearing safer? Does this constitute financial war? It would appear to me that 2.4 TN Euro sovereign debt for 500M+ not as dramatic as the (not sure here) 8+ TN the US is already in for. So why all the drama around Europe?
hi David,
thanks, that helps clear some o' the confusion. So sort of another private-public divide between commercial and sovereign ratings. Commercial ratings based on less than transparent private-sector data are the agencies' bread and butter while the public availability and reliability of national data makes for relatively accurate sovereign ratings(unless we are talking USA, UK, Japan, Germany, etc.)
Wildebeasts is indeed a better analogy (I knew I was being too kind writing 'worker bees'!), though I am still fascinated by the relationship between wildebeasts, amongst others, and the collective herd or ecosystem as a whole. Nobody admits membership of 'the markets', Goldman sachs speak of the markets as though it were otherly and yet as far as I am concerned they are lifetime members.
Thanks again David, you are performing a wonderful public service 🙂
Oh come on crew. The USD's Quantitative Easing BS is making it easy for the WallSt Shills to put all this pressure on the EUO Sovereign bond markets. All the EUO has to do is change accounting from mark to market to mark to fantasy world just like the US Banks/Financial Cos. Then you'll have all kinds of freed up reserves to battle back against the US Fed. Drive that dollar down into the dirt. Rub "The Bernank's" face in it!
I'd kick Moody's and any other ratings agencies right out of the country and start getting creative. Real Enron/Arthur Anderson/WorldCom accounting. That'll do the trick! Hell, it's working in the US.
ahimsa
"relatively accurate sovereign ratings"
Unfortunately, the ratings agencies have never had a good record on sovereign default risk either. I recall in Reinhert & Rogoff's "This time is different" that rating agency default risk assessment was one of the worst predictors of collapse.
I suspect that they are in fact just tools for the economic hitmen to wield around.
This is article contains the first half or so of the book. Quite powerful stuff, especially given it is coming from within the establishment:
http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf
I prefer the sheep anology where the farmer is the one who benefits from the trust that owns the shares of the company that holds the bonds of the banks that own the central bank he informs the shephard as to what must be done, the shepard is the politician , his job is to make sure a proper fleecing takes place,or a sufficient slaughter, without upsetting the sheep too much, the dogs are the corporate media who persuade the sheep which way to move, the sheep are anyone not informed by the farmer or their own insight of whats about to happen, individual investors or fund managers mainly, the field is the market. The profits from the slaughtered and the fleeces are none of the sheeps business.
I saw this yesterday http://www.zerohedge.com/article/youll-lose-money-and-buy-load-hooey-unless-you-arm-yourself-basic-information-about-how-your
The idea of insuring risk, is I think one of the most under-debated problems we have.
A distant aquaintance of mine – lets call her Jane – works in a large financial institution in London.
We had an interesting chat about her work, which as I understand it, includes directing a large team of mathematicians to model the risks associated with the artificial structured products she is creating.
(That is, structured products made from pools of other structured products in the way that MBS were made from pools of mortgages.)
I gently offered some of the worries we have about that sort of thing.
She explained that what they did was figure out a statistically rigorous model of the potential risks for each tranche of the product in various scenarios – both pessimistic as well as good ones.
And then they hedge that risk – insurance if you like, with a counterparty who will pay out if the product goes bad.
So, she explained with a flourish – there's no risk any more at all because it has been insured & the risk is covered.
I thought about this for a moment. I had a final question.
'So,' I asked, 'how do you put into your model the risk of the entire hedging system breaking down and not paying out?'
There was a long, thoughtful pause.
'Ah.' she said. 'Well, no, that's not built into the models. You do have to assume the system doesn't suddenly stop working.'
Ben
You should maybe get your friend Jane to look up a book called "A Demon of our own Design" by a guy called Richard Bookstaber who was one of the early designers of derivatives and ran a hedge fund..in other words one of the original "rocket scientists" He describes the 1987 Crash and the demise of Long Term Capital Management and why such instability was built in… the key areas that make the markets vulnerable ever greater leverage and structures that demand a non human level of rationality that the bankers certainly dont possess. That trying to control risk in the end just promotes it by creating the illusion that its been overcome. This is the gen from one of the clever insiders who began to see the calamities he was helping create
its a mad world my brothers and getting no saner it seems
@ Hawkeye
Well if the ratings agencies also have a shoddy record on sovereign risk that brings me back to my initial unease – why do we bother with anything they say?
Thanks for the link, haven't checked it yet.
And I seem to recall an article I read somewhere that ratings agencies have a poor record with developing countries. They are often much more credit worthy than they are given credit for. Can't find the link now.
@ Ben
Nice question to Jane. Implicit in all their models is that the system is unsinkable. Tell that to the Titanic passengers.
Re: the Titanic, interesting to note that accounts report that even when informed the ship was sinking many passengers continued to drink in the bar refusing to entertain the unthinkable. Sound familiar?
One of the reasons the establishment makes use of rating agencies and covertly sponsors it is the same reason we have a central bank.
It is only to give the appearance of separation of power which should elicit a feeling of third party opinion in the market place.
However, just like the Central Bank is neither independent nor is it objective, the rating agencies take their marching orders from the entities that pay for their opinions; ergo the banks.
@Ben…
Reminds me of an old joke (apologies for those who've heard it before)
An Economist, Physicist and Chemist are stranded on a desert island. They have abundant food but no means of starting a fire.
The Physicist says: "By applying some fairly fundamental principles of thermodynamics I'm confident we can solve this"
The Chemist says: "I'll have a hunt around, see if I can whip up the basics for a chemical reaction that'll provide us with heat."
The Economist says: "Let's just assume we have some matches"
…It's a weak gag that unfortunately says so much about Economic modelling.