There has been a lot of noise in both the alternative and the mainstream financial press regarding potential risk to the ECB regarding its exposure at roughly 48 to 72 cents on the dollar to sovereign debt purchases through leverage, and at par at that. This concern is quite well founded, if not just over a year or so too late. In January, I penned The ECB Loads Up On Increasingly Devalued Portuguese Bonds, Ensuring That They Will Get Hit Hard When Portugal Defaults. The title is self explanatory, but expound I shall. Before we get to the big boy media's "year too late" take, let's do a deep dive into how thoroughly we at BoomBustBlog foretold and warned of the insolvency of both European private banks and central banks, including the big Kahuna itself, the ECB! The kicker is that this risk was quite apparent well over a year ago. On April 27th, 2010 I penned the piece "How Greece Killed Its Own Banks!". It went a little something like this:
Yes, you read that correctly! Greece killed its own banks. You see, many knew as far back as January (if not last year) that Greece would have a singificant problem floating its debt. As a safeguard, they had their banks purchase a large amount of their debt offerings which gave the perception of much stronger demand than what I believe was actually in the market. So, what happens when these relatively small banks gobble up all of this debt that is summarily downgraded 15 ways from Idaho.
Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…
The same hypothetical leveraged positions expressed as a percentage gain or loss…
A reader wrote me complaining about the nonsensical bubble blowing in multi-family properties before the last bubble was even finished bursting. I feel his pain. Let's run through a quick pictorial of how I see the macro climate for real estate as of right now...
Of the major economic powers, China is the only economy that is facing true inflation as I see it and China is primed for a hard landing - at best. The US, EU, and UK face stagflation. After the AP excerpt below is a clip from my recent keynote presentation at the ING Real Estate Valuation seminar in Amsterdam on this very timely topic.
LONDON (AP) — Rising inflation around the world weighed on stock markets Friday as investors wondered how fast central banks will raise borrowing costs to counter the threat of rising prices, while the euro was undermined by ongoing worries that Greece will have to restructure its massive debts.
Figures Friday reinforced market expectations that both the European Central Bank and the People's Bank of China will soon be raising interest rates again to counter rising inflation.
In China, figures showed consumer prices rose 5.4 percent in the year to March, up from February's 4.9 percent. The increase was largely driven by surging food costs and represents a setback for the government, which has boosted interest rates four times since October to cool prices.
Analysts expect the People's Bank to enact further measures in the days to come in response to those figures.
Here is a collection of my archived posts on the topic:
- Economic contractions AND rising prices, dare Reggie utter the “I” word – Enter a global phenomenon
- Reggie Middleton’s Take on Investing for Inflation, pt. 1
- Reggie Middleton’s Take on Investing for Inflation, pt. 2
- Reggie Middleton’s Take on Investing for Inflation, pt. 3
- Reggie Middleton’s Take on Investing for Inflation, pt. 4
- Reggie Middleton’s Take on Investing for Inflation, pt. 5
- More on my stagflation rant
- Deflation, Inflation or Stagflation – You Be the Judge!
- Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?
- China’s Most Expensive Export: Price Inflation
Attention subscribers: related content is available for download: BoomBustBlog Complimentary FX Index model
I’m fresh back from my trip to Amsterdam where I lectured ING institutional clients and staff on the potential of a European banking collapse. Below are a few clips from the first of two lectures.
Now that the mainstream media has been reporting what BoomBustBloggers knew as fact as far back as two years ago. Today, the FT printed an article titled “Greek debt hit by restructuring fears“, whose pertinent points are as follows:
The euro tumbled on Thursday and premiums charged on Greek debt over Germany’s hit euro-era highs after the countries’ respective finance ministers talked of Greece needing more time and raised the prospect of debt restructuring.
In an interview with the Financial Times, George Papaconstantinou said Greece needed more time to convince international investors of its commitment to reform its finances.
Separately, Wolfgang Schauble, Germany’s finance minister, told Die Welt newspaper that, if a study already under way showed Greece’s debt levels were unsustainable, “further measures” would have to be taken.
When asked what those could be, he ruled out any involuntary restructuring before 2013, but warned investors could face losses after that point… Yields on Greek two-year bonds jumped nearly a full percentage point to 17.884 per cent.
… “Greek bonds are getting crushed today due to the comments from the German finance minister and the Greek equivalent,” said Gary Jenkins, head of fixed income at Evolution Securities. “The European Stability Mechanism allows a roadmap towards restructuring, indeed it insists upon it if debt cannot be restored to a sustainable path.”
Investors… flight left yields on equivalent Greek debt 24bp higher at 13.162 per cent while Portuguese 10-year notes yielded 8.88 per cent, up 14bp. Mr Jenkins said investors expected that any restructuring would start with Greece trying to extend repayment deadlines on existing debt, or asking investors to “forgive” interest on the loans. But he warned it could take more than that. “Ultimately we believe that if the idea is to get the debt back to a sustainable level then the target will be the Maastricht treaty limit of debt-to-GDP of 60 per cent. In order to reach that level bonds will have to take a haircut of some 62 per cent,” he said.
Online Spreadsheets (professional and institutional subscribers only)
Professional and institutional subscribers should feel free to look at a variety of haircut scenarios via out proprietary sensitivity analysis for the Greek head grooming. If you remember last year when illustrated How Greece Killed Its Own Banks!, you realize the main reason why the EU has been using the kids gloves with the Greeks. To make a long story short, let’s employ the old adage “A picture is worth a 1,000 words”…
Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…
The same hypothetical leveraged positions expressed as a percentage gain or loss…
When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:
- Leveraged European Entities from a Sovereign Risk Perspective – retail
- Leveraged European Entities from a Sovereign Risk Perspective – professional
If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…
From ZeroHedge: Greek 10 Year-Bund spreads just passed 1,000 for the first time ever and were last trading north. Following this statement from Germany's Hoyer, it seems all hell is about to break loose for peripheral spreads.
- *GERMANY WOULD BACK VOLUNTARY GREEK RESTRUCTURING, HOYER SAYS
- *GREEK DEFICIT CUTTING MAY NOT BE ENOUGH, HOYER SAYS
- *GERMANY ‘WORRIED’ ABOUT GREEK FISCAL DEVELOPMENTS, HOYER SAYS
- *GREEK DEBT RESTRUCTURING `WOULD NOT BE A DISASTER,' HOYER SAYS
- *GERMAN EUROPE MINISTER HOYER SPEAKS IN INTERVIEW IN BERLIN
For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.
Banks NPAs to total loans
Source: IMF, Boombust research and analytics
Euro banks remain weak as compared to their US counterparts
Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.
I really do mean substantial!
The definition of "Inflation" is when the "value" and "price" of some of the most widely held and most used assets fall dramatically in price... NOT!!! Well then, why are all the financial rags, blogging pundits and mainstream media outlets crowing about inflation? Mr. and Mrs. Editor, stand up and stick that "S" on your chest. That's right, not Superman, but "Stagflaton Man".
The ING real estate valuation seminar in Amsterdam that I have been invited to as the key note speaker (see www.seminar.ingref.com) with a capacity of several hundred seats, is now sold out. This is, of course, no surprise being that we're in a global real estate depression and I've been declaring a rate storm emanating from insolvencies and potential haircuts in Europe that will spike CRE cap rates. It is not these bombastic declarations which make the seminar interesting. It's probably not even that I have been correct about each and every past declaration. It's most likely that my proclamations of European insolvencies are coming to fore in lockstep fashion in the here and now, and right before everybody's eyes. No, I am not that smart, I don't have a crystal ball, nor do I employ tarot cards. My secret is that I'm realistic as hell and tend to look at things for what they are - no the way I want them to be, nor they way they use to be, but the way they are. With that being said, there is significant risk to those who are exposed to rate sensitive assets, with bonds, real assets and the debt behind them standing at the forefront.
What I plan on doing at the seminar is not only outlining the specific issues in REALISTIC detail, as I routinely do on my blog. I will introduce real world solutions to the risks swallowed by those who are exposed to the European (not so) slow train wreck. Yes, that's right. Not just bitching about the problems, but proffering real, actionable solutions. Till then, though...
I made specific warnings of insolvency: Portugal, Ireland and Greece - complete with hundreds of pages of analysis for my site's subscribers. Thus far, two of the three have been bailed out and the third (Portugal) is about to tap out as its yields go vertical after revealing what BoomBustBloggers already knew...
Last week I posted a comprehensive piece, The Coming Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions: Here’s The Answer To Valuing Global Real Estate Through This Mess. The goal was to outline the literal mess that those who decided to drag us through this “Great Global Macro Experiment”have left us in. Since then, in merely one week's time, we have bore witness to:
- The potentially imminent toppling of another multi-decade, long standing regime, the third in as many months. Gaddafi asserts control amid worldwide dissent - Libyan U.N. mission urges Gaddafi's downfall - Gaddafi son denies civilians bombed - Analysis: Libya could face chaos in post-Gaddafi era. Leading up to the Libyan affair, Tunisia and Egypt fell into the hands of virtually weaponless protesters (at least from a conventional weapons perspective) armed with simply laptops and cellphones (the new age computers and apparently the weapon of choice for those in uprise) to post messages on Twitter and Facebook, amassing solidarity with supporters to converge in certain areas to join the mass protests. Identifying, fearing, and failing to understand the true power of the Internet in toppling a regime, Libya has repeated the faux pas of Egypt in attempting cut the country off from cyberspace - attempting to halt the charge of an African bull elephant with an Acme Walmart (by way of China) fly swatter. It is apparent that Egypt's efforts to isolate its populace from the Internet, although failing to halt the toppling of its regime, did succeed in hiding the futility of such an effort from Quadafi, et. al. This not only forms another basis for contagion, but one that was actually foreseeable nearly a year in advance- see Egypt’s Social Unrest As A Pan-European Economic and Financial Contagion? It Can Happen!!! and First Tunisia, Then Egypt, Now Yemen: Will This Reach The Powder Keg That Is The EU & What Will Happen If It Does? Subscribers should reference Potential Spillover Effects from the Middle East to the EU.
The Harlem Community Development Corporation and AAREPNY hosted a breakfast symposium on real estate last Thursday in which I was the keynote speaker. The audience consisted of bankers, developers, investors, lawyers... the usual fare. I fear I may have rained on the optimism parade with my presentation, but I also feel a few salient points were communicated. I have included portions of the presentation here for the blog readers to peruse. One of the main themes of the presentation was that of "lost decades". How likely is it that we can have 20 more years of housing price declines? Note: The "74%" reference below is a typo, the Japanese residential index did not drop that far.
Let's see if any of this sounds familiar, as excerpted from Wikipedia:
This is my response to an inciteful insightful comment posted by GJK313. It is in reference to an article which readers can find here, titled "FASB Surrenders - America Win". I suggest readers read the aforelinked document in its entirety before moving on. Notice how this is written by economists and analysts, not real world investors that are investing THEIR OWN CAPITAL! When I state "own capital" I mean their money, and not that of their clients. I cannot fathom how anyone who had their own money at stake would ever want more ambiguity in pricing assets, in lieu of less.. Let me pick this apart...