This is the 2nd to last installment in my Pan-European Sovereign Debt Crisis series. After covering western and southern Europe, we are moving eastward. Before we go any further, be sure you have caught up on the previous portions:
- Can China Control the "Side-Effects" of its Stimulus-Led Growth? Let's Look at the Facts - Explains the potential fallout of the excessive fiscal stimulus in China. While not European, it is quite likely to kick off the daisy chain effect.
- The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
- What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
- The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
- The Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European Countries
Austria, Belgium and Sweden, while apparently healthy from a cursory perspective, have between one quarter to one half of their GDPs exposed to central and eastern European countries facing a full blown Depression!
Click to Enlarge...
These exposed countries are surrounded by much larger (GDP-wise and geo-politically) countries who have severe structural fiscal deficiencies and excessive debt as a proportion to their GDPs, not to mention being highly "OVERBANKED" (a term that I have coined).
So as to quiet those pundits who feel I am being sensationalist, let's take this step by step.
Depression (Wikipedia): In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen as part of a normal business cycle.
Considered a rare and extreme form of recession, a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation, financial crisis and bank failures are also common elements of a depression.
There is no widely agreed definition for a depression, though some have been proposed. In the United States the National Bureau of Economic Research determines contractions and expansions in the business cycle, but does not declare depressions. Generally, periods labeled depressions are marked by a substantial and sustained shortfall of the ability to purchase goods relative to the amount that could be produced using current resources and technology (potential output). Another proposed definition of depression includes two general rules: 1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more years.
Before we go on, let's graphically what a depression would look like in this modern day and age...
Rising fiscal deficits and pending bond maturities due in 2010 are paving the way for the next wave of the Pan-European Sovereign Debt Crisis - Supply, potentially in excess of demand, which portends higher yields and more onerous debt servicing at a time of record fiscal spending!
Please read the following in sequence if you have not already done so for the requisite background to this post:
1. Can China Control the "Side-Effects" of its Stimulus-Led Growth? Let's Look at the Facts - Explains the potential fallout of the excessive fiscal stimulus in China
2. The Coming Pan-European Sovereign Debt Crisis - introduces the crisis and identified it as a pan-European problem, not a localized one.
3. What Country is Next in the Coming Pan-European Sovereign Debt Crisis? - illustrates the potential for the domino effect
4. The Pan-European Sovereign Debt Crisis: If I Were to Short Any Country, What Country Would That Be.. - attempts to illustrate the highly interdependent weaknesses in Europe's sovereign nations can effect even the perceived "stronger" nations.
Expected higher fiscal deficit and bond maturities due in 2010 have increased the need for bond auction financing for all major European economies.
Amongst all major European economies, France and Italy have the highest roll over debt due for 2010 of €281,585 million and €243,586 million, respectively.
This is a trick question, for the fates of many European countries are now inextricably tied by what appears to be a poorly conceived methodology of handling diverse political and economic entities under a single currency without a truly authoritarian governing body. Basically, it's the old American saying, "Too many Chiefs and not enough Indians". If one member faces a harder landing, chances are that several others will follow. When I first started this series, a few pundits accused me of being sensationalist. I assume their weren't studying the numbers. It's funny how a few days can bring so many to your side of the table. Now it is becoming much clearer that this is more of a pan-European issue than a pan-Hellenic one.
The printer of the world's reserve currency had a problem selling debt. How well do you think the EMU members will be able to hawk their record trillions of (now apparently obvious to all) relatively stressed debt? Well, Europe's
Economic Recovery Almost Stalls as Germany Unexpectedly Stagnates as the IMF Joins EU, ECB in Pledging Support for Greece. This is an extreme blow to the credibility of the Euro. Just a year ago, (silly) pundits were speculating that the Euro would replace the dollar as the world's reserve currency, and now the IMF is coming to a EMU members aid just has it has third world and emerging countries.
This is part 3 of my Pan-European Sovereign Debt Crisis Series. See The Coming Pan-European Soverign Debt
Crisis and What Country is Next in the Coming Pan-European Sovereign Debt Crisis? for the first two parts.
UPDATED -It is beyond a hallucinogenic-induced pipe dream to even consider that the Eurozone will come out of this attempt at replicating the US "extend and pretend" policy intact and unscathed. The mere concept of global equity rallies should have macro traders and fundamental investors chomping at the bit. The US won't even get away with it, and we have the world's reserve currency printing press in our basement running with an ink-based, inter-cooled, twin-turbo supercharger strapped on that will make those German engineers green with envy, not to mention green with splattered printer ink as the presses go berserk!
In part 2 of my series on the Pan-European Sovereign Debt Crisis, we will review Italy and Ireland in comparison to the whipping child of the media - Greece (see "The Coming Pan-European Sovereign Debt Crisis" for part one covering Greece and Spain along with tear sheets for the Spanish banks at risk for subscribers).
I have another paper available for download outlining my China short thesis available for subscribers here: China Macro Discussion 2-4-10
In addition to the issue-specific ETFs (proffered (Chinese
ETFs with Exposure to Real Estate, Banks, Insurance and Export
Industrials) that I have already proferred, I will be offering my
viewpoints on specific companies across various geographic regions
as well. Those ETF's have actually performed quite well on the short side YTD. For those who don't subscribe to my blog, here are some excerpts from the 11 page download:
Can China Control the “Side-Effects” of its Stimulus-Led Growth?
The strongest argument for a Yuan-revaluation relies on a basic tenet of economics: tinkle with prices and you disturb the resource allocation equilibrium prevailing in the economy. China’s endeavor to push economic growth through stimulus spending and its lax control over money supply has started to affect the “side effect” - INFLATION. The very contrivance used to maintain stability has become a threat to economic resurgence. And if there is one such thing that could force China to drop its dollar peg, it is out-of-control inflation.
One of the major reasons for inflation in China is the rescue program initiated during the recent global slowdown. The Stimulus program aimed at creating a temporary demand within the economy has apparently worked wonders – aiding the Chinese economy to grow by a healthy 9% in 2009. This program has apparently overheated the economy, gorging on what may become untamed GDP growth, currently 10.7% in 4Q09 - its fastest quarterly growth in two years - which was uncannily higher compared to the 6.1% growth in 1Q09, the lowest since the introduction of quarterly GDP figures in the fourth quarter of 1999.
It has come to my attention that regulators are not familiar with the concept of the Butterfly Effect, wherein (from Wikipedia) :
The butterfly effect is a metaphor that encapsulates the concept
of sensitive dependence on initial conditions in chaos
theory; namely that small differences in the initial condition of a dynamical system may produce large variations in the long
term behavior of the system. Although this may appear to be an esoteric
and unusual behavior, it is exhibited by very simple systems: for
example, a ball
placed at the crest of a hill might roll into any of several valleys
depending on slight differences in initial position. The butterfly
effect is a common trope in fiction when presenting scenarios involving time
travel and with "what if" scenarios where one storyline diverges at
the moment of a seemingly minor event resulting in two significantly
Well, it looks like Blankein, Dimon, et. al. really should have tried
harder to make that meeting with the President a couple of weeks ago.
It appeared as if he may have had something important to discuss. As my
readers and subscribers know, I have been very bearish on the big money
center banks since 2007, and quite profitably so. The last 3 quarters
saw a much larger trend reversal than I expected, that resulted in the
disgorgement of a decent amount of those profits - a disgorgement that I am still
beating myself up over. You see, as a fundamental investor, I don't do
well when reality diverges from the fundamentals for too long a period.
Luckily for me, fundamentals always return, and they usually return
with a vengeance. To keep things in perspective though, I am still up
on a cumulative basis many, many multiples
over the S&P (which is still negative, may I add) as well as your
average fund manager. Why? How was I able to do this? Well, its not
because I am supersmart, or well connected. It is because I keep things
in perspective. Those that look at the records that I publish say,
"Well he was down the last couple of quarters, so..." while
disregarding what happened the 8 or even 40 or so quarters before that.
Such a short term horizon will probably not be able to appreciate the
longer term perspective and foresight that enabled me to see this
entire malaise coming years ago and profit from it. No, I am not
perfect and I do mess up on occasion, but I also do pay attention to
These facts pointed to a massive overvalutation in banks throughout the
bulk of last year, again! I made it clear to my subscribers that the
banks simply have too many
things going against them: political headwinds, nasty assets,
diminishing revenue drivers, over-indebted consumers, and a soft
economic cycle. I also warned explicitly that I didn't think Obama
would be nearly as lenient on the banks as Bush was. Well, the
headwinds are stiffening. On that note, let's take an empirical look at
just what this means in terms of valuation (note, I will following this
up with a full forensic re-valuation for all subscribers, incuding a
scenario analysis of varying extents of principal trading limits). Some
of these banks are I-N-S-A-N-E-L-Y overvalued
at these post bear market rally levels considering the aforementioned
headwinds. Methinks fundamental analysis will make a comeback in a big
way for 2010 as it meets the momentum and algo traders in a mutual BEAR
feast on the big investment banks cum hedge funds. I can't guarantee it
will happen, but the numbers dictate that it should. We shall see in
the upcoming quarters.
We have retrieved information about trading revenues for GS, MS, JPM and BoFA. We have also retrieved some balance sheet data to reflect the trend in investment holdings and the level of leverage, but I will address that in a future post for the sake of expediency. While the banks don't break out the P&L for principal trading, we can sort of back into it. Remember, traders are fed bonuses off of net revenue, not profit.
A little more than a year and a half ago, I penned "A little more on HELOCs, 2nd lien loans and rose colored glasses",:
I syndicate my work across various sites on the web and occasionally go through the comments to see what people think. I get viewers of all types, from first time investors and the curious to multi-billion dollar portfolio managers and directors of analytical departments of the bulge brackets. It is the guy in the middle, the arm chair investor that seems to throw some of the wierdest comments, though. One of which was, "banks are more complicated than HELOC exposure and LTVs and it will take more than that to determine a bank short". Well, that comment is partially true. Today's banks are much more complex than LTVs and 2nd liens, but when these risky products on the downturn are multiples of your tangible capital, it really doesn't take more than that to start causing some severe solvency issues. You can have a trillion dollars in assets, but if you have $20 billion in equity with $100 billion in investments that will take a 50% loss, you are underwater by $30 billion. You can talk about these banks using terms such as "complicated", "complex", "fancy" and all of the other high falutin' adjectives that you can think of, but at the end of the day, if you lose more than you own you are insolvent. Now, that's a simple concept and it works quite well for my investment pursuits. This is coming from a guy who use to design offshore, option embedded structured products to fund illiquid private sector liabilities for things such retiree health care risks. Having some experience in the structured product arena, being an entrepreneur, and simply having to balance the family budget, I have come to learn - without a doubt - that complicated usually means less valuable. Either that, or it means an opportunity to charge the client more through lack of transparency in the pricing and profit structure.
Following the geographic default graph for HELOCs reproduced from the last posting, you see the two states that have been in the news the most lately have big spikes in my pretty little graph.
From Bloomberg: Mortgage-Bond Leverage Reaches 10-to-1, Markets Heal
Jan. 19 (Bloomberg) -- Wall Street firms are loosening terms of their lending to mortgage-bond investors as markets heal, an RBS Securities Inc. executive said.
Repurchase agreement, or repo, lending against the debt has expanded so much since freezing in late 2008 that some banks now offer as much as 10-to-1 leverage and terms as long as one year on certain securities backed by prime jumbo-home loans, said Scott Eichel, the Royal Bank of Scotland unit’s global co-head of asset- and mortgage-backed securities.
I was not going to bother to comment further, but after hearing pundit after pundit attack Obama for the bank levy and Glass Steagal 'lite', after banks allegedly paid their dues... I just couldn't take it anymore.
Yes! Obama has made a lot of policy errors in dealing with the banks. Yes! I believe he has not solved the problems, but has chased the symptoms. The separation of prop trading from deposit banking IS the RIGHT thing to do. In addition, the banks have not come anywhere NEAR repaying their debt to the government. Not even close.
Yes, some of the banks repaid TARP, with interest and warrants. Okay. The investment big banks (that were still in existence) were offered expedited financial holding company (bank) charters. That is why they didn't fail, at least in part.
So, running down the list, the banks paid back TARP. That's a +, but....