Wednesday, November 2, 2011

Today's links

1--It is almost game over for the euro zone, Credit Writedowns

Excerpt: Papandreou's decision to call a referendum has put the Greek government at risk. Indeed, the government may collapse before any referendum is called.

But the decision was necessary because austerity is deeply unpopular in Greece and has already caused tremendous social unrest… Given the widespread perception among Europeans that the E.U. system is undemocratic, there was no alternative but to put these measures to a vote to ensure their political viability in an already volatile social environment.

Will the collapse of the Greek government destroy the euro zone? It certainly could. Italy’s recoupling to the periphery is well-advanced, making it now the focal point of the sovereign debt crisis. Bond yields in Italy and elsewhere in the European periphery have skyrocketed. Contagion has spread to the banks as well.

The E.C.B. has been forced to intervene for Italy. However, the damage is already done. Unless the E.C.B. acts as a lender of last resort, it is game over for the euro zone.

2--H.K. Home Prices May Fall 45%: Barclays, Bloomberg

Excerpt: Hong Kong’s residential property prices would drop by 35 percent to 45 percent over the next two years in the “hard landing” scenario of a deflationary economic environment, Barclays Capital Research said.

In a “soft landing,” continued mortgage rate increases and a slowing economy would drive prices 25 percent to 30 percent lower over 2012 and 2013, Andrew Lawrence and Vivien Chan, analysts at Barclays, wrote in a report dated today.

“Given the economic outlook, it is difficult to see property prices and transaction volumes reverting to their long- term relationship without a price correction,” the analysts wrote. “The depth of that correction depends upon the external economic environment.”

3--Greece’s Papandreou Seeks Euro Referendum, Bloomberg

Excerpt: Greek Prime Minister George Papandreou said a referendum on Europe’s rescue package will confirm the nation’s membership of the euro as he stuck to plans to hold the vote amid signs his government may collapse.

“The referendum will be a clear mandate and strong message within and outside Greece on our European course and our participation in the euro,” Papandreou told his ministers in Athens early today, according to an e-mailed transcript. It will “ensure this course in the most decisive way.” The cabinet voted unanimously to endorse the plan.

Papandreou will fly to France today to face European leaders surprised by his decision to put the bailout plan to a national vote and call a confidence vote in parliament. His grip on power weakened after a lawmaker from his socialist Pasok party defected, leaving him with 152 deputies in the 300-seat chamber, while another, Vasso Papandreou, called for the formation of a national unity government.

4--Home prices heading for triple-dip, CNN Money

Excerpt: The besieged housing market has even further to fall before home prices really hit rock bottom.

According to Fiserv (FISV), a financial analytics company, home values are expected to fall another 3.6% by next June, pushing them to a new low of 35% below the peak reached in early 2006 and marking a triple dip in prices.

The first post-bubble bottom was hit in 2009, when prices fell to 31% below peak. The First-Time Homebuyer Credit helped perk prices up by mid-2010, but by the time the credit expired, prices fell again.

In the second dip, which was reached last winter, prices were down 33%before staging a mild rally that was artificially spurred as banks slowed the processing of foreclosures following the robo-signing scandal, which found that loan servicers were rapidly signing foreclosures without properly vetting them....

There's also a "shadow inventory" of homes in foreclosure that have yet to go back onto the market.

The specter that those foreclosed homes could flood the market at any time and drive prices significantly lower is a huge concern, said Mark Dotzour, an economist for Texas A&M University. "That's the elephant in the room," he said, noting that there are 6 million home currently in shadow inventory.

5--Greek PM convinces cabinet, next up Merkel and Sarkozy, Reuters

Excerpt: Greek Prime Minister George Papandreou fought off a barrage of criticism to win the backing of his cabinet Wednesday to push ahead with a referendum the government said would take place as soon as possible on a European Union debt bailout deal.

Some of his party lawmakers called for him to quit for jeopardizing Greek euro membership with his shock decision to call a popular vote, a move that pummeled the euro and global stocks, but the cabinet support at least gives him a stay of execution before a confidence vote in parliament Friday.

"The referendum will be a clear mandate and a clear message in and outside Greece on our European course and participation in the euro," Papandreou told the seven-hour cabinet meeting, according to a statement released by his office.

"No one will be able to doubt Greece's course within the euro."

6--Fitch statement on the Greek referendum: full text, The Telegraph

Excerpt: Ratings agency Fitch has said that the Greek referendum poses a threat to the eurozone's financial stability. Here is its statement in full.

Fitch Ratings says that the announcement by the Prime Minister of Greece of a public referendum to approve the economic and financial conditions associated with the new EU-IMF programme, including the debt restructuring under the 'private sector involvement' (PSI), dramatically raises the stakes for Greece and the eurozone as a whole.

A rejection of the EU-IMF programme recently negotiated by the Greek government would increase the risk of a forced and disorderly sovereign default and - whilst not Fitch's central rating case (see 'The Euro Area Financial Crisis - How Does it End?', 20 September) - potentially a Greek exit from the euro. Both of which would have severe financial implications for the financial stability and viability of the eurozone.

The announcement of a referendum late Monday underscores the urgency of establishing a credible firewall to prevent contagion from Greece destabilising the eurozone. The uncertainty over whether Greece will accept the EU-IMF programme and PSI also increases the uncertainty around the losses that creditors may incur and hence bank recapitalisation.

In Fitch's opinion, it is essential that there is rapid progress in making operational the enhanced 'firepower' of the EFSF and that the ECB stands ready to intervene in the secondary market to moderate the contagion to solvent but potentially illiquid sovereigns, notably Italy and Spain.

It is highly uncertain what would be the consequences of a no vote. In light of the prolonged and difficult negotiations between the Greek government and the 'troika' of the IMF, European Commission and ECB, securing agreement on a new package could prove unobtainable. Given the heavy debt repayment schedule in the first quarter of 2012, without continuing external financial support, a coercive and potentially disorderly sovereign default could follow.

7--Selling More Insurance on Europe Debt Raises Risk for U.S. Banks, Bloomberg

Excerpt: U.S. banks increased sales of insurance against credit losses to holders of Greek, Portuguese, Irish, Spanish and Italian debt in the first half of 2011, boosting the risk of payouts in the event of defaults.

Guarantees provided by U.S. lenders on government, bank and corporate debt in those countries rose by $80.7 billion to $518 billion, according to the Bank for International Settlements. Almost all of those are credit-default swaps, said two people familiar with the numbers, accounting for two-thirds of the total related to the five nations, BIS data show.

The payout risks are higher than what JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc., the leading CDS underwriters in the U.S., report. The banks say their net positions are smaller because they purchase swaps to offset ones they're selling to other companies. With banks on both sides of the Atlantic using derivatives to hedge, potential losses aren't being reduced, said Frederick Cannon, director of research at New York-based investment bank Keefe, Bruyette & Woods Inc.

"Risk isn't going to evaporate through these trades," Cannon said. "The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who's ultimately going to pay for the losses?"...

The CDS holdings of U.S. banks are almost three times as much as their $181 billion in direct lending to the five countries at the end of June, according to the most recent data available from BIS. Adding CDS raises the total risk to $767 billion, a 20 percent increase over six months, the data show. BIS doesn't report which firms sold how much, or to whom.

8--Satyajit Das – Europe’s Plan To End the Debt Crisis – Putting The “Con” in “Confidence” Part 1, Naked Capitalism

Excerpt: According to the European Banking Authority stress tests conducted in July 2011, the 90 largest European banks have exposure to Greece of Euro 90 billion. These European banks have larger exposures to Spain (Euro 287 billion) and Italy (Euro 326 billion) as well as to France (Euro 215 billion). These banks also have large exposures to private sector debt in these countries, which would be affected by problems of the sovereign. For example, French banks hold around Euro 400 billion of Italian private debt.

In addition, the recapitalisation does not take into account “second order” effects. The write-offs, covering the cost of recapitalisation and the general de-leveraging (reduction in debt) is likely to reduce economic growth resulting in increasing credit losses that must be covered. This may increase the required recapitalisation by another Euro 100 billion bringing the total to Euro 300-350 billion.

It is not clear where the additional capital is coming from. Banks must try to raise the capital privately through equity raising or restructuring and conversion of existing instruments into equity. Banks should also reduce dividends and bonus payments to improve their capital position. If this is insufficient or unsuccessful, national governments are required to provide support. Recapitalisation funded via a loan from the European Financial Stability Fund (“EFSF”), the European bailout fund, is the last resort.

Reluctant to dilute existing shareholders, some large banks may choose to sell assets and stop new lending to meet capital targets. The EU and national regulators will prevent excessive “deleveraging” to ensure adequate flow of credit flow to the real economy to avoid slowing down growth. As much as $2 trillion of assets may be sold as part of the program to reach the new capital levels with an unknown effect of economic activity.

9--Aftershocks, Tim Duy, Fed Watch via Economist's View

Excerpt: Now the insurance component of the EFSF is blowing back in their faces. From the FT:

“It is kind of ironic: it is Draghi’s first day. His first decision is ‘yes, buy Italian bonds’,” said Gary Jenkins, head of fixed income at Evolution Securities. He added that the move to make Europe’s rescue fund, the European financial stability facility, issue insurance on new Italian and Spanish debt was deterring buyers: “They have created a situation where the only people buying Italian debt are themselves.”

A trader of Italian government bonds said: “It was meltdown at one point before the ECB came in. There were no prices in Italian government bonds. That is almost unheard of in a big market like Italy. There were just no buyers and therefore no prices.”

By not creating a backstop for previously issued bonds, the Europeans have clearly identified those bonds at risk of default. If the Europeans are not willing to buy or insure the bonds, why should investors? Answer: They shouldn't. Consequently, the ECB was forced to do what it hates, buy Italian debt, and even then yields climbed above 6%, nearing levels that many believe is the point of no return for Italy.

Moreover, one should question the what is the meaning of "insurance" for Europe. I can't imagine the ESFS actually making good on any promises to insure bondholders, as the Europeans appear adept at defining defaults as "voluntary" and therefore not credit events covered by insurance.

Will the ECB be Europe's white knight? I think we all agree that lacking a lender of last resort, Europe has something of a credibility problem. As in, no credibility. And it has been pointed out repeatedly that the ECB could step into this role. After all, we are talking about the future of the Euro, which should be something of a concern for central bankers. And, as noted by Kash Mansori at The Street Light, by guaranteeing a price for Italian debt, the ECB would like have to buy far less than they think. But here is the problem - why should the Italians get an ECB backstop at 6%, while the Irish pay 8% and the Portuguese 12%? Politically, the ECB needs to backstop either everybody equally or nobody. Setting a ceiling on Italian debt alone risks setting off a firestorm of public anger within those nations already struggling under the weight of austerity programs. And note that even if the ECB does come into the fight, the will only do so in return for additional austerity. In other words, they might stave off financial collapse, but not recession.

Bottom Line: No matter how many summits they have, there is no easy out for the Europeans at this point.

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