Thursday, May 17, 2012

Today's links

1--Time to Admit Defeat --Greece Can No Longer Delay Euro Zone Exit, Der Speigel
2--Dental Abuse Seen Driven by Private Equity Investments, Bloomberg
3--ECB sends message to Greek banks, Bloomberg video
4--Goodbye Euro, Welcome Back Drachma, US World

Excerpt: With a quarter of the population unemployed and fully half of Greece's youth without work, Greece is clearly in an economic depression that can only worsen as government budget and wage cuts suck money out of the Greek economy. The depression has radicalized the voting population, pushing the Greek people to their breaking point; many voters have defected from the two mainstream Greek parties which they hold responsible for the depression and have flocked to more extreme fringe parties. These parties have rejected the crushing austerity programs carried out by Greece's two mainstream parties.

Meanwhile, in Germany, voters are concerned about rewarding Greece's so-called fiscal profligacy with German taxpayer money. Germany, with a government debt burden now in excess of 80 percent of gross domestic product, has long been in violation of the European government debt hurdle of 60 percent debt to gross domestic product itself. German voters are fearful that despite the wage sacrifices of the last decade, they could end up paying to reduce their own government debt burden and the Greek government burden at the same time. Because the perception in Germany is that Greece's problem is of its own making, German voters will not reward domestic political parties that advocate aiding Greece without very onerous bailout conditions attached.

But since the Greek economy is on the verge of collapse, German voters demanding more pain means there is little hope in the economic and political situation in Europe for Greece continuing in the euro zone. The political situation in Greece mandates noncompliance with the existing austerity regimen, which will result in European Union and International Monetary Fund assistance being withheld. Greece will have no choice but to default and exit the euro zone. However, once Greece reverts to the drachma, after the extreme economic chaos that results, Greece will benefit from a substantially weaker currency that is the missing link in allowing the country to pull out of its debt deflationary spiral. Will Greece exit the euro zone? The answer is resoundingly yes.

5--"The Austrian Analysis of the Great Depression and the Recent Recession are Wrong", economist's view

Excerpt: Although the Austrian theory was initially viewed sympathetically by conservative economists..., it was abandoned when it became clear that there is no Austrian cure for depressions; the only course ... is to suck it up, let unemployment rise, and purge the mal-investment no matter how painful. Anything ... whatsoever the government does to ... counteract the economic downturn ... is inherently counterproductive...

In the 1960s, conservative economists adopted a different view. The government error was ... responding inappropriately to a garden-variety recession that began in August 1929. ... This “monetarist” theory of ... Milton Friedman and Anna Schwartz ... argued that if the Fed had acted as a lender of last resort, as it was created to do, it could have stopped the Great Depression in its tracks...

The monetarist theory was a far more attractive explanation for the Great Depression that also blamed government. It was largely adopted by conservatives except for a few Austrian holdouts... One attraction of the monetarist theory is that it allows for government action to respond to economic downturns, as opposed to the Austrian do-nothing policy.

When economic downturns arise, monetarists say the Fed should respond by expanding the money supply, not through an expansionary fiscal policy, as Keynesian economics recommends. ...

6--Fed’s Bullard Says Labor Policy Is Key to Cut Joblessness, Bloomberg

Excerpt: “Labor market policies such as unemployment insurance and worker retraining have direct effects on the unemployed,” Bullard said in his presentation.

7--Sub-prime auto ABS shrugs off crisis years, IFR

Excerpt: The sub-prime auto ABS primary market is making a spirited comeback, helped by a rising conviction among investors that the asset class is a solid yield play in current markets.

The rush to buy ABS has already led to some established issuers cutting back on investor allocations, while smaller issuers are now making plans to raise sizeable funds from the market.

The extra yield that sub-prime auto ABS offers to investors – compared with the prime-auto sector – has been the main draw. The fact that auto ABS as a whole has fared better than expected has also helped to boost interest.

Fitch said in March that prime auto loan ABS delinquencies and annualised net losses had declined 24% and 11% month-on-month. In the sub-prime sector, 60-plus-days delinquencies sank by 25% to 2.56% month-on-month, to the lowest level in just under a year.

Expectations are that these loss levels will improve further during the first half of 2012 and, as a result, secondary activity in auto ABS has gone up several notches with spreads consistently tightening.

8--Rallying cry for pooled eurobonds, IFR

Excerpt:  Pushing ahead with pooled eurozone bonds is the only way to bring the crisis gripping the single currency union to a close, senior bankers have warned, claiming that a failure to amalgamate government debt will result in a heftier bill for keeping the eurozone afloat in the long run.

“I don’t see a way out of this crisis other than a eurobond solution. I think if they’d done it a year ago it would have cost them about a third of what it’s going to cost them now to stem the crisis,” said Tim Gately, European head of credit trading at Citigroup.

“The problem is that action only comes when there is significant systemic risk in the market, so things will have to get worse before we even get to that point.”

A pledge to issue short-dated eurobonds could lower eurozone borrowing rates to levels enjoyed by the US government, according to some estimates, and could draw a line under a crisis that looks set to force policymakers to come to the rescue of another peripheral country.

Fears have mounted that Spain – whose 10-year government bond yields have hovered around 6% since mid-April – and its faltering banking sector will soon require bailing out. Mariano Rajoy’s government stepped in to rescue ailing lender Bankia last week, and further measures to restore confidence in the banking system were set to be announced on Friday (see “IPO bankers respond to Bankia bailout”)....

Overall, Europe is currently paying more in interest rates than it should be for the situation. We estimate that pooled eurozone debt wouldn’t cost much more than Germany is currently paying. Interest rates would probably be only slightly higher than fed funds and a 10-year note could be close to US yields or perhaps even lower,” said el Hayek.

9--Back from the brink--The story of the LTRO, IFR

Excerpt:  At the very moment Trichet was speaking in Germany, in fact, the European Banking Authority was meeting in London 600 miles away, sketching the first draft of the long-term refinancing operations that the ECB would eventually implement under his successor Mario Draghi. The EBA, itself a by-product of the financial crisis and still less than a year old, had been put in place to advise the ECB and its member nations by working through numbers and soliciting comment from across the European banking industry.

Regulators, central bankers and industry officials had spent two days holed up in the 18th floor meeting room at EBA headquarters, crunching the data to try to find out just how precarious a situation Europe’s banks were in, and how much money might be needed to address it. Stress tests that summer had brought troubling revelations about the extent of holdings that European banks had in sovereign debt. And looming on the horizon, less than two months away, was the start of 2012 – a year in which the banks faced a €650bn reckoning as hundreds of debt instruments came due. Banks had planned to borrow more from the markets to pay off the old debts, but most could no longer find takers for new paper. With options running out, and the clock ticking ominously, some faced the possibility of collapse.

There was a problem with bank funding that couldn’t be solved by private markets,” Piers Haben, director of oversight at the EBA and one of those present at the October meeting, told IFR. “Spreads were blowing out, and tensions rising. We wanted to ensure there wasn’t a disorderly slamming-on of the brakes, and were pushing for coordinated steps on funding and capital to strengthen the banking system in an orderly manner.”...

Dozens of banks were on the edge of disaster, as the EBA knew only too well – its stress tests had forced banks across Europe to open their books for the first time, and those findings made for decidedly grim reading. Most worrisome of all was the size of bank holdings in sovereign debt. Even after the initial bailout of Greece, few in the market seemed to believe that sovereigns were anything but rock solid. BNP Paribas, then the largest bank in Europe, was discovered to have €235bn of government debt on its books at the end of 2010 – five times the value of its common equity. Almost every bank in Europe, it would soon emerge, was in the same boat...

Government bonds were assumed to be a risk-free asset,” Charlie Berman, head of public sector EMEA at Barclays, told IFR. “This was reinforced by the Basel directives, and it suited all parties for banks to hold large positions in government securities in both liquidity portfolios and from hedging other risks as well as proprietary investments. These holdings were supposed to safeguard the system, rather than be pro-cyclical and actually accelerate and exacerbate the systemic risk.”...

All you had to do was mention the word European, and everyone would run for the hills,” said one capital markets head. “I can’t think of a period in history when funding markets were closed for such a long time.”

Even worse than bad

Across the industry, panic had set in. “There was a real, genuine sense of worry,” recalled one financial institutions banker at a US firm, who advised banks throughout the crisis. “People were preparing for the worst.”

But as no one knew exactly what the worst looked like, or when it would come, those banks that had any cash to spare were looking for a safe place to put it. Deposits at the ECB and other European central banks surged, which only made the liquidity problems worse.

“Individually, banks were making the right decision for themselves, but collectively it was suicide,” said David Soanes, global head of capital markets at UBS. Between June and July 2011, deposits at the ECB almost doubled. In August they doubled again – and then again in September. By October, banks had €169bn on deposit at the central bank. Cash that once sloshed around the interbank market lay dormant, of no use to the many banks across the region that were starved of liquidity....

But everything stopped seeming okay on March 11, when a magnitude nine earthquake hit off the Pacific coast of Japan. The quake triggered a powerful tsunami that devastated much of the northeast coast of the main Japanese island of Honshu, killing more than 15,000 people and injuring almost double that. Whole towns and villages disappeared in an instant....

As the scale of the devastation became clear, bank treasurers and CFOs realised that Japanese investors would retrench massively from international capital markets, selling out their holdings to pay for the rebuilding costs that the World Bank estimated at US$235bn.

Although the Japanese had traditionally lent little to European banks directly, the knock-on effect of their withdrawal from other markets pushed borrowing costs for banks up even higher. Credit supply became ever scarcer, and concerns deepened. The average cost of insuring European five-year senior unsecured bank bonds against default rose from 80bp on the day of the earthquake to more than 200bp by the beginning of May.

“The Japanese tsunami changed banking,” said UBS’s Soanes, who was one of the architects of the UK government’s rescue of RBS back in 2008. “Many banks started to prepare for a possible drought of dollars, as the Japanese could have repatriated their dollars, taking their money home to pay for reconstruction. Whether they did repatriate or not became secondary, as banks reacted as if they would. There was real illiquidity.”

That liquidity crisis was in its full throes by July. Bank debt issuance collapsed to just €6bn that month, less than a tenth of the volume issued in January. The vast majority of banks were completely shut out of markets. Those that hadn’t brought their plans forward earlier in the year were beginning to regret the decision.

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