by Pater
Tenebrarum
The importance of what has happened on
Friday probably can not be overstated, widely expected though the event was. It
represents a cesura the likes of which have not been seen since the
end of World War I. PIMCO chief Bill Gross, the world's biggest bond trader,
complained that the 'sanctity
of sovereign bond contracts' has been violated:“The “sanctity” of bondholders’ contracts has been diminished by Greece’s pushing through the biggest sovereign restructuring in history, according to Bill Gross of Pacific Investment Management Co.
“The rules have been changed here,” Gross, co-chief investment officer at Pimco, said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “The sanctity of their contracts is certainly lessened. Bondholders have that to look forward to going into the future.”
We can only say to that: finally.
Finally investors have been woken from their slumber and have been forced to realize that the promises of governments often aren't worth the paper they are printed on. By now it must surely dawn on everyone that what is often referred to as the 'age of financial repression' has truly arrived. Finally investors must come to terms with the fact that when a politician or high-ranking bureaucrat opens his mouth, chances are very good that a blatant lie or grave misjudgment of the situation is about to cross his lips. Here is what the French career bureaucrat and former chief of the ECB, Jean-Claude Trichet, said in late July 2011:
“Speculating on Greece defaulting is a sure way to lose money, European Central Bank President Jean-Claude Trichet was quoted as saying in remarks released on Wednesday.
"Such a speculation would be a sure-fire way of losing money given the decisions taken last Thursday," Trichet told French magazine Le Point, according to a transcript of the interview provided by the ECB.”
And below is the outcome of that
speculation that was such a 'certain way to lose money' according to Trichet –
it was one of the best trades of the century, in all likelihood it is among the
top trades in all of history. 5-year CDS on Greece were once available at
a premium of a mere 44 basis points (this was back in 2007). Last week, they
went out at 26,000 basis points, an increase of 59,000% in five years. The
return since Trichet made the remark quoted above was 'only' 1,000%. As sure
fire ways of losing money go, we could think of a few other trades, like buying
Greek bonds 'because the EU will never allow Greece to default', as German
economist Stefan Homburg wrongly concluded in June of 2011.
Homburg:
“In recent days, I myself have invested a considerable sum in Greek bonds. They will mature in one year's time and, if all goes well, produce a 25 percent return on investment. I sleep very soundly at night because I believe in the boundless stupidity of the German government. They will pay up.”
Oops.
In light of the above, we would
be remiss not to point out that another bureaucrat hailing from France,
IMF chief Christine Lagarde, has just seen fit to dispense investment advice as
well. She warns: 'Don't short
Italy'.
“International Monetary Fund chief Christine Lagarde Thursday warned against markets betting against Italy returning to economic health, saying Rome's recent reforms could well prove to be a light in the euro-zone darkness.
"I would not short Italy at all," she said in an interview at the Women in the World conference in New York.”
We conclude that one should probably short
Italy with both hands, although we actually believe that Italy is in somewhat
better shape – at least in terms of its total public obligations, both funded
and unfunded – than is generally believed. Moreover, we can report that
we have proof
positive that Greece can be immediately re-shorted:
“French President Nicolas Sarkozy said on Friday that Greece's debt crisis had been solved after Athens won strong acceptance from private creditors for a bond swap deal.
"I would like to say how happy I am that a solution to the Greek crisis, which has weighed on the economic and financial situation in Europe and the world for months, has been found," Sarkozy said in the southern city of Nice.
"Today the problem is solved," he added. "A page in the financial crisis is turning."
Yes, a page is turning, but Sarkozy may not
like what the next page contains.
Before we continue, a general
remark: although we have expressed a favorable view of investing in US treasury
bonds in the past (we have often pointed out that this 'market investors love to
hate' would likely deliver superior returns), we harbor grave reservations
about this type of investment as a matter of principle.
At times investors may
undoubtedly feel practically forced to buy 'safe' government debt: when an
entire banking system finds itself on the knife's edge and threatens to
implode, investment managers with a fiduciary duty to look after the funds
entrusted to them may be excused for concluding that they have no other choice
but to flee into the debt instruments of what are considered the safest
debtors. However, this can not detract from the fact that the income produced
by government bonds is obtained by coercion and that many of the expenditures
financed with government debt are of highly dubious value. Moreover, all the
resources commandeered by the government are no longer available to businesses
operating in the private sector. Their ability to best serve consumers is
curtailed to the extend that scarce resources are appropriated by the
government.
Other Reactions to the Debt Swap and Meet the
Biggest Losers in CDS on Greece: Austria's Tax Payers
The IIF, which has sought in
vain to contain the 'haircut' on Greek bonds to something resembling the
officially declared size (instead of the 50% mooted at the last Greece-centric
euro-group summit, the reality is closer to 78%) has decided to grin and bear
it and declared
itself happy with the deal.
In an example of hopeless
exaggeration, it even pronounced the deal to represent a 'major opportunity for
Greece'.
“The very strong and positive result provides a major opportunity now for Greece to move ahead with its economic reform program, while strengthening the Euro Area’s ability to create an economic environment of stability and growth,’ said Dr. Josef Ackermann, Chairman of the IIF Board of Directors, and Chairman of the Management Board and the Group Executive Committee, Deutsche Bank AG.”
We should point out to this that Greece has in
any case no choice but to pursue economic and administrative reform – at
least if it wants to avoid losing its first world status.
We don't want to give the
impression that there is nothing good about getting rid of € 100 billion in
unsound debt. However, it would have been far more effective if public sector
lenders had accepted a haircut on their exposure as well, instead of creating a
two-tiered structure of lenders to Greece with private sector holders of Greek
debt subordinated to public ones. The problem with this approach is that it
makes clear that private sector bond holders are going to end up as
subordinated creditors elsewhere as well, which casts a significant pall over
the ECB's bond market manipulation program (a.k.a. the SMP) and the
bailout funds extended to Ireland and Portugal.
As Patrick Armstrong from Armstrong Investment Manager LLP remarks, 'the Greek debt restructuring will raise borrowing costs across the euro area':
“Greece’s decision to force losses on some bondholders will drive up borrowing costs for all European nations, according to Armstrong Investment Managers LLP.
“The market will demand a risk premium for all euro-zone bonds, even from Germany, following today’s restructuring,”Patrick Armstrong, a managing partner at the London-based money manager that oversees about $350 million, said today in an e- mailed response to questions. “Over the long-term this will lead to higher borrowing costs for everyone, as a risk-free rate does not exist.”
The official statement of the euro-group via
its current president Jean-Claude Juncker can be seen here (pdf). Apart from
containing the usual pablum, it confirms that the necessary financing
arrangements to avert a Greek default in March will be made and mentions
as an aside that bondholders have until March 23 to comply with the exchange
offer, which Juncker describes as “attractive against the backdrop of possible
alternatives”.
So who is on the hook for the
CDS payments? Would you be surprised to learn that a significant liability has
actually been incurred by tax payers, to be more precise, Austria's tax payers?
It turns out that one of the
biggest writers of CDS on Greece that has failed to net out its position is
Austria's state-owned 'bad bank' KA Finanz, a spin-off of the nationalized
Kommunalkredit, the 'good bank' part of which will also take a sizable hit.
As Reuters
reports:
“KA Finanz (KF), split off after Austria nationalised Kommunalkredit in 2008, said its risk provisions for Greece could amount to 1 billion euros should the portfolio of credit default swaps – Greek debt insurance it has written – be triggered as a result of the country's debt revamp. [by now it's a certainty, ed.]
"The owner knows the support that would be needed. It has been committed and is around 1 billion," Chief Executive Alois Steinbichler said. Austria's Finance Minister had also cited this sum last weekend, saying 600 million euros in provisions had already been built up and 400 million more was at risk.
KF said it was still open
whether its Greek CDS portfolio would be triggered by collective action clauses
Athens plans to invoke for investors who did not tender bonds. "For
KF, activation of the CDS with an assumed loss ratio of about 80 percent would
mean an additional provisioning charge of 423.6 million," it said in a
statement. That is included in the 1 billion euro figure. KF contributed a
nominal 305 million euros in Greek bonds toward the country's debt swap this
week. It owned as of the end of 2011 another 160 million worth of bonds of
Greek corporate debt covered by state guarantees.
KF will publish its 2011
results in April. Hits on Greek debt will tip state-owned Austrian lender
Kommunalkredit Austria (KA) – the healthy part of Kommunalkredit – to a 2011
loss of around 140 million euros ($184 million) but it will not require more
state aid, KA said separately.
"Due to the one-off charge (for Greece) … KA expects to close 2011 with a negative result for the year of around 120 million euros according to Austrian GAAP and approximately 140 million according to IFRS," it said. "KA continues to have a sound capital position and will not require government support," it said. It exchanged a nominal 150 million euros of Greek bonds this week.
Based on preliminary figures,
it still expected a Tier 1 capital ratio of "well above 11 percent"
as of the end of 2011. Austria has also agreed to take a stake of up to 49
percent in ailing lender Volksbanken in a second bailout for that bank that
will cost the state more than 1 billion euros in writedowns, fresh capital and
guarantees. Hypo Alpe Adria,
which the state took over in 2009, might also need more help if it is unable to
get rid of risky assets in its portfolio.
In short, Austria's tax cows
not only have to pay a share of the Greek bailout via capital contributions to
euro-land's bailout vehicles, but now also have to pay up for the speculations
of Austrian bankers that have gone wrong (it appears the bankers concerned made
the mistake of believing the promises of Mr. Trichet and other eurocrats).
Moreover, while the 2008
financial crisis has left the government presiding over numerous bailed-out
casualties and putrid financial corpses already, there is every chance that
even worse prospects await once the debt crisis goes haywire again. This is due
to the fact that the exposure of Austria's banks to the CEE region (central and
eastern Europe) remains enormous relative to the size of the country's economy.
Not surprisingly, the Austrian central bank has issued a directive to the
banks that they must reduce their credit exposure in the East to no more than
110% of local deposits a little while ago.
Meanwhile, Greece's new bonds have been trading
on a 'when issued' basis in 'gray markets' already, and it appears that yields
remain at levels that would make a return of Greece's government to the market
prohibitively expensive. Remember that the new bonds sport a coupon of 3.5% as
well as certain 'enhancement' features that are tied to Greece's future
economic performance.
“Yields on Greece’s new bonds may climb to as high as 20 percent amid “material risks” stemming from implementation of terms for the biggest sovereign restructuring in history, Morgan Stanley said yesterday in a report.
Traders are offering to buy and sell the
potential new bonds at yields on 11-year securities of 22 percent, according to
a person yesterday familiar with the prices who declined to be identified
because he wasn’t authorized to comment. Pimco has said that the firm doesn’t
own any Greek debt.
“I’m not forecasting a second default but the markets certainly are,” Gross [Bill Gross of PIMCO, ed.] said. “Markets expect another one down the road.”
The so-called gray market for the new Greek
debt is trading actively as prices have risen about 7 cents on the dollar to
yield about 15 percent to 20 percent, according to a person familiar with the
trades who declined to be identified because he wasn’t authorized to discuss
the transactions.
Open Europe's head of economic research, Raoul Ruparel commented on the 'Pyrrhic
victory' of the Greek debt swap as follows:
“With the use of CACs Greece has entered a coercive restructuring or default – something which Greece and the eurozone have spent two years trying to avoid. While the financial markets can handle the triggering of CDS that this will entail, at some point serious questions need to be asked over the amount of time and money which policymakers have wasted on what has ultimately amounted to a failed policy. Instead, Greece should have undergone a full restructuring combined with a series of pro-growth measures.”
[…]
The debt write-down offered to Greece is far
too small to allow Greece any chance of recovery. Of the total amount
(€282.2bn) that is entailed in the various measures now on the table to save
Greece – through the bailouts and the ECB – only €159.5bn, or 57% will actually
go to Greece itself. The rest will go to banks and other bondholders.
Greek banks have taken substantial losses.
These banks will be recapitalised, but ‘only’ by €23bn. In contrast, to meet
the 9% capital requirements set by the European Banking Authority, Greek banks
could need between €36bn and €46bn. It is unclear if further money will be
forthcoming, but valid questions will continue to be asked about state of Greek
banks.
For the most part, Greek pension funds (which
held around €30bn in Greek debt) have seen their assets reduced significantly.
Some public sector pension funds did refuse to take part voluntarily. But they
are likely to be forced to do so by the CACs. Importantly, it is unclear where
Greek pension funds will recover their money from – the political fallout of
having to cut pensions would only add to social unrest.
The upcoming Greek elections at the end of
April mean that the future of the second bailout package is still uncertain.
Athens is highly unlikely to meet its debt
targets by 2020. This means that combined with the poor growth prospects due to
continuous austerity, Greece will almost inevitably need either another bailout
in three years’ time, or be forced to default on its outstanding debt.
In parallel, the deal sets the eurozone up for
a political row involving Triple-A countries. At the start of this year, 36% of
Greece’s debt was held by taxpayer-backed institutions (ECB, IMF, EFSF). By
2015, following the voluntary restructuring and the second bailout, the share
could increase to as much as 85%, meaning that Greece’s debt will be
overwhelmingly owned by eurozone taxpayers – putting them at risk of large
losses under a future default.
Therefore, this deal may have sown the seeds of
a major political and economic crisis at the heart of Europe, which in the
medium and long term further threatens the stability of the eurozone.”
We substantially agree with the points outlined
above. Not only is another default highly likely, but next time it will open an
even bigger rift in Europe and put serious stress on the 'solidarity' among
euro area members, given the large exposure to Greek debt tax payers elsewhere
in Europe now involuntarily call their own. Open Europe's full report on Greece
can be downloaded here (pdf).
So much for Sarkozy's idea that the 'Greek debt
crisis has been solved'.
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