Saturday, July 2, 2011

Europe didn't dodge judgment day

As commented on a couple of years ago on this BLOG, that there was no good reason for why the Euro was higher!

Aivars Lode

Europe didn't dodge judgment day

By Katie Benner June 30, 2011: 1:21 PM ET

Why Greece's bailout may not prevent a Continental credit crisis and another global economic slowdown.

The Greek Parliament approved a tough austerity plan so that the country could get money from the European Union and the International Monetary Fund, including the rest of the bailout hammered out last year and a second aid package. Europe's officials have now spent nearly $270 billion to keep Greece going, signaling that they will spend whatever it takes to keep an insolvent country from declaring the equivalent of bankruptcy. German and French banks, Greece's largest lenders, are also pitching in with complex plans that push off the day when debts come due.

The hope is that these strong messages of support will calm markets, stave off a fiscal collapse that could destroy the European Union, and let the Continent's highly levered countries refinance their problems away when market pricing is more forgiving.

Unfortunately, that's not how the marketplace works. As a hedge fund manager who has been studying sovereign debt told me, 1) you don't need an actual maturity default for yields to run so high that they force a restructuring; and 2) the market always forces a restructuring. Brian Whitmer, an analyst with Elliott Wave, agrees. "There is a light bulb moment when everyone wakes up and says that a crisis is just too big to manage," says Whitmer. First officials first say it can't happen. Then they say it will be contained. And then a loss of confidence comes out of nowhere and politicians say that no one could have predicted it would occur overnight or with such severity. Looking past Greece's most recent Band-Aid, some economists and investors think it's time to accept that in the next few year's we'll witness Europe's sovereign credit collapse and be thrown into another global recession.

Just think back to 2008, when our officials failed to stave off a come-to-Jesus-moment on Wall Street. First, the Federal Reserve put up about $30 billion to keep Bear Stearns from outright failure and pushed it into the arms of JPMorgan. The move was supposed to prevent a "chaotic unwinding" of Wall Street, Federal Reserve chairman Ben Bernanke told Congress that spring. Once the Bear situation was in hand, the thinking went, pressure would ease on other over-levered financial players that could face similar liquidity problems if markets stopped providing them short-term money. "I hope this is a rare event, I hope this is something we never have to do again," Bernanke testified.

But bondholders next fled Fannie Mae and Freddie Mac, forcing then-Treasury Secretary Hank Paulson to declare that the government would back the mortgage companies. Sheriff Paulson called the guarantee his bazooka, and thought that investors would calm down once they knew he was packing so much heat. But Fannie and Freddie stocks and bonds continued to fall throughout the summer, and the government was forced to take over the companies and provide $200 billion in immediate financial support.

Shortly thereafter, financial institutions hit the skids in rapid succession. No one wanted to lend to the likes of GE Capital, Lehman Brothers, AIG [NYSE: AIG], or Merrill Lynch; and the government needed to throw money at these companies, broker rescues, and in the case of Lehman, deal with the fallout from a very messy bankruptcy.

Bazookas and the risk of a systemwide castastrophe didn't really matter to the players who were able to keep the liquidity spigots open. Lenders stopped lending almost all at once when they decided that the risks were too high. After all, no one wants to be the last guy giving out money after everyone else has fled.

So now let's look at Europe. The market knows that Greece, Ireland, Italy, and Portugal have more debt than they can pay. Last year's Greek bailout didn't solve the problem and now it's back with a vengeance. Debt spreads in Portugal and Ireland are near all-time highs, and Michael Darda, chief economist at MKM Partners, thinks these countries will need a second bailout, too.

"The market is saying, get together and impair the stock and bondholders and come up with a restructuring that makes sense," says Bill Laggner, a co-founder of the hedge fund Bearing Asset Management. "But the pain would be so extreme, mainly for the bankers, that they don't want to do it and the political class doesn't want to make them do it."

Protesters in Greece are showing us that austerity plans work better on paper that in real life. Citizens aren't embracing the idea of cutting their personal income and net worth so that it can be funneled directly to financial players who loaned to Greece.

And when those bondholders -- European banks, American money market funds, and credit default swap counterparties around the world -- are finally forced by the market to admit that they've lost money on their investments, what happens next? If politics cloud decision making, financial institutions try to hide losses, and no one is sure how financially dented their counterparties are, "it could create a panic, contagion, total systemic fear, and things start to unravel," says Laggner. That's a formula for another global credit freeze.

"Then do we take the pain, or do we go with the nuclear option of increasing the balance sheets of the ECB and the Fed," Laggner asks. Whether the world's banks, insurance companies, and investors come clean with big losses, or central bankers try to print enough money to try to fill the hole, you get slow growth (Great Recession part II anyone?) and possibly flirt with the possibility of global hyper inflation. "You go into a very dark place," says Laggner.

Whitmer has been predicting a double dip recession, with the next phase of the bear market "to be stronger than the last." This is how he sees Europe playing out. Government officials will continue to transfer liabilities onto tax payers from those investors who took the risk willingly. There will be more civil unrest. Sovereign debt problems will spread into the core of Europe -- France, Germany, and Britian -- and then to the US. He expects an actual slowdown to come to pass between 2014 and 2016.

It's hard to not sound like Harold Camping when predicting a meltdown, but it's harder still to see how Europe does not hit the wall.

Wednesday, June 29, 2011

As Greece goes, so goes Italy?

A few years ago in this BLOG I discussed that I don't understand why the Euro was stronger than the USD. This was in response to an article that suggested that Europe was more efficient and did not have the debts that the USA did. At the time I said that this did not make sense based upon my experiences and now the articles like the one below support that view.

Aivars Lode

As Greece goes, so goes Italy?

June 28, 2011: 10:18 AM ET
A panic of sorts is sweeping through European trading desks concerning all things Italian. A sovereign default in the world's third-largest public debt market would be catastrophic.

By Cyrus Sanati, contributor

Italian Parliament

FORTUNE -- With the Greek crisis coming to a head this week, traders in Europe have started to worry about the fiscal health of other eurozone members. Now the worry has moved up the scale to one of the core eurozone members: Italy.

A sovereign default in the world's third-largest public debt market would be catastrophic. While such a default doesn't appear imminent, there is growing fear on European trading desks that a default may occur sometime down the road -- set off primarily by troubles in the nation's banking sector. Traders are scrambling to hedge their exposure to the country and its banks just in case the unthinkable happens sooner rather than later. This panic could spread to other core eurozone members if the Italians fail to make a serious effort to rein in spending.

There's a panic of sorts sweeping through European trading desks concerning all things Italian. Moody's has said that it may downgrade the country's debt due to macroeconomic structural weaknesses and the economic turmoil in neighboring countries. And last Thursday the ratings agency said that it might downgrade 13 Italian banks if the nation's sovereign rating was cut.

The market initially ignored the Moody's report, but by midday on Friday traders started to "de-risk" their portfolios en masse. There was a mad dash to buy up protection against Italian debt using credit default swaps. Other traders then started to dump their Italian bank stocks and head for the hills. UniCredit and Intesa SanPaulo, the two largest banks in Italy, saw their stocks fall 10% in the panic, setting off circuit breakers, suspending trading. They later settled the day down 5.5% and 4.3%, respectively, once trading resumed. Meanwhile, the spread between Italian and German 10-year bonds widened to 212 basis points, its highest level since the creation of the euro.

The Italian banks have troubles, but they seem to be acting as a proxy for the general health of Italy's sovereign debt. After all, they hold more than 150 billion euros of the stuff. On Monday, calm seemed to have set in with some of the Italian banks up slightly from Friday's close. But Friday's panic has clearly shaken the market's confidence in Italy.

"Most Dutch and European banks are worried and are not accepting Italian [debt] as collateral and reducing overall exposure in anything southern European," a trader at a major Dutch financial firm tells Fortune. "Even the Dutch pension funds are avoiding it."

Italy was forced to pay a much higher interest rate to investors when it came to the market to sell new debt on Monday. The Italian treasury sold 8 billion euros in six-month bonds at a yield of 1.988%, which is up sharply from the 1.657% paid during the last sale of government debt. Yields on bonds maturing in 2013 were issued at 3.219%, up from 2.851%.

Roots of the crisis

Italy's main economic problem doesn't stem from a large fiscal deficit, as is the case with the other troubled eurozone members. What worries economists and traders is the nation's very high debt-to-GDP ratio emanating from structural inefficiencies in its economy. This has led to decades of declining productivity and poor growth.

Italy's current debt load is around 1.8 trillion euros, making it the fourth-highest public debtor in the world. Having debt is not a bad thing; it just becomes a problem when the amount of debt on the books exceeds productivity. The nation's debt to GDP ratio stands at an alarming 120%, the second-highest in Europe after Greece at 140%. To put that into perspective, Italy's ratio is double that of Spain.

Overspending is of course a problem, but the ratio has popped up recently due to anemic economic growth in the country. Italy's real GDP shrank by 1.3% in 2008 and a whopping 5.2% in 2009. To make matters worse, the unemployment rate has increased by more than two percentage points since the beginning of the financial crisis and stands at around 8.3%, with youth unemployment at around 29%.

Italy has a number of problems it needs to deal with to get its house in order. It needs to cut waste, grow its economy and due a much better job of collecting taxes (the Italian government estimates that tax evasion will cost the nation 120 billion euros in 2011). A strong euro is hurting the country's exports, which accounts for around 30% of Italy's GDP, a very large number.

The Italians are moving to cut spending. The government is targeting a budget deficit of 3.9% this year, down from the 4.6% last year. This week, Prime Minister Silvio Berlusconi plans on holding a vote on austerity measures meant to wipe out the budget deficit by 2014. The 43 billion euros in cuts that have been proposed are deep, with most of the pain pushed down the road. It is widely believed that Berlusconi will be successful in getting the austerity measures through the Italian Parliament, but there has been some grumbling from members in his coalition government who believe that the proposed cuts go too far.

Cutting spending, though, is just one part of the equation. Italy needs to revamp its economy to put it on a strong growth path. This is where it gets tricky. The Italian economy isn't really cutting edge – how many Italian tech firms can you name? It moves manufacturing and tourism, both hurt by the strong euro, and has an aging population who demand higher wages.

To get its house in order, the analysts at Barclays (BCS) believe that the government should increase the retirement age, simplify the tax system and adopt clear budgeting ceilings. They also believe the government should take further measures to enhance labor market participation and should reduce public ownership of some the nation's largest corporations. The analysts believe that this should encourage foreign direct investment inflows in to the country to help dig it out of its debt hole.

But such structural reforms will be hard to accomplish as it becomes increasingly more expensive to service new debt. Every percentage point increase in borrowing costs makes it that much harder to get the nation's fiscal house in order. For now, the interest rate demanded on Italian government debt is manageable. But if Berlusconi doesn't move fast to address the structural problems in Italy's economy, the rate could skyrocket up, handicapping Italy's chances in avoiding a devastating default.
Posted in: Eurozone, Greece, italy, Macro, Silvio Berlusconi

Tuesday, June 28, 2011

The Day the Law Left Town

As I have predicted in earlier posts. Cities will need to consolidate and administrations will be collapsed in order to deliver the same services with lower cost through lower overhead. Australia did not suffer when this occurred in the 90's, in fact it went on to prosper.

Aivars Lode

The Day the Law Left Town Text By ANA CAMPOY
ALTO, Texas—Folks here are bracing for a crime wave after the city put its police force on furlough.

Budget woes in Alto, Texas have forced drastic measures, including laying off the five-member police force. A newspaper's antique printing press is being moved to a museum for safe keeping. WSJ's Ana Campoy reports.
."Everybody's talking about 'bolt your doors, buy a gun,' " said Monty Collins, Alto's mayor, who was against the measure.

But Alto wasn't going to make payroll in the coming months. So the City Council made the call, and on June 15 the police chief and his four officers secured the evidence room, changed the passwords on their computers and locked the department's doors for six months—longer if local finances don't improve by then.

Meanwhile, Cherokee County Sheriff James Campbell, based 12 miles north in Rusk, is policing Alto, a city of about 1,200. Mr. Campbell said the extra load would strain his 25 deputies and reservists, who oversee a 1,000-square-mile territory. The sheriff is already responsible for the nearby city of Wells, which has a population of about 800 and earlier this year shed its only police officer. Crime went up initially, the sheriff said, but has stabilized.

"I'm going to try, but I can't guarantee you there will always be an officer in the town," he said of Alto.

With city budgets tight across the country, police departments are under the gun to cut costs. Some are disbanding special units. Some are shedding other personnel. And some small jurisdictions are doing away with their police forces altogether.

Half Moon Bay, Calif., a picturesque surfside city, is now patrolled by the San Mateo Sheriff's Office after city government earlier this month dissolved the local department to save more than $500,000 a year. Nazareth Borough, Pa., is negotiating a contract for public-safety services with a regional force. In Wenonah, N.J., voters will decide in November whether to sign up with another municipality to replace its seven officers. The move has the potential to slash around $300 to $400 from the average property tax bill of $9,000, in part by reducing employee insurance costs, according to the mayor.

Whether a county sheriff is obligated to provide public-safety services free of charge or is paid for them depends on state law. In most cases, the sheriff's office is paid, said Fred Wilson, director of operations at the National Sheriffs' Association.

The closure of small-town police departments is part of a broader consolidation of services in communities all over the U.S. Keeping the peace is rarely a revenue-making operation and is easier to outsource to county or state agencies than other city responsibilities, such as utilities, some officials say. Others see advantages in having a bigger, more professional force watch over their communities.

Proponents of local police say regional forces are stretched too thin as it is and may not have enough staff to take over security in individual cities. Outsourcing services to a bigger entity also erodes the ties between officers and the community, an essential element in crime fighting, said Mark Marshall, president of the International Association of Chiefs of Police and chief of the Smithfield, Va., police department.

"You get to the more reactive model that was used in the 1960s and 1970s, which was proven not to be the most successful," he said.

Alto, meaning "high" in Spanish for its perch above the wooded countryside, has been struggling. The city-owned natural-gas distribution system from which it derives most of its revenue was in dire need of expensive repairs, wiping out several hundred thousand dollars. Reduced sales and property tax collections from the sluggish economy are putting pressure on the town, where residents mostly make their living in cattle ranching, lumber and the oil and gas industry.

City Council officials calculate a budget shortfall of around $185,000 for the fiscal year ending Sept. 30. It costs about $230,000 to run the police department.

"We had to do something drastic," said Jerry Flowers, councilman and hay farmer. "The police department, being a non-money-making entity, was the easiest to get rid of while we catch our breath and build up some cash."

James Green, Alto police officer, on patrol in Alto, Texas.
.Some in town, including Police Chief Charles Barron, complain that the city should have cut elsewhere, given local crime. Last year in Alto, which clocks in above the statewide crime rate, there were 39 larcenies, 23 burglaries, two assaults, one robbery and one auto theft, or 66 crimes, compared to 51 the year before, although that year included a rape and four aggravated assaults.

"Why did they totally throw public safety to the wind?" said Chief Barron. "If the city is broke as they say, I would think they can't afford anybody else either."

Mr. Flowers said the council was looking at cuts in other departments and would try to reinstate the police department after the furlough, although he thinks it should employ fewer officers in the future.

Residents are circulating a petition demanding the city government restore the force. Some business owners said they had removed valuable objects they don't use regularly from their places of work in preparation for the furlough. Others worry that the absence of local police could dissuade businesses and visitors from coming to town.

And some on the outskirts who are already under the sheriff's jurisdiction are worried, too. Because of their proximity, Alto police officers were often the first responders to crime calls until county deputies arrived.

"The thought that we could be 35 or 40 minutes from getting the sheriff's deputy here, depending on where they are in the county, is scary," said Kelly Curry, manager of the Shiloh Ridge off-road vehicle park. Ms. Curry has two guns for self-defense.

Terri Underwood asks who's going to alert citizens when something goes awry in the middle of the night, like the time water began to cascade from the front door of her downtown cafe. "It could have been a lot worse had they not called me," Ms. Underwood said of the furloughed police.

Write to Ana Campoy at