Below is this week’s market commentary from Craig Columbus, our chief economist. This week’s selected articles mostly pertain to Europe as that has dominated US trading/markets over the past few weeks.
Where Is the ECB Printing Press?
In my opinion, John Mauldin has done some of the best writing on the European debt crisis because he focuses on the deep, underlying structural issues rather than on the pronouncements of Europe’s leaders. Take, for example, the fact that few have reported that the “voluntary” haircut on Greek bonds only applies to private reditors: “Greece has been told that they can write off 50 percent of their debt held by private entities, but not that owed to the IMF, ECB, or other public entities. This means something more like a 20-30 percent haircut on total debt. Sean Egan suggests that eventually Greece will write off closer to 90 percent.”
He also explains, “European regulators allowed their banks to leverage up to 450 to 1 on their capital, on the theory that sovereign nations in an enlightened Europe could not default, and therefore no reserves need to be kept for investing in government debt.”
Markets have rallied again on the political headlines that Prime Minister Silvio Berlusconi is leaving and the patchwork Italian Parliament appears ready to approve additional austerity. And while the skilled technocratic successor Mario Monti is likely an upgrade, the likelihood of his ability to get things done with the Italian Parliament is very uncertain. Nor does Monti come to power by popular election. And as Mauldin indicates, European Central Bank purchases have been the only real support propping up Italian debt markets.
The European Central Bank purchases are complex — the mechanics, the legality and the politics. Mauldin illustrates some of the complexity, “The path of least resistance, and I use that term guardedly, is for the ECB to find its printing press. Perhaps they can borrow one from Bernanke. Yes, I know they are buying sovereign debt now, but they are sterilizing it, meaning they sell euro paper to offset the monetary base effects (large oversimplification, I know).” Many believe that despite Germany’s strong objections to devaluing the euro, that is ultimately where the Europeans are headed in an attempt to grow their way out of the crisis.
Europe’s Banks Found Safety of Bonds a Costly Illusion
A piece by The New York Times’ Liz Alderman and Susanne Craig illustrates the changing face of risk. Sovereign debt of developing nations, once seen as a less risky investment vehicle, is now a toxic asset infecting many bank balance sheets.
The Times says banks are racing to reduce their exposure, “European banks face tens and possibly hundreds of billions of dollars in losses on loans to nations that use the euro. Worried about even greater losses if the crisis worsens, the banks have been scrambling to reduce their holdings of an investment that, like triple-A-rated subprime mortgage bonds, was once thought to be bulletproof.”
Alderman and Craig explain how European sovereign debt became the new subprime: “Banks had further incentive to overlook the perils of individual euro zone countries because of the fees they earned for underwriting sovereign debt sold to other investors. Since 2005, several dozen banks in Europe and the United States have earned $1.1 billion in fees from selling bonds for European governments, according to Thomson Reuters and Freeman Consulting Service.”
I agree completely with the authors that European regulators bear much of the blame for not requiring banks to set aside capital for sovereign defaults and encouraging financial institutions to load up on risky government debt.
Swallowing Austerity Turns Into Irish Way as Strikes Grip South
Bloomberg’s Finbarr Flynn explores why austerity in Ireland has not produced the social unrest it has in other indebted Eurozone nations. First off, Ireland maintains a viable export economy for growth and markets have viewed the Kenny government’s measures as credible: “Yields on Irish bonds maturing in 2020, which soared to a high of 15.5 percent in July, are now down to 8.12 percent. That’s compared with 6.81 percent for similar Italian debt, 13 percent for Portugal and 31.1 percent for Greek bonds.”
Flynn says Irish notions of collective responsibility are also at work. “Analysts suggest a mix of reasons behind the Irish willingness to accept austerity. Some, such as Hughes at KBC, say it’s partly because many Irish accept they fueled the boom and bust, by pushing up property prices and seeking pay raises that contributed to the country’s loss of competitiveness.”
Finally, he says, “Other analysts point to unions agreeing to work with the government and a lot disgruntled Irish leaving the country.” Many of the most disillusioned have simply left the country, suppressing the size of any protest movement. I think it’s important to recognize the different political climate in Ireland versus Greece and Italy.
Hungary: The Next European Crisis
The Wall Street Journal’s MarketBeat blog describes the growing refinancing risks for Hungary, not a member of the Eurozone although often mentioned as a prospective one. MarketBeat’s Mark Gongloff expresses crisis fatigue: “I know what you’re thinking: We don’t quite have enough terrifying sovereign-debt meltdowns to worry about, am I right? It’s so boring, only having to worry about Greece and Italy and Portugal and Spain and Ireland and France and Austria. And the United States.”
Gongloff points to the latest bond auctions, off most of radars: “Hungary’s auction had a bid-to-cover ratio of just 1.0, and it had to pay a 6.79 percent yield to move the debt. Galloping Goulash, Batman, that’s harsh. That’s almost what Italy is currently paying to borrow for 10 years.” One more hotspot to add our global macro risk list!
American Migration Reaches Record Low
A component of this country’s labor woes is the lack the mobility due to negative housing equity — and the data backs its up. The New York Times’ Economix blog reports, “From spring 2010 to spring 2011, just 11.6 percent of the people moved residences, the lowest rate since the government began keeping track of migration in 1948. The difference between that rate and the 2009 rate of 12.5 percent was not statistically significant, but it was a far cry from its heights in the mid-20th century. From 1951-52, for example, 20.3 percent of Americans moved.”
And then there was this stat that California Governor Jerry Brown would probably not find encouraging: Of the 6.7 million people who moved between states, the most common migration was from California to Texas (68,959 movers)!
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