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There is a right way and a wrong to handle the macroeconomics of debt insolvency. All the routes are closed, and the only choices left are the right painful way or the dumb and dumber. After the close Friday BBC reported and Bloomberg confirmed that Germany’s Merkel is saying prepare for a disorderly default. The reason given in a Guardian interview is that Germany need to “conserve it’s capacity”. Then over the weekend (again) comes news that a debt restructure is being reached that excludes the Troika from haircuts. As of Monday morning in Europe nothing has been announced.
There would be no point in promising more and more money without tackling the causes of the crisis,” said Merkel. “Amid all the billions in financial assistance and rescue packages, we Germans also need to watch that we don’t run out of steam. After all, our capacities aren’t infinite, and overstretching ourselves wouldn’t help us or the EU as a whole.”
If the details are accurate, this debt deal is absurdly inadequate without the Troika in the deal. The whole burden is going to private holders, and now they know the formula for the rest of Europe, SUBORDINATION. This is a horrible approach. Euromoney wrote a concise, strong article to this point.For starters Greece debt is nearly 160 percent of the country’s annual economic output this year and going higher. Private creditors hold around €206 billion of Greek debt. Assuming a participation rate in the debt swap of 80%, a 50% writedown to private holders would cut Greece’s debt by around €80 billion, or 35% of GDP, a spit in the bucket, leaving it still at 125% and climbing.
With the private debt subordinated to the ECB, and EU, and IMF, this subordinates the private holders into an even bigger hole as they become more junior with every official intervention. Der Spiegel this weekend reports that even more money needs to be thrown down the rat hole: 145 billion euros now, not 130 billion. Further the private debtholders get a tiny 3.5 or 3.75% coupon on the new 50% markdowned junior indentures.
It is hard to imagine this new subordinated low coupon, long maturity Greek bond trading well at all, in fact even one-fourth of the old par bonds would be a real stretch. Greece, or for that matter any other stressed European nation, is going to struggle getting new private investment involved especially with the operating theme being constant subordination to official holders. Since half ass debt reduction is being undertaken, why would any IMF nation step up? Indeed, leading GOP Congressional leaders have released a letter stating no support for more US funds for the IMF. Clearly if Obama commits to this, he is going to hear it in the campaign. I really believe this subordination issue is a big part of why Portuguese bonds are trading so poorly. There is increasing talk that a 50% haircut is needed on this front, and if they wait, this will increase.
Bloomberg: Portuguese 5- year
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But in many respects the PSI agreement is so yesterday. It is important to remember that this inadequate voluntary deal is merely one condition for the next Greek bailout. As if this wasn’t enough, now Merkel has come back at Greece calling on that country to turn over fiscal sovereignty to the ECB/Germany. Specifically (among other demands) Greece would cede fiscal sovereignty to the EU. The euro zone finance minister would appoint a budget commissioner that would have control over important spending and tax decisions. Second, and just as inflammatory, the German proposal called upon Greece to accept that its debt servicing obligation is paramount. It is the first and foremost demand on state revenues.
Greece has refused that. So as to emphasis the point, the leader of Merkel’s coalition party and her Economy Minister hammered the point home on Sunday followed by a tag teaming by the Finance Minister. Oh what a tangled web, and without EU control, it is put up or shut up time, thus Merkel’s comment about the hard default. Greece if it has any sense, should just default and teach the banksters a lesson. What ever happened to national pride?
On the other side of the coin, if the curtain is thrown back on loss participation from central banks (not just the ECB), and the big eight CB holdings of nearly 16 trillion dollars, then long overdue questions about transparency and holdings are turned loose. This will be even more evident when Portugal is restructured, or one of Europe’s many zombie banks fails. Then we will find out who owes what to whom, and given the ECB’s big bloated portfolio of 2.75 trillion euro (3.5 trillion USD) it will be revealed in case by case that most roads lead to, drum roll please, the ECB. The EU and IMF will have some explaining to do as well. Then once the ECB’s thin $81 billion capital is used up, we will understand what Merkel means by overstretch capacity. As far as Germany, I wrote about it in Is Germany the Savior of Europe. Add that they will need to fund 29% of ECB capital shortfalls. Italy and Spain combined are up for 31%, nao combinam, nao combinam.
During the Friday last hour of the innumerable low volume market pushes, I sold Feb 42.5 naked calls on Deutsche Bank at 3.30. Unfortunately our servers were down so I was unable to post in comments, and I don’t know what Monday will bring. Still DB has rallied about 50% since the ECB allowed banks to dump another half trillion euros of sludge collateral on it. DB reminds me of how Fannie and Freddie traded in 2007. DB is hard to borrow so the only way I can see to trade this is the options. The IV is high at 56, so this favors the seller, not the buyer.
DB has equity of $43 billion, against $141 billion in PIGGS debt. They have sleazy bankster practices to boot, so call this a karma trade. DB was already downgraded to A. Keep in mind the European banks were involved in the commodity bubbles and are now exposed to shipping defaults. This IHT article estimates $100 billion in European bank shipping write offs, as big as Greece. French banks and DB as well were quite involved with commodity and trade lending. I think DB is going to be hit on some of the gas shale excesses. They are trying to shop their portfolio. DB in reality will be a ward of the state, and is a prime example of how debt needs to be reconciled by banksters. Let’s just say DB stinks to high heaven, and their financials as well, described by David Stockman [article written for Wall Street Examiner].
It is only a matter of time before these French and other European banks, which are stuffed with sovereign debt backed by no capital due to the zero risk weighting of the Basel lunacy, topple into the abyss of the shadow banking system where they have funded their elephantine balance sheets. And that includes Germany, too. The German banks are as bad or worse than the French. Did you know that Deutsche Bank is levered 60:1 on a TCE/assets basis, and that its Basel “risk-weighted” assets are only $450 billion, but actual balance sheet assets are $3 trillion? In other words, due to the Basel standards, which count sovereign and other AAA assets as risk free, DB has $2.5 trillion of assets with zero capital backing!
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