From Mark J. Grant, author of 'Out of the Box and onto Wall Street'
The Longer View
Saturdays are good days for mulling about. We are not rushing from meeting to meeting and facing the aggravation of lawyers and auditors and the countless personal problems of ruffled employees; we can take some time to actually ponder what we face. There is no substitute for thinking, assessing the facts and making some decisions based upon our collective deductive abilities. So then let us begin.
"Yes, I have a turn both for observation and for deduction. The theories which I have expressed there, and which appear to you to be so chimerical are really extremely practical -- so practical that I depend upon them for my bread and cheese."
-Sherlock Holmes
The LTRO
More than $1.3 Trillion handed to the European banks at a low interest rate to be used how they like. The maturity is three years for most of it so that it has to be paid back and there is the rub of course. Liquidity issues for the banks and then the sovereigns fixed in the short term but not so fast I tell you. As the European banks deleverage, as mandated by the Basel III rules, their balance sheets will deteriorate as a result. The debt to assets and the debt to cash ratios of the European banks will significantly worsen so that I predict a continuing stream of downgrades which are quite unavoidable two to three quarters out along with an increase in counterparty risk. The money that has been used in the short term to buoy the sovereign debt prices of countries such as Italy and Spain will begin to dry up and this will be especially notable for debt five to ten years out as the banks are fearful of using short term money to buy longer term assets so that the knee jerk reaction accompanying the surreptitious printing of money by the ECB will come to a halt and reverse as the structural problems of Portugal, Italy and Spain do not disappear by the use of liquidity. It is always the case that solvency is helped by liquidity in the briefest of terms but the band aid never cures the patient of its ills. As Spain misses its deficit goals and they demand the relaxation of the rules Austria replies with negative vehemence so that it will either be a change of rules or forced austerity or a large fine by the EU for not complying. No pleasant possibilities but one or the other will be the conclusion and then not just in Spain but likely in Italy as standards of living decline and social unrest continues. As it dawns on us that Europe’s Quantitative Easing has ended then the course reverses direction as easy money dries up. You may recall that when QE ended in America that the stock market dropped approximately 50% in value so that as America ends its easing and Europe ends it easing the stock markets will not be such a great place to park money and this, coupled with a deepening recession in Europe, will play havoc with the world’s equity markets in the next few quarters I think. The collective “WE” has a mindset these days that does not want to worry about China, 2012 as the first year when Japan has to depend upon outsiders to finance its debt, the escalating price of oil, the end of QE in both America and Europe, the threat of Iran attacking our battleships, the recession in Europe or the structural problems of many of the nations on the Continent; we have been lulled into a state of lethargy by all of the printing of money but long experience in the financial markets has taught me that easy money has its consequences and that the rubber band when stretched past the constraints of elasticity snaps back and always with force.
“Excess generally causes reaction, and produces a change in the opposite direction, whether it be in the seasons, or in individuals, or in governments.”
-Plato
Greece
By March 9 we will all see who signs up for the Greek bond swap and who does not. I expect consequences here that vary from bad to far worse. If not enough participants sign up then the deal fails and the Bull droppings hit the fan while the Bear cranks the engine as Greece does not receive any new funding. If the deal ekes by then the “Collective Action Clause” will surely be triggered which means a new assessment by the ISDA, a defining moment for the CDS market, and law suits instigated around the globe. It appears that the law firm of Bingham McCutchen is leading the early charge and if you are a hold-out from the Greek bond swap you may wish to get in touch with them. Then if the “CAC” is utilized there will also be more ratings downgrades and “Default” will be the operative word which will force selling at many institutions. Currently the ECB will no longer accept Greek bonds as collateral and they have thrown a lifeline to the Greek banks but a failed deal will cause further large write downs at the French and German banks and no such lifeline has been extended to them and if one were it would cause consternation and quite negative knee-jerk reactions for their bonds. Then I have the suspicion, given recent comments from various German officials, that everything is not as it seems as Germany may be trying to force Greece from the EU and if more austerity measures are demanded as the Greek economy reported out even worse financials, then the Greek “bend over and take it” position may become unsustainable. This game is not over or close to being over; in fact, the real show has just gotten underway.
“Greece is reneging on programs to spur its economic competitiveness that it signed with Germany since July, calling into question its willingness and capacity to revitalize its economy.”
-German Economy Minister Philipp Roesler
Portugal and Possibly Spain
Portugal cannot make it; that is my honest assessment. They will be back at the till soon which will provide us a new adventure and a new focus for our attention. The numbers are not big but how the EU handles will be and we will all get to see if Greece was a one-off situation or not. Spain has already fallen behind and they have regional debts, not reported on the Spanish balance sheet, that are slowly coming out into the open air and I think their financial condition is far worse than is generally realized so that I expect real trouble to be forthcoming in this country. Any notion that Europe is out of the woods is a flight of not only fancy but fantasy and I place zero credence in this notion. We are currently in the Quantitative Easing lull; nothing more.
Don Quixote: Dost not see? A monstrous giant of infamous repute whom I intend to encounter.
Sancho Panza: It's a windmill.
Don Quixote: A giant. Canst thou not see the four great arms whirling at his back?
Sancho Panza: A giant?
Don Quixote: Exactly.
France
April 22 marks the date of the French elections. Unless Joan of Arc reappears the socialist candidate, Francois Hollande, will be the winner either in the first election or the May 6 runoff election. He is not any friend to the banking institutions, wants to lower the retirement age, increase governmental spending, impose a tax bracket as high as 75% and is culturally and financially in direct opposition to the German positions. As spring unfolds there is going to be a quite serious rift that will take place between these two countries and the position of Germany is going to be quite isolated with the very real possibility of unintended consequences as a result of what is demanded by the European Union and what Germany refuses to do. We may well see a full blown German revolt.
“Chateau and hut, stone face and dangling figure, the red stain on the stone floor, and the pure water in the village well--thousands of acres of land--a whole province of France--all France itself--lay under the night sky, concentrated into a faint hairbreadth line.”
-Charles Dickens, A Tale of Two Cities
The IMF & Europe
They apparently have only offered $13Bn to help Greece in Bailout II. They said they might offer more if the firewalls are expanded. Germany has stated they will not expand them. If the German position holds then the EU bailout is $17Bn short and the additional money has been approved by no one. With both the ECB and the EIB exempting themselves from the Greek “CAC” one wonders if the IMF will not be next. Subordination to two institutions is bad enough; I fear there will be three. The laws for European bonds are clearly not the same as for American bonds and this should be carefully noted and spreads for all the bonds in Europe will be adjusted accordingly over time and as the injection of liquidity dies on the vine. There is no brandishing of any sword that is necessary to now correctly identify that private bond holders are now second class citizens in Europe.
The Lull
We are in “The Lull” which has been caused by the injection of capital by the Fed and by the ECB. This is exactly, exactly, what took place I remind you during the weeks after the subprime mess exploded. Massive injections of capital, run-ups in equities, compression in bonds, higher prices for commodities and then the reversal of course took place. When easing ends then the course back tracks and I predict a re-do of this in the coming months. It will not take some trigger event, though there may well be one, to cause this; just the easy money being placed and no more manufactured money to follow.
“As the well runs dry the throat parches and dehydration begins.”
-The Wizard