Monday, April 26, 2010

Can contagion in Europe be avoided?

Good post by Felix Salmon here.  The outlook for Greece is indeed depressing. But it's not just for Greece.  What keeps me puzzled is why does anyone think that bailing out Greece and avoiding Greek default make the situation in Portugal and Spain any easier? Consider:

1. If a mere promise of a bailout along the lines of "we will not let a Euro member fail and here is a nice chunk of change in committments to prove it" worked, Greece would already be safe and be able to fund itself in the market. To put it in H. Paulson's terms, they already brought out the bazooka, but it's been mostly ineffective - though probably because the use of bazooka still needs to secure political approval and because caliber is too small.

2. Even if they bring out an unlimited-caliber bazooka for Greece (i.e. Germany somehow agrees to an open ended funding committment), why would that make anyone think that a blank check is waiting for Portugal, Spain and Italy as well, if those three ever need it? It's not like France and Germany have unlimited appetite for bailing out their neighbors, right? Politically, pushing any bailout after the Greek one is going to be much more difficult (go on, try selling another bank bailout to the American public today), so a bailout for Greece means that Portugal is actually LESS likely to be bailed out. Meaning that if Greece is fully contained, Portugal is definitely next up for bond vigilantes.

The key difference to TARP here is that Germany and France have to consider bailouts in succession, while TARP (plus emergency lending by the Fed) was a blanket promise big enough in size to cover all of the major US banks, all at the same time.  The latter requires one-shot political agreement - which is difficult but possible in sufficiently dire circumstances. The former is virtually impossible -- it's political suicide, even if the eventual economic outcome is the same. So the only way to avoid contagion that I see, would be for Germany and France to agree to a creation of an pan-European treasury, fund it with, say, 500 billion of seed capital and authorize it to issue its own bonds backed by full faith and credit of all EMU members. In other words, they need to replicate the federal system.

Thursday, April 15, 2010

It's deja vu all over again...

Greece speads have been blowing out wider again. Back to the levels before the bailout was announced.  What gives? Wasn't the unveiled plan supposed to stop the run by reassuring the creditors that there will be no default - so that, as Hank Paulson would have us believe, once you show that you brought a bazooka out, you'd never actually have to use it?

Well, if that was the plan, we've got some 'splaining to do, because it's pretty clearly failing. 

First, we need to figure out what's actually happening with the market for greek debt, which, alas, I cannot. But perhaps someone else could answer this question: is there widespread selling (and therefore widespread buying just not at prices that Greece can bear) or is the market incredibly shallow such that the brief blips of tightening are immediately offset by another seller who is trying to liquidate his longs.  I suspect it's the latter. I suspect that there are virtually no buyers except a few random hedge funds that are speculating and a central bank or two (paging Mr. Bernanke!). I suspect that there are also not too many sellers at these prices: whatever banks are holding long-term Greek sovereign debt have decided that the better strategy is to hold out and hope for a better price and continue the practice of "mark-to-myth" accounting than to liquidate the positions in full and take an immediate and large hit to the balance sheet. 

So no one's really buying the bonds and no one's really buying the Kool-aid that Papandreu is selling. You can see why too. Take a look at this excellent spreadsheet and see for yourself. At first blush the curve looks kinda primising. And the numbers that result in that curve don't look particularly weird either... until you realize that these are probably fairly optimistic projections on every metric for United States, let alone Greece. To pick out a few obvious examples:
 - The interest rates are way too optimistic. There is no way that Greeks are getting under 5% rates for 2010 and 2011. Just think: the European bailout will cost then 5%. So that's a floor, below which any new debt they raise is highly unlikely to fall. On a hunch - go ahead and plug in 6% for the debt cost in 2010 and 2011 and see what that does.
 - Inflation??? Hasn't Latvia taught us anything? Deflation is what Greece is about to experience, and that's the end of it. Plug in a modest -1% into the Inflation boxes for 2010 and 2011 (let's assume that after that modest inflation will return) and see what that does.
 - Account balance at a mere -3.7% in 2010? How the fuck is that supposed to happen, pray tell?

So we can easily see how the Greek assumptions begin to unravel. And even with the bailout, the fiscal situation looks pretty hopeless. There is just no compelling reason why this will not be just another Argentina, which held stayed afloat for a bit but finally caved in and defaulted.  Unless, that is, one bailout is followed by another... and another.

Wednesday, April 14, 2010

WaMu pity party

Killinger, the ex-CEO and chairman of WaMu, complains that his bank was subject of "unfair treatment" during the crisis, ultimately leading to WaMu being place in receivership. Which, according to him, didn't even need to happen (REALLY???). The hillarity of this pity-party aside, Killinger is an embodiment of the two grave moral vices that have been all but institutionalized:
 - If you ran your organization into ground through fraud and malfeasance (as WaMu did), blame others. Rubin's "everyone is to blame" mantra is a variation on this theme.
 - How the fuck is it still OK for Killinger to keep his $14 million in compensation in 2007 and $21 million in 2008???

Thursday, April 8, 2010

Is Greece about done?

Latest check-up on GGGB10YR reveals further deterioration - the yield is now 7.32%, which is 17bps wider than yesterday all-time wide. The spread to Bunds is now a whopping 424 bps. ZeroHedge reported yesterday that 450 bps is about as much as Greece will be able to stand.  At this rate of deterioration, we will reach that point very soon, possibly by the end of the day or by Monday at the latest. 

A European "Lehman weekend"?

Monday, April 5, 2010

So... what about those jail terms for bankers?

Matt Taibbi does another takedown of the banksterscamster culture we had (have?) in this country. Jefferson County has made headlines before, of course - so how come none of the guys from JP Morgan that were involved in these blatant violations of the Sherman Act and federal and state anti-bribery statutes have been even indicted yet?

Does size matter?

Among the central topics of debate on the FinReg proposals is whether size matters.

Some (or many) think that downsizing TBTF is absolutely essential to the new legislation. The Volker rule which would limit activity is but a step in that direction, albeit an important step. Another, more decisive step would also limit the amounts of deposits that any banking instutution can keep and the amount of aggregate assets that it can have (on an off the balance sheet).

Others, like notably Paul Krugman in today's column, believe that size is not an issue. The basic argument here is that even if the financial institutions are small, in a pinch they'll have to be bailed-out anyway and a run on big banks is neither more nor less likely to happen than a run on small banks. In fact, both the Great Depression (and many bank panics that preceded it) as well as the more recent S&L crisis featured such runs on rather small financial institutions. And, as Krugman points out, it was very likely a mistake for the government to let the banks fail willy nilly during the depression.

So where do I come down on this? The former view - and here is why.

Krugman and others of the same view a missing the point and the problem of bailouts. It may not, indeed, necessarily be the case that we would let a bunch of small banks and financial firms fail in the next financial crisis without trying to prop up the system in some way or another - putting aside whether this is a good thing to do or not for a moment, the politics of the moment usually overwhelm sound thinking in these types of situations.

However, there are key advantages to having a world composed of small instututions from regulatory point of view at the time of a crisis:

 1. When financial instututions are less inter-connected and have fewer tentacles, it is easier for regulators to operate them in receivership without much help from their management. In many cases, this should obviate the need for one of the most puke-inducing part of the AIG bailout where the chumps who caused all the trouble were nevertheless kept on board because they were the only ones who could help untangle the mess they created.

2. The most egregious players could be simply let go of, and made an example of. This did not happen in the last crisis - because the most egregious players were also some of the biggest. Lehman WAS made into a test-case, but that did not exacly ended well.

3. You could even experiment with different resolution regimes and test in real time which one is working better. It is highly unlikely that the whole system will be brought to its knees in a matter of days - what we'd probably have is an accelerating wave of failures that would be spaced out over the course of several months. This was the case in the current crisis - with Bear Stearns being the canary in the goldmine. But because Lehman and other systemically important players managed to put off the inevitable by a few more months through creative accounting, the regulators were basically caught flat footed both by the Bear Stearns failure and by the avalanche of near-failures that followed 6 months later. Imagine now, instead, that we'd have a slow at first but gradually building wave of small instututions going under: regulators would have a much better chance of developing a coherent responce by the time the crisis peaked in the Fall of '08.