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With the Euro Disintegrating, You Can Calculate Your Haircuts Here
Note: For those who have been reading my work for a while
and will not benefit from a backgrounder in my investment style,
successes and faux pas, you can move directly to the Sovereign
Debt Haircut Model Summary below. Those who wish to view the live spreadsheets will have to do so directly on BoomBustBlog via the link above.
The Asset Securitization Crisis of the US and much of
the developed and emerging markets (2007-2009) apparently ended for
many relatively quickly, despite being the worst economic downturn the
country (and most likely the world) has seen since the Great Depression.
How did the US pull out so fast, or more importantly, did the US
actually pull out of it at all? Well, it was never my belief that the
problem was over, simply papered over with some accounting changes and
force fed massive amounts of liquidity coupled with a drive to privatize
profits while socializing losses. Of course, the natural result of such
actions was the gorging of the public sector on debt and bad assets.
This sleight of hand was able to create a positive GDP print in many
countries while rescuing sub par private companies that would have
toppled under less generate corporate welfare, but more importantly, it
succeeded in poisoning several governments whose finances could not
handle the extra burden of unrestrained spending during economic boom
times combined with the assumption of massive private sector losses
during the “bust” times.
Thus the Asset Securitization Crisis has been morphed,
through direct and explicit government and central banker intervention,
into a Pan-European Sovereign Debt Crisis, Soon to be the
Global Sovereign Debt Crisis. This particular environment have been
custom-made for my proprietary investment style, see “The Great Global Macro Experiment, Revisited“.
Understanding my proprietary investment
style
My own, personal and discretionary
investment style leverages long and short positions in any traditional
or alternative asset class, in any instrument, in any market around the
world with the goal of profiting from macroeconomic trends.
Basically, I attempt to profit off of the policy errors of
governments and central bankers world wide. This has been a most
profitable profession over the last 10 years or so, with said errors
causing massive and obvious bubbles in real estate, equity and credit
markets which paid those in the real estate markets handsomely. This
“multi-asset bubble” culminated in what was “an easy to see coming”crash
that allowed both me and my subscribers to score abnormal returns on
the downside as well. Back when I tabulated my results publicly, 300%
and 400% returns were common place (see Sample
Research & Performance), not including the equally impressive
levered returns garnered during the bubble. I was able to time the exit
from the real estate market 6 months before the market peak, a
combination of luck, intuition and spreadsheets. This 9 year performance
was dampened in the last 3 quarters of 2009, where I took a 39% loss by
misjudging the timing of the effect of central bankers’ policy errors
(yes, they are still making big mistakes and no, this is not a bull
market but a bear market rally – I was simply off about 9 months in the
anticipation of the European Sovereign Debt Crisis). I wrote about this
in detail in my Year End Note to BoomBustBlog Readers and Subscribers
in an attempt to both put things in perspective and
self-flagellate.
Case Shiller index has been amplified
by a factor of 10x for the sake of comparison to the S&P 500.
Click any graphic to enlarge.
Needless to say, the time to ride the bear is here again, and in a
fashion that many do not appreciate for I fear the Sovereign Debt Crisis may make the Asset Securitization Crisis look like a mini-bull
rally in and of itself, dwarfing the capital destroying potential of the
latter in both size and scope. This brings us to the analysis below.
The PIIGS at the Center of the Global Sovereign Debt Crisis
Greece, Portugal, Ireland, Spain and Italy, collectively referred as
PIIGS, are a reflection of how the developed countries, the credibility
of whom have been endorsed over the years by high credit ratings and low
credit spreads, are turning out to be the epicenter of sovereign risk
in Europe. Huge fiscal deficit and unimaginably high levels of public
debt, dragged these nations to the verge of default when the markets
refused to lend money at prevailing rates against their fragile fiscal
situation and structurally decaying economies. Greece, the weakest of
all, has effectively defaulted on its debt obligations when it
approached EU/IMF for funds (see How
the US Has Perfected the Use of Economic Imperialism Through the
European Union!). The support extended by the European Union was
primarily to contain the contagion effect (resulting from common
currency as well huge inter-country claims) which would have done
greater damage and would have cost more. However, the aid extended by EU
and IMF is quite insufficient as it will solve only a fraction of the
liquidity problem, and even then for a short term, while the major
solvency and liquidity issues over the medium-to-long term remain. Thus,
the only inevitable outcome which can bring sustainability to the
public finances of these countries is the restructuring of their
sovereign debt.
The Sovereign Debt Restructuring
Sovereign debt restructuring can be done either by taking haircuts on
the principal amounts or by extending the maturity of the debt. While
the latter will result in some losses to the creditors owing to
resultant reduction in Net Present Value , the losses shall be
significantly lower than in case of haircuts in the principal amount.
However, in the case of PIIGS, this option will solve the liquidity side
of the problem rather than solvency issues. In the following model, we
have estimated the haircuts on the principal amounts that might be taken
to bring the sovereign debt of PIIGS to a more sustainable levels.
The restructuring of the sovereign debt of PIIGS nations, especially
Greece, is likely to occur owing to, either or both, of the following
reasons
Government debt ratio (Government debt as % of GDP) is at
unsustainably high levels
- Government debt levels in excess of 100% of GDP are highly
unsustainable owing to the the huge re-financing risk as well as the
interest rate risk. Interest expense on such a high debt level is
already a huge burden on the fiscal situation; an increase in interest
rates can put more pressure on the public finances of the country.
Further, the country runs the risk of failure to refinance or roll-over
such high level of debt in the market . - PIIGS have been facing tough times meeting their debt obligations
(interest expense and the principal repayment) owing to increasingly
expanding spreads over the perceived safe haven rate of the German bund.
The liquidity crunch (pre-EU/IMF bailout announcement) that they are
witnessing in the market is owing to high risk perception build due to
poor public finances situation (rising primary and fiscal deficits) as
well as bleak economic outlook of these countries. Subscribers should
reference:
- While the IMF/EU package will be a short term liquidity relief over
the next three years, after 2013 these countries will again turn to the
credit markets to finance not only the scheduled bond obligations but
also repay IMF and EU loans (reference What
We Know About the Pan European Bailout Thus Far). Thus,
restructuring of the debt might become inevitable for PIIGS countries
specially those which have debt levels in excess of 100% of GDP. Out of
the PIIGS countries, Greece and Italy already have government debt in
excess of 100% of GDP while Ireland and Portugal are rapidly approaching
those levels. Greece in particular has unsustainably high debt ratios
which are estimated to spiral from 116% of GDP to 140-145% of GDP in
2013
Increase in government debt ratio (Government debt as % of GDP) is
unsustainable
- Increases in government debt ratios stem primarily from the
“snowball effect” and the primary deficit. The snowball effect is the
self-reinforcing effect of debt accumulation arising from the spread
between the interest rate paid on public debt and the nominal growth
rate of the national economy. If the average interest rate paid on
existing public debt is higher than the nominal GDP growth rate, it will
result in increase in government debt ratio (Government debt as % of
GDP). - PIIGS are recording huge primary deficits, i.e, government
expenditures (excluding interest expenditure) exceeding government
revenues, which are leading to additional borrowing that then adds to
the government debt levels – wash, rinse, repeat… This coupled with the
snowball effect, which itself increased substantially due to negative
nominal GDP growth and rising interest rates, has been contributing
substantially to the increase in the government debt ratios of these
countries. In the case of Greece, this effect has been extremely large
owing to very high government debt, rising borrowing cost and the
shrinking economy.
The
BoomBustBlog Haircut Model
Below is a live spreadsheet summary, currently updated by
our analysts with new developments and refinements, that calculates the
expected haircuts in several of the PIIGS members, followed by a much
more comprehensive sheet for our professional subscribers.
Please upgrade
your browser[If you can't see a spreadsheet, Click here now!]
your browser[If you can't see a spreadsheet, Click here now!]
Professional and Institutional
subscribers may access this full model (which calculates each of the
PIIGS members’ estimated haircuts individually) online by clicking this link. You may click here to subscribe or upgrade to the
professional/institutional level.
»
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I feel like I must be wrong because everyone keeps just saying the same thing over and over.
So the EU countries are starting to make the needed changes to their economies to control their deficits, so their currency should be devalued to the economies that think the solution to deficits are higher deficits?
At some point people are going to realize that the USD is doing everything they can to go to parity with the peso. The Euro is a sideshow, at best. They don't have to take haircuts on their debt. That is what inflation is for and has been since the beginning of government deficits.
There will be no direct haircuts as long as there is fiat, only implied haircuts.
Apologies for the interruption, now back to the "OMG Euro to go to parity with the USD, lets all go buy Yen" show.
Thanks for the link. Well heres hoping the Irish tell their banker buddies to go fuck themselves and their austerity and let the banks just implode.
Having looked at Reggies blog in the past it appears to me if the Irish banks went down that would be game over for Europe.
There was an Irish Prophet called Malachy who prophesised that Ireland would be under water 7 years before the rest of the world. I wonder if he meant financially? :)
Apparently he was so good he got the title of Saint.
PIIGS mavens should take a look at Morgan Kelly's new article "Whatever happened to Ireland?"
and probably the research paper it's trailing (I haven't seen the latter).
EUR/USD parity, or something close to it, seems like a plausible result if you look at the aggregate data. I think a lot of it depends on what happens with CNY, and I am not smart or connected enough to know what's going to happen there.
Reggie,
Do you have either a short term or long term opinion as to the value of the Euro against the dollar?
Thanks.
If you are bald as a billiard ball - nobody can give you a haircut. Note to aspiring leaders on Wall Street.
Heard on Bloomberg this am that someone at GS stated the Euro won't go below 1.21. Have the banksters gotten together to prop up the Euro? Wonder if the fleeing investor is more powerful than the banks?
Or it IS the fleeing investor peddling misinformation to create more profits on the short side as usual.
EURO won't go under 1.21 for a few days because it is the GBP's turn to crash as pre-election "hide the weenie" debt accounting" has been revealed...
Not to worry. GDP is right this second undergoing complete and total revisions in how it is calculated, and we expect the old model that you are now using will be judged obsolete, irrelevant, and antediluvian.
Our spiffy new one will be far more efficacious. Maybe even accurate, but that is a tertiary goal. The real one is to move the goal posts.
When the going gets tough the tough forsake Marx and embrace Nietzsche, we can then demystify and simlutaneously obscure.
Better search out a secure place to stash your electronic money.
.
A good point, never underestimate the power of government to extend and pretend.
Oh, didn't you get the memo?
"Extend and pretend" is SO pre-TARP!
The official financial policy of the federal government is hereafter to be referred to as:
"Spend, Transcend, Extend, Attend, Lend, Condescend, Rend, Amend, Pretend".
Or it may alternately be referred to by its acronym:
STEALCRAP
Love it. Mind if I steal that?
It's all yours Beastie!
When the going gets tough the tough forsake Marx and embrace Nietzsche, we can then demystify and simlutaneously obscure.
Outstanding! [golf clap]
Love it, love it. +55