David Rosenberg On The Insanity Of Fixing Excess Leverage With More Leverage, And The Relentless Euro Rumormill
We though we were the only ones brought to the verge with the relentless lies out of a completely clueless Europe, which as we learned at last weekend's G20 meeting, has 3 more days to get is act together. Oh wait, they were lying too? Got it. Well, no, David Rosenberg has also had it pretty much up to here. More importantly, Rosenberg also, like us, but also like Citi's and RBS, to throw some more "credible" names, is convinced that this latest deux ex machina is D.O.A. To wit: "How cool is it that we live in a world where complicated financial engineering in a radically overleveraged system forms the cornerstone of the solution to these debt problems...Why are we so skeptical? Well, when you go back to the opening months of 2010, it was all about Greece and the prime goal was to prevent contagion to Portugal and Ireland. We know how that went. Then that fall, the risk was Greece, Ireland and Portugal and this was when the term PIG was coined. At that time, the goal was to protect Spain and Italy. And we know how that went. Then just this past July, the crisis moved beyond just Greece, Ireland and Portugal to include Italy and Spain (and this is where PUGS was coined). At this point it was about preventing contagion to the banks, but nothing has worked. The contagion has merely spread, and this is not the first time a late-day press release or policy announcement was leaked to juice the market. So, we are still living in a world were levering up is somehow deemed to be a solution to a world of excessive credit and all this will do, again, is just kick the can down the road." As we made it all too clear, far less diplomatically yesterday, "Are we the only ones dazed, confused, and tired beyond comprehension with this endless, ridiculous, pathetic, grovelling Groundhog Day bullshit? Stop risking civil and international war just to satisfy your bureaucratic vanity. THERE IS NO MONEY! YOU KNOW IT, WE KNOW IT, THE PEOPLE KNOW IT. ENOUGH!!!" So much for enough: 6 hours later we had the latest European rumormongering fiasco courtesy of The Guardian which has now devolved to the status of England's latest "paid for publication" tabloid.
From David Rosenberg of Gluskin Sheff
The Europeans are living in a world of denial that they can continue to give funding to Greece as it continuously refuses to meet its fiscal targets
Well, once again a leaked press report from a pro-EU newspaper (the Guardian) has cooked together a new strategy that leverages up the EFSF and insures bondholders against first losses on their sovereign bond holdings has the markets in a brand new giddy mood. Equities are rallying across the planet (check that — what is with China down now two days in a row?) and safe-havens like the U.S. dollar and high-quality bonds are selling off (and we ask, why in this pro-cyclical buying of stocks and selloff in Treasuries and bunds is copper of all things down three days running? The red metal is down 1.2% today!). Again, not even gold is rallying, and we admit that we are becoming a tad perturbed over how the yellow metal is trading of late.
It's an open question as to whether this is the deal breaker at this weekend's EU leaders' meeting but there is reason to be skeptical that nirvana has just been discovered with respect to this complex European debt crisis — involving governments, banks and all locked into a single currency zone. And nobody wants to pay the price for bad decisions made, so why not end up going through the back door by penalizing the taxpayers of the rich countries? In terms of commitments, Italy and Spain account for 30% (it's interesting that Italy is committing to a program that will be used to backstop Italian bonds, no?). As one of the co-managers of our hedge fund, Michael Isenberg put it, "It is a quasi-euro bond — without constitutional, legal, historic, linguistic, cultural or political backing — so it's weak." Yet, the market sees a headline: wow, 2 trillion euros in a new fund — that's QE — I better cover and get out of the way. So we have to recognize this and understand that we're playing in a game where rules change every day.
I remember people saying the agreement to expand the power and funding for the EFSF on July 21st was going to be the panacea — the Dow actually swung +185 points that day (the amount it rallied yesterday), only to be totally erased in the next three sessions. How cool is it that we live in a world where complicated financial engineering in a radically overleveraged system forms the cornerstone of the solution to these debt problems. I would not be surprised at all to see stories coming out in the next few days that contradict this plan. In fact, now we see German Finance Minister Schaeuble saying that the EFSF firepower will be expanded to 1, not 2, trillion euros. Go figure.
Both Dow Jones and Reuters have run with 'denial' articles from EU officials, but don't you see, it's always like this with the equity market crowd — react first, worry about the details and repercussions later. At this stage, the surprise is that we have another 'leak' on our hands with no credibility, like all the noise someone in the media created ahead of last weekend's finance minister meeting and we ended up with nothing but policy discord.
In fact, what is interesting is to go back and see how the markets reacted to each of the brave new plans unveiled during this crisis. The DAX, for example, surged 5.3% when the EFSF was first introduced back in May 9, 2010 and then rallied 1% on the July 21st agreement to expand the bailout fund; each rally faded. I have no reason to believe this one will be different.
Or just go back to the 'leak' late in the afternoon (these always happen about an hour before the close in New York — have you noticed that too?) on September 12th that China and other Asian sovereign wealth funds were going to line up and start to bailout out the Eurozone bond market. The very next day the DAX rallied 2% and over 3% the day after that and euphoria reigned ... for about a week.
All these leaks are doing is generating more market volatility, though as we are told, one of them is bound to come to fruition at some point. Better to be a spectator here than a participant.
Let's look at what else is happening that deserves attention that is not exactly validating this new announcement-led risk-on rally.
- First, Spain's credit rating was cut by Moody's for the third time in the past 13 months to Al from Aa2 (note the two-notch downgrade and the 'negative' outlook was retained). This is actually big news because what it shows is that Spain's vulnerability to market stress and event risk remains acute, and leaving the 'negative' outlook is a sign that there is no confidence in the country's economic, fiscal or political prospects. Indeed, have a look at Spain Hit by Downgrade, Falling Home Prices on page A8 of the WSJ — home prices are deflating now for three quarters in a row and at an accelerating pace.
- Second, and this is buried in the small print because the big print is all about the Guardian's "extra extra!" but Standard & Poor's, to little fanfare, downgraded 24 Italian banks and financial institutions last night (and people are buying the euro at levels that are 20 points above where the IMF pegs 'fair-value'. What a bizarre world this is). Have a look at Martin Wolf's column on page 11 of the FT—There Is No Sunlit Future For The Euro.
- Third, there has been no relief so far in the Eurozone bond market, with Italian yields still backing up (now just lbps shy of 5.9%) even though apparently this new plan is intended largely to bring down debt-service costs in countries like that (Spain as well).
- Fourth, France-German spreads have not reacted anything close to what the global stock market has as they remain near historically wide levels of 107 basis points (see Ratings Firm Warns on French Debt on page A8 of the WSJ as well). The spread of the problems to France is relatively new and as such makes 'leaks' necessary to buy time and adds extra pressure for a quick solution; a French downgrade would deal a huge blow as it would mean that the EFSF would lose one-third of its AAA-rated firepower.
- Fifth, there is no sign of meaningful improvement in the fiscal situation and in the next two days Greece is going to be experiencing the most intense protests against austerity since the deficit-reduction plans were unveiled. In other words, the Greeks have had it with years of economic implosion and, as such, the risk of outright default is high and rising from a political standpoint. Will bailout money continue to flow in if the fiscal targets are deliberately abandoned?
Why are we so skeptical? Well, when you go back to the opening months of 2010, it was all about Greece and the prime goal was to prevent contagion to Portugal and Ireland. We know how that went. Then that fall, the risk was Greece, Ireland and Portugal and this was when the term PIG was coined. At that time, the goal was to protect Spain and Italy. And we know how that went. Then just this past July, the crisis moved beyond just Greece, Ireland and Portugal to include Italy and Spain (and this is where PUGS was coined). At this point it was about preventing contagion to the banks, but nothing has worked. The contagion has merely spread, and this is not the first time a late-day press release or policy announcement was leaked to juice the market.
The Europeans are living in a world of denial that they can continue to give funding to Greece as it continuously refuses to meet its fiscal targets. Ditto for Portugal. How will France be able to avoid a downgrade? And how do the banks not take a big haircut in all this? It's not as if the countries have refrained from tough measures — they simply aren't tough enough. In the meantime, creating a vicious cycle of deflationary and recessionary pressures that makes it impossible to maintain the fiscal austerity and hence the quality of credit continues to erode, alongside that, the quality of the assets in the European banking system.
The reason why EU kingmakers are in a rush is because even with all the ECB support, Italian bond yields are heading back to 6%, a level consistent with high and rising default risks. France and Belgium are now tarred with Dexia support. The dangerous game of not allowing a Greek default has continued because of the fear of triggering a CDS, and we have Tim Geithner convincing the Europeans that allowing Greece to default outright and have the bondholders take the pain invoke a "Lehman moment" (it's not even clear that things would have turned out to be better if Lehman had been propped up ... it's not as if allowing WaMu to fail produced any long-lasting effects on anything and that was a biggie too).
So, we are still living in a world were levering up is somehow deemed to be a solution to a world of excessive credit and all this will do, again, is just kick the can down the road. Unfortunately, post-Lehman the concept of cramming down debt holders to arrive at a more sound financial position has been thrown out the window. Causing pain to bond-holders or equity holders is a sin right now, believe it or not. There will be a price to be paid down the road for failing to allow bad risky decisions to be penalized. Instead we paper over our issues with QE and financial engineering that may make things worse down the road.
It is truly hard to believe that a Greek default could produce any worse results than what we have already seen from all these bailout attempts. This too-big, or too-important to fail strategy has got to come to an end if we are ever to fully emerge from this increasingly unstable global debt cycle.