Below is Goldman's quick take on the E-Tarp MOU (completely detail-free, but who needs details when one has money-growing trees) announced late last night. In summary: "We recommend being long an equally-weighted basket of benchmark 5-year Spanish, Irish and Italian government bonds, currently yielding 5.9% on average, for a target of 4.5% and tight stop loss on a close at 6.5%." By now we hope it is clear that when Goldman's clients are buying a security, it means its prop desk is selling the same security to clients.
Moving Towards ‘E-TARP’
- Last night, European leaders agreed on widely expected measures to support growth, took steps towards a “banking union”…
- …and defined the terms of Spanish financial assistance programs for banks.
- Market expectations were very low heading into the Summit and active risk-taking is still low.
- In light of the decisions reached overnight, we think that an extension of a bull steepening rally in peripheral bond markets can occur.
- We recommend being long an equally-weighted basket of benchmark 5-year Spanish, Irish and Italian government bonds, currently yielding 5.9% on average, for a target of 4.5% and tight stop loss on a close at 6.5%.
1. A Move Towards ‘E-TARP’
Last night, European leaders agreed to: (i) allocate funds amounting to roughly 1% of Euro area GDP to stimulate growth; (ii) delegate supervisory and resolution authority of banks to a federal authority, involving the ECB; (iii) allow the ESM to inject capital directly into banks once the common resolution regime is in place; (iv) assist in recapitalizing the Spanish banks (for which up to EUR100bn had been already committed) through the EFSF, and subsequently through the ESM, on a pari passu basis with existing bondholders; and (v) re-examine the Irish financial aid package with respect to the support to banks presumably along similar lines as those taken for Spain.
The growth measures had been already widely expected, and most of the other initiatives will become operational only over the coming months. Disagreements on technical elements and delays can always emerge along the way. The ESM Treaty, for example, will have to be amended to allow for the possibility of recapitalizing banks directly. However, the political commitment to break the link between sovereign and bank balance sheets has been established and to our eyes this is very important. Funds to assist Spanish banks will be provided initially as a loan to the FROB. It is likely that banks that have received the funds will in the future be able to convert them into preferred stocks. On balance, the measures are supportive for Spain and Ireland, and in our view justify the rally in sovereign bonds and bank stocks this morning.
The European negotiations continue today. The remaining issues on the table are politically intensive and involve a further integration of fiscal sovereignty against the partial mutualisation of existing liabilities. This part of the discussion is related to the draft legislation known as the Two-Pack, recently approved by the European Parliament. Depending on the outcome of the discussions, short-term measures to stabilize financial markets may be announced. According to the statement last night, the authorities intend to make use of the existing EFSF/ESM instruments in ‘a flexible and efficient manner’ to stabilize government bond markets, with the ECB acting as agent in the case of secondary market activity. The involvement of the ECB’s balance sheet at this stage has not been mentioned.
As we discussed in the latest issue of the Fixed Income Monthly, market expectations were very low heading into the Summit, below our economists’ conservative views. Our sense is that active risk-taking is still low, and we think that an extension of a bull steepening rally in peripheral bond markets can occur. We would now crystallize our view by being long an equally-weighted basket of benchmark 5-year Spanish, Irish and Italian government bonds, currently yielding 6% on average, for a target of 4.5% and a tight stop loss on a close at 6.5%.
2. The Bill, Please
We provide a summary of the costs of the financial crisis and the resources behind some of the policy measures taken. We focus on some of the Euro area countries, the US and the UK. The data should help reflect some of the most frequent questions we receive on topics such as: (1) what has country “x” done to improve its imbalances? (2) how much has the crisis cost? and (3) how much ‘burden sharing’ and solidarity has there been among the Euro area countries?
3. Output costs
Output costs have been not significantly dissimilar across the aggregate Euro area, the UK and the US. Output losses (measured as the cumulative sum of the differences between actual and trend real GDP in the three years since the beginning of the crisis, as a percentage of trend real GDP) have been 31% in the US, 25% in the UK and 23% in the Euro area. Within the Euro area, however, the dispersion has been substantial. Output losses have been 11% in Germany, 23% in France, 32% in Italy, 37% in Portugal, 39% in Spain, 43% in Greece and a stunning 106% in Ireland.
4. Fiscal costs to restructure the financial sector
Gross fiscal outlays related to the restructuring of the financial sector (including costs associated with bank recapitalizations, but excluding asset purchases and direct liquidity assistance measures from the Treasury) have been 4.5% of GDP in the US, 8.8% in the UK and 3.9% in the Euro area. Within the Euro area such costs have been 0.3% in Italy, 1% in France, 1.8% in Germany, 3.8% in Spain, 27.3% in Greece and 40.7% in Ireland. Central Banks’ balance sheets expanded significantly. Total assets held by the Fed as a share of GDP increased from 6.3% in August 2008 to 18.6% in May 2012. Over the same period, ECB’s assets/GDP increased from 15.6% to 31.6% and the BOE’s assets/GDP went from 6.6% to 23.4%.
5. Fiscal imbalances
From 2009 to 2011, the improvement in the primary (net of interest) budget balance to GDP ratio has been 1.8% in Italy, 2.2% in Germany, 2.3% in Ireland, 2.6% in France, 3.3% in Spain, 6.9% in Portugal, and 8.4% in Greece. By comparison, the primary balance to GDP ratio improved by 4.4% in the UK and 3.9% in the US, although from a weaker level than across the Euro area. According to IMF projections, the additional improvement in the primary balance from 2011 to 2012 will be 0.3% in Germany, 0.7% in France, 1.3% in Greece, 2.2% in Italy, 2.3% in Ireland, 0.3% in Portugal, and 3.0% in Spain, compared to 1.2% in the US and 0.5% in the UK. Even though debt levels are still elevated, the size of the fiscal consolidation implemented in many European countries has been quite remarkable and larger than the actual change in the primary balance. Controlling for the weak business cycle, the improvements in structural public balances in peripheral Europe have been impressive.
6. External imbalances and competitive indicators
The current account position as a share of GDP deteriorated between 2009 and 2011 in Germany (-0.2%), France (-0.7%), Italy (-1.1%), the US (-0.4%) and the UK (-0.4%). It improved in Spain (+1.5%), Greece (1.3%), Ireland (+3%), and Portugal (4.5%). Relative unit labour costs in the manufacturing sector, one of the competitiveness indicators produced by the OECD, show a decrease in costs by 1.5% in France, 7% in Germany, 9% in Spain, 24% in Ireland and 13% in the US. Costs increased by 3% in Italy and 8% in the UK between 2008 and 2011. Southern European countries certainly need to take further steps to improve their competitiveness positions. The conditionality associated with financial aid, and the limitations of sovereignty on public finances as part of the evolving Euro area governance architecture, can support this adjustment.
7. Structural reforms
A summary statistic does not exist to quantify structural reforms countries have taken. Moreover, institutional features of structural reforms differ widely across countries. But, Italy, Spain, Greece, and Ireland have all passed pension reforms. Labour market reforms that reduced firing and hiring restrictions and that reduced wages or tended to make wages more competitive and negotiable at the firm level have been passed in Italy, Spain, Greece and Portugal. Reforms that liberalized the goods market have been passed in Italy and Greece. Italy and Spain introduced debt-brake rules into their Constitutions. As our European economists have discussed in many reports, although Southern European countries have started to deregulate labour and product markets, the journey is just beginning.
8. Costs of the Troika’s programs
So far, the contributions paid to Greece, Ireland and Portugal as part of the financial assistance programs have been split as follows among Germany, France, Italy and Spain. These are the sum of bilateral loans and commitments to the EFSF.
Germany has disbursed a total of EUR54bn: EUR3.5bn to Ireland, EUR4.3bn to Portugal and EUR46.7bn for Greece, of which EUR15.4bn is in the form of a bilateral loan.
France has disbursed a total of EUR41bn: EUR2.6bn to Ireland, EUR3.2bn to Portugal and EUR35.1bn for Greece, of which EUR11.5bn is in the form of a bilateral loan.
Italy has disbursed a total of EUR36bn: EUR.3bn to Ireland, EUR2.8bn to Portugal and EUR30.8bn for Greece, of which EUR10.1bn is in the form of a bilateral loan.
Spain has disbursed a total of EUR23.9bn: EUR1.5bn to Ireland, EUR1.9bn to Portugal and EUR20.5bn for Greece, of which EUR6.7bn is in the form of a bilateral loan.
Italy and Spain have jointly contributed as much as Germany to the financial assistance programs.
9. Foreign banks’ exposure to Greece, Portugal and Ireland
Between Q12010 and Q42011, banks reporting to the BIS reduced their exposure to the public sector and to banks of Greece, Portugal and Ireland by the following amounts (source: BIS)
- German banks: a total of EUR52bn (or 96% of the bail-out funds disbursed so far)
- French banks: a total of EUR48bn (or 118% of the bail-out funds disbursed so far)
- Italian banks: a total of EUR5bn (or 15% of the bail-out funds disbursed so far)
- Spanish banks: a total of EUR7bn (or 30% of the bail-out funds disbursed so far)
- US banks: a total of EUR16bn
- Spanish banks: a total of EUR32bn
The financial assistance packages to Greece, Ireland and Portugal allowed a sizable reduction of the private sector exposure and a migration of liabilities from the private sector balance sheet to the official sector one. In the case of Greece, the committed amount of financial aid is EUR253bn, equal to 84% of the EUR300bn stock of Greek general government debt in 2009. Italian and Spanish banks reduced their exposure to Greece for a total amount of EUR3.2bn, while French and German banks reduced by EUR 39bn. These were about 5% and 48% of the funds the respective governments committed to Greece.