By Peter Tchir of TF Market Analytics
Austerity - Mais, non. Spending - Nein. PSI - Tal Vez?
Austerity hasn’t worked for countries. So far the austerity path has made situations worse, rather than better. Without stimulus, economies have seen their problems compound. So now virtually everyone is against the idea that austerity is helpful.
That takes us back to spending. Maybe it’s just me, but spending is what got us into this mess in the first place. If spending worked so well and was so easy we wouldn’t have a sovereign debt crisis in the first place. Virtually every country was spending, yet deficits grew and economies shrank. Why is there any faith that spending now will work? Are we so good at targeting specific things that will really, truly, work? Not a chance. Spending will ensure debt grows just as fast, make the problem even bigger in the end, but will make people slightly happier in the near term.
So if austerity doesn’t work, and spending hasn’t worked, what will?
PSI, or Default, or Restructuring.
Debts have grown so big, that the only way to bring them under control is to default on them in one form or another and wipe some out permanently. Doing it sooner than later is key.
Now is the time. Portugal 75% haircut. Ireland 50%. Spain 40% haircut (once they put all the Spanish guaranteed debt on balance sheet, they will need 40%). Italy 25%. Greece – just make EU and ECB eat the same dish they served to public sector. Only IMF money is sacrosanct. The ECB, EFSF, and EU can take losses like the rest of us. The EU talks about “firewalls”, well, put up or shut up. The ECB can print away the losses.
Using current data, here is the amount of debt at the sovereign level for each country (I think if they are going to do the restructuring, they should put on balance sheet a lot of the guaranteed debt, so they only have to do this once).
Portugal: €171 billion * 75% = €128 billion
Ireland: €122 billion * 50% = €61 billion
Spain: €712 billion * 40% = €285 billion
Italy: €1,631 billion * 25% = €408 billion
Total write-downs would be €882 billion.
A lot of banks have written down holdings in Portugal already and taken reserves on other countries. Greece shows that banks had done a semi decent job reserving against it. Let’s assume €100 billion of losses have been reserved against or already marked.
That leaves €772 billion of losses.
The ECB has about €175 billion of non Greek bonds on its SMP balance sheet (or a number close to that)? Assume an average loss of 40% on that (it is a mix of debt from the various countries). That is €70 billion accounted for. The ECB should just print that money. Call it a one-time exercise. With all the default/restructuring, inflation isn’t likely to be a concern.
So that leaves €702 billion still that needs to be taken out of the system.
Unicredit has an equity market cap of €23 billion. Intesa is about the same. Assgen (an insurance company, where the bond ticker is so much more fun than actual equity ticker) has a market cap of €19 billion. BBVA is €30 billion. DB is €35 billion.
The losses will be a massive hit to the banking and insurance industry. But to some extent, so what? The big “money center” banks will all survive it. The DB’s, SocGen’s, BNP’s, HSBC’s of the world will take some serious hits. US banks will take some hits. But they have plenty of equity capital to support it, and they made bad lending decisions.
The BBVA’s of the world will get hit extremely hard, but they should be able to survive it. I’m less sure about some of the Italian banks as they seem to have bigger concentrations, but in the end, there are a lot of banks.
So let the restructurings begin and figure out what to do with the banks after.
Many will survive without assistance.
Some banks may fail. If the ECB and EU and EFSF protect senior unsecured creditors from losses at the expense of equity and sub debt holders, then the risk of a banking death spiral goes away. How much needs to be protected and at what level is unclear. Some banks that were truly over exposed should see losses to bondholders too. Less losses for the public to bear and more losses for the bad decision makers to bear.
Provide “Warren Buffet” style equity capital to banks that want it or need it. Why shouldn’t the taxpayers make money like Warren does? Stop with the easy money for banks, make them pay the country like they would a private investor.
There has been ZERO evidence that bank share prices influence lending. It doesn’t seem to matter what we currently do to banks, they aren’t lending much. So let’s not worry about their share price. So long as they have access to money, they will or won’t lend regardless of whether their share prices are low.
Banks that are prepared and prudent will thrive in this environment.
Rather than making it hard to start new banks, the ECB and Fed should encourage new banks. There has to be 10’s of billions of Private Equity money that would start good mid-size banks. Heck, maybe we could get an i-Bank. But seriously, new money has been crowded out of the space by zombie banks and kick the can policies.
Take the hit. Figure out who excels, who fails, and for those in between, what is the cost of surviving. Open the markets to new equity capital and new participants.
Maybe this is too harsh and will never work, but it is a better path than pursuing the same policies that have failed year after year.