Rating Agencies

A few weeks ago, some of the more naive media elements reported that Greece has "all the cards" in its negotiations with private creditors, a topic we had the pleasure of deconstructing in its entirety to its constituent flaws? Well, a day ahead of the February 15 Eurozone meeting at which Greece's fate is finally supposed to be settled, things appear to be quite amiss. As a reminder, a critical part of the Greek debt deal is the private sector's agreement to roll over existing holdings into new bonds, which as we learned may now see the 15 cent per bond sweetener into new EFSF debt reduced. According to the Handelsblatt, that is now off the table. Dow Jones summarizes: "Some central bankers expect that Greece will fail to enlist enough private investors in a voluntary debt restructuring to avoid a technical default, a German newspaper reported Tuesday.  Greece is likely to make its case for a voluntary debt swap after a meeting of euro group finance ministers Wednesday, the Handelsblatt newspaper says. The Greek government is seeking to lower its burden by EUR100 billion. Handelsblatt cites unnamed central bank sources as saying the country will fail to achieve that goal, leaving the government little choice but to make the write-down mandatory for investors holding out. Requiring investors to take a loss would prompt credit rating agencies to declare a debt default for Greece, an event with unforeseeable consequences for financial markets. The report doesn't specify whether its sources are with the European Central Bank or with the German Bundesbank. Neither bank would comment early Tuesday." Which of course is not news: after all even the rating agencies have long warned a Greek default is now inevitable, and a CDS trigger will follow. The only thing that there is massive confusion over is whether and how this event will impact everyone else, and whether it will lead to an explusion of Greece from the Eurozone. Optimism is that it is all priced in. So was Lehman.

You know there is a reason why Europe just came crawling with an advance handout looking for US assistance: Moody's just went apeshit on Europe.

• Austria: outlook on Aaa rating changed to negative
• France: outlook on Aaa rating changed to negative
• Italy: downgraded to A3 from A2, negative outlook
• Malta: downgraded to A3 from A2, negative outlook
• Portugal: downgraded to Ba3 from Ba2, negative outlook
• Slovakia: downgraded to A2 from A1, negative outlook
• Slovenia: downgraded to A2 from A1, negative outlook
• Spain: downgraded to A3 from A1, negative outlook
• United Kingdom: outlook on Aaa rating changed to negative

In other news, we wouldn't want to be the company that insured Moody's Milan offices.

S&P just downgraded 34 of the 37 Italian banks it covers. Below is the full statement. And so get get one second closer to midnight for Europe's AIG equivalent: A&G. As for S&P, this is the funniest bit: "We classify the Italian government as "supportive" toward its banking sector. We recognize the government's record of providing support to the banking system in times of stress." Even rating agencies now have to rely on sovereign risk transfer as the only upside case to their reports. Oh, and who just went balls to the wall Italian stocks? Why the oldest (no pun intended) contrarian indicator in the book - none other than permawrong Notorious (Barton) B.I.G.G.S.

Since the start of the year, global markets have been apparently buoyed by the understanding that Draghi's shift of the ECB to lender-of-last-and-first-resort via the LTRO has removed a significant tail on the risk spectrum with regard to Euro-banks and slowed the potential for contagious transmission of any further sovereign stress. In fact the rally started earlier on the backs of improved perceptions of US growth (decoupling), better tone in global PMIs, and potential for easing in China and the EMs but it does seem that for now the ECB's liquidity spigot rules markets as even in the face of Greek uncertainty, as George Magnus of UBS notes, 'financial markets are most likely to defer to the ECB's monetary policy largesse' as a solution. Both Magnus and his firm's banking team, however, are unequivocal in their view that the next LTRO will unlikely be the last (how many temporary exceptions are still in place around the world?) and as we noted earlier this morning, banks' managements may indeed not be so quick to gorge on the pipe of freshly collateralized loans this time (as markets will eventually reprice a bank that holds huge size carry trades at an inappropriate risk-weighting) leaving the stigma of LTRO borrowing (for carry trades, substitution for private-sector funding, or buying liquidity insurance) as a mark of differentiable concern as opposed to a rising tide lifts all boats as valuations reach extremes relative to 'broken' business models, falling deposits, and declining earnings power.

They expect a EUR300bn take up of the next LTRO, somewhat larger than the previous EUR200bn add-on - but not hugely so - as the banks face a far different picture (in terms of carry profitability) and yet-to-be-proven transmission to real-economy credit-creation that will make any efforts at a fiscal compact harder and harder to implement as its self-defeating austerity leave debtor countries out in the cold. The critical point is that unless the market believes there will be an endless number of future LTROs, covering the very forward-looking private funding markets for banks, then macro- and event-risk will reappear and volatility will flare.

A lot of stuff in here this morning.

A few days after Germany proposed the stripping of Greek fiscal authority from the insolvent country, in exchange for providing funding for what German FinMin Schauble called today a "bottomless pit" (and Brüderle chimed in saying that "a default of the Greek government would be bitter but manageable), Sarkozy decided to demonstrate his "muscle" if not so much stature, and openly denied Germany, saying "There can be no question of putting any country under tutelage." Sure enough, it was now Germany's turn to reciprocate the favor. According to Bloomberg, "Finance ministers from the four euro- area countries with AAA ratings -- Germany, Finland, Luxembourg and the Netherlands -- will meet in Berlin tomorrow afternoon, a German Finance Ministry spokesman said." And as is well known, FrAAnce no longer a member of this, however meaningless, club. "The gathering is part of a a series of meetings convened by officials from the highest-rated euro states, the spokesman said, speaking on the customary condition of anonymity. Ministers will discuss current issues without briefing reporters after the meeting." And so the gauntlet of public humiliation is now once again back in Sarkozy's court. The good news: if the de minimis Frenchman does not get his act in order, and overturn the massive lead that his challenger in the April presidential elections has garnered, he will need to endure the humiliation for at most 3 more months. In other news, it appears that when it comes to saving political face, the rating agencies are actually quite useful.

Was the Chapter 11 Petition of MF Global Holdings filed fraudulently?

You're about to hear a big boom come from across the Atlantic, but I've yet to hear a peep from the rating agencies. And many of you guys think they were delinquent during the other credit bubble!!!????

Ever want to know what a documentary that spits the truth about the rating agency scam and overall Ponzi would look like if it actually aired on international TV???

Humans are a flawed species. Our minds are easily manipulated. We don’t like pain. We prefer instant gratification. We are susceptible to mass delusion. We will often choose hope over critical thought. Those with higher IQs will regularly attempt to take advantage of those with lower IQs. Fear and greed are the two motivations used by the minority in power to control and manipulate the majority. The American people have been led astray by a small group of powerful men. We were herded through a door in the wall of perception that promised an American dream of material goods, entitlements and pleasure with no obligations or responsibility to future generations. There is only one choice that can save this country from ruin. Each individual must make a choice to either to continue supporting the manipulative, corrupt status quo or coming back through the Door in the Wall.

“The man who comes back through the Door in the Wall will never be quite the same as the man who went out. He will be wiser but less sure, happier but less self-satisfied, humbler in acknowledging his ignorance yet better equipped to understand the relationship of words to things, of systematic reasoning to the unfathomable mystery which it tries, forever vainly, to comprehend” – Aldous Huxley

All you need to read.

Nowhere in S&P’s statement about “global economic and financial crisis”, did it clarify that sovereigns were hit due to backing their largest national banks (and international, US ones) which engaged in half a decade of leveraged speculation. But here’s how it worked: 1) Big banks funneled speculative capital, and their own, into local areas, using real estate and other collateral as fodder for securitized deals with derivative touches. 2) They lost money on these bets, and on the borrowing incurred to leverage them. 3) The losses ate their capital. 4) The capital markets soured against them in mutual bank distrust so they couldn’t raise more money to cover their bets as before. 5) So, their borrowing costs rose which made it more difficult for them to back their bets or purchase their own government’s debt. 6) This decreased demand for government debt, which drove up the cost of that debt, which transformed into additional country expenses. 7) Countries had to turn to bailouts to keep banks happy and plush with enough capital. 8) In return for bailouts and cheap lending, governments sacrificed citizens. 9) As citizens lost jobs and countries lost assets to subsidize the international speculation wave, their economies weakened further. 10) S&P (and every political leader) downplayed this chain of events.... The die has been cast. Central entities like the Fed, ECB, and IMF perpetuate strategies that further undermine economies, through emergency loan facilities and  bailouts, with rating agency downgrades spurring them on. Governments attempt to raise money at harsher terms PLUS repay the bailouts that caused those terms to be higher. Banks hoard cheap money which doesn’t help populations, exacerbating the damaging economic effects. Unfortunately, this won't end any time soon.

The Greek PSI is once again (still) hitting the headlines. Here is what we think the most likely scenario is (80% likelihood). Some form of an agreement will be announced.  The IIF will announce that the “creditor committee has agreed in principle to a plan.”  That plan will need to be “formalized” and final agreement from the individual institutions on the committee and those that weren’t part of the committee will need to be obtained.  The headline will sound good, but will leave a month or so for details to come out.  In the meantime every European and EU leader (or employee) with a press contact will say what a great deal it is.  That it confirms that Europe is on the path of progress and that they are doing what they committed to at their summits. That will be the hype that will drive the market higher (or in fact has already done so). However, the reality (as we noted earlier in Einhorn's market madness chart) is that this still leaves hedge funds to acquiesce (unlikely) and furthermore focus will switch to Greece's actual debt sustaianability post-default (yes the d-word) and as we are seeing recently, Portugal will come into very sharp focus. If they cannot bribe and blackmail and threaten their way into something they call PSI, then we will see Greece stop making payments, and then the markets will get very ugly in a hurry.

While his diagnosis of the balance sheet recessionary outbreak that is sweeping global economies (including China now he fears) is a useful framework for understanding ZIRP's (and monetary stimulus broadly) general inability to create a sustainable recovery, his one-size-fits-all government-borrow-and-spend to infinity (fiscal deficits during balance sheet recessions are good deficits) solution is perhaps becoming (just as he said it would) politically impossible to implement. In his latest missive, the Nomura economist does not hold back with the blame-bazooka for the mess we are in and face in 2012. Initially criticizing US and now European bankers and politicians for not recognizing the balance sheet recession, Koo takes to task the ECB and European governments (for implementing LTRO which simply papers over the cracks without solving the underlying problem of the real economy suggesting bank capital injections should be implemented immediately), then unloads on the EBA's 9% Tier 1 capital by June 2012 decision, and ends with a significant dressing-down of the Western ratings agencies (and their 'ignorance of economic realities'). While believing that Greece is the lone profligate nation in Europe, he concludes that Germany should spend-it-or-send-it (to the EFSF) as capital flight flows end up at Berlin's gates. Given he had the holidays to unwind, we sense a growing level of frustration in the thoughtful economist's calm demeanor as he realizes his prescription is being ignored (for better or worse) and what this means for a global economy (facing deflationary deleveraging and debt minimization) - "It appears as though the world economy will remain under the spell of the housing bubble collapse that began in 2007 for some time yet" and it will be a "miracle if Europe does not experience a full-blown credit contraction."

As the buy-the-ratings-downgrade-news surge on European sovereigns stalls (following a few weeks of sell-the-rumor on France for example), the ever-ready-to-comment mainstream media remains convinced that the impact is priced in and that ratings agencies are increasingly irrelevant. UBS disagrees. In a note today from their global macro team, they recognize that while the downgrades were hardly a surprise to anyone (with size of downgrade the only real unknown), the effect on 'AAA-only' constrained portfolios is important (no matter how hard politicians try to change the rules) but of more concern is the political impact as the divergence between France's rating (and outlook) and Germany (and UK perhaps) highlights harsh economic realities and increases (as EFSF spreads widen further) the bargaining power of Germany in the economic councils of Europe. Furthermore, the potential for closer relationships with the UK (still AAA-rated) increase as the number of AAA EU nations within the Euro only just trumps the number outside of the single currency. This may be one of those rare occasions where politics is more important than economics.