The Great Debate UK

Hungary: The Greece of Eastern Europe

By Kathleen Brooks. The opinions expressed are her own.

It used to be Greece that was the canary in the coal mine, these days it’s Hungary. The new year got off to a bad start for the Eastern European nation after it experienced a failed bond auction, causing its bond yields to surge.

This caused major jitters across global financial markets and once again a small, relatively unknown economy is dominating the headlines and causing a massive headache for the European authorities.

But while there are many similarities, the reasons for the panic in Hungary’s debt markets are different from Greece’s problems. Athens borrowed too much and public spending spiralled out of control. However, Hungary’s problems were not based on the size of its budget deficit, which was a fairly manageable 4.2 percent of GDP at the end of 2010, but the amount of debt in its public and private sector that was denominated in foreign-currency.

While the post-Communist era in Hungary helped to modernise the state, its capital markets did not keep up to date. Borrowing costs were lower in the euro zone and other parts of Europe where banks were willing to lend relatively cheaply across the Eastern European bloc, especially to Hungary. While the Hungarian forint was strong it was fine to have liabilities in euro and Swiss franc, however, since the start of 2011 the forint has deteriorated at a rapid pace. Since August alone the forint has lost more than 17 percent of its value against the euro.

Here is the problem: when your liabilities are in euro but you earn forint, all of a sudden servicing your debts becomes much more expensive and bad debts start to rise.

That’s where the similarities with Greece start. If bad debts start to rise then Austria and Italy could be on the hook. Austrian banks hold a whopping $40 billion of Hungarian liabilities, while Italian banks have a slightly more manageable $20 billion.

Why is the West bankrupt?

By Laurence Copeland. The opinions expressed are his own.

The UK, USA, the PIIGS (Ireland and Italy are together in the same stye), France is in poor fiscal shape  – OK, Germany is ostensibly living within its means, but it looks a lot less solvent when you remember that it has underwritten the rest of the euro zone (in large part, to protect its own irresponsible banks). In any case, as I have argued in previous blogs, this or a future German Government is likely to cave in to the pressure from its own electorate and from inflationist economists at home and abroad to join the party and spend, spend, spend. Only Australia and Canada, riding high on the commodities price boom, and a handful of small countries, look stable.

Where will it all end?

With inflation, almost certainly, but beyond that, it is hard to say. However, there is one prediction I would offer for the medium to long term outcome, and it applies not only to the euro zone, but to Britain and America too – in fact to the whole of the comfortable, complacent industrialised world – and it is this.

We are living through the death throes of an ideal, a dream which has turned into a nightmare – it is the end of the social democratic welfare model.

I am referring to the whole panoply of benefits (entitlements, as they are called in America), labour market regulations (employment protection, minimum wage legislation, limits on the length of the working week etc. etc.) and other social democratic devices intended to inflate like airbags to protect us all from shocks from any possible direction. The whole edifice built up in Western countries to shelter us from the need to earn a living is now clearly unsustainable. We can no longer afford a regime which allowed, indeed encouraged us to live permanently beyond our means both as individuals and as a society.

Two aspects of the current crisis make this apparent. First, and most obviously, we are all more or less like Greece – our debts may be proportionately smaller, but they are still crippling. Our pensions regime may be less egregiously wasteful than Greece’s, but they are still more generous than we can afford. As for healthcare and care for the aged, they are a crippling burden and demographic pressures will make them impossible for any country to sustain at anything like present levels.

Trichet’s United States of Europe?

By Kathleen Brooks. The opinions expressed are her own.

Another week another round of EU officials proposing solutions to the Greek insolvency problem.

First there was the President of the European Council Jean Claude Juncker who suggested that bond holders could be tempted into rolling over their maturing debt and buying more Greek bonds as long as a few sweeteners like higher coupon or interest rates were thrown in.

But while this will plug short-term financing needs it is still only adding more debt to Greece’s enormous debt pile and not dealing with the core problem:  the financial malaise at the heart of the euro zone that allowed Greece to get away with a flagrant breach of fiscal rules for years.

It came down to Jean-Claude Trichet, whose tenure as President of the European Central Bank (ECB) comes to an end in October, to suggest a long-term solution that would hopefully avoid another debt crisis, but would also require a degree of economic centrality never imagined by the euro zone’s founding fathers.

His idea is for a euro zone-wide Ministry of Finance that would have three critical powers. Firstly, it would be in charge of ensuring adherence to fiscal and competitiveness policies, secondly, it would control the region’s financial sector and thirdly it would centralise representation of the currency bloc in international financial institutions like the International Monetary Fund (IMF). “Would it be too bold?” the Frenchman shrugged as he spoke of his dream at a ceremony in Germany where he picked up the highly coveted Karlspreis.

While Trichet didn’t go as far as to suggest his ministry should control state budgets or issue debt, it is still an extremely interesting idea that – if implemented – could re-invigorate the currency bloc.  Firstly, fiscal integration is often considered the missing piece of the united Europe puzzle. Without actually controlling states’ revenues and expenditure directly, Trichet’s plan would give the EU direct powers to alter the course of national economic policy. For example the central ministry would have if it thought they could jeopardise the financial health of the member.

from Breakingviews:

Four events Spain doesn’t want to happen

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

LONDON -- Spain is feeling the heat in the debt markets. Fears of contagion explain why it paid a much higher yield on short-term treasury bills than the same issue from last month. The country may avoid a debt crisis if it stays its course. But an unexpected event throwing doubt on the true state of the country's finances could precipitate the mother of all bailouts. Here are four of the unpleasant surprises that could trigger a meltdown.

* A Spanish lender in dire straits. One of the most pressing problems for Spanish banks is access to long-term funding. Spanish lenders lend more than they gather in deposits, which makes them dependent on wholesale financing. True, banks and savings banks have sharply reduced dependence on the European Central Bank since the peak in July, thanks to improved access to the short-term repo market. But only the larger lenders have been able to borrow in the longer-term wholesale funding after the publication of the stress tests. A large number of the cajas, the savings banks, have been shut out, and the system as a whole faces massive refinancing needs in the next two years. Some institutions have already exhausted their allotment of state guarantees for senior debt. The brutal deposit war is a sign that Spanish banks are worried about their reliance on wholesale markets.

* A big region going bust. The state of Spanish regional and municipal finance remains a serious source of worry. Madrid, for example, is months behind on its bills, and the central government has so far rejected the mayor's pleas for further debt funding. Catalonia recently issued a one-year bond to retail bank clients. Some economists believe regions could improve access to markets with more transparency. But an unexpected hole leading to a regional insolvency could trigger markets panic.

* Any whiff of wavering in the government's commitment to structural reform: Spain found it hard to come up with a credible turnaround plan, including the beginning of structural reforms that might favour growth. Any hesitation, particularly on pensions financing, wouldn't go down well with the markets.

* A severe economic slowdown. The government will have to make more budget adjustments next year if its optimistic growth assumptions fall short, as looks likely. But Spain couldn't afford a serious slump, if the global economy were to stall, or if new unpleasant surprises were on the horizon.

from The Great Debate:

Europe’s speculator full Employment Act

Far from setting a trap for the "wolfpack," Europe's $1 trillion bailout package amounts to a full employment act for speculators, or should that be the reality-based community, for the foreseeable future.

Hoping to tame markets it accused of "wolfpack behavior," the European Union on Monday unveiled a 750 billion euro package intended to avert a rolling sovereign debt crisis that has engulfed Greece and threatens to spread widely among the weaker euro zone countries.

The package can't be blamed for being too simple: it contains loans from the International Monetary Fund, an EU emergency fund and euro zone governments, as well as an interesting undertaking by the European Central Bank to buy bonds in order to restore liquidity to supposedly poorly functioning parts of the bond market. In a move straight out of a Russian fairy tale, Spain and Italy, to name just two, are pledging money towards a package that may well be used to bail themselves out. Maybe they should have put up even more money.

Once again, those in power look at a solvency issue and pronounce gravely that is a matter of mere liquidity.

Well, it isn't.

That move worked, at least for the time being, when the United States bailed out its banks, but the U.S. was able to create easy conditions in which its banks could earn their way out of the hole. Rather than create easy conditions, this bailout imposes tougher ones. Greece, Spain and Portugal will face even greater austerity as a result of budget cuts, austerity that will make it even tougher for them to earn their way out.

The plan was greeted with joy on financial markets, with bonds and stocks rallying sharply, but the rally had the feel not of speculators heading for the hills but of children learning how to push their parents' buttons more effectively.

from MacroScope:

Brit Euro Shock Horror: Part II

A week ago we ran a post on MacroScope noting, in part, that Britons have a strange relationship with the euro, sometimes bordering on disbelief that it exists at all. Some new numbers from the monthly Bank of America Merrill Lynch fund managers poll underline the extent of UK scepticism compared with that of others.

For two months, BofA Merrill has asked fund managers around the world what they think will eventually happen as a result of the Greek debt crisis. Four choices are on offer:

1) The Greeks will sort it out themselves

2) The European Union will bail Greece out

3)  Greece will default or restructure in an orderly manner and remain in the euro zone

4) Greece will default in a disorderly manner and exit the euro zone

Guess which region's/country's  fund managers have been most likely to predict that Greece will leave the euro zone. You're right -- Britain.

Globally, the March poll shows 24 percent of respondents reckoning Greece will handle the debt problem itself , 52 percent seeing an EU bailout and 19 percent betting on an orderly restructuring. Only 2 percent predict default and euro zone exit.

Among British fund managers, however, 11 percent reckoned Greece was headed out of the euro zone. Back in February, this number was  22 percent. No other region/country comes close. No U.S. fund managers, for example, voted for the exit outcome.

It begs the question whether British investors and analysts know something that others do not. Or perhaps they are being influenced by decades of political and media scepticism. If the latter, is there not a danger of making the wrong financial decisions?

from The Great Debate:

Dubai not a canary but another miner needing oxygen

- James Saft is a Reuters columnist. The opinions expressed are his own - Taken all in all, Dubai's debt crisis is the most significant financial development of 2007. Here in late 2009 it amounts to far less. Back in the day it would have been a newsflash that apartments ultimately require occupants, that investment needs to be ratified by cash flows, and that debt, Sharia-compliant or garden variety, someday must be repaid. Dubai's difficulties are being sold as the commercial real estate debacle somehow morphing into a sovereign debt crisis and it is true that the effective borrowing rates of the more raddled national borrowers such as Ireland have been driven up in recent days. Dubai's government said on Monday that it is not responsible for the borrowings of Dubai World, a state-controlled development conglomerate saddled with huge debts amid a property market where the going rate has halved. Dubai last week applied for, or imposed depending on your point of view, a six-month repayment freeze for Dubai World and its property developer Nakheel. "Creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct," said Abdulrahman Saleh, director general of Dubai's department of finance. Quite, and hopes that credit extended to Dubai World would be made good by the state of Dubai or by the richer emirate of Abu Dhabi seem to be foundering. This is bad news for those creditors, with the worst potential losses traceable to banks in Britain and Europe, but its probably just not that big of a deal. For one thing, the amount potentially at issue, even if you allow for an extra 50 percent off balance sheet taking it to circa $125 billion, is simply not big enough in the scale of things to tip significant players over the edge. And it tells us very little about the state of the world or the likely outlook for real estate. It is very hard to call something a canary in the coal mine when you are already cleaning up after a mining disaster. For a time the magical thinking behind Dubai, "build it and they will come", worked and despite it being remote, having an inhospitable climate and little inherent commercial reason for existing, the city boomed. It's a bit like having a feast so the harvest will be good rather than when it actually is, but it was effective for a time as prices rose and investment was attracted. DUBAI WORLD MEETS MORAL HAZARD WORLD The nub of the meme in financial markets is that this is about sovereign exposure and that creditors will be shocked if the state support they thought they had coming never arises. But is it terribly bad news for the rest of us? Probably not. Investors should have seen it coming - there have been quite a few headlines recently about the real estate crash-  and should not have conflated "implicit" with "explicit". Dubai has made clear in its own bond prospectuses that it might lend support but that it was under no obligation to do so. Teaching investors the difference between "quasi-state" and "state" is a good thing. So why then did the cost of borrowing for Greece and Ireland, as expressed in insurance contracts against default, go up? Nothing about Dubai's predicament will have much of an impact on Irish or Greek tax revenues clearly, and the banks and the pool of lendable capital has not been diminished by much. Nor is it easy to draw a new connection between Dubai and the emerging European countries which represent a muchmore substantial and potentially grave threat to banks in Europe. Perhaps this is ultimately about moral hazard - risk taking under the belief that you are "insured" -  as are all stories involving the words "quasi," "government," and "debt." Fannie Mae and Freddie Mac's quasi-government status fed moral-hazard driven risk taking, as did Dubai World's, as is most certainly the case where government insurance allows for cheap borrowing. Markets went down on Dubai because they have become addicted to moral hazard and anything that doesn't conform with the idea that all shall be bailed out is scary. It is apparently terrifying that a government should say "hard luck" to anyone anywhere, no matter how difficult the government's situation is or how ill-founded the investors claim to relief. None of this is to say that the commercial real estate crash isn't terrifying, or that countries like Ireland and Greece don't face difficult times and huge risks, but only that Dubai tells us little new about those things. There is definitely a moral hazard trade out there, but Dubai is not the event which will cause it to unwind.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.)

from The Great Debate:

Dubai not a canary but another miner needing oxygen

- James Saft is a Reuters columnist. The opinions expressed are his own - Taken all in all, Dubai's debt crisis is the most significant financial development of 2007. Here in late 2009 it amounts to far less. Back in the day it would have been a newsflash that apartments ultimately require occupants, that investment needs to be ratified by cash flows, and that debt, Sharia-compliant or garden variety, someday must be repaid. Dubai's difficulties are being sold as the commercial real estate debacle somehow morphing into a sovereign debt crisis and it is true that the effective borrowing rates of the more raddled national borrowers such as Ireland have been driven up in recent days. Dubai's government said on Monday that it is not responsible for the borrowings of Dubai World, a state-controlled development conglomerate saddled with huge debts amid a property market where the going rate has halved. Dubai last week applied for, or imposed depending on your point of view, a six-month repayment freeze for Dubai World and its property developer Nakheel. "Creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct," said Abdulrahman Saleh, director general of Dubai's department of finance. Quite, and hopes that credit extended to Dubai World would be made good by the state of Dubai or by the richer emirate of Abu Dhabi seem to be foundering. This is bad news for those creditors, with the worst potential losses traceable to banks in Britain and Europe, but its probably just not that big of a deal. For one thing, the amount potentially at issue, even if you allow for an extra 50 percent off balance sheet taking it to circa $125 billion, is simply not big enough in the scale of things to tip significant players over the edge. And it tells us very little about the state of the world or the likely outlook for real estate. It is very hard to call something a canary in the coal mine when you are already cleaning up after a mining disaster. For a time the magical thinking behind Dubai, "build it and they will come", worked and despite it being remote, having an inhospitable climate and little inherent commercial reason for existing, the city boomed. It's a bit like having a feast so the harvest will be good rather than when it actually is, but it was effective for a time as prices rose and investment was attracted. DUBAI WORLD MEETS MORAL HAZARD WORLD The nub of the meme in financial markets is that this is about sovereign exposure and that creditors will be shocked if the state support they thought they had coming never arises. But is it terribly bad news for the rest of us? Probably not. Investors should have seen it coming - there have been quite a few headlines recently about the real estate crash-  and should not have conflated "implicit" with "explicit". Dubai has made clear in its own bond prospectuses that it might lend support but that it was under no obligation to do so. Teaching investors the difference between "quasi-state" and "state" is a good thing. So why then did the cost of borrowing for Greece and Ireland, as expressed in insurance contracts against default, go up? Nothing about Dubai's predicament will have much of an impact on Irish or Greek tax revenues clearly, and the banks and the pool of lendable capital has not been diminished by much. Nor is it easy to draw a new connection between Dubai and the emerging European countries which represent a muchmore substantial and potentially grave threat to banks in Europe. Perhaps this is ultimately about moral hazard - risk taking under the belief that you are "insured" -  as are all stories involving the words "quasi," "government," and "debt." Fannie Mae and Freddie Mac's quasi-government status fed moral-hazard driven risk taking, as did Dubai World's, as is most certainly the case where government insurance allows for cheap borrowing. Markets went down on Dubai because they have become addicted to moral hazard and anything that doesn't conform with the idea that all shall be bailed out is scary. It is apparently terrifying that a government should say "hard luck" to anyone anywhere, no matter how difficult the government's situation is or how ill-founded the investors claim to relief. None of this is to say that the commercial real estate crash isn't terrifying, or that countries like Ireland and Greece don't face difficult times and huge risks, but only that Dubai tells us little new about those things. There is definitely a moral hazard trade out there, but Dubai is not the event which will cause it to unwind.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.)