Italy Downgrade

As predicted in my post Sleepwalking into Disaster just two days ago, Italy has been downgraded by Standard & Poor’s today. It’s only a question of time before the remaining ratings agencies follow.

Italy and several other Eurozone countries are facing a credit rating monitoring starting this week. In my opinion, the outlook is negative. A ratings downgrade of Italy may be averted, but is unlikely. I forecast a 55-65% chance of a ratings downgrade. This will set off yet another financial firestorm, both in terms of bond yields of other at-risk countries, as well as in shares of banks exposed to Italy. Beware a run on France.

The market results will be immediate, and will likely lead to contagion in France by the end of the week. As quoted in the Financial Times: 

S&P cited Italy’s “weakening economic growth prospects” and the difficulty of the “fragile governing coalition” being able to “respond decisively” to the crisis.

“This is a downgrade of EU and Italian politicians,” said Sony Kapoor, head of Redefine, a Brussels-based economic think-tank. “The miserable failure of EU leaders to tackle the problems posed by Greece does little to inspire any confidence that the much larger and more urgent problems faced by Italy would be managed any better.”

Unless urgent measures are taken, including a radical expansion of EFSF and an explicit commitment that between the ECB and the EFSF, the Eurozone has at least EUR 2 trillion at its disposal to refinance its member states, the results are going to be dire as we move towards December 2011.

© Philip Ammerman

Navigator Consulting Group

www.navigator-consulting.com

Unreal

Watching Antonis Samaras’ speech at the Thessaloniki International Exhibition, the only word I could think of to describe his performance was “unreal.”

The entire speech sounded like an election campaign speech: lots of criticism, lots of promises, no real plan for the immediate future.

Some statements were simply absurd. Here’s one example:

Όταν ματαίωσε και τα μέτρα που είχε προγραμματίσει η προηγούμενη κυβέρνηση. Όταν συνέχισε να μοιράζει «παροχές»! Κι όλα αυτά στοίχησαν στον Προϋπολογισμό της χρονιάς εκείνης σχεδόν 10 δισεκατομμύρια! Τα 10 από τα 36 δισεκατομμύρια έλλειμμα του 2009 ήταν δημιούργημα του τελευταίου τρίμηνου!

Mr. Samaras claims that EUR 10 bln of the EUR 36 bln final deficit in 2009 was due to cancelled actions that the ND government “had planned,” and due to hand-outs. This statement ignores the fact that much of ND’s campaign promises in 2009 were based on cuts, which had not been implemented, let alone planned. They were campaign promises. It also ignores the fact that in the 6 years Prime Minister Karamanlis was in power, Greece’s deficit increased by at least EUR 143 bln. This is exclusively the responsibility of the ND government, of which Antonis Samaras was a minister.

Here’s another example:

Όμως, η ελληνική φύση δεν δίνει μόνο προϊόντα. Έχει και μοναδικές ομορφιές. Ο Τουρισμός είναι ήδη ένας από τους δύο «πρωταθλητές» μας. Αλλά μπορούμε πολύ περισσότερα....

Που είναι οι μαρίνες που έπρεπε να είχαμε εδώ και χρόνια; Που είναι τα θαλάσσια και υποθαλάσσια πάρκα; Που είναι τα οργανωμένα σκάφη που θα μπορούσαν να οργώνουν κατά χιλιάδες τις θάλασσές μας και να προσφέρουν μοναδικές υπηρεσίες σε προσιτές τιμές σε εκατοντάδες χιλιάδες επισκέπτες; Που είναι τα θεματικά πάρκα; Που είναι οι σύγχρονες ψηφιακές υποδομές στα Μουσεία μας, που θα μπορούσαν να αναδείξουν την Ελλάδα σε μοναδικό διεθνή προορισμό, για εκατοντάδες χιλιάδες μαθητές ή φοιτητές, απ’ όλο τον κόσμο, συνδυάζοντας μια μοναδική πολιτιστική εμπειρία με αναψυχή; 

Mr. Samaras is asking where are the marinas, the marine parks, etc. He asks this of George Papandreou, but he should have been asking Constantinos Karamanlis, who was sitting in the front row of the exhibition hall. Karamanlis not only did very little for tourism, but his Minister of Tourism, Aris Spiliotopoulos, left a shambles at the Ministry of Tourism, including questionable procurement on yacht rentals and hotel suites and unpaid bills at World Travel Market. EOT’s unpaid bills for international advertising campaigns numbered in the millions, and a major problem for Greece both in the past, and today. The fact that after this abysmal performance, Mr. Aris Spiliotopoulos is now ND’s shadow minister of Education says a lot.

Με την Εφεδρεία που προτείνουμε εμείς, μαζί με το πλήρες πάγωμα προσλήψεων για μια τριετία (με εξαίρεση υπέρ-επείγουσες ανάγκες σε Άμυνα, Παιδεία και Υγεία), μπορεί να μειωθεί σε τρία χρόνια το προσωπικό του δημοσίου κατά 150 χιλιάδες! Με καθαρό όφελος για το κράτος περίπου 2 δισεκατομμύρια το χρόνο. Και χωρίς απολύσεις…

Mr. Samaras also spoke about the “labour reserve” and reducing headcount in the civil service. He promised to freeze recruitment for one year, leading to a total reduction of 150,000 staff in three years. Is he not aware that both options are currently being implemented? The only difference is that his labour reserve is for three years, while PASOK’s is for one year. Overall, I prefer one year and departure, rather than three years and yet more money spent on “training.” Greece’s public service ills are not going to be solved through training, without a far more comprehensive framework. The latter has not been explored in any serious depth by either party.

Θα ελέγξουμε αναδρομικά την περιουσιακή κατάσταση όσων κατέλαβαν δημόσιες θέσεις, υπουργικούς θώκους κλπ., από τη Μεταπολίτευση μέχρι σήμερα. Το έχω υποσχεθεί και θα το κάνω! Για να έλθουν στην επιφάνεια όλες οι περιπτώσεις «περίεργου» πλουτισμού. Και θα θεσπίσουμε μέτρα για να μην επαναληφθεί ποτέ πια. Αυτός ο νόμος της σιωπής, αυτή η «ομερτά» για το «πολιτικό χρήμα», θα σπάσει!

There was at least one entertaining promise: ND will conduct a forensic audit on all public servants and ministers from 1974 onwards. “The “omerta” of “political cash” will break!” promised Mr. Samaras. I sincerely look forwards to this. I suggest that first on the list should be the financing of “Politiki Anoixi” (Political Spring), Mr. Samaras’ party, founded in 1992. They should also check the financing of ND by Siemens and Intracom. They should open up once again the structured bond scandals, Vatopedi, and the scandalous allocation of EU and OPAP funds during the Karamanlis years. This will be highly instructive. It has as many chances of occurring as I have of becoming President of the United States.

And yet, I think of what might have been. I think of the political impact Mr. Samaras would have created had he come to Thessaloniki and said the following few words:

“My fellow citizens, I come to you not with more impossible promises which you have heard before, not with more excuses for past failures, nor with unachievable dreams for the future.

I come instead with an offer: that we will put our differences behind us and join in a government of national unity with Mr. Papandreou and PASOK for a period of 2 years until the original term of PASOK is over in October 2013.

During the next two years, we will implement the following policies:

a.     We will achieve a primary surplus by the beginning of 2013. 2012 will be the last year of a primary deficit, which we target at 3.5-4% of GDP.

b.     We will implement the Mid-term Fiscal Adjustment Programme and our promises to our European creditors to the best of our ability. This will cause undeniable economic pain, but we have no other choice, absent a real default.

c.     We will lay the groundwork for a competitive tax environment as far as is possible given the economic crisis. We will pursue tax evasion with far more effective and direct measures, both within Greece but also outside it, so that the financial crimes which have occurred for far too long will be prosecuted and resolved.

As a condition for participation, we ask that the cabinet be restructured to include the following six major Ministries, three of which should be given to representatives we select:

·       Ministry for Investment and Privatisation separate from the Ministry of Finance

·       Ministry of Energy separate from the Ministry of Environment

·       Ministry of Shipping separate from the Ministry of Development

We call Mr. Papandreou to join us in an emergency planning session to achieve these goals by the end of September, leading to a Government of National Unity on October 1^st. We suggest that both PASOK and we appoint the best people we have at our disposal to these positions.  

My fellow citizens, we, the political class of Greece, have failed you. Whether on the right or on the left, great crimes have been committed in the name of political power and economic benefit. The results should be clear to everyone today.

But if we are to survive, we must put the past behind us. We must fulfil the promises we have made, and save Greece from bankruptcy. The following two years will be full of hardship, but with the grace of God, the help of our diaspora and our European friends, and the hard work Greeks are known for, we will prevail.”

© Philip Ammerman, 2011

Navigator Consulting Group

www.navigator-consulting.com

Sleepwalking into Disaster

The conclusions of the Eurozone financial council and central bank governors meeting which took place in Wroclaw, Poland these past two days resulted in no major new commitments or measures. Given the rapid pace of events, this non-decision is likely to feed the flames of a financial disaster later this month, and into October.

The date of the decision of the eventual disbursement of the sixth Greek instalment of the first bail-out package was pushed back to mid-October at the earliest, pending a Troika review at the beginning of October. Greece was asked to provide more details on its fiscal consolidation plan, which is code for introducing yet more measures.

No decision was taken on two other critical issues: alternatives for EFSF capitalisation, and capital support for the European banking system. This is likely to be the greatest policy-making fault on the European, and global levels, and will soon put Europe further behind the policy curve, where it’s been all along.

US Treasury Secretary Tim Geithner was invited to this meeting and made two important proposals:

(a) that Europe leverage the capital of the European Financial Stability Fund (EFSF) in the same way the New York Federal Reserve was able to leverage its assets to deal with the 2008 banking crisis, and

(b) that Germany and other rich nations provide, directly or indirectly, additional financial stimulus. This could have been provided by the European Central Bank, had German resistance to its bond-buying programme not been as vehement.

Geithner’s recommendations were shot down. The EFSF capital expansion will continue to wind its slow way through European capitals, with a final decision hopefully made in October. Jean-Claude Juncker was quoted by Reuters as saying that

"We are not discussing the expansion or increase of the EFSF with a non-member of the euro area," he told reporters. He also ruled out any further fiscal stimulus, something Washington has also called for. "Fiscal consolidation remains a top priority for the euro area," he said.

The difference with US policy-making at the height of the financial crisis in 2008 could not be greater. Not only did the Federal Reserve and the US Treasury launch a massive financial stimulus (TARP, TALF), quantitative easing, and emergency liquidity assistance (ELA) programmes, but they extended this to all banks, not just American banks. I found these comments unacceptable:

·   Has Europe forgotten the emergency liquidity assistance provided by the US Federal Reserve to European banks such as Royal Bank of Scotland ($84.5 bln); Hypo Real Estate Holdings ($28.7 bln), Dexia, and Societe Generale?

·     Has Europe forgotten the fact that the TARP funds bailed out European AIG counterparties such as Deutsche Bank and others at face value in 2008-2009?

·      Is Europe ignorant of the fact that the Fed provided a massive recapitalisation of European banks via the QE2 programme, and that 8 of 22 primary dealers are European?

It’s fully indicative of the provincial approach taken by European policy-makers on this subject. Instead of listening to one of the point men on the US crisis, this turned into yet another “Europe vs. USA” moment.

Geithner also made one extremely good comment this week:

“What is very damaging (in Europe) from the outside is not the divisiveness about the broader debate, about strategy, but about the ongoing conflict between governments and the central bank, and you need both to work together to do what is essential to the resolution of any crisis,” he said.

“Governments and central banks have to take out the catastrophic risks from markets … (and avoid) loose talk about dismantling the institutions of the euro.”

No comment necessary: he is exactly right.

So why are we sleepwalking into disaster? The following reasons apply. I’ll probably be repeating them in one form or another each week.

1.   Europe has not gotten a handle on the Greek debt crisis, or Greek contagion. Greece’s slippage on fiscal consolidation is insignificant and is fully explained by rational policy choices. We have already seen the massive erosion of market confidence at the end of last week: this is now set to continue as a result of an extremely poor Troika management of the situation. On the other hand, Greece’s overshot on higher taxes and lower expenditure forced by recent Troika decisions will push the country into depression. Instead of looking for ways of saving the Greek bail-out, Troika policy and public comments appear to be ready to destroy it.

2.   Italy and several other Eurozone countries are facing a credit rating monitoring starting this week. In my opinion, the outlook is negative. A ratings downgrade of Italy may be averted, but is unlikely. I forecast a 55-65% chance of a ratings downgrade. This will set off yet another financial firestorm, both in terms of bond yields of other at-risk countries, as well as in shares of banks exposed to Italy. Beware a run on France.

3.  Progress of ratification and expansion of EFSF lending is too slow, too low and now hindered by German decision-making based on the decision of the German High Court.

4.  The European Central Bank has not been fully allowed to extend emergency liquidity assistance or buy bonds, again largely due to German decision-making. This means that the prime function of Europe’s Central Bank has been hobbled.

5.     European banks need an urgent recapitalisation, estimated by the IMF to be in the region of EUR 200 bln. The European policy response has been to ignore this. The recent stress tests do not take a realistic sovereign bond mark-down into effect. There are also  any number of toxic debts in the European system, not least of which are commercial real estate.

6.   Economic growth is slowing due to market contagion, consumer fear and lower capital spending. Chinese weakness is visible: all signs (oil prices, shipping rates, Chinese port traffic) point to an anaemic or declining global economy. Far too much of UK and French growth remains attributed to unreasonably high property values.

7.     With the summer over, unemployment in Europe and America is likely to increase.

8.   The chances of another “Black Swan” event remain elevated. Whether this will be a run on European bank deposits or contagion in French bonds or a conflict in the Persian Gulf is unknown. But it is likely just around the corner. The lack of coordinated policy and the lack of financial reserves in the European banking and sovereign funding systems means that Europe is exposed.

9.   Over the longer term, European political differences are increasing, while domestic political stability is increasingly fragile. Neither Angela Merkel nor Nicholas Sarkozy enjoys a strong political position. Italian politics remain fragmented. Barack Obama enters another pre-election period. Decision-making in the next 12-18 months will be even worse than usual. We see this most vividly in the CDU-FDP-CSU imbroglio on a Greek default.

I know believe that no matter which scenario plays out, the greatest threat will be a liquidity and solvency crisis in the European banking system. Given the roller-coaster bank share prices in the last month, this opinion is widely shared.

If anyone knows of a stable bank in a stable country (Norway? Canada?) with no exposure to European bonds and no dodgy derivatives contracts or rogue traders or large amounts of Florida property loans, I’m looking to shift accounts.

© Philip Ammerman, 2011

Navigator Consulting Group

www.navigator-consulting.com

Greek Debt Crisis Reading List

Some interesting articles or opinion pieces from the international press published recently provide a good picture of the current situation in Greece.

Does the Euro have a Future?

George Soros, Reuters: September 14, 2011

This opinion piece explores the link between the 2008 banking / mortgage collapse and the 2010 sovereign debt crisis. It contrasts the US approach to crisis management, where the US Treasury Department, the national and regional Federal Reserves, and the banks acted fairly quickly to provide emergency liquidity assistance and restore faith in the banking system. The article is excellent in pointing out the missing link in the Euro: the lack of a common treasury, and the contrasting roles played by the European Central Bank and the European Financial Stability Fund. It also correctly places this in the political context, which is critical to understanding part of the failure of policy. An interesting quote from the piece:

In 2008 the U.S. financial authorities that were needed to respond to the crisis were in place; at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe. The political will to create a common European treasury was absent in the first place; and since the time when the euro was created the political cohesion of the European Union has greatly deteriorated. As a result there is no clearly visible solution to the euro crisis. In its absence the authorities have been trying to buy time.

In an ordinary financial crisis this tactic works: with the passage of time the panic subsides and confidence returns. But in this case time has been working against the authorities. Since the political will is missing, the problems continue to grow larger while the politics are also becoming more poisonous.

German Hotheads are Close to Destroying the Euro

Jeffrey Sachs. Financial Times (registration required)

One of the first opinion pieces pushing back against the comments by FDP leader and Minister for Economics Philipp Roesler and CSU leader and governor of Bavaria Horst Seehofer, who’s comments last week did so much to destabilise the Euro and the markets. It also confirms comments made in my earlier post, that Greece’s missing its fiscal targets so far this year is relatively modest given the scale of reforms made to date.

Schroeder Calls for More Time on Greek Reforms

Peter Spiegel. Financial Times (registration required): September 5, 2011

An interview with former German Chancellor Gerhard Schroeder, in which he presses for a more reasonable approach to the Greek reform programme timeline, and links the domestic political pressures in Germany which lead to “Greece bashing”.

 “What we expect of Greece right now, the question is can that really be achieved? The Greek government is trying to introduce austerity programmes that are unprecedented,” he said, warning social unrest was a “great possibility” given the country’s continued economic contraction.

“Europeans in general should not stop expecting reforms from Greece, but Greece should get more time to introduce them.” …

Ms Merkel inappropriately played on German resentment towards Greece, he said, a mistake that now prevents her from winning public support for measures he believes are necessary to solving the crisis, including the creation of bonds backed by all 17 eurozone countries.

Mr Schröder specifically singled out Ms Merkel’s widely reported assertion that Greeks worked less hard and took more holidays than Germans, a claim he said was wrong and was “a huge mistake” politically.

“In the first months of the Greek crisis, Merkel looked too much at public opinion and she participated in this bashing of Greece,” he said. “Her position has definitely changed but it is now very difficult for her to introduce that kind of thing in her own party.”

The Worse of the Euro Crisis is yet to Come

Wolfgang Muenchau. Financial Times (registration required): September 5, 2011

A superlative article on why the structure of Eurozone institutions are preventing a rapid resolution to the crisis. Again, contrast this with the US Federal Reserve and its operations following the September-October 2008 crisis in the United States.

This policy paralysis, together with domestic political considerations, the demographic change in Europe, and declining competitiveness at the microeconomic level are the main reasons I am so negative about the future. It is hard to see how the entire western structure of “social partnership” can be maintained in the world we currently live in, without radical reform. This comments is not ideological comment, but quantitative, based on what I’m seeing in companies and sectors on a daily basis.

Loose Talk on Greek Default Could “Cost Billions”

Der Spiegel International: September 13, 2011

A review of German press and its analysis of political comments made in the last two weeks on the debt crisis. In English. 

Greek Bailout: A Pillar in Peril

Peter Spiegel & Karin Hope. Financial Times: September 12, 2011

An excellent and timely analysis of the structure and challenges facing the second Greek bail-out. These factors, together with some other ones, were the reasoning behind my blog post: Continued Risks in the Greek Reform Programme (August 22, 2011). Yet unless this second package is passed, and quickly, there is almost no hope that the Greek debt crisis will be resolved without a real, “hard” default.

© Philip Ammerman, 2011

Navigator Consulting Group

www.navigator-consulting.com

When “Austerity” and “Reform” are Probably Meaningless

The latest austerity measures announced by the Greek government in an effort to comply with the Troika’s demands for meeting fiscal targets are certain to prolong and exacerbate the current economic recession, and transform it into a depression.

These measures include:

·       The cut of one entire monthly salary for all public sector workers. This is on top of the elimination of nearly one monthly salary for most workers (through reduction of the thirteenth and fourteenth salary “bonuses) as well as the fact that salaries above EUR 1,500 were reduced.

·       The levy of an additional special tax on property values. This is estimated based on varying rates per square meter, adjusted by a regional coefficient as well as other factors, and multiplied by the number of square meters of floor area. This tax is collected on electricity bills, which already contain municipal taxes, a wealth tax, a tax for the public television broadcaster, and value-added tax. It should also be remembered that there are already two additional property taxes in effect.

·       Rationalisation of semi-governmental organisations as well as placing some 30,000 public sector workers in a “labour reserve”, which implies reducing their salaries to a level of 60% their former salary for a period of 12 months. If they do not find another public sector position in this time, they are fired.

·       Acceleration of other structural reforms, including privatisations and the implementation of a uniform pay structure in the public sector.

Whether these measures are justified or not in the name of greater public sector efficiency is debatable. It is difficult to see a strategy which translates into greater efficiency or productivity in the public sector. Most likely, the burdens on the citizen and company will increase, since the public sector will simply under-perform yet further.

What is not debatable is the deleterious impact these “reforms” will have on the real economy. Public sector salaries have already been cut extensively: cutting an entire additional monthly salary is not only a major counter-incentive to productive work, but it bears a real price in terms of consumer spending.

Given that Greece’s GDP (as with that of most countries) is based on consumer spending for about 70% of total economic activity, it is only logical that reducing spending reduces GDP, which in turn reduces VAT income as well as income taxes.

As September nears its end, we expect a further decline in basic economic indicators:

a.     The tourism summer boom is over. Seasonal employment is ending; tourism enterprises are closing for the winter. Unemployment is likely to accelerate dramatically, perhaps reaching 18% by the end of 2011.

b.     The collection of the new property income taxes for 2009, 2010 and 2011 will shortly start to occur. Today, several classes of self-employed professionals also received supplemental income tax demands. These will now be increased by the latest round of tax increases and payment cuts.

c.     As the winter approaches, heating fuel will be distributed, priced up at least 100% over 2010 prices due to the increase in taxes designed to bring the price of heating fuel to the price of diesel gasoline.

All this translates into a major shock to consumer disposable income, either due to wage cuts or tax increases. Together with continuing government cutbacks in the public investment programme and operating expenditure, this means that the recession will probably continue at a rate of at least 5% GDP in 2012, while unemployment may rise to 20-22%.

It is remarkable that, looking back to September 2010 when the Prime Minister made his last “Speech to the Productive Classes” at the Thessaloniki Trade Fair, just how little the fundamentals have changed.

With the Athens Stock Exchange index trading between 800 and 900 points, privatisation income from the sale of state-owned enterprises is likely to be less than 50% of most enterprise book value, depending on how the privatisations are handled. The National Bank of Greece, for instance, has assets of EUR 119 billion and a total market capitalisation of just over EUR 3 billion. Other companies on the privatisation list have far lower valuations.

Although Spain, Luxembourg, France, Italy and Belgium have passed a national law expanding powers for the European Financial Stability Fund (EFSF), other countries face delays. This means that the second bail-out package for Greece remains in limbo. Results on participation by private banks in Greek loan restructuring, coordinated by the IIF, remains unknown. It is ironic that Greece is being pressed to implement its commitments, when so few Eurozone commitments have been implemented.

A pushback against talk of a Greek Eurozone exit or default has thankfully started. Yet the fundamentals remain the same, while the domestic and international economies are slowing. Angela Merkel’s CDU has lost five regional elections in Germany this year; this Sunday, it is likely to face its sixth loss. 

Absent a major, concerted effort to address the fundamentals of this present crisis, we are likely to see a continuing failure to meet fiscal targets in Greece, and a worsening economic situation in Europe. In such a situation, neither “austerity” nor “reform” are the panaceas they are made out to be.

We see the manifest signs of the real crisis: international companies are pulling their expat staff out of Greece and preparing for the worse. The number of empty apartments and commercial sites has reached record numbers. Sales at all retail outlets are down. The number of homeless people is apparently the highest it’s been since World War II.

On July 22, 2010, I concluded a blog post with these words:

My advice is: prepare for the worse-case scenario to materialise. The clock is ticking. The scale of the problem is clear; the end-date in the best case is late 2012 or early 2013: it may come sooner than we think if the bond yields on recent issues are any guide. 

Regrettably, so little has changed in this assessment. What is unfortunate is how long all this has been visible, and that so little has been done to reverse it.

Related Posts

Some Progress: Major Problems Ahead. 10 September 2010

The Greek Bail-out Package and the Future Political Risks of Debt Restructuring. 22 July 2010

© Philip Ammerman, 2011

Navigator Consulting Group Ltd.

www.navigator-consulting.com