Tremors were heard across
Europe and around the world last week. There was little mistaking the clear
fracturing sounds of the European Monetary Union.
Receiving less fanfare than
the political hyperbole of EU solidarity, was surfacing evidence of serious
fissures that exposed similar financial schemes which took the US to the
financial abyss.
Our research has identified
eight fault lines now visible in the Euro experiment. Each is serious. As a
combination they have the potential to be devastating. They are all now fully
in play.
FAULT LINE #1: CURRENCY
SWAPS
Greek
accounting 'irregularities' that have resulted in massive distortions of
Greece's actual fiscal imbalances was not the news last week. Manipulated
Greek government bookkeeping has been known for some time. What sorcery the
Greek government had magically mixed in its hidden brew to accomplish the
irregularities however began receiving much higher levels of media attention
after the Feb. 1 release of their report commissioned by the Finance Minister
in Athens. Currency Swaps it turns out were what the great Merlin - Goldman
Sachs had recommended and sold to the hapless Greek politicians with which to
hide their spendthrift ways. Goldman Sachs was not initially identified in
the Feb 1st report. (1)
Suspicious eye brows were
quickly raised when Greece's Finance Minister responded to the new details
reported by Reuters:
"The kind of
derivatives contracts reported by some newspapers were legal at that time, Greece
was not the only country to use them... They were made illegal, [and] we
have not used them since then."
The obvious questions that
alarmed investors:
WHO ARE THE OTHER COUNTRIES HE
IS REFERRING TO? - HOW BROAD BASED WAS IT?
ARE THEY STILL USING THEM BUT IN DIFFERENT HYBRID FORMS?
It also begged the question of
overall supervision of accounting that the EU statistical agency exerts? How
transparent are the EU sovereign country books? There are a lot of questions
that will be asked of Greece and other countries over the next few weeks. As
my grandmother wisely advised me - "There is never only one cockroach!"
FAULT LINE #2: SPC &
PPI / PFI
Delving into the details as
the breaking news on Greece unfolded; I was reminded of my research during
the early stages of the Enron scandal. At that time I started discovering the
world of SPE's (Special Purpose Entities) that until
that time were almost unheard of, but it turned out were being slyly and
extensively employed. I remember Enron CFO Andrew Fastow defending his
extensive use of such vehicles by referring to the fact GE had over 2400. I
was also reminded of the early stages of the financial crisis when I learned
about banks using SIV's (Structured Investment Vehicles)
to sell CDOs and protect themselves with CDS's - all new instruments and
somehow never visible to the light of day. The experience taught me that in
today's wild west of global financial gamesmanship to always dig deeper - and
fast!
Last week I discovered SPC's
(Special Purpose Company) & PPI / PFI's. Not familiar with
them? You had better be because they will soon likely be cocktail party
chatter. These are financial instruments and arrangements that allow
governments to factor 'receivables' and thereby camouflage debt. They are
being broadly employed as the standard marketing slide below would indicate.
Public Private Partnership
- PPI: An umbrella
term for Government schemes involving the private business sector in public
sector projects.
Private
Finance Initiative - PFI:
a form of PPP developed by the Government in which the public and private
sectors join to design, build or refurbish, finance and operate (DBFO) new or
improved facilities and services to the general public. Under the most common
form of PFI, a private sector provider will, through a Special Purpose
Company (SPC), hold a DBFO contract for facilities such as hospitals,
schools, and roads according to specifications provided by public sector
departments. Over a typical period of 25-30 years, the private sector
provider is paid an agreed monthly (or unitary) fee by the relevant public
body (such as a Local Council or a Health Trust) for the use of the
asset(s), which at that time is owned by the PFI provider. This and other
income enables the repayment of the senior debt over the concession length.
(Senior debt is the major source of funding, typically 90% of the required
capital, provided by banks or bond finance). Asset ownership usually returns
to the public body at the end of the concession. In this manner, improvements
to public services can be made without upfront public sector funds; and
while under contract, the risks associated with such huge capital commitments
are shared between parties, allocated appropriately to those best able to
manage each one (2).
Edward Hugh at Credit
Writedowns does a first rate job of laying out how all this works and
where the looming exposures are hidden in his February 14th article: Just
what is the real level of government debt in Europe? He concludes:
a) They assume
a certain level of headline GDP growth to furnish revenue growth to the
public agencies committed to making the payments. Following the crisis these
previous levels of assumed growth are now unlikely to be realized.
b) They assume growing
workforces and working age populations, but both these, as we know, are now
likely to start declining in many European countries.
c) They assume unchanging
dependency ratios between active and dependent populations, but these
assumptions, as we also already know, are no longer valid, as our population
pyramids steadily invert.
Given all this, a very real
danger exists that what were previously considered as obscure securitisation
instruments, so obscure that few politicians really understood their
implications, and few citizens actually knew of their existence, can suddenly
find themselves converted into little better than a glorified Ponzi scheme.
And if you
want one very concrete example of how unsustainable debt accumulation can
lead to problems, you could try reading this
report in the Spanish newspaper La Verdad (Spanish, but Google translate
if you are interested), where they recount the problems being faced by many
Spanish local authorities who are now running out of money, in this case it
the village of San Javier they have until the 24 February to pay a debt of
350,000 euros, or the electricity will simply be cut off! The article also
details how many other municipalities are having increasing difficulty in
paying their employees. And this is just in one region (Murcia), but the
problem is much more general, as Spain's heavily over-indebted local
authorities and autonomous communities
steadily grind to a halt.
FAULT LINE #3: TITLOS PLC
(SPV)
But it gets
worse, unfortunately much worse!
TITLOS PLC (SPV) may be to
Greece what 'RAPTOR' was to Enron. TITLOS PLC (SPV) may be the real smoking
gun in the Greek crisis and unfolding Euro Crisis.
Tyler Durden and Marla Singer
at Zero Hedge have done a masterful
job of investigation and outlining the murky relationship between the rating
agencies and the rating of the underwritten swap agreement securitization SPV
called Titlos PLC. All brought to you by Goldman Sachs.
As I mentioned earlier, I feel
like I've seen this play before. The script is right out of the pages of
Enron and the US Sub-Prime debacle! It even has the same supporting cast
member: Goldman Sachs!
Durden and Singer's Feb 15th
article is entitled: Is
Titlos PLC (Special Purpose Vehicle) The Downgrade Catalyst Trigger Which
Will Destroy Greece? It is extensive with supporting Scribd documents of
documentation that has now mysteriously been removed from public viewing by
Greek officials.
Their conclusions:
On December
23, 2009, Moody's downgraded Titlos, following the prior day's downgrade of
Greece itself from
A1 to A2 with a negative outlook.
Fact: last week Moody's said
it could further
downgrade Greece to Baa1.
Fact: the Titlos PLC rating mirrors that of Greece itself.
Fact: according to Moody's "Framework for De-Linking Hedge Counterparty
Risks from Global Structured Finance Cashflow Transactions Moody's
Methodology" a counterparty can enter into a hedge transaction with an
SPV and continue to participate in that transaction without collateralizing
its obligations so long as it maintains a long-term senior unsecured rating
of at least A2.
When (not if) Titlos is
downgraded again, and its rating drops below the A2 collateralization
threshold, look for AIG's margin call driven liquidity crisis escalation from
the fall of 2008 to spread to Greece. And that's not all.
The Titlos SPV itself may be
null and void should the rating of the National Bank of Greece, as the Hedge
Provider, drop below a "relevant rating" as defined in the hedge
agreement. Should Greece then be forced, at Titlos' option, to unwind the
swap agreement, and be forced to cash out to the tune of €5.4 billion (net of
the 107.54 issuance price), look for all hell to break loose.
Greece has
suddenly found itself at the mercy of a Moody's, whose just one additional
notch down, would increase the funding needs by almost 40% in addition to
near term maturity requirements. Score yet one more for the off-balance sheet
securitization puzzle, so prevalent in our day and age, courtesy of Wall
Street's "innovation" masters - Goldman Sachs.
Do you have the stomach to go
on?
FAULT LINE #4: GREEK CDS's
The Wall Street Journal reports:
Germany's
willingness to consider a rescue may also reflect the exposure of the
country's own banks to the vulnerable countries.
German banks are major lenders
in Greece, for example, collectively carrying about $43 billion in Greek debt
on their books, including loans to private individuals and companies,
according to Bank for International Settlements data for the third quarter of
2009. Among EU countries, only France's banks, with $75 billion, carry a
larger share of Greece's $303 billion in debt to foreign banks.
In addition, some of
Germany's public-sector banks, known as Landesbanken, have issued
insurance-like contracts on Greek debt, known as credit default swaps. The
total exposure of the country's eight Landesbanken is unclear.
Two of the
banks, Bayern LB and West LB, described their exposure to Greek credit
default swaps as negligible. Hanover-based NordLB and LBBW in Stuttgart
declined to comment. Frankfurt-based Helaba and HSH Nordbank in Hamburg
didn't immediately respond to requests for comment. SaarLB, in Saarbr ücken,
couldn't immediately be reached.
Credit Writedown reports on
the CDS
exposure of the German Landesbanks to Greece:
If Greece were to default, the
Landesbanks, which have already lost tens of billions, would be on the
hook for even more. Clearly, the German government
is aware of this situation and this is certainly a major part of their
political calculus.
The real driver here is not
that the private debt problem is becoming a sovereign debt problem, but the
opposite - the sovereign debt problem is threatening to renew the private
sector banking crisis. Consider the BIS data that is cited in press
reports today: German bank exposure to Greece is 43 bln euros, to Portugal 47
bln euros, to Ireland 193 bln euros and to Spain 240 bln euros.
FAULT LINE #5: REPO
ARRANGEMENT
The FT Alphaville reported on
December 8th in How
do you say vicious circle in Greek?:
When you take
bank asset size into account, the Greeks are the biggest user of ECB
liquidity
The interesting bit is that
the Greek banks don't seem to have an immediate funding crisis on their hands
since the lion's share of liabilities come from their deposit base. UBS
analysts speculate that the banks are merely using the ECB to receive low
cost funding with Greek sovereign debt assets as collateral. That makes
the Greek sovereign debt crisis a Greek bank crisis then - as this funding
source may disappear with sovereign credit
downgrades.
Now, if you were a Greek
resident, you have to feel a bit panicky about the safety
of your hard-earned savings given this scenario (see
Guardian article). So, we could easily see the sovereign debt crisis
spill over into bank runs. And if Greek banks implode, there is going to be a
knock-on effect for other weak banking sectors like the Austrian or Irish.
This is how contagion works.
Let's not forget that Greek banks
do have some funding needs. How are they going to roll over repo debt if
the sovereign is having trouble?
Rumors
are starting that counterparties are not rolling over repo arrangements; this
is exactly how Bear Stearns failed
FAULT LINE #6: GREECE &
THE BALKANS
Credit Writedown reports
the following:
Another fault
line lies in the connection between Greece and the Balkans, where Greek banks
are very active. For example, around the time that the Bear Stearns crisis
was brewing in March 2008, the internet site Global Politician reported the
following (3):
According to the Greek
newspaper, Elefteros Topos, between the years 2000-2006, Greeks invested
almost 263 million USD in their nascent neighbor. That would make Greece the
second largest foreign investor in Macedonia. Of the 20 most sizable investments
in Macedonia's economy, 17 are financed with Greek capital. More than 20,000
people are employed in Greek-owned enterprises (c. 6% of the active workforce
in this unemployment-plagued polity).
Greeks are everywhere:
banking (28% of their total investment
in the country); energy (25%); telecommunications (17%); industry (15%); and
food (10%).
The foundations of the
current presence of Greece in all Balkan countries - including EU members,
Romania and Bulgaria - were laid in the decade of the 1990s.
The Greeks
banks are heavily exposed in the Balkans and elsewhere in Eastern Europe. But, as I said in a previous post,
Greek banks are using the ECB for low cost funding - with Greek sovereign
debt as collateral. Therefore, a Greek sovereign debt crisis could impair
the liquidity of Greek banks and therefore have knock-on effects in Eastern
Europe through a reduction of credit
availability as well.
FAULT LINE #7: SWITZERLAND
Another fault line which is quite worrying is
in Switzerland. Swiss Daily Tagesanzeiger (4)has a good piece on this, which
I have translated below:
A sovereign bankruptcy in
Athens would hit the European banking sector with full force. Swiss banks in
particular have invested heavily in Greece - for them, the risk is the
greatest in Europe. But help
is at hand.
The horror deficit of
Greece is making the banks concerned. A failure to pay would hit first and
foremost European institutions. "50 percent of foreign bank claims
against debtors in Greece are to the Greek state. An Athenian bankruptcy
would, therefore, hit other European countries and their banks hard,
Citigroup strategist Giadi Giani said to the Financial Times Deutschland
(FTD)."
In Greece, the fiscal situation
is catastrophic. If the country does not find enough buyers for its bonds to
reduce the deficit, it could lead to insolvency. Should no help come from EU
countries or the IMF then, European banks would be threatened with massive
writedowns, write the economists at Commerzbank.
Switzerland particularly
affected
According to the International Monetary Fund (IMF), about two thirds of
the debt of Greece is held by foreign creditors - an above average value.
European Banks are particularly involved. According to data from the Bank for
International Settlements, Swiss institutions, at around 68 billion francs,
rank as one of the largest donors. Only the French banks, with 80 billion
francs [of exposure] have stashed a bit more money in Greece.
But in relation to GDP,
the risk to Switzerland, according to FTD, is the highest by far: According
to Morgan Stanley economists [Swiss] commitment in Greece comes to almost
twelve percent of Swiss GDP. France follows as the largest country in the
eurozone at 2.5 percent.
FAULT LINE #8: EUROPEAN
LENDING RATES
Bloomberg Reports:
A bailout of
one will produce the same outcome as the rescue of Bear Stearns did; moral
hazard will kick in, and instead of allowing economic Darwinism to cleanse
the gene pool, the weaker nations will lose any incentive to cut spending and
trim their swollen deficits.
Welcome to "Credit
Crunch II." By stuffing billions of dollars of taxpayers' money into the
balance-sheet holes of the banking industry, governments have transmogrified
private risk into public liabilities. The "too-big-to-fail" label just reattaches
itself to governments from financial companies.
The sequel, if
the European Union or its members are suckered into some kind of Greek rescue
package by buying, guaranteeing or even repaying its bonds, could end up
featuring Portugal as Lehman Brothers Holdings Inc. and Spain as American
International Group Inc.
Warren Buffett is often heard
to say - "you find out who was swimming naked when the water goes out."
European lending rates are
headed higher. This will place further pressures on sovereign debt loads.
CONCLUSION
The apparent dithering of the
ECB and the EC, along with the tremendous deficiencies in financial controls
and audits of member countries, makes European leadership look empty headed.
But maybe, just maybe the EU Boy is smarter than we think?
According to Martin
Wolf writing in the Financial Times, what ails Europe is DEMAND. Without
demand by consequence there emerges fiscal crisis. The Euro's strength over
the last 11 months has been the Euro Zones Achilles heel. Many pressured
politicians felt a much weaker Euro would assist with increasing demand for
European products and potentially alleviate some of the fiscal pressures. The
problem needed to be fixed urgently and a weakened Euro was the immediate
solution. A 10.3% devaluation of the Euro in 11 weeks is best described as
dramatic and exactly what the doctor prescribed!
Is the Euro devaluation a
byproduct of inaction or a strategy? Did those in control unwittingly unleash
demons they didn't understand were lurking just below the financial surface?
I will leave that debate to
the academics and conspiracy buffs. (5)
"What if Greece is
Fannie Mae, Portugal is Freddie Mac, Spain is AIG, Argentina is Wachovia Bank
and Ireland is Lehman Brothers?" Bulls are certainly hoping Greece is
more akin to Bear Stearns, whose Fed-engineered fire sale to JPMorgan in
March 2008 sparked a brief but furious "relief" rally that
spring".
Todd Harrison, CEO of Minyanville.com.
Yahoo Finance 02-11-10
Dubai World is to Corporate
Debt what Sub-Prime was to Consumer Debt
Greece is to Sovereign Debt
what Dubai World is to Corporate Debt
FREE Additional Research
Reports at Web Site: Tipping Points
SOURCES:
(1) 02-15-10 Europe
Finance Ministers Face Pressure Over Greece Emma Ross-Thomas Bloomberg
(2) A useful
description of what are known as PPI/PFI schemes, from UK building
contractor John Laing
(3) 03-13-08 Greece
and its Investments in the Balkans: Trojan Horse or Reliable Partner? -
Global Politician
(4) 02-10-10 Griechisches
Finanzdebakel bedroht Schweizer Banken - Tagesanzeiger
(5) 02-16-10 European
Conspiracy Theory WSJ
12-08-09 How
do you say vicious circle in Greek? FT Alphaville
02-09-10 Europe
needs German consumers Martin Wolf Financial Times
02-10-10 A
Greek crisis is coming to America Niall Ferguson Financial Times
02-10-10 Greek financial debacle
threatens Swiss banks Credit Writedowns
02-10-10 Chandler:
Uncertainty and contagion at work with Greece Credit Writedowns
02-11-10 'PIGS'
in Rescue Lipstick Are Uglier Than Default Mark Gilbert Bloomberg
02-11-10 France,
Germany Weigh Rescue Plan for Greece Wall Street Journal
02-11-10 Beware
"Unintended Consequence" of Gifts for Greece, Todd Harrison Says
Yahoo Finance
02-14-10 Just
what is the real level of government debt in Europe? Credit Write-down
02-15-10 Is
Titlos PLC (Special Purpose Vehicle) The Downgrade Catalyst Trigger Which
Will Destroy Greece?
Zero Hedge
