Wednesday, April 28, 2010

European Banks Exposure to Greece

As suggested in the chart below, French banks have the greatest collective exposure to Greece, holding nearly $79 billion of the country's bonds.  In second place are German banks with $45 billion of exposure.  As such, while the Eur30+ billion committment from the ECB is being couched as a "bailout" of Greece, a more appropriate characterization would be a bailout of the major French and German banks (hence my belief that a large rescue package is imminent).  Not coincidently, France has shown little resistance to the bailout.  In order to appease their rightfully angry citizens, German government officials have made a big public stink about the proposed bailout, but they too will eventually come around.

Given the absurdity of bailing out the profligate Greek government to save its own banks, one has to ask why the ECB doesn't just directly inject capital into the German and French banks who will undoubtedly be hurt most by a Greek debt default.  While the merits of this path should be explored, I suspect the ECB is concerned about the knock on effects that will undoubtedly spread to Portugal and Spain should they allow Greece to twist in the proverbial wind (particularly as Portugal and Spain have recently received downgrades from the major rating agencies).  By bailing out Greece, the ECB will send a message to foreign creditors that the region intends to stand by its members, thereby giving Portugal and Spain breathing room to get their own fiscal houses in order. 

While this may be the intention, I remain highly skeptical that Portugal and Spain (and eventually the UK) will avoid a similar fate as Greece.  With negative GDP growth forecasted for at least 2010, double digit budget deficits, and structurally high unemployment (particularly Spain which is approaching 20%!), it is only a matter of time before foreign creditors turn against both countries.  Most analysts suggest a bailout of the PIIGS could cost the European Central Bank 600 billion euros (~8% of the region's GDP).  Such a scenario would gravely impair the ECB's balance sheet rendering it an almost impossible solution.  While a bit premature, I think it is only a matter of time before a breakup of the EU begins to seep into the public dialogue.  The problem is simply too big and too widespread to fix in the absence of several large defaults. 

Ironically, I think the US will be the biggest short-term beneficiary of the contagion spreading in Europe.  While our long-term fiscal situation remains far from perfect, it certainly looks a lot better compared to the PIIGS!  Since capital has to go somewhere, much of it will likely find a home in the US.  With excess capital flooding into the US, real interest rates should remain low, helping to forestall our own day of reckoning.  I suppose this is the upside to Europe's woes, but it will only make the fallout from our own debt binge that much worse when the bill inevitably comes due. 

Friday, April 23, 2010

GreeK Government Bonds Continue to Blowout

As concerns over Greece’s fiscal situation continue to mount, the country’s bond yields have blown out over the last few days. At nearly 9%, Greece’s 10 year government bonds yield 585bps points more than that of German sovereign debt (see charts below). Most perplexing about this continuing spread widening is that the EU and IMF have collectively pledged over €45 billion to help bail out the country. As such, I would attribute much of the rapid decline in Greek bond prices to technical factors relating to European banks dumping their holdings for fear of having to come clean to the investment community on their exposure. While Greece has continued to increase their estimate of their 2009 fiscal deficit (currently at 13.6% and climbing), I find it highly unlikely that this would be enough to deter the EU/IMF consortium from standing by its pledge to help. If they did, the contagion risks for other PIIGS nations would be felt immediately (particularly Portugal).

Many investors fear that bondholders will be forced to take a haircut, though Dubai’s recent bailout of Nakheel creditors (with funds that were previously received from its neighbor, Abu Dhabi) shows the pains that sovereign nations will go to in order to remain in good stead with external creditors. When fears over a Dubai World default gripped the investment community last fall, the holding company’s Nahkeel subsidiary bonds plunged to between 50 and 60 cents on the dollar. However, last month Dubai announced that maturing bonds would be paid in full, resulting in a huge gain for those hedge funds willing to bet that Dubai World wouldn’t let its troubled subsidiary go.

While Greece’s fiscal situation is untenable and requires severe austerity measures to bring under control, the recent plunge in its government bonds presents a good trading opportunity for those investors willing to bet that the EU and IMF will stand by their commitment. 

On a somewhat related point, I find it ironic how on one hand the German government is lambasting Goldman for selling it subprime bonds backed by troubled US homeowners and on the other hand they are about to write a huge check to bail out Greek pensioners. In a world marked by overlevered consumers and their equally irresponsible governments, there appears to be no easy choices for German savers.

Thursday, April 15, 2010

China GDP Grows 11.9% in Q1

More evidence of China’s overheated economy emerged yesterday with the release of the country’s Q1 2010 GDP estimate of 11.9%. This is the highest reading since Q2 2007 when GDP grew by an impressive 12.6%. In a statement by the country’s State Council accompanying the GDP release, the agency noted “the problem of excessive increases in housing prices in some cities is particularly acute.” This follows on the release of the March property-price index which rose 11.7%, accelerating from February’s 10.7% rise. While concerns are mounting that China will begin raising interest rates, official readings of broader inflation were only 2.4% in March, below Beijing’s target of 3%, suggesting that rate hikes may not be imminent. 
Though I firmly believe that China has all the makings of a growing asset bubble (i.e. debt-fueled growth in property prices, an overheated banking system, fixed asset investment approximating 30%), without the government taking decisive steps to prick the bubble, it’s exceptionally difficult to call the top. One of the most dangerous corners of investing is shorting a bubble that has yet to run its course (think tech in 1997/1998). While Lumpy Investor will continue to report on the mounting bubble forming in China, I will do so from the sidelines. Headlines like this: “Time to Deal? Carlyle Raises $2.55 Billion In Asia Fund” suggest to me that we many only be in the early innings of the China saga. Private equity funds are lemmings and I can assure you that every other mega buyout fund is plotting their strategy on how to benefit from the “Asia Miracle.”

The only thing I can say with reasonable certainty is that the longer the insanity takes place, the more painful the reckoning will be when rationality inevitably reemerges.

Thursday, April 8, 2010

Mortgage Rates Starting to Creep Up

With the conclusion of the Fed’s $1.25 trillion MBS program last month, mortgage rates have quietly started to rise. Rates for 30-year fixed mortgages rose to 5.21% last week, the highest rate in nearly eight months. While rates are still low by historical levels, the quick rebound off the December lows (when rates bottomed at 4.71%), could derail the slowly improving housing market, particularly with the planned expiration of the new homebuyer tax credit on April 30th.