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It's nothing new to say that we are living in a "black hole" economy, in which productive capital is continuously vacuumed up by speculative financial structures, as we continue spiraling down a non-stop path of fiscal "stimulus", bailouts and central bank monetization of debt-assets, without any chance of those capital "influxes" reaching enough velocity to escape into the real economy any time soon. As long as we continue operating under the same structures of economic organization, nothing we do will overcome that gravitational force and we will fall towards the singularity until we are wholly digested. Perhaps shreds of our former system will eventually radiate back into space, detectable to future generations, but its structures will be radically different for quite awhile.
On the other hand, you rarely ever hear the analogy extended much further than that. The productive economy is essentially being dismantled and vacuumed into another dimension, but how quickly will it happen? That question brings us to two related concepts that are frequently found in nature, and also a bit too often in modern human society - predicaments and paradoxes. As we are rapidly descending into the black hole of ponzi capitalism, a critical paradox involving time reveals itself. The closer you are situated to the event horizon of a black hole, the more gravitational force is applied (less gravitational potential) and the more time is dilated ..
The equivalence principle in Einstein's theory of general relativity allows even stationary bodies with relative distances from a gravitational mass to be treated as having accelerated frames of reference with respect to each other. So we are not talking about an absolute measure of time, but its measure relative to other observers situated at different distances from the black hole. If observer A is closer to it than observer B, then a clock in A's possession will tick slower than one in B's possession, and both A and B will agree that A's clock is moving slower than B's.
From an absolute perspective, the gravitational force tearing at A's tendons is an extremely violent one, but, from a relative perspective, the time over which that force is applied is smoothed out towards infinity (as A's relative frame of reference approaches the speed of light). The clock in A's possession will continue to slow in relative terms, until an entire year in the life of B is just a few short ticks on the second hand, and eventually it will appear to B that A is barely aging at all (and to A that B barely exists for any time at all).
To see how this time paradox applies to the global economy's black hole of speculative capital, we only have to look around us. Observer A could be represented by the largest economies in the world, hosting the largest financial/equity markets (U.S., China, Japan, Western/Central Europe, Canada, Russia), while observer B is represented by every other economy that is linked into the global financial system (this ranges from the economies of Iceland, Tunisia, Egypt and Syria all the way to those of Ireland, Greece, Italy and Spain). .
The biggest economies are closest to the event horizon of financial capitalism, since they have the highest levels of unproductive debt sitting on their private and public balance sheets. Their citizenry is being systematically poisoned by excessive debt, collapsing revenues, unprecedented bailouts, subsidies, taxes, regulatory oppression, unemployment, speculative inflation, etc., but it is also a very slow death. Relative to an Observer B, such as the Egyptians, Irish or Greek, the populations of these countries do not feel that their lives have significantly changed in the last few years or even decades, despite the changes most certainly taking place.
The time dilation effect has smoothed over these changes to make them appear much less drastic. Almost all asset markets in the U.S., Europe and China are now wholly subsidized by their respective governments/central banks, but the taxpayers fail to recognize that the bill was drafted in their names and will come due well within their lifetimes. Millions of people have lost their jobs, retirement savings and employment benefits in the West, but millions of them are also collecting welfare benefits such as food stamps, Section 8 housing, medicaid, medicare and/or unemployment insurance (or the equivalents in Western Europe).
Meanwhile, the clocks in North Africa, the Middle East, South Asia and the EU periphery are ticking much faster, as a new financial or sociopolitical "crisis" in those regions seems to erupt every other day of the week. While the size of their individual economies are relatively small and are capable of being partially backstopped with imaginary capital generated by the alchemy of Observer A, the rate at which their respective populations experience economic deterioration still renders it a very painful process. That is especially true when the pace is relative, and the people are forced to watch local economic and political institutions "age" much faster than their counterparts in larger economies.
The amount of suffering experienced by the average Tunisian, Egyptian, Libyan or Greek in one day generally equals the amount the average American, Canadian, Brit or German will experience in a year or more. The fundamental reasons we suffer do not differ, since we are all a part of the same economic system and are being consumed by the same black hole of debt, but the temporal schism makes that shared reality difficult to see. The dilation of time for the central economies of our world may not be fair or just, but it's a fact of our existence, and it behooves us to now use it to our advantage and the advantage of those we can reach.
For some, that might mean undergoing extensive financial and physical preparations and working towards 100% self-sufficiency, by learning how to grow/preserve food, access/purify water, generate renewable energy, use weapons for self-defense, develop community ties, etc. For others, it may not mean much more than getting out of debt, gathering knowledge and speaking their minds whenever others will listen. Regardless of one's specific strategy, it should be remembered that a dilated time frame does not mean the economy is recovering or the status quo will persist.
Our frame of reference may be relatively slower and more drawn out, but we are still being digested by the financial black hole of global civilization. In fact, we are positioned closest to its event horizon, and there will come a time when we can no longer afford to linger in the relative safety of its boundaries, but rather must cross over to the other side. When that happens, our relatively slow clocks will synchronize with all of the others and quickly make up for the time that was lost before. This time may be dilated, but, in the end, it's really no different.
Germany's judges hold the euro's fate in their hands
by Ambrose Evans-Pritchard - Telegraph
Whether or not Europe's monetary union survives in its current form, shrinks to a Carolingian core, or shatters, depends as much on abstruse legal arguments put forward on Tuesday in Germany's constitutional court as it does on the parallel drama unfolding on Greek streets.
If the eight judges in Karlsruhe rule that Europe's €500bn bail-out machinery breaches of Germany's Basic Law – or Grundgesetz – in any significant way, they risk knocking away the central prop beneath the debt edifice of Southern Europe.
The judges have distilled a plethora challenges to the Greek, Irish, and Portuguese bail-outs into three complaints. These include one by a group of professors who argue that the Greek loans subvert the Bundestag, violate the "no bail-out" clause of the Lisbon Treaty, and amount to the creation of a fiscal transfer union, by stealth, without the requisite changes in the German Grundgesetz, and "strike a blow at the constitutional foundations of our state and our society".
Wolfgang Schäuble, Germany's finance minister, told the court on Tuesday that Greek bankruptcy would have set off epic contagion and triggered an even greater financial cataclysm than the US credit crunch.
The judges know the risks. They will bend a long way to find a formula that does not set off a banking collapse, or threaten Germany's strategic investment in post-war Europe. But will they bend enough to satisfy the bond markets when they issue their verdict, probably in September? Andreas Vosskuhle, the court's president, noted acidly that the hearings were not about the "future of Europe or the handling of the debt crisis". They are a matter of law.
This is the same court that stunned EU elites with its volcanic ruling on the Lisbon Treaty in June 2009, cautioning Brussels that the EU is a club of sovereign states, not a state itself; that national parliaments are the only legitimate fora of democracy; and that certain fields "must forever remain under German control" – including budgets.
The court has been the backbone of German democracy for 60 years. It is über-vigilant because it knows where pliant judges went wrong in the 1930s. It must be irked by Pierre Lellouche, France's Europe minister, who said with relish after the summit deal on Greece last year that EU leaders had carried out a constitutional coup. "De facto, we have changed the treaty," he said.
Tübingen professor Joachim Starbatty, one of the litigants, expects the court to reach a "Yes, but" ruling that allows agreed rescues to go ahead, but imposes a strict "corset" on future bail-outs. This could have serious implications.
Further doubts over how far Germany will go to backstop the EMU system risks accelerating capital flight from Spain and Italy. Neither country is safely out of the woods yet. The PMI Composite index for Spain and Italy both tumbled below 50 in June, signalling economic contraction in the third quarter. France's index saw the sharpest drop since the series began in the late 1990s. EMU's North-South divide is becoming wider.
At the least, the court is expected to insist that the Bundestag has a veto on rescue packages, a gift to the populists as German bail-out fatigue turns to fury. A recent Allenbach poll found that 71pc of Germans now have "little" or "no trust at all" in the euro.
For Greece, events have already moved beyond the point of no return. The country is being pushed deeper into economic and political ruin by an IMF austerity drive that lacks the usual shock absorbers. The IMF's twin cures of devaluation and orderly default are both blocked, one by euro membership, the other by EU contagion fears.
Greece's public debt will rise to 161pc of GDP by next year, up from 120pc when the crisis erupted. Its economy will contract by a further 3.8pc this year. The deficit remains stuck near 9pc of GDP because the slump is choking tax revenue. The strategy is self-defeating.
"Is there anybody out there who really thinks this crisis is over?" said Jacques Cailloux, Europe economist at RBS. "The policy has failed completely. It must be revamped. There needs to be a Marshall Plan, and the penal interest rate on EU loans must be cut to zero."
None of this is happening because Europe's creditor states have not faced up to the reality that saving monetary union requires years of subsidies – not loans – from North to South. The EU authorities are instead lost in minutiae, arguing over collateral rules, or floating plans for bond rollovers at effective rates of up to 10pc. The sole aim is to buy time for banks to offload liabilities – mostly on to EU taxpayers – and for Spain and Italy to beef up defences.
The Greeks are being sacrificed for the greater cause. Their reward is to learn from Eurogroup chief Jean-Claude Juncker that Greek sovereignty will be "massively limited". A body overseen by EU officials and modelled on East Germany's Treuhand will liquidate Greece's national assets to cover debts.
Suzerainty has begun in earnest.
Portugal’s Debt Rating Cut to Junk by Moody’s
by David Jolly and Liz Alderman - New York TImes
Moody’s Investors Service cut Portugal’s debt rating to junk status on Tuesday, ratcheting up the pressure on euro zone governments to work out a lasting solution to their financial woes.
Moody’s cut its rating on Portugal’s long-term government bonds to Ba2 from Baa1 and said the outlook was negative, suggesting more downgrades might be in store. Even though Portugal negotiated a $116 billion rescue package in May, the ratings agency cited the risk that the country would need a second bailout before it could raise funds in the bond markets again and that private sector lenders would have to share the pain.
It also warned that Portugal might fall short of the financial goals it had worked out with the European Union and the International Monetary Fund under the terms of its bailout because of the "formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system."
The downgrade came a month after a general election in Portugal in which voters unseated the Socialist government of José Sócrates. Since then, the new center-right coalition government, led by the Social Democrats and Prime Minister Pedro Passos Coelho, have pushed ahead with austerity measures and other reforms pledged by Portugal in return for its bailout.
Among such austerity measures, Mr. Passos Coelho’s government said last week that it would need to raise taxes to meet its budget deficit target. Under the plan, the government hopes to collect 800 million euros ($1.2 billion) in additional tax receipts this year by introducing a special tax that will amount to a 50 percent cut on the traditional Christmas bonus given to Portuguese workers, equivalent to one month of salary.
Responding to Moody’s decision on Tuesday, the finance ministry said in a statement that Moody’s had "ignored the effects" of the tax plan outlined last week in Parliament. The tax increase, the ministry added, "constitutes a proof of the government’s determination to guarantee the deficit targets for this year."
The finance ministry said Moody’s downgrade vindicated the government’s recent policy initiatives since "a robust program of macroeconomic adjustment constitutes the only possible approach to reverse the tide and recover credibility." The new government has also shelved several infrastructure projects, including a new high-speed train link between Lisbon and Madrid, as well as pledged to speed up the privatization of state-controlled companies.
Still, proposals like raising taxes will most likely yield more pain for citizens of a country whose economy is forecast to contract 2 percent this year and next. As a practical matter, the downgrade "means that a smaller universe of investors can hold Portuguese debt on their books," said Carl B. Weinberg, chief economist at High Frequency Economics in New York, referring to rules banning many investment vehicles from holding debt rated below investment grade. Portugal does not have to borrow in the markets, he noted, so the immediate damage to government finances is limited
Still, with all the confusion about another bailout for Greece, "this adds to the perception that there might not be a ready solution," Mr. Weinberg said. "It revives the concern that a multicountry sovereign default could happen." "They’re playing with dynamite in euro land," he added.
Hopes that Greece’s problems might be brought under control soon were deflated after Standard & Poor’s said Monday that a proposal by French banks to help Greece to meet its medium-term financing needs would constitute a de facto default because banks would be required to roll over loans for a longer term at a lower interest rate. "We’re continuing to work for a possible solution," Michel Pébereau, chairman of BNP Paribas, the biggest French bank, said Tuesday at the Paris Europlace conference, a gathering attended by hundreds of international bankers. If the current ideas do not work, Mr. Pébereau said, "we’ll come up with something else."
French and German bankers were scheduled to meet Wednesday morning at BNP Paribas’s headquarters in Paris with central bank officials, under the auspices of the Institute of International Finance, an association of the world’s biggest financial companies, to discuss how to proceed, said people briefed on the plan who were not authorized to speak about it publicly.
The banks are to discuss the implications of S.& P.’s determination that their proposal to roll over Greek debt would constitute a "selective default," as well as what would constitute a full-blown default, the people said. The difference is crucial, because in the case of full-blown default, the European Central Bank would not be able to accept Greek debt as collateral.
"Everyone here is anxious," said an executive with the French unit of a large United States financial institution, who was not authorized to speak publicly. "Everyone is interconnected. It’s not just a problem for Greece. All the banks are nervous and strongly desire a solution."
Investors are looking not only at how much financial support Greece is receiving from its European partners and the I.M.F. but also at whether Greece’s private creditors might have to declare any losses on their holdings of Greek debt, which would affect the banks’ balance sheets. Banks are eager to achieve clarity on how large any potential losses may be.
Moody’s said Tuesday that banks might have to book losses on their existing Greek bonds if they choose to roll over the maturing debt.
French bankers had not contacted the ratings agencies before publicizing their proposal to roll over Greek debt. "The French banks jumped too soon," said a banker involved in the discussions. Euro zone finance ministers reached a deal last week to keep the Greek government operating through the summer but put off the question of how to provide a second bailout to meet its financing needs through 2014.
There is wide agreement that some kind of debt relief is necessary, and officials, particularly in Germany and the Netherlands, want banks to share part of the pain of a debt restructuring. Negotiations are complicated by the fact that a declaration of default by the ratings agencies could cause a dangerous escalation of the crisis.
The German chancellor, Angela Merkel, said Tuesday that the opinions of the I.M.F., the European Central Bank and the European Commission should be given more weight than those of the rating agencies, according to The Associated Press. "I trust above all the judgment of those three institutions," Mrs. Merkel said.
In a sign of how complex the calculus of bailouts has become, Germany’s top court on Tuesday heard a lawsuit filed a year ago by six plaintiffs who argued that German aid to Greece was illegal under a European rule that bars member states from taking on governments’ liabilities. The case was serious enough that Finance Minister Wolfgang Schäuble attended, arguing that the government had no choice but to back aid for Greece. "A common currency can’t do without the solidarity of all members," Mr. Schäuble said, according to The A.P.
Greece blasts ratings agency 'madness' as Portugal downgraded to 'junk'
by Louise Armitstead - Telegraph
Portugal's debt downgrade by Moody's to 'junk' status provoked more anger on Thursday, as Greece's foreign minister blasted the 'madness' of ratings agencies.
Stavros Lambridinis told a conference in Berlin that the decision by the ratings agency late on Tuesday to downgrade Portuguese debt was not based on any failure to implement economic reforms. Lambridinis said that this had "the wonderful madness of self-fulfilling prophecy" by aggravating Portugal's fiscal straits, and exacerbating an already difficult situation.
The move by Moody's sent Britain's benchmark share index back below the psychological 6,000 mark, after the index had posted eight straight days of gains. The FTSE 100 index of leading shares fell as much as 0.7pc in early morning deals, to 5,988.34, after Portugal's debt was relegated to junk status on Tuesday night by Moody's Investor Services, which warned that the country's prospects had been damaged by the international efforts to rescue Greece.
Big holders of European government debt suffered the biggest losses, with Royal Bank of Scotland and Barclays shedding more than 2.5pc each on Wednesday morning, as the Moody's move brought the eurozone's debt crisis back to the fore. In Paris, the CAC 40 shed 0.44pc, while Germany's Dax dropped almost 0.3pc.
Moody's singled out the insistence of European leaders on private bondholders taking part in the Greek bail-out as a reason for the downgrade. Moody's slashed Portugal's debt four notches to Ba2, saying that the country was likely to need a second bail-out before it could raise money in the capital markets. Based on the conditions imposed on Greece, it was likely that "private sector participation would be required as a precondition" to a second cash injection, said Moody's.
The outlook was left at negative, signalling the possibility of more downgrades. The blow came after markets closed in Europe, but the euro fell against the dollar for the first time in seven days, finishing 0.9pc down on the day. In America markets also slid. Moody's said that it also had "heightened concerns" that Portugal would not be able to achieve the deficit reduction targets that have been set by the European Union (EU) and International Monetary Fund. The targets in terms of "reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system" represent "formidable challenges", said Moody's.
Although the targets and structural challenges faced by Greece are far tougher – Greek debt is graded at Caa1 – the rating agency said that the increasingly hardline approach of European leaders "is an important factor for Portugal".
In a statement, Moody's said that "the EU's evolving approach to providing official support" to debt-laden countries "increases the economic risks facing current investors". It added that the change "may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms".
Last week, Portugal – which received a €78bn (£70bn) bail-out in May – said its deficit fell to 8.7pc of GDP at the end of the first quarter, down from 9.2pc three months earlier. But it has committed to cutting the deficit to just 3pc by 2013. International banks are meeting in Paris on Wednesday in an effort to salvage talks with European regulators over sharing the cost of bailing out Greece. The lenders will debate a plan that will be more advantageous to Greece than the proposals put forward by French banks last week.
The French banks had offered to roll over 70pc of debt maturing by the end of 2014. The new deal could include rolling over more debt and lowering the interest rates even further. The meeting, which will be chaired by the Institute of International Finance, follows Standard & Poor's verdict that the French plans would constitute a default. European authorities are determined for Greece to avoid an official default but still want private creditors to share the costs of bailing out the shattered economy.
Greece has €82.6bn (£74.2bn) of government bonds maturing before the end of 2014. European banks hold about €25bn of this. Meanwhile, Hans Hoogervorst, the new head of the International Accounting Standards Board, suggested allowing European banks to adopt a new accounting rule, called IFRS 9, to gain a "bit more leeway" on Greek debt. IFRS rules have attracted controversy in Britain for hiding risks and distorting accounts.
Moody’s downgrades Portugal on… Greece fears
by John McDermott - FT Alphaville
Well, sort of. The full rationale behind Portugal’s downgrade to Ba2 from Baa1, with negative outlook, is pasted below. Moody’s offers two main reasons. The second is Portugal’s ongoing high-debt-low-growth mash-up. This you know about.
The first reason is more interesting (and emboldened below). Moody’s writes that the "voluntary" involvement of private creditors in Greek bailout efforts bodes ill for Portugal’s ability to access capital markets. It suggests that bondholder burdensharing would be a precondition of future lending to Portugal, which in turn would scare off new creditors.
Contagion, amplified.London, 05 July 2011 — Moody’s Investors Service has today downgraded Portugal’s long-term government bond ratings to Ba2 from Baa1 and assigned a negative outlook. Concurrently, Moody’s has also downgraded the government’s short-term debt rating to (P) Not-Prime from (P) Prime-2. Today’s rating action concludes the review of Portugal’s ratings initiated on 5 April 2011.
The following drivers prompted Moody’s decision to downgrade and assign a negative outlook:
1. The growing risk that Portugal will require a second round of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a pre-condition.
2. Heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilisation targets set out in its loan agreement with the European Union (EU) and International Monetary Fund (IMF) due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.
The first driver informing today’s downgrade of Portugal’s sovereign rating is the increasing probability that Portugal will not be able to borrow at sustainable rates in the capital markets in the second half of 2013 and for some time thereafter. Such a scenario would necessitate further rounds of official financing, and this may require the participation of existing investors in proportion to the size of their holdings of debt that will become due.
Moody’s notes that European policymakers have grown increasingly concerned about the shifting of Greek debt held by private investors onto the balance sheets of the official sector. Should a Greek restructuring become necessary at some future date, a shift from private to public financing would imply that an increasingly large share of the cost would need to be borne by public sector creditors. To offset this risk, some policymakers have proposed that private sector participation should be a precondition for additional rounds of official lending to Greece.
Although Portugal’s Ba2 rating indicates a much lower risk of restructuring than Greece’s Caa1 rating, the EU’s evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well.
This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.
The second driver of today’s rating action is Moody’s concern that Portugal will not achieve the deficit reduction target — to 3% by 2013 from 9.1% last year as projected in the EU-IMF programme — due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system. As a result, the country may be unable to stabilise its debt/GDP ratio by 2013.
Specifically, Moody’s is concerned about the following sources of risk to the budget deficit projections:
1) The government’s plans to restrain its spending may prove difficult to implement in full in sectors such as healthcare, state-owned enterprises and regional and local governments.
2) The government’s plans to improve tax compliance (and, hence, generate the projected additional revenues) within the timeframe of the loan programme and, in combination with the factor above, may hinder the authorities’ ability to reduce the budget deficit as targeted.
3) Economic growth may turn out to be weaker than expected, which would compromise the government’s deficit reduction targets. Moreover, the anticipated fiscal consolidation and bank deleveraging would further exacerbate this. Consensus growth forecasts for the country have been revised downwards following the EU/IMF loan agreement. Even after these downward revisions, Moody’s believes the risks to economic growth remain skewed to the downside.
4) There is a non-negligible possibility that Portugal’s banking sector will require support beyond what is currently envisaged in the EU/IMF loan agreement. Any capital infusion into the banking system from the government would add additional debt to its balance sheet.
Moody’s acknowledges that its earlier concerns about political uncertainty within Portugal itself have been largely resolved. Portugal’s national elections on 5 June led to the formation of a viable government, both components of which had campaigned on the basis of supporting the EU-IMF loan agreement negotiated by the previous government. Moody’s also acknowledges the policy initiatives announced at the end of June demonstrate the new Portuguese government’s commitment to the programme.
However, the downside risks (as detailed above) are such that Moody’s now considers the government long-term bond rating to be more appropriately positioned at Ba2. The negative outlook reflects the implementation risks associated with the government’s ambitious plans.
WHAT COULD CHANGE THE RATING UP/DOWN
Developments that could stabilise the outlook or lead to an upgrade would be a reduction in the likelihood that private sector participation might be required as precondition for future rounds of official support or evidence that Portugal is likely to achieve or exceed its deficit reduction targets.
A further downgrade could be triggered by a significant slippage in the execution of the government’s fiscal consolidation programme, a further downward revision of the country’s economic growth prospects or an increased risk that further support requires private sector participation.
Could Italy Be the Next European Domino to Fall?
by Simon Johnson - BloombergIn recent days, Greece’s parliament adopted new austerity measures and Europe’s finance ministers approved another round of Greek loans. So the European debt crisis is under control, right?
Probably not. One obvious reason is Standard & Poor’s July 4 threat to declare a default if banks roll over Greek government bonds coming due over the next year. That could force everyone back to the drawing board.
Less obvious, but no less worrisome, is Italy. With a precarious fiscal picture, it could be the next to come under pressure. And this time, U.S. banks are in the line of fire, with about $35 billion in loans to Italy and potentially more exposure to risk through derivatives markets.
U.S. regulators should call for a new round of stress tests that assume sovereign-debt restructurings in Europe and take a realistic view of counter-party risks in opaque markets such as foreign exchange swaps. Based on those tests, the biggest banks probably need to suspend dividends and raise more capital as a buffer against losses. Many market participants believe Greece will eventually attempt an orderly restructuring of its debt, in which European governments, together with the IMF, commit more resources and European banks agree to lengthen bond and loan maturities. The effect on Italy could be significant.
In the most recent International Monetary Fund projections, Italy’s headline debt will reach 120 percent of national output this year, and then decline only slightly to 118 percent by the end of 2016. Italian bonds last week yielded about 4.9 percent, with the spread over German bonds widening to about two full percentage points (in contrast, the Greek-German spread is now about 13 percentage points). Further increases in interest rates could push the forecasts for Italy’s debt toward Greek levels.
How could that happen? Investors are just beginning to understand that they will soon face losses on loans to Greece. Until recently, the presumption had been that German, Dutch and other northern European taxpayers would bail out failing governments in peripheral eurozone countries, at least to the extent necessary to protect creditors against losses.
This logic made some sense for smaller countries like Greece. It has about 360 billion euros in debt outstanding and the potential credit losses in any restructuring are in the range of 100 billion to 200 billion euros. The amounts are small relative to the EU’s 12 trillion-euro economy.
Italy, though, has close to 2 trillion euros in debt outstanding. It’s inconceivable that Germany or the IMF could provide a rescue to protect its creditors. Such a package would have to involve loans and guarantees of at least 500 billion, and possibly 1 trillion, euros to impress the markets. This would be a significant fraction of Germany’s gross domestic product of about 2.5 trillion euros. With a debt-to-GDP ratio of about 80 percent, Germany’s ability to take on new debt is limited.
The Netherlands, Finland and Austria, combined with Germany, have a GDP of about 3.5 trillion euros. France adds 2 trillion more, but its debt, already 85 percent of output, is expected to grow over the next several years.
It all adds up to one sobering fact: Europe does not have enough fiscal firepower to handle an Italian crisis -- at least in such a way as to protect creditors completely. Beyond the difficult numbers, why would Germany or other EU countries lend to Italy, particularly when its politicians show no sign of coming to grips with their new reality?
Once these facts dawn on investors, they are likely to demand higher yields on Italian government bonds. If Italy’s economic growth is disappointing or if its recently announced fiscal austerity measures fail to impress the markets, its debt will look even more dubious. Long-term investors hate this kind of volatility and will shift out of Italian assets. By itself, that could push Italian rates up, similar to what happened in Greece, Portugal and Ireland over the last 18 months.
Italy has one major advantage over other eurozone countries: Much of its government debt is held by domestic financial institutions. If foreigners bolt, Italian authorities could pressure local institutions to support new bond auctions. But most Italian institutions have attached a very low -- and perhaps zero -- risk-weight to Italian government bonds. As yields rise, the value of those bonds falls. The losses will quickly threaten to swamp banks’ equity capital.
Italian banks aren’t likely to fail. Regulators will offer plenty of forbearance, so the banks won’t have to value assets at true market values. But the overhang of sovereign-debt losses and a potential ratings downgrade (after a recent warning on Italy from Moody’s Investor Service) could cause banks to cut back on private-sector lending. This would lower GDP growth and further worsen Italy’s debt-to-GDP projections.
Italian banks will be able to draw on substantial credit from the European Central Bank, especially once Mario Draghi, former head of the Bank of Italy, becomes the ECB president in November. But the entire euro system -- the ECB plus the 17 central banks sharing the euro -- has a combined balance sheet of only about 1.9 trillion euros. It’s unlikely that ECB credit can do more than postpone sovereign-debt problems on an Italian scale.
What are the implications for the U.S.? Think about the market turbulence that questions over Greece, Ireland and Portugal caused in the last year, and multiply. And think about an endgame in which moral hazard is really over -- meaning creditors that bet big on bailouts are allowed to suffer losses.
Previous bank stress tests did not factor in such difficult events, so the private sector and policymakers have no information to guide them. They are just guessing. All of this means the U.S. needs another round of stress tests for systemically important institutions. It would be wise for U.S. banks to raise enough capital now to withstand any trans- Atlantic storms.
Italy's Banks Sail in Choppy Waters
by Sabrina Cohen - Wall Street Journal
Europe's banking emergency room has a new patient: Italian lenders.
Investors have focused on their poor performance since banking shares fell by as much as 10% in a single day late last month, a decline triggered by negative reports on the lenders by credit-rating companies. In reality, though, Italy's banking sector has been in the doldrums since March, when the first news of a new Greek crisis started to circulate.
Stocks of the largest five Italian banks have lost around 27%, on average, since the beginning of the year. Concern over contagion risks from other European countries' sovereign-debt problems has weighed heavily on investors' minds, even though the exposure of the country's five leading banks to Greece stands at a relatively low €2 billion ($2.9 billion). The sluggish economic recovery in Italy, mirrored by the banks' own balance sheets, has also done little to assuage concerns.
At the end of March, several Italian lenders announced so-called rights issues—plans to sell stock to existing shareholders—to raise capital ahead of European-wide stress tests. The move was taken after Bank of Italy governor Mario Draghi, who is soon to be president of the European Central Bank, urged lenders to strengthen their balance sheets.
Analysts say political uncertainty during talks over key government budget measures worsened the situation at an inopportune time. Marcello Zanardo, a senior banking analyst with Sanford C. Bernstein & Co. in London, said the sector has been battered but isn't broken. "Italian banks suffered more than other European banks mainly because of their lower profitability and country risk, which led to right issues, but their fundamentals remained sound," Mr. Zanardo said.
In the last two years, while large lenders were busy strengthening their capital ratios in order to comply with European rules on bank capital, small banks offered better pricing to their clients, gaining market share. "Given the aggressive pricing done by smaller banks in Italy, leading to market-share gains, I believe in today's difficult funding environment they will have no choice but to slow down, with bigger and recapitalized lenders finally starting to grow again," Mr. Zanardo added.
The fall in stocks on June 24 was prompted by credit-rating companies Moody's and Standard & Poor's putting the outlooks on Italy and 16 of its domestic lenders under review. In the last two quarters, the profitability of Italian banks has come under pressure because of an age-old Italian problem: an inability to cut costs and boost efficiency. Italy's banking system has expanded in the last five years from 31,400 branches to 33,600, due in part to the arrival of foreign lenders such as BNP Paribas SA, Crédit Agricole SA and Barclays PLC.
But given the cost of cutting jobs, and the difficulty of negotiating layoffs with Italy's powerful unions in the wake of the global downturn, banks found it difficult to streamline their operations, getting rid of some of their 325,000 staff. Italian mutual bank Banco Popolare on Thursday became one of the first institutions to bite the bullet. Having secured a €2 billion capital injection through a rights issue at the start of 2011, it announced plans last week to close 140 of its 1,992 branches and cut costs as part of an updated three-year business plan.
Still, more trimming needs to be done by the sector before the outlook can turn more rosy. The chief problem has been the multi-billion-euro rights issues most banks have been forced to seek. Unlike most European-based lenders, Italian lenders didn't benefit from a government bailout during the height of the economic crisis. Instead, several Italian lenders used expensive government-sponsored bonds, named "Tremonti bonds" after Finance Minister Giulio Tremonti, to strengthen their capital ratios.
It was the Italian government that benefitted the most, gaining around €200 million from interest on those bonds, according to a study by Mediobanca. In early 2011, Banco Popolare, UBI Banca SpA, Intesa Sanpaolo SpA and Banca Monte dei Paschi di Siena SpA, had to announce rights issues valued at a total of around €10.4 billion to strengthen their capital ratios and, in some cases, repay the same bonds.
Market participants believe the sector will improve once the impact of the rights issues passes. Giuseppe Vegas, chairman of Italy's market watchdog, Consob, said last week that he expects European-wide stress results this month to give Italian banks a seal of approval. Antonio Guglielmi, an analyst based in London with Mediobanca Securities, believes that an increase in interest rates by the ECB may have a negative impact on the cost of funding, but will still help Italian banks' net interest income. Italian bank stocks may be in need of some aid, but at the least, a corner has been turned.
Banks to meet to sweeten Greek terms
by Patrick Jenkins - Financial TImes
The eurozone’s big banks will meet again in Paris on Wednesday in an attempt to end the deadlock with European authorities over the terms of investors’ participation in the restructuring of Greek sovereign debt.
According to people briefed on the talks, a new proposal will ease the burden on Greece, sweetening the terms of the banks’ original plan that would have seen them roll over for 30 years half of their holdings of Greek debt due to mature in the next three years.
The banks met last week, under the auspices of the Institute of International Finance, in an effort to thrash out the terms of that voluntary plan. They used a blueprint drawn up by the French banking federation, and endorsed by Nicolas Sarkozy, French president, as the basis of negotiation.
Under that plan, the rolled-over debt would have carried an interest rate capped at 8 per cent, comprising a basic 5.5 per cent coupon plus a "kicker" of up to 2.5 per cent depending on the rate of Greek economic growth.
There was also a plan to force the Greek government to buy top-grade European debt – most likely issued by the European Financial Stability Facility – as an insurance policy against default. The equivalent of 20 per cent of the maturing debt from the next three years would be held in that collateral pool.
Although the French government backed the French banks’ plan, other governments, European officials and Greek negotiators complained that the terms were too limited. German financial institutions, which separately argued that the 30-year rollover time frame was too long, said they would only roll over only €3.2bn.
Now, according to two people involved in the talks, two key elements of the initial French plan – the coupon and the proportion of debt targeted for rollover – are to be changed.
Under a new form of the proposal, the interest rate would come down to as little as 5.76 per cent. The basic coupon would be floating depending on the Euribor 3-month rate, currently 1.56 per cent, plus a buffer of as little as 1.7 per cent, according to one person close to the talks. The "kicker", also limited to a maximum of 2.5 per cent, would be based not on growth but on the level of Greek inflation.
The 50 per cent buy-in target could be raised to as much as 70 per cent, negotiators said. Politicians are pushing for the rollover of as much as €30bn of Greek debt out of the €100bn or so that is set to mature by end-2014. But participation is voluntary, so even a 70 per cent rollover by those who agree to sign up might not equate to €30bn in total.
French and German banks, insurers and pension companies are the biggest private sector holders of Greek debt, with close to €30bn between them. However, it is unclear what proportion of that total falls into short-dated maturities covered by the current talks.
People close to the negotiation process cautioned that several other mechanisms for dealing with the Greek sovereign restructuring problem had been proposed, including a side proposal mentioned in the French plan for a five-year rollover. But they said the French 30-year blueprint – albeit with significant changes – remained the most likely basis for a broad agreement.
The news came as Moody’s, the credit rating agency, warned that banks rolling over debt into the 30-year instruments risked having to take credit impairments. Avoiding such impairments is a crucial pre-requisite for the deal, bankers said.
On Monday, fellow rating agency Standard & Poor’s said the French plan would trigger a downgrade of Greece to selective default, another obstacle to the proposal reaching fruition. However, European bankers and officials played down S&P’s move as just a temporary technicality.
ECB will continue to accept Greek debt
by Richard Milne and Gerrit Wiesmann - Financial TImes
The European Central Bank will continue to accept Greek debt as collateral for loans unless all the major credit rating agencies it uses declare it to be in default, said a senior finance official.
The ECB would rely on the principle of using the best rating available from the agencies – Standard & Poor’s, Moody’s and Fitch – the official said. The comments came after S&P on Monday became the first agency to warn that a plan, pushed by France and endorsed by Germany, for banks to roll over their holdings of Greek debt into new bonds would constitute a "selective default".
The ECB’s continued support for Athens is crucial given that Greek banks are almost entirely dependent on the European Central Bank for funding. Analysts had feared that the ECB’s seemingly tough Greek stance could lead to the collapse of the Greek banking system, whose borrowings from the ECB topped €100bn (£90bn) last month.
S&P’s move knocked the euro and put bank shares under pressure as a week-long rally in equities faded. Analysts viewed the move as a further obstacle to the second bail-out for Greece in a year as the debt rollover proposal was conditional on it not triggering a downgrade.
Fitch, the third-largest rating agency, has also indicated it is likely to call a rollover a default. But Moody’s has yet to comment. If only one of them does not downgrade Greece, the ECB could continue to prop up the Greek banking system. "This would give the ECB significant wiggle room," said one large investor. The ECB on Monday night declined to comment.
The second bail-out has already been delayed as countries haggle over how to get private holders of Greek debt to contribute to the rescue. The size of their contribution is causing concern among European officials as German banks, the largest holders of Greek debt after French lenders, said last week that they would only put in about €2bn in holdings.
French and German officials said they were not unduly concerned by the S&P statement. They underlined that a rollover was unlikely to constitute a so-called credit event, which would trigger payments on credit default swaps, a form of insurance against default. "The important thing is that we avoid a credit event, with all the resulting negative impact on credit-default swaps which occupied us after the Lehman bankruptcy," a German official said.
Niall Ferguson: The Eurozone is a government-killing machine
Brazil risks tumbling from boom to bust
by Paul Marshall and Amit Rajpal - Financial Times
Back in February, in an earlier Insight column, we highlighted the major build up of consumer debt at extremely high rates of interest, putting a significant cash flow burden on the repayment capacity of borrowers. Since then, the situation has deteriorated further. Pressures are building in the Brazilian credit cycle.
The average rate of interest on consumer lending has jumped from 41 per cent in 2010 to 47 per cent most recently in May 2011. This rise from an already elevated level reflects the cumulative effect of tightening by the Brazilian central bank in order to contain inflation. The consumer debt service burden, which stood at 24 per cent of disposable income in 2010, is now slated to rise to 28 per cent in 2011. This compares with 16 per cent for an "overburdened" US consumer and a mid-single digit reading for other emerging markets such as China and India.
In short, the cash flow burden is astronomical and rising. We calculate that the debt service burden for the so-called "middle class" in Brazil has now breached 50 per cent of disposable income, as high income earners have little need to borrow at rates which are punitive and most of the consumer credit is therefore being directed to the "middle class" for consumption.
The strain is already evident among the smaller banks, which are finding it difficult to access funding. The central bank has now rescued or taken over three banks in distress over the past six months.
Meanwhile, delinquencies in Brazil (defaults in excess of 15 days) have begun to move up rapidly, from 7.8 per cent to 9.1 per cent of total loans between December 2010 and May 2011. Delinquencies are now rising at a very hectic rate. They have risen at 23 per cent in the first five months of this year in absolute terms or at an annualised rate of 55 per cent.
This is troubling as credit indicators have deteriorated even as the economy has stayed strong and the unemployment rates are at a record low. Normally credit indicators cyclically follow (read lag) the economic cycle. When they begin to deteriorate before any economic weakness it usually represents a structural problem relating to underlying cash flow or underwriting weakness in the quality of credit – Brazil has both problems.
Over time as the economy weakens this is only likely to exacerbate weakness in the domestic credit cycle and could potentially create a fully fledged credit crisis. Ultimately, Brazil needs to restructure the way it dispenses credit to consumers. More of the lending needs to be collateralised (ie housing related). And the infrastructure to support credit expansion needs to be put in place, via a credit bureau which is able to share "positive" data (before a customer default) across the industry.
More strategically, we believe the country has to build a higher savings rate and reduce cross subsidies to bring down the cost of credit to levels which are less punitive than currently both in nominal and, more importantly, real (adjusted for inflation) terms. Brazil has a national savings rate which was 17 per cent for 2010 (this includes savings by consumers, corporates and the government). This compares with a developed market average of 19 per cent and is significantly lower than an emerging market average of 32 per cent.
Hence, if Brazil is to grow to its "potential", it has to build a reasonable stock of savings which allows it to invest as the economy grows without creating bottlenecks and inflationary pressures that exist as a growth constraint today.
These three basic foundations (ie the right level of collateralisation, the right infrastructure to support credit extension and the right level of lending rates) need to be in place to create a self-sustaining positive cycle. Without these buildings blocks we are afraid that Brazil will be exposed to significant boom-bust cycles. Unfortunately, we are currently at risk of transitioning from a boom to bust.
The markets seem to be taking cognisance of these factors gradually with the Bovespa index now down 10 per cent since the start of 2011 in local currency terms, making it among the worst performing markets globally. Despite this, most analysts and investors still seem to be sanguine about the prospects for Brazil. The disconnect will be answered one way or the other before the end of this year.
The credit ratings agencies are getting it right at long last
by David Prosser - Independent
Outlook: The eurozone view that a default in Greece can be brazened out may prove to be yet another example of the wishful thinking seen during this debt crisis
Given that they performed so woefully in the run-up to the credit crisis, why should we take any notice of what the credit ratings agencies have to say about the sovereign debt crisis in the eurozone?
It would certainly suit those charged with coming up with a political solution to the question of what to do about Greece for the likes of Standard & Poor's to support them in the way they once did the issuers of CDOs. But we ought to be grateful the credit ratings agencies are not prepared to play ball – Moody's, like S&P yesterday, has said the current proposal for rolling over Greece's debt would be a default even if Europe's banks volunteer to agree.
For one thing, it is no good for those who have been so critical of the role of credit ratings agencies during the crunch – and eurozone governments have been up there with the best of them – to complain now that they are on the wrong end of more realistic assessments of debt and default.
For another, eurozone governments may not like what S&P had to say yesterday, but the rating agency's customers – those who pay it to assess the risk of borrowers not repaying what they owe – treat its views with the utmost seriousness. S&P's views – and those of its counterparts – matter because the markets think they matter.
And for yet another, it is very difficult to take issue with what S&P has to say. The crux of the French proposal for restructuring Greece's debts is that lenders would not be forced to accept the plan. Even leaving aside the question of the extent to which European banks are to be pressured into "volunteering" to accept losses on Greek holdings, the fact that losses are occurring is the textbook definition of a default. How could any self-respecting ratings agency not describe it as such?
The importance of the argument about default, by the way, is not so much the immediate impact on European banks of crystallising losses on Greek sovereign debt, but what might take place in the credit default swap (CDS) market, where the fear is of as yet unquantifiable losses for many issuers. It was these contracts – effectively, insurance policies that pay out to borrowers if the lender cannot – that caused so much trouble after the Lehman Brothers collapse.
The prevailing view in the finance ministries of France and Germany, the other promoter of the voluntary haircut scheme, is that a technical default would not necessarily trigger demands for huge CDS pay-outs. Isn't that just the sort of wishful thinking that saw eurozone policymakers insist for so long that Greece did not need a restructuring?
Europe’s bigger crisis waiting to happen
by Kathleen Brooks - Reuters
So it looks like Greece has staved off default for another few months at least. Investors are breathing a sigh of relief and buying up risky assets like the world is a rosy place again.
The markets always suffer from a chronic case of short-termism, but once a sovereign debt crisis takes hold it is very difficult to reverse. Investors may be concentrating on Greek, Irish and Portuguese funding needs for the next 24- 36 months now, but it won’t be long before investors start to scrutinise longer-term liabilities that are currently being clocked up for the next 10,20 even 30 years.
The bigger beast that threatens Europe’s solvency is the demographic and entitlements crisis. While a lot is known about Europe’s aging population, the scale of the problem and its urgency are not well understood. The IMF predicts that Greece will have the second highest growth in pension costs as a percentage of GDP in the G20 by 2030. Spain and Belgium aren’t in great shape either. Interestingly, by 2030 Italy and Germany will actually see their pensions’ costs start to fall, but that is because their populations are aging so fast that the bulk of their pension spending will be done in the next 10-15 years.
In Germany and Italy the demographic damage is done. Research from Eurostat predicts that by 2040 there will be less than two people of working age for every retired person in Germany and Italy that compares with just over three today. In France things are slightly better as there will be just about two workers for every retired person. These statistics tell a bleak story, with this type of demographic shift it is inevitable that living standards will deteriorate in the next decade or so.
The fiscal crisis of the future could also have a domino effect. Once investors realised there was an enormous hole in Greece’s public finances they started to punish Ireland, Portugal, Spain and even Italy saw its bond yields rise. In the future investors may start to punish the credit markets of those countries with poor demographics.
To get a sense of how large this problem is it’s worth putting it in perspective. The cost to bailout the banks after the 2008 subprime crisis cost 1.1 trillion dollars globally. The cost to bailout Europe’s periphery is 700 billion euros so far and counting. However, the cost to bailout the union from an entitlements crisis would be on a far larger scale and could bankrupt the entire currency bloc.
While investors seem fairly confident that Germany will act as fairy godmother and bailout the peripheral nations until the current problem goes away, it won’t be able to play a similar role in the next crisis. Germany has some of the worst demographic stats in the world, let alone the euro zone, so while it remains in a healthy financial position right now, it is inevitable that it will draw down on its fiscal surpluses in future to pay for its aging population.
The challenge of dealing with an aging population - by 2060 in the E.U. the number of 14-year olds and under will have fallen nearly 10 percent, while the number of people over 80 will have tripled – has a social impact as well as a financial one. Old age poverty is a growing phenomenon in the Western world, especially for women who live longer and typically have much smaller pension pots than men at retirement.
From a financial perspective, who is going to want to lend to a country that has to spend its revenue on health care and pensions rather than infrastructure and investment? This will make it more expensive for countries already nursing huge deficits to finance themselves going forward.
The focus of this article is the euro zone, but that doesn’t mean that the U.S. and the UK don’t having aging populations it is just that Europe’s problems are more acute. The U.S. and the UK both have slightly higher birth and immigrations rates than the currency bloc, which might give them some protection in the future.
As mentioned above the problem with a sovereign debt crisis is that once it takes hold it’s hard to reverse. They also tend to have a snowballing effect, but Europe’s demographic crisis is more like an avalanche. It won’t be long before investors start to worry about long-term liabilities and how western nations with high debt-to-GDP ratios will fare when the cohort of retirees in their populations start to rapidly increase.
To conclude, one of the main consequences of Europe’s demographic crisis is that the notion of sovereign debt as a risk-free asset class dies out. Since sovereign debt has been at the centre of our financial system for decades its demise could make the whole investment universe more risky.
Moody's Gives Banks Greek Debt Warning
by Margot Patrick - Wall Street Journal
Banks rolling over some of their Greek debt into new instruments may have to take impairment charges on the original, unpaid bonds, Moody's Investors Service said Tuesday, though the ratings agency still hasn't explicitly said the plan would result in a default.
Rival agency Standard & Poor's Corp. on Monday rocked efforts to involve the private sector in giving Greece more time to work out its fiscal problems by saying a proposal being promoted by French banks would likely put the country in "selective default."
The ratings agencies' reaction to the French proposal is being regarded as a crucial element in whether it will proceed or not, because euro-zone and European Central Bank officials have repeatedly said they want a deal that doesn't result in Greece getting a default rating. It could also affect the ECB's willingness to accept Greek bonds as collateral, which has been vital to keep the Greek banking sector functioning during the crisis. The Financial Times Tuesday reported that the ECB would continue to accept the debt as collateral for loans unless all the major credit ratings agencies declared Greece in default, citing an unnamed senior finance official.
Moody's in a note dated Monday and emailed early Tuesday said the French plan, which involves allowing banks to roll over debt maturing up to June 2014 into new five- or 30-year securities, could mean immediate charges against debt held on bank balance sheets as "available for sale," and that bonds "held to maturity" on banks' books could also be subject to impairment charges. Moody's said the ultimate treatment of the bonds would depend on how banks and their auditors interpret international accounting rules.
Moody's so far hasn't weighed in directly on the default issue, though analysts say the agency's default criteria make it pretty clear it would count as such. Under those criteria, investors would have to voluntarily participate in the exchange; Greece would still have to be capable of making its debt service payments; and the terms of the new transaction would have to be attractive on their own merit.
"Given that criteria I can't see any way in the sweet world that Moody's can say anything other than 'default.' So they probably won't," credit analyst Gary Jenkins at Evolution Securities said Tuesday. Moody's wasn't immediately available to comment.
S&P Selective-Default Risk for Greece 'Surmountable,' HSBC Says
A declaration by Standard & Poor's that Greece is in "selective default" after a bond rollover may cause limited harm as long as the European Central Bank keeps accepting the debt as collateral, said HSBC Holdings Plc.
"If the ECB lets it be known that regardless of the rating they would still take the bonds as collateral, then that will help as that's all that matters to banks," Steven Major, the global head of fixed-income research at HSBC Holdings Plc in London, said today in an interview. "There could be some temporary arrangement. The problem could be surmountable."
French rollover proposals being considered would qualify as a distressed debt restructuring because they would offer creditors "less value than the promise of the original securities," S&P said in a statement. That may leave the bondholders unwilling to complete the exchange and the ECB unable to accept Greek government debt as collateral, impairing the lifeline it has provided the country's banks.
Damage may also be contained should other rating agencies refrain from considering the rollover a default, Major said. The selective default rating is likely to be temporary too, he said. S&P moved Uruguay's rating to B- in June 2003 after marking it a selective default on May 16 following the country's debt- exchange program.
Europe is inching toward a goal of getting banks to roll over 30 billion euros ($44 billion) of Greek bonds instead of opening a funding gap for official lenders to fill.
French banks, with the biggest holdings of Greek debt, worked out a rollover formula that is serving as an example elsewhere, with two options for investors to replace their maturing securities. "I'm surprised by the statement today because we thought any plan on this would have been designed to make ratings agencies comfortable," Major said.
Hedge Funds Seeking Gains in Greek Crisis
by Julie Creswell - New York Times
It has been a tough year for the London-based hedge fund Algebris Investments.
Algebris, a $1.3 billion fund that focuses on global financial stocks, was down about 7 percent for the year through late June because of shares it held in European financial companies. Those stocks fell sharply recently amid fears they could have losses if Greece defaulted on its debt.
Still, undaunted by the risks that the Greek crisis could spread to other countries, managers at Algebris decided to buy more shares of European financial companies on the cheap. "The volatility in the market gave us the opportunity to buy a number of stocks of European banks and insurance companies where we think there is tremendous value and the risk of systemic meltdown was very low," said Eric Halet, a co-founder of the fund.
As Greece’s fiscal turmoil has rattled global equity, bond and currency markets, hedge funds have scrambled to figure out how to make the big score. Last week, financial markets rebounded sharply on news that the Greek Parliament had approved a tough austerity package, a move that staved off a default and was a condition for further international assistance.
Over the weekend, European ministers agreed to finance Greece through the summer but deferred crucial decisions on a second bailout. After a two-hour conference call late Saturday, the finance ministers from the 17 euro zone countries said they would sign off on an 8.7 billion euro, or $12.6 billion, loan to Greece, part of a 110 billion euro package agreed upon last year. The board of the International Monetary Fund was expected to approve its part of this installment, 3.3 billion euros, or $4.8 billion, within days.
Without the loans, the Greek government faced the prospect of insolvency in weeks. But with Greece still struggling to shore up its finances, European finance ministers also need to put together a second package of loans to help it through 2014. That bailout is expected to amount to 80 billion to 90 billion euros but, because of conflicts over the extent of private sector involvement in the effort, the package may not be agreed upon until September.
Wolfgang Schäuble, the German finance minister, said that the new program could "be completed before the release of the next tranche in the autumn — provided, as always, that the implementation of the program in Greece takes place as planned," Reuters reported from Berlin.
"Greece has enough cash over the summer so the very acute worry that Greece would be unable to pay in July has gone," said Nicolas Véron, senior fellow at Bruegel, an economic research institute in Brussels. "But Europe has not been proactive for some time, and it will probably remain in strong crisis management mode over the next few weeks."
Constrained by the unpopularity of bailouts at home, political leaders appear able to act only at the 11th hour, when they have no alternative, Mr. Véron said. "The E.U.’s institutions are not effective, and the bigger the crisis, the less effective they are," he said. "Discussion is driven by governments accountable to domestic constituencies and not to the E.U. as a whole."
The twists and turns of the crisis and the whipsaw market activity are making it tough for some hedge funds to maneuver. While it is possible that a hedge fund received a hefty payday from betting that the euro would rise in value against the dollar or that Greece would not default on its debt, no big winners have emerged, several hedge fund investors and managers said.
Only nine out of the more than 300 hedge funds tracked by HSBC’s private bank through mid-June showed double-digit returns this year, and the best-performer, Jat Capital, which bets on high-flying technology and Internet stocks, was up about 19 percent. In a separate survey, hedge funds tracked by Lyxor Asset Management showed that almost every fund across nearly every strategy lost money in June.
Some investors said that many hedge funds appeared to have sat out much of the euro zone crisis, particularly in bets involving Greek sovereign debt, concluding it was a "no-win situation," said Gerlof de Vrij, the head of the global asset allocation team at APG Asset Management in the Netherlands, which oversees $395 billion in investments for seven Dutch pension funds.
"If you were long Greece, your investors are going to ask, how could you be long? Why didn’t you see all the difficulties? And if you’re short, people will blame you for being a speculator and for all of the problems the country has," Mr. De Vrij said.
Those sentiments were echoed by Philippe Jabre, the former star trader of British hedge fund GLG, who now oversees Jabre Capital Partners, which is based in Geneva. "The hedge fund industry, in general, is being sidelined because we know things will be tougher, we’re just not sure where it’s going to come from, so we’re trying to reduce our exposure," Mr. Jabre said. He noted, for instance, that his firm had reduced its holdings of European banks.
"The problems could come from stocks, could be bonds, could be banks, could be the illiquidity of the market or a change in the short-selling rules. All of these things could come back and hurt hedge funds," he said.
Concerns that European regulators could suddenly ban short selling or take another unusual step to shore up their banks caused Pedro de Noronha, the manager of the $63 million Noster Capital Fund in London, to close out short positions, or bets he had made that European bank shares would fall, some time ago. He positioned his fund instead to bet that the sovereign debt of emerging-market countries could run into trouble.
"The problem with being short the European banks is that politicians will do everything they can to save them," said Mr. De Noronha. "You’re fighting against people who can change the rules of the game in the middle of the game."
Still, investors say hedge funds were active as much as 12 to 18 months ago in putting on positions through credit default swaps — contracts that would pay out in the event of a default — to benefit from rising concerns about the fiscal health of Greece, Ireland and Portugal.
As the price of those contracts became too expensive, some hedge funds moved into credit-default swap contracts for the sovereign debt of larger, more stable European countries, like Germany or even France, betting that those contracts could become more valuable. Others used credit-default swap contracts to bet that certain European banks that held Greek debt would run into trouble.
In June, amid the Greek crisis, the cost to insure Greek sovereign debt more than doubled from a year ago while the cost to insure German sovereign debt was virtually the same, according to Markit, a financial data business in London. "I don’t think Germany is going to default, but I think the threat of default is going to increase massively," said Mark Yusko, the president of Morgan Creek Capital Management, which invests in hedge funds.
Investors say hedge funds that bet the euro would tumble in value against the dollar, as countries in the euro zone came under pressure from high debt levels and low economic growth, had losses as the euro rose against the dollar.
"There were hedge funds who viewed that the Greek problems might lead people to question the survival of the euro as a common currency," said Eric Weinstein, who oversees $4 billion in investments in hedge funds at the asset manager Neuberger Berman. "They shorted the euro, believing it would drift lower towards a possible breakup," he said. "Those who shorted the euro versus the dollar have had that trade work against them as it has gotten stronger."
Mr. Halet and Davide Serra, a former financial analyst star with Morgan Stanley, co-founded Algebris in London in 2006, and decided to focus strictly on investing in global financial stocks.
Some bank stocks have been under pressure from potential losses and downgrades from the ratings agencies because of the Greek debt they hold. In addition, investors have worried the additional capital requirements that regulators in the United States and Europe are demanding to shore up the banking systems and prevent broader systemic risk will sharply reduce profits.
Still, the Algebris co-founders said the market overreacted to those concerns. "The market has been very concerned and very spooked about the possibility of a Greek default in July, whereas the decisions that have taken place in the last three weeks made that outcome less likely," Mr. Halet said in an interview before the Greek Parliament voted last week. "Yes, we do have exposures to European financials. We are not doing great," he said. "But we’re not doing worse than many other hedge funds."
7 reasons U.S. needs a Good Depression now
by Paul B. Farrell - MarketWatch
No, do not raise the debt-ceiling. You heard me: Block the debt ceiling vote. Don’t raise it. America’s out-of-control. A debt addict. Time to detox. Deal with the collateral damage before it’s too late.
We need to fix America’s looming credit default, failing economy and our screwed-up banking system. Now, with a Good Depression. If we just kick the can down the road one more time, we’ll be trapped into repeating our 1930’s tragedy, a second Great Depression.
Yes, depression. Spelled: d-e-p-r-e-s-s-i-o-n. Wake up America, recessions do not work. Won’t work in the future. Remember that 30-month recession after the dot-com crash? Didn’t work. Why? Because in the decade since that 2000 peak, Wall Street’s lost an inflation–adjusted 20% of America’s retirement money.
And what about the so-called Great Recession of the 2008 credit meltdown? Didn’t work either. In fact, made matters worse: Wall Street got richer by stealing from the other 98% of Americans, the middle class, the poor. And now their conservative puppets in Washington want to make matters worse, widening the wealth gap further to benefit the Super Rich.
Seems nobody really gives a damn about our great nation any more. America’s now a capitalists anarchy: "Every (rich) man for himself." Proxy battles are fought by high-priced lobbyists in a broken political system. America needs a 21-gun wake-up call. Yes, that’s why America needs a Good Depression. The economy’s bad now. But kicking the can down the road again will make matters much worse later.
America’s leaders lost their moral compass, lack a public conscience
This is not our first call for a Good Depression. As early as 2005 we began reporting on excessive debt. In November 2007 we warned of a crash dead ahead. The subprime credit meltdown had been accelerating for many months, although for a year our leaders kept misleading Americans: Fed Chairman Ben Bernanke’s "it’s under control." Treasury Secretary Henry Paulson’s delusional "best economy I’ve ever seen in my lifetime."
In August 2008 came the original of our seven reasons why America needs a Good Depression. Yes August, just two months before Wall Street banks collapsed into de facto bankruptcy, after many warnings predicting a crisis. This was no Black Swan. In September 2008 we reported on Naomi Klein, author of "Shock Doctrine: The Rise of Disaster Capitalism," warning of Wall Street’s insidious plan to take over America:
"Nobody should believe the overblown claims that the market crisis signals the death of ‘free market’ ideology." Then as the meltdown went nuclear, Klein warned: "Free market ideology has always been a servant to the interests of capital, and its presence ebbs and flows depending on its usefulness to those interests. During boom times, it’s profitable to preach laissez faire, because an absentee government allows speculative bubbles to inflate."
But "when those bubbles burst, the ideology becomes a hindrance, and it goes dormant while big government rides to the rescue. But rest assured," she predicted, Reaganomics "ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis that will be the rationalization for deep cuts to social programs, and for a renewed push to privatize."
Totally predictable: No Black Swans in 2000, 2008 … nor in 2012
Yes, all was predictable: The events of the past few years were well known in advance. In fact, the events of the entire decade were predictable. The rich got richer off the backs of the middle class and the poor. Why? "There’s class warfare all right," warns Warren Buffett. "But it’s my class, the rich class, that’s making war, and we’re winning." And they are also blind and deaf to the havoc their free-market Reaganomics policies are creating, selfishly undermining America, the world’s greatest economic power.
Lessons learned? Zero. Why? Wall Street, Washington and Corporate America are focused on one narrow-minded short-term strategy: Economic g-r-o-w-t-h, bull markets, megabonuses, tax cuts. In good times they tout "free markets." But when greed bombs, they throw free-market "principles" under the Reagan Revolution bus and unleash their mercenary lobbyists to go whining to Congress for huge taxpayer bailouts and access at the Fed discount window, to siphon off more taxpayer money. And they’ll do it again soon,
Wall Street and their cronies are doing such a miserable job, America needs a new strategy: First, stop "kicking the can down the road." Let a good old-fashioned Good Depression do the job that our hapless, happy-talking leaders refuse to do. Take our medicine. Let a new depression clean house and reawaken Americans to core values.
Trust me folks, it’s either a Good Depression now … or a Great Depression 2. Here are seven reasons favoring the do-it-now strategy:
1: Capitalism’s now a lethal soul sickness, needs a reawakening
What’s the real problem? Not the economy, not markets, nor even politics. Yes, our economic pains are real. But they’re just symptoms. Something’s structural wrong. Since 2000 endless bad news: Greed, deceit, stupidity, corruption, unethical behavior, lack of moral conscience.
The real problem’s deep in our character, the "mutant capitalism" Jack Bogle warned of in "The Battle for the Soul of Capitalism." Sadly, that battle was lost. With it we lost our soul, our moral compass. America’s character is measured by our net worth.
2. We’re already in the early stages of a Great Depression
Comparing today with the Great Depression is common sport. In a Newsweek special "Seeing Shades of the 1930s," Dan Gross wrote: "Wall Street, after two terms of a business-friendly Republican president, self-immolated on a pyre of greed, incompetence and excessive optimism." Today’s "new normal" economy means high unemployment for years, inflation driving prices, rising interest rates, more debt, chaos.
We are destroying ourselves from within. Former U.S. Comptroller General David Walker warns that "there are striking similarities between America’s current situation and that of another great power from the past: Rome." Three reasons "worth remembering: declining moral values and political civility at home, an overconfident and overextended military in foreign lands, and fiscal irresponsibility by the central government." We are becoming more vulnerable to external enemies.
3. Good Depression exposes our self-destruct bubble-thinking
Before the 2008 crash, "Irrational Exuberance" author Robert Shiller warned in the Atlantic magazine that "bubbles are primarily social phenomena. Until we understand and address the psychology that fuels them, they’re going to keep forming." Housing inflated 85% in the decade: "Historically unprecedented … no rational basis for it."
Bubble thinking is an toxic virus that infected everyone. Shiller warns of another coming: "We recently lived through two epidemics of excessive financial optimism … we are close to a third episode."
4. Good Depression will stir outrage, force real reforms
Writing in the Wall Street Journal, Jim Grant, editor of the Interest Rate Observer, wrote: "Why No Outrage? Through history, outrageous financial behavior has been met with outrage. But today Wall Street’s damaging recklessness has been met with near-silence, from a too tolerant populace." Grant worries that Wall Street will run "itself and the rest of the American financial system right over a cliff."
But we only went to the edge in 2008. Today, a rebellious "throw the bums out" hostility is blowing a new kind of bubble: Three years ago we did not have Tea Party, union fights, the Arab Spring and Greek austerity riots, all signs of an dark angry future sweeping across America.
5. Good Depression forces Wall Street to think outside the box
In a powerful Bloomberg Markets feature, "No Easy Fix," we’re told Wall Street’s "profit formula has hit a wall." Their "money-making machine is broken and efforts to repair it after the biggest losses in history are likely to undermine profits."
Even Mad Money’s Jim Cramer openly admits hedge fund managers are pocketing megaprofits at capital gains rates while laughing at the stupidity of a broken political system that gives hundreds of billions in tax breaks to the richest, then takes taxes off the table as our middle class is dying under massive unsustainable deficits. Soon angry mobs will "fix" Wall Street.
6. Good Depression will deflate America’s warring soul
The American economy is a "war economy" driven by a egomaniac. I saw it firsthand as a U.S. Marine. Americans love being king of the hill, world’s cop, the global superpower. Why else spend 54% of our tax dollars on a war machine, 47% of the world’s total military budgets.
Why? Our war machine generates such "spectacular profits that many people around the world" are convinced America’s "rich and powerful must be deliberately causing catastrophes so that they can exploit them," warns Klein in "Shock Doctrine." No wonder the GOP takes military spending, like tax cuts for the rich, off-the-table: The war industry is a major political donor.
7. Good Depression now … avoids a far bigger depression later
In "The Price of Liberty: Paying for America’s Wars," Robert Hormats, undersecretary of state and a former Goldman Sachs vice chairman, traces America’s wartime financing from the Revolutionary War to present wars. He warns that today we’re "relying on faith over experience, hoping that sustained growth will erase deficits and that the ballooning costs of Social Security, Medicare and Medicaid will be manageable in the coming decades without difficult reforms."
Absent a brutal reset, we are on a historically predictable course says Kevin Phillips, Nixon strategist and author of "Wealth & Democracy:" "Most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out." Yes, burned out, unprepared.
So pray for a Good Depression earlier rather than later. Choose now and we can be prepared for whatever comes. Or a Great Depression will hit later, when we’re least prepared, the problems bigger, our faith weaker … don’t raise the debt ceiling.
The beginning of the end of this extremely dangerous project
Nigel Farage is the leader of the UK Independence Party
IMF and EU to make €9 billion profit on Ireland bailout
by Fionnan Sheahan, Emmet Oliver and Donal O'Donovan - Independent.ie
The IMF and EU will make a €9bn profit over the lifetime of the bailout loans to Ireland. Finance Minister Michael Noonan last night revealed for the first time just how much the international agencies will make if the €85bn in loans are drawn down in total.
The British government is also entitled to send auditors and accountants here to check the books as part of its bilateral deal to Ireland, the Irish Independent has learned. It is also insisting that if Ireland ever leaves the euro the UK must be repaid in full and in sterling -- and not in any new Irish currency.
The developments come as the IMF-EU bailout team arrives back in Dublin today to begin the latest examination on whether the Government is meeting the terms of the €85bn programme of aid. The progress of public sector reform and changes to wage-setting systems for low earners will be discussed in talks with IMF-EU bailout team.
And it also appears likely the Government will have to seek an extra €400m in savings in December's budget if the official outlook for economic growth worsens. Mr Noonan said yesterday that he may have to slash €4bn from Government spending next year to meet the IMF-EU budget deficit target, rather than the €3.6bn previously flagged. He said the international agencies want the deficit to be reduced to 8.6pc of gross domestic product in 2012.
The present plan pencils in €3.6bn of savings to meet this target but also relies on high economic growth to push down the deficit. But the Finance Minister gave no indication that the Government was near achieving a 1pc reduction in the interest rate on the loans, which would save €150m per annum. Mr Noonan said France and Ireland continued to disagree about proposals on the corporation tax base.
Tanaiste Eamon Gilmore made a keynote speech on Ireland's relationship with the EU this week without mentioning a cut to the bailout interest rate. Mr Noonan also revealed for the first time just how much the international agencies will make if the €85bn in loans are drawn down. When all the loans are put together, Mr Noonan said: "The total margin applying under existing arrangements could be of the order of €9bn over the period."
Although the Government has another three months to show the reforms in the public sector and for low-paid workers are being delivered on, the pace to date is expected to be flagged in talks with the IMF-EU team. Enterprise Minister Richard Bruton's contentious labour market reforms will be touched upon in talks over the coming weeks with the IMF-EU team -- a move expected to strengthen the minister's hand in his negotiations with the Labour Party.
Mr Bruton's proposals to end Sunday premium pay were not discussed by the Cabinet yesterday. The final decision on the proposals will take into consideration both the IMF-EU team's views and a High Court case challenging the constitutionality of the joint labour committee agreements. The team from the International Monetary Fund, the European Commission and the European Central Bank will begin their latest three-month review of the €85bn international bailout today.
Mr Noonan said he and his officials will be discussing a range of economic and budgetary issues, including the current outlook for 2012. "On the review due to take place next week, we have not signalled any major items for renegotiation. However, during the quarter in the run-up to the budget there will be items for renegotiation because the manner in which we will make the correction in the budget may not accord with what is in the memorandum of understanding," he said. "As long as our approach is fiscally neutral, we will be in a position to substitute one measure for another," he added.
Mr Noonan said the previous review agreed "major changes", including the jobs initiative, an expenditure review and a review from 2012 to 2015. The minister said the programme negotiated by the previous government was to run straight through to 2014, but "there is now a commitment to a review following the first two budgets, which is significant".
The IMF is expected to give the thumbs up to the Government's progress so far in meeting budgetary targets, recapitalising the banks and bringing in the jobs initiative.
As part of the €85bn bailout package, the British government is lending €3.5bn.
Moody’s Sees Much Bigger Local Debt in China
China’s local government debt may be 3.5 trillion renminbi ($540 billion) larger than auditors estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, the rating agency Moody’s said Tuesday.
China’s mountain of local government debt has long been seen as a major risk by investors. The worry is that slower growth in the world’s second-biggest economy after that of the United States could set off a wave of loan defaults and hobble its banking system. "Banks’ exposure to local government borrowers is greater than we anticipated," Yvonne Zhang, a Moody’s analyst, said in a statement.
Unless China comes up with a "clear master plan" to clean up the problem, the credit outlook for Chinese banks could turn negative, Moody’s said. Moody’s debt tally is near the midpoint of various estimates from Chinese authorities, which used different definitions and accounting methods to compute their debt totals. The varying figures have led to confusion about just how serious the problem could become if heavily indebted local governments default, saddling banks with large loan losses.
Moody’s said it was hard to judge which banks had taken on the most local government debt, but Bank of China and China Citic Bank were among those that had lent more aggressively than their peers during China’s bank lending spree in 2009. China’s state auditor reported last week that local governments had accumulated 10.7 trillion renminbi of debt, about half of it amassed during a stimulus spending binge as Beijing sought to cushion the blow of the global recession.
Moody’s said the auditor’s report excluded some bank-funded loans because they were not deemed to be "real claims" on local governments. But the rating agency said that those loans posed the greatest risk of delinquency and that banks may face losses. The warning weighed on Chinese bank shares, which were the biggest drag on the Hang Seng index for the Hong Kong stock market Tuesday. However, the share declines were modest, and analysts expressed confidence that banks could withstand loan losses.
"Even if the worst-case scenario happened, it’s not going to be fatal," said Victor Feng, an equity strategist at Everbright Securities in Shanghai. "Profits may drop, but banks will not go bankrupt." The rating agency said a jump in local government loan defaults could push the nonperforming loan ratio for Chinese banks as high as 12 percent, well above its base-case scenario that envisions losses in the range of 5 percent to 8 percent. Government figures show the average nonperforming loan ratio was 1.1 percent at the end of March.
Moody’s outlined three scenarios for resolving the debt problem. Most likely, Beijing would work on a case-by-case basis to help local governments to get funding. China might ask banks to absorb losses on loans for which local governments are not liable. Moody’s said this scenario would probably involve a fair amount of debt restructuring by banks.
In the worst-case scenario, Beijing would leave banks and local governments to thrash out the issue on their own. This could hurt investor confidence in China, as there would be no clarity on China’s debt problems and loan disputes could drag on, thereby worsening losses.
The best case would involve Beijing’s stepping in to supply local governments with funding or take on some of their debt, although Moody’s acknowledged that this would raise so-called moral hazard issues of banks’ assuming excessive risk, knowing the government would always come to their rescue.
Reuters reported on May 31 that China’s regulators planned to shift 2 trillion to 3 trillion renminbi of debt off of local governments to ease the default threat. About half of the debt dates to the 2008 financial crisis, when Beijing unveiled a 4 trillion-renminbi fiscal stimulus package that compelled the local authorities to spend their way back to economic health.
But the legacy of the massive spending is now catching up with China, as maturity dates for the loans, many of which are due in 2013, draw closer. While most loans were used to build roads and other infrastructure that some analysts argue that China needs, it has also generated some wasteful spending.
Peter Elston, a strategist at Aberdeen Asset Management Asia, said the episode served as a reminder that Chinese banks can be used as instruments of the state, making them less attractive as investment options. "It is very sad, because it is going to take a very long time for them to convince investors that they are run for the benefit of shareholders and not for the benefit of the broader economy," Mr. Elston said in an interview in Singapore.
Generations of Pork: How Greece's Political Elite Ruined the Country
by Ferry Batzoglou, Manfred Ertel, Clemens Höges, Hans Hoyng - Spiegel
Three generations of a Greek political dynasty, with current Prime Minister Georgios Papandreou as a young boy with his late father Andreas, right, and grandfather Georgios, both former leaders of Greece.
The latest tranche of loans from the EU and the IMF has helped buy debt-ridden Greece some time. But the Greeks will find it hard to get back on their feet. Their country has been ruined by three political dynasties, which created a bloated system of cronyism that is hard to change.
The queue of hungry people snaked across the courtyard and into the street at the homeless shelter behind Omonoia Square in Athens last Thursday, just as it does every day at lunchtime. The retired, the unemployed, mothers with children, immigrants; they were all waiting patiently for church members to press something to eat into their hands.
Georgios Levedogiannis, 38, managed to get his hands on some peas with root vegetables and potatoes, along with three hunks of bread and a few cups of yoghurt. Levedogiannis has been coming here regularly for nine months. "I have to, in order to survive," he says.
Levedogiannis worked in security at Athens Airport for seven years. He wasn't rich, but he got by -- until his bosses fired him in 2009. At the moment, his poverty is not yet visible. Levedogiannis wears a clean shirt, smart blue slacks and a new-looking bag slung around his waist. He clearly makes an effort. But there are tears in the man's eyes as he says: "If I had work, I wouldn't do this to myself." He says he has "zero" money and that he sleeps at the Red Cross, eats at the church and dreams of a different time, a time where there was still work. "If you don't have connections, no one will take you," he explains. "And it's only getting worse."
Number of Needy Increasing Rapidly
Nearly all of Greece's 400 church districts have started distributing food to the poor, including at Omonoia Square. "The number of needy is increasing rapidly," says one helper there, "and we don't know whether the end is even in sight."
In fact, it probably isn't. Last Wednesday, the governing Socialists passed a massive austerity package in parliament by a slim majority, despite intense protests. The decision paves the way for the next round of emergency loans from the EU and the International Monetary Fund (IMF). Without this €12 billion ($17 billion), Athens would default on its debt within two weeks.
George Provopoulos, governor of the Bank of Greece, believes torpedoing the austerity package, as the country's conservative opposition tried, would have been "suicide." Still, Provopoulos also believes Greece has "reached the limit" and that it would be impossible to squeeze any more out of the people. In remarks to the conservative newspaper Kathimerini, he spoke about what he saw as the root cause of the crisis. "There is little doubt that the failings of (the existing social and political) system hindered the implementation of policies that would have averted the existing ills," he said. "We are paying the price of past mistakes."
The emergency financing will help Greece through the next months and it will buy the rest of the EU some time -- time in which the euro crisis may ease somewhat. But it's unlikely that it can save Greece. The last few decades have seen an elite, with the Papandreou, Karamanlis and Mitsotakis families at its core, establish a system of economic patronage. They threw around billions the government didn't actually have and showered friends and relatives with prosperity that was all based on credit. These leaders bloated their country's administration so that everyone could have a piece, and created a bureaucratic monster in the process.
The political parties' business dealings were always more about favors than policies. Anyone with access to public funds used them to buy friends and voters, who were then beholden to the party -- and to the family running it. The result for Greece has been a feudal democracy, where the generations come and go, but the names remain the same: Papandreou and Karamanlis and Karamanlis and Papandreou, with a Mitsotakis thrown in every now and then. No other European democracy has seen the like.
Olive Trees, Blue Skies and Beaches
Meanwhile, the parties' feudal princes accustomed their people to living beyond their own means. Greece, with its 11 million inhabitants, is a poor country at the far edge of the EU that has olive trees, blue skies, beaches and not much else. One in four people who work, do so for the government. It's the source everyone wants to tap. With political parties fleecing the nation wholesale, the people also grabbed whatever they could. The rich evaded taxes to the tune of billions, the poor scraped by with under-the-counter work and public officials opened their doors to bribery.
Now Prime Minister Georgios Papandreou has to fix what his father helped to create, a system in which people could retire earlier and work less. The time has come for drastic measures, the younger Papandreou believes. "Either we change, or we all go down together," the prime minister has said. He's perfectly well aware, though, of just what has been going wrong for decades.
Papandreou's grandfather, who was also called Georgios, founded the family's political dynasty, serving first in various ministerial positions and later as prime minister. After the 1967-1974 military dictatorship, Georgios' son Andreas Papandreou created the socialist party PASOK. In the 1980s, he gave so much to his cronies and supporters that the country's debt ballooned.
Greece's conservatives, meanwhile, were led more by a clique than a family, and they alternated with the Papandreous for turns at the helm. Konstantinos Karamanlis, the family patriarch, held office multiple times before his nephew, also Konstantinos, or Kostas, took over. Occasionally there was also a bit of room at the top for the Mitsotakis family. Konstantinos Mitsotakis served as prime minister and, more importantly, has maintained a position as the most powerful man in the New Democracy party for two decades.
In his 2004 election campaign, the younger Karamanlis promised to reform the country. After his win, though, the scandals began to pile up, with billion-euro property deals and money shifted out of retirement funds. Karamanlis' people falsified the financial data reported to the EU, and shortly before being voted out of office, quickly created tens of thousands of administrative posts for relatives and friends of the party. By the end of their term, the conservatives had doubled the national deficit. Mitsotakis' daughter Dora Bakoyannis, foreign minister at the time, then tried to take over leadership of New Democracy. Antonis Samaras managed to squeeze her out to become the party's leader -- with the elder Mitsotakis still performing the function of honorary leader.
EU Feels Lucky to Have Papandreou
Samaras, like Papandreou a wealthy member of the upper class, is now the prime minister's opponent. He is a tough rival who's not afraid to use whatever tactics necessary. The two men are on familiar terms, though, having shared a student apartment in the US in the 1970s.
EU financial policymakers consider themselves lucky to have Papandreou, who's trying to cut costs. Samaras, on the other hand, is promising voters to lower taxes and drive a hard bargain with the EU over austerity measures.
While Papandreou's standing with the public has fallen rapidly in the past few weeks and his PASOK party has slumped to 27 percent in the polls, its lowest rating in 34 years, Samaras' New Democracy has held steady at 31 percent. That was enough to rank the party as the most popular in the eyes of voters in mid-June, but was still 2.5 percent less than its results in the 2009 parliamentary elections.
About three weeks ago, Papandreou gave his conservative opponent a call, wondering if the two battered parties couldn't work together to save the country, in a grand coalition. Papandreou suggested he would even be willing to make the post of prime minister available.
'Like a Cat Chasing its Own Tail'
The conversation was supposed to remain confidential, but Samaras alerted journalists. He then embarrassed Papandreou in parliament again shortly afterwards, making it clear that he wasn't interested in a consensus government.
Regardless of whether it happens under Papandreou alone or with both politicians working together, if Greece starts economizing, it risks choking its own economy. "It's like a cat chasing its own tail," says Greek economics professor Yanis Varoufakis. Former IMF chief economist Kenneth Rogoff recently warned: "If they just continue with the European Union's austerity program, they're going to be in slow growth or recession as far as the eye can see, and at the end of the day they're still going to default."
And it's not as if Greece hasn't already adopted austerity measures. Athens managed to cut its budget deficit from 15.4 percent of its gross domestic product to 10.6 percent last year, thanks to its first austerity package. The government made cutbacks in salaries, retirement funds and social benefits, among other things. This austerity policy also caused 200,000 people to lose their jobs last year, with unemployment reaching an all-time high of 15 percent by late March.
With pay in the private sector also often falling by 10 to 20 percent, consumption likewise dropped by nearly 10 percent and the recession intensified. It's a vicious circle. Since taxes need to increase and spending needs to decrease, the situation is likely only to get worse. The austerity package approved last week certainly envisions plenty of tax increases and spending cuts. There's a solidarity tax for everyone, and property taxes will go up. The government has also finally pledged to take more effective action against tax evaders, although no one knows precisely how.
Run-Down Stadiums and Old Airbuses
The package includes cutting around 150,000 public sector jobs by 2015, with the sale of state-owned assets bringing in a further €50 billion. The only problem is that many of those assets will prove difficult to sell. They include run-down Olympic stadiums and four aged Airbuses, although the government also holds thousands of square kilometers of land, some of it in prime coastal locations.
The state will also offer up to 17 percent of the utility company PPC, currently 51 percent government owned, to private investors. This is despite bitter opposition from the union, which is right to anticipate that the sale would mean layoffs among the current workforce of 21,500. During the parliamentary vote on Wednesday, the lights went off in several regions of Greece as a sign of protest.
Economics professor Georgios Argitis from Athens University sounds disdainful as he talks about the "ruling class of politics and capital that made the country its prey" and caused this mess. Contentious best-selling author Petros Markaris derides the "ailing state apparatus." Its representatives "have only one interest, namely maintaining their privileges," he says. "They don't give a damn about anything else."
He's referring, for example, to the parliament employees who still draw 14 months' salary each year, with an additional two on top of that. He's referring to the land of plenty that is the public sector, where politicians provide for those who have helped them, fathers for their family members and agency heads for their personal favorites.
Each new government which has taken office in Greece has hired thousands of officials and employees, without firing the old ones. No one was bothered by this, as long as each person's own job prospects remained good. Now, though, people are rejecting the entire political elite. This May, 71 percent of Greeks said they didn't have confidence in their government, while 76 percent had just as little confidence in the opposition.
Bacteria From Dutch Poultry Linked to Superbugs in People, Scientists Find
by Jason Gale - Bloomberg
Bacteria on raw poultry meat in the Netherlands may be a source of superbugs in people, according to a study that suggests the use of antibiotics in food animals is causing life-saving drugs to lose their potency.
Multidrug-resistant bacteria were found in 80 percent of raw chicken bought from grocery stores in the southern Netherlands. When the researchers compared the germs with specimens collected from hospital patients, they found the predominant resistance genes were identical.
The findings, reported in the July edition of the journal Emerging Infectious Diseases, indicate drug-resistant bacteria in food are leading to harder-to-treat infections in people. While human use of antibiotics in the Netherlands is among the lowest in Europe, the country is one of the region’s biggest users of the medicines in farm animals, the researchers noted. "The Netherlands provides a good setting to monitor spread of drug resistance from an animal reservoir into the human population," Ilse Overdevest, a physician in the microbiology laboratory at St. Elisabeth Hospital in Tilburg, and colleagues wrote.
Their research focused on a genetic component in bacteria that causes resistance to a range of antibiotics, including a class known as third-generation cephalosporins. These medicines, which include Sanofi’s Claforan and GlaxoSmithKline Plc’s Fortaz, are used to treat bacterial meningitis, pneumonia as well as some infections caused by E. coli and other so-called Gram- negative bacteria. Pfizer Inc. makes a similar product, called Excede, for use in cattle, swine and horses.
Hospital patients infected with a bacterium resistant to a third-generation cephalosporin typically stay five days longer than those without the resistant bugs. They are also 2.5 times more likely to die within a month of being infected, according to a 2010 study in the Journal of Antimicrobial Chemotherapy.
In the Dutch study, 262 samples of fresh chicken, beef, pork and ground meat were tested for drug resistance. Of 71 chicken samples tested, 80 percent carried bacteria producing an antibiotic-destroying enzyme known as ESBL. In comparison, ESBL- producing bacteria were found in fewer than 12 percent of the other meat types. When rectal swabs were tested from 876 patients, the researchers found 4.9 percent of people harbored ESBL-producing bacteria in their bowels.
Among E. coli samples collected from patients in the Netherlands, resistance to third-generation cephalosporins increased to 4.3 percent in 2009 from 0.1 percent in 2000, according to data compiled by the European Antimicrobial Resistance Surveillance Network.
ESBL contamination of retail chicken meat in the Netherlands is a "plausible source" of the increase in multidrug-resistant infections in people, the authors said. "Most samples of retail chicken meat contain transmissible drug resistance genes in bacterial species that are part of the normal human intestinal flora," they said. "This finding may have a profound effect on future treatment options for a wide range of infections."
The Netherlands is trying to reduce the volume of antibiotics used in food-animal production, Christianne Bruschke, the nation’s chief veterinary officer, said in an e-mail today. The government aims for a 20 percent reduction from 2009 levels this year, with a 50 percent cut targeted by 2013, she said.
"There is an increasing abundance of evidence showing superbugs such as ESBL E. coli are in the foods we eat and people get serious infections with them," said Peter Collignon, head of infectious diseases at Australia’s Canberra Hospital, who serves on a World Health Organization panel studying antibiotic resistance in the food chain. "It’s time we banned the use of antibiotics in food animals that cause superbugs to develop and spread."