No Such Thing As Risk? (Hussman)

Monday, July 30th, 2012

by John Hussman, Hussman Funds

The enthusiasm of investors about central-bank interventions has reached a pitch that is already well-reflected in market prices, and a level of confidence that with little doubt, investors will ultimately regret. In the face of this enthusiasm, one almost wonders why nations across the world and throughout recorded history have ever had to deal with economic recessions or fluctuations in the financial markets. The current, widely-embraced message is that there is no such thing as an economic problem, and no such thing as risk. Bernanke, Draghi and other central bankers have finally figured it out, and now, as a result, economic recessions and market downturns never have to happen again. They just won’t allow it, printing more money will solve everything, and that’s all that any of us need to understand. And if it doesn’t solve everything, they can just keep doing more until it works, because there is no consequence to doing so, and all historical evidence to the contrary can finally, thankfully, be ignored. How could anyone ever have believed, at any point in history, that economics was any more complicated than that?

Unfortunately, the full force of economic history suggests a different narrative. Up to a certain point, which seems to be about 100-120% debt-to-GDP, countries can pull themselves from the brink of sovereign crisis through a combination of austerity (spending reductions), restructuring (putting insolvent financial institutions into receivership and altering the terms of unworkable private and public debt), and monetization (relief of government debt through the permanent creation of currency). Austerity generally reduces economic growth (and corporate profits) in a way that delivers less debt reduction benefit than expected, restructuring is often stimulative to growth because good new capital no longer has to subsidize old misallocations, but is politically contentious, and monetization of bad debt produces clear but often quite delayed inflationary pressures. None of these choices is simple.

Moreover, once countries have created massive deficits and debt burdens beyond about 120% of GDP – typically not to accumulate of productive assets and investments that service that debt, but instead to fund consumption, bail out insolvency, and compensate labor without output – austerity produces further economic depression, restructuring becomes disorderly and produces further economic depression, and attempts at monetization tend to be hyperinflationary.

Europe is fast approaching the point at which every solution will be disruptive, and remains urgently in need of debt restructuring, particularly across its banking system. It is a pleasant but time-consuming fantasy to believe that governments that are already approaching their own insolvency thresholds can effectively bail out a banking system that has already surpassed them. To expect the ECB to simply print money to solve the sovereign debt problems of Spain, Italy and other members is also dangerous. This hope prevents these nations from taking receivership of insolvent institutions now, and allows them to continue to operate in a way that threatens much more disorderly outcomes later. The reality is that Europe is not a unified economic and political entity with a single national character and obligations that are mutualized among its members. It is instead a geographic region where the economic, political and cultural differences remain very distinct. While each country is willing to cooperate in setting common rules and practices that are to their own benefit, they are unlikely to cooperate when it comes to decisions that require the stronger economies to interminably subsidize the insolvent ones through direct fiscal transfers or permanent money creation that has the same effect.

With regard to last week’s ebullience over the possibility of ECB buying of sovereign debt, my concern continues to be the danger of assuming that a solvency problem can simply be addressed as a liquidity problem. If the European Central Bank buys Spanish or Italian debt in volume, there is very little likelihood that it will ever be able to disgorge this debt. This is because: any eventual ECB sales of debt holdings – or failure to roll those holdings over – will have to be offset by private demand in the same amount, when Spanish and Italian debt/GDP ratios are unlikely to be smaller; the European banking system is already largely insolvent, and; the European continent is already in recession, which means that the volume of distressed sovereign debt is likely to expand even beyond the reasonable capacity of the ECB to absorb it. So major ECB purchases would effectively amount to money-printing, and Germany, Finland and other countries in opposition are fully aware of that. Reversible liquidity operations may be monetary policy, but non-reversible money-printing is quite simply fiscal policy.

For a review of some of the issues the ECB faces, see Why the ECB Won’t (and Shouldn’t) Just Print. In evaluating the repeated assurances that emerge out of Europe, keep in mind that details matter. For example, the phrase “Germany is prepared to do everything that is necessary to defend the Euro” has repeatedly meant “everything that is politically necessary” and “everything that is legally required.” It has also been demonstrated again and again that Germany (among other stronger European countries) has no intention of allowing a blank check for direct EFSF or ECB bailouts without a change in the EU law that imposes a surrender of fiscal sovereignty and centralized fiscal control of Euro member countries. Following Thursday’s assurances by ECB head Mario Draghi to protect the Euro (just after Germany’s Angela Merkel left on a hiking trip), it took until Saturday for the German finance minister to step into the void with the predictable, “No, these speculations are unfounded.” It was widely reported that Germany again tossed out the “everything that is necessary” bone on Sunday, but one had to read the French dispatch to find that this accord referred to nothing but an agreement between Germany and Italy to do everything necessary to quickly implement June’s plan for a plan to establish a centralized banking regulator: l’Allemagne et l’Italie sont d’accord pour “que les conclusions du conseil européen des 28 et 29 juin soient mises en oeuvre aussi rapidement que possible.”

In the U.S., quantitative easing has had the effect of helping oversold financial markets recover or slightly surpass the peak that the S&P 500 Index achieved over the preceding 6-month period, but there is much less evidence that it will do much for the financial markets when prices are already elevated and risk-premiums already deeply depressed (see What if the Fed Throws a QE3 and Nobody Comes?). The upper Bollinger band of the S&P 500 on both weekly and monthly resolutions is at about 1430. That level represents our best estimate for the market’s upside potential in the event that the Federal Reserve initiates a third program of quantitative easing. Given that our economic measures continue to indicate that the U.S. has entered a new recession, it is not clear that another round of QE will even achieve that effect.

In the event that another round of QE has a greater or more durable effect, we’ve introduced enough additional constraints on our staggered-strike hedges that we wouldn’t expect the decay in option premium that we experienced during QE2. The market reestablished an “overvalued, overbought, overbullish” syndrome last week, so another round of QE is unlikely to move us to a significantly constructive investment stance as long as that syndrome is in place. Still, we don’t expect to move our strike prices higher in the event of further improvement in market internals, so the “tight” character of our present hedge will moderate in the event the market advances from here. Suffice it to say that I’m not worried that another round of QE will create difficulties for our approach, though it should also be clear that such an event wouldn’t automatically prompt us to shift to a bullish investment stance.

What worries me most

Investors sometimes ask what I worry about most from the perspective of our investment strategy. Do I worry that the Fed will initiate another round of QE and distort the markets to such an extent and duration that our approach will not capture new realities? Do I worry that government interventions have created a world where old economic rules and relationships no longer apply? Do I worry about the quality of government statistics or the potential for misreporting or seasonal adjustment distortions in the data we use? The answer is that all of these issues can exert a short-run influence on the course of our investment approach, but none of them alter the relationship between valuations and long-term returns, and I don’t expect any of them to significantly reduce the effectiveness of our strategy over the complete market cycle.

As I noted as the market approached its highs a few months ago, what I worry about most is that conservative investors will become impatient with maintaining a defensive position in a dangerous and elevated market – not because investment prospects have materially improved, but simply because short-lived runs of speculative relief seem too enticing to miss. Volatile but ultimately directionless periods of elevated valuations, as we saw in 2000-early 2001, 2007-early 2008, and which we’ve observed since April 2010, tend to exhaust defensive investors and encourage complacency toward market risk at the worst possible time.

Certainly, for our shareholders in Strategic Growth Fund, I’ve compounded this impatience, because our “miss” in 2009-early 2010 – which I would not expect to be repeated in future cycles even under identical conditions – blends in with our defensiveness since early-2010, which aside from a few differences related to option positions, I would expect to be repeated in future cycles under identical conditions. The result is one long period of defensiveness, which understandably leaves those unfamiliar with that 2009-early 2010 period with the assumption that our approach will never be constructive.

I view these weekly comments as something of a conversation with shareholders, so I do my best to address questions that come up more than once or twice in a short period of time. In Strategic Growth Fund, understanding performance in recent years is one of those questions, so I ask the indulgence of shareholders who have walked through this discussion before, and I hope that the comments are useful even for those that have. Thanks.

Let’s first address the period since early 2010. Given the policy of central banks in recent years to provide what amount to free put options to investors, there are certainly ways we could have saved a few percent in actual put option premium (incorporated in our present methods as added criteria related to trend-following measures). But the fact is that the S&P 500 Index was within 5% of its April 2010 peak only a few weeks ago, and there remains a strong risk that the market will move significantly below that level in the months ahead. From a historical standpoint, the conditions we’ve seen since early-2010 have warranted a generally defensive position, and the negatives have accelerated significantly in recent months. We would expect to adopt a similarly defensive position again in future cycles under the same conditions. The only way to get around that would to be to take actions that would have produced significant losses if they were taken regularly on a historical basis.

Unfortunately, the warranted and repeatable defensiveness we’ve adopted since 2010 blends in with a non-recurring intervention during 2009-early 2010 (which I discussed regularly during that period) to ensure that our hedging approach was robust to Depression-era data.

Recall that this intervention was not driven by any problem with the performance of our investment approach. Indeed, by the beginning of 2009, a dollar invested in Strategic Growth Fund at its inception in 2000 had grown to about four times the value of the same investment in the S&P 500 Index. The Fund was ahead of the S&P 500 at every standard and non-standard investment horizon, with dramatically smaller losses. For example, from the 2007 stock market peak, the S&P 500 Index had suffered a peak-to-trough loss of 55.25%, while the deepest loss experienced by Strategic Growth Fund was 21.45%. To put that difference in perspective, note that simply moving from a 55.25% loss to a 21.45% loss requires an offsetting recovery of 75.53%. It takes extraordinary good fortune to recover from deep drawdowns, which is why we make such an effort to avoid them.

Still, as the credit crisis worsened in 2009, it became clear that both the economy and the financial markets were behaving in ways that were “out of sample” from the standpoint of the post-war data on which our existing return/risk estimates were based. That kind of situation demands stress-testing; a concept that too few investors take seriously until it’s too late. I took our existing approach to Depression-era data and found that though it performed reasonably well over the full period from a return perspective, it also allowed a number of very deep interim losses before recovering. Even though our approach had performed well, a Depression-like outcome could not be ruled out (and to some degree still can’t), so I insisted that our methods should be robust to “holdout” data from both the Depression era and the post-war period. I discussed that challenge repeatedly in the weekly comments and annual reports as our “two data sets” problem. We reached a satisfactory solution in 2010 through the introduction of ensemble methods in our hedging approach. But by that point, we had also missed a significant market rebound.

The result has been my elevation to the title of Permabear, Doomsayer, and other lovely aliases. It’s kind of tragic that I both lessened my reputation and missed returns for shareholders – though I expect only temporarily – because of what I viewed (and continue to view) as fiduciary duty. At least shareholders can be sure that I’ll never knowingly lead them down a rabbit hole. While we have – apart from the most recent cycle – been successful in strongly outperforming the market over complete cycles (bull-peak to bull-peak, bear-trough to bear-trough) with substantially smaller drawdowns, it’s important to recognize that we do have a much greater tolerance for tracking differences versus the S&P 500 over the course of the market cycle than some investors can accept. Our investment approach is simply not appropriate for those investors. Significant tracking differences will occur again and again over time, because they are inherent in our approach, particularly in the richly-valued portion of a given market cycle.

Meanwhile, I’m confident that that our stress-testing miss during the most recent cycle (which works out to a cumulative lag of just under 13% over the peak-to-peak market cycle from 2007-2012) is something we can more than offset in future cycles. Also, given our willingness to remove the majority of our hedges in early 2003 at valuations that were in no way compelling from a historical standpoint, it should be clear that we don’t require Armageddon to adopt a constructive or even aggressive investment stance.

So what do I worry about? I worry that investors forget how devastating a deep investment loss can be on a portfolio. I worry that the constant hope for central bank action has given investors a false sense of security that recessions and deep market downturns can be made obsolete. I worry that the depth of the recessions and downturns – when they occur – will be much deeper precisely because of the speculation, moral hazard, and misallocation of resources that monetary authorities have encouraged. I worry that both a global recession and severe market downturn are closer at hand than investors assume, partly despite, and partly because, they have so fully embraced the illusory salvation of monetary intervention.

Market Climate

Our measures of prospective stock market return/risk deteriorated slightly last week, from the most negative 0.8% of market history, to the most negative 0.6%. These are minor distinctions, of course, but it is important to emphasize how rare and negative present conditions are from a historical standpoint. I recognize that many analysts consider stocks to be cheap on the basis of “forward operating earnings,” but I continue to believe that the 50-70% elevation in profit margins relative to historical norms is an artifact of extreme deficit spending and depressed savings rates, and that as a U.S. recession unfolds, profit margins and forward earnings estimates will collapse. This is currently seen as heresy (as was my assertion just before the tech-collapse that technology earnings would turn out to be cyclical), but that’s how earnings and profit margins work.

Looking out anywhere from 2 weeks to 18 months, our measures remain very defensive, with the worst horizon being about 7 months out. Additional firming in market action from here would modestly improve our near-term measures of prospective return (which are more dependent on trend-following factors), but would generate little improvement beyond a horizon of several weeks. Meanwhile, our estimate of prospective 10-year S&P 500 total returns (nominal) is now only 4.7%. This figure may seem appealing relative to a 1.5% yield on 10-year Treasury bonds, but as I’ve noted before, you don’t “lock in” a long-term return on an investment; you ride it out over time. My expectation is that this ride will be extremely uncomfortable for passive buy-and-hold investors over the coming decade, and that there will be numerous opportunities to accept both stock and bond market risk at substantially higher prospective returns.

Strategic Growth and Strategic International remain tightly hedged, Strategic Dividend Value remains hedged at about half of the value of its holdings – its most defensive stance, and Strategic Total Return continues to carry a duration of about one year, with about 10% of assets in precious metals shares and a few percent of assets in utility shares and foreign currencies.

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Tags: Austerity, Bad Debt, Brink, Corporate Profits, Debt Reduction, Draghi, Economic Growth, Economic History, Economic Problem, Economic Recessions, Evidence To The Contrary, Financial Institutions, Financial Markets, Fluctuations, Full Force, Government Debt, Hussman, Hussman Funds, John Hussman, Public Debt, Receivership
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The Heart of the Matter (Hussman)

Sunday, June 10th, 2012

by John Hussman, Hussman Funds

Over the past 13 years, the S&P 500 has underperformed even the depressed return on risk-free Treasury bills. Real U.S. gross domestic investment has not grown at all since 1999, and even as a share of GDP, real investment remains weak.

The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren’t low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives.

Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.

Specifically, over the past 15 years, the global financial system – encouraged by misguided policy and short-sighted monetary interventions – has lost its function of directing scarce capital toward projects that enhance the world’s standard of living. Instead, the financial system has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.

What is central here is that the government policy environment has encouraged this result. This environment includes financial sector deregulation that was coupled with a government backstop, repeated monetary distortions, refusal to restructure bad debt, and a preference for policy cowardice that included bailouts and opaque accounting. Deregulation and lower taxes will not fix this problem, nor will larger “stimulus packages.” The right solutions are to encourage debt restructuring (and to impose it when necessary), to strengthen capital requirements and regulation of risk taken by traditional lending institutions that benefit from fiscal and monetary backstops, to remove fiscal and monetary backstops and ensure resolution authority over institutions engaging in more speculative financial activities, and to discontinue reckless monetary interventions that encourage financial speculation and transitory “wealth” effects without any meaningful link to lending or economic activity.

By our analysis, the U.S. economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a “boomerang” from the credit crisis we experienced several years ago. The chain of events is as follows:

Financial deregulation and monetary negligence -> Housing bubble -> Credit crisis marked by failure to restructure bad debt -> Global recession -> Government deficits in U.S. and globally -> Conflict between single currency and disparate fiscal policies in Europe -> Austerity -> European recession and credit strains -> Global recession.

In effect, we’re going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.

Once we abandoned Glass-Steagall, removing the firewall between traditional banking and more speculative activities, and allowing those activities to have the effective protection of the U.S. government, it was only a matter of time until a credit crisis would unfold. My 2003 piece Freight Trains and Steep Curves detailed the problem: “So the real question is this: why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That’s the secret. The borrowers don’t actually issue it directly. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government. These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam.”

The ability to use the Federal government as a backstop for risk-taking was the central element in creating the housing bubble. As long as a borrower was physically breathing, you could make a mortgage loan without really worrying about whether the loan could be paid back. By the time it was packaged up, tranched out, and securitized either by a bank or by Fannie and Freddie, all of which had the government backstop, the loan was somebody else’s problem. When the bubble crashed, our policy makers made their crucial mistake – first through the Bush Administration, and then continued by the Obama Administration – they failed to require bondholders to take losses on bad loans.

Every major bank is funded partially by depositors, but those deposits typically represent only about 60% of the funding. The rest is debt to the bank’s own bondholders, and equity of its stockholders. When a country like Spain goes in to save a failing bank like Bankia – and does so by buying stock in the bank – the government is putting its citizens in a “first loss” position that protects the bondholders at public expense. This has been called “nationalization” because Spain now owns most of the stock, but the rescue has no element of restructuring at all. All of the bank’s liabilities – even to its own bondholders – are protected at public expense. So in order to defend bank bondholders, Spain is increasing the public debt burden of its own citizens. This approach is madness, because Spain’s citizens will ultimately suffer the consequences by eventual budget austerity or risk of government debt default.

The way to restructure a bank is to take it into receivership, write down the bad assets, wipe out the stockholders and much of the subordinated debt, and then recapitalize the remaining entity by selling it back into the private market. Depositors don’t lose a dime. While the U.S. appropriately restructured General Motors – wiping out stock, renegotiating contracts, and subjecting bondholders to haircuts – the banking system was largely untouched.

The failure of our policy makers to restructure debt resulted in the worst of both worlds – an economy where banks were relieved of the need for transparency (thanks to accounting changes by the FASB), and yet homeowners strapped with bubble-sized mortgage obligations saw very little in terms of debt restructuring. The reason we never got any economic traction in this “recovery” is that these debt burdens remain in place. While we certainly don’t advocate “freebie” principal writedowns – which would almost surely result in a tsunami of strategic defaults, we’ve long proposed what we’ve called Property Appreciation Rights as a way to partially substitute mortgage premium for a marketable claim on future appreciation. Failing any meaningful debt restructuring, however, we’ve got a financial system that continues to operate with a confident government backstop for risk taking, while aggregate demand remains suppressed by a burden of existing debt.

Economists define a standard of living as the amount of goods and services that people in the economy can consume as a result of the work they do. They define productivity as the amount of goods and services that people in the economy can produce as the result of the work they do. In the long run, a rising standard of living requires rising productivity, which in turn requires the economy to accumulate a stock of productive investments – factories, machines, inventions, education, and so forth. In the short run, the benefits of productivity growth can be retained through profits in a way that prevents those benefits from being enjoyed by workers, but even then, redistributing wealth can only achieve limited improvements in living standards. Over time, an economy that squanders its scarce savings will predictably suffer for it.

Tragically, nobody seems to have learned a thing from the dot-com crash, or the tech crash, or the housing crash. Wall Street continues to beg for monetary interventions to reward speculative trading, even though these rewards have repeatedly proved to be short-lived. What investors don’t seem to appreciate is how much of our nation’s scarce savings have been burned to ashes as a result.

I really don’t mean to pick on Facebook. It’s a neat company, a neat platform, and I respect Mark Zuckerberg’s charitable initiatives. But the example is too instructive to miss, so let’s think about it as a recipient of investment capital. If you go on Amazon or Ebay, you want to stay in order to buy something. That’s a fine business model, and network effects work in your favor because there are a lot of sellers on the other side. If you go on Google, you want to find what you’re looking for and then leave, which is a situation where advertising is welcome, and also works as a business model. But consider Facebook. If you go on Facebook, your whole intention is to stay on Facebook for a while, but not to buy something. Here, network effects work against advertising because responding to the ad pulls you away from the network.

Tags: Backstop, Bad Debt, Cowardice, Debt Restructuring, Deregulation, Financial Sector, Global Financial System, Government Programs, Gross Domestic Investment, Heart Of The Matter, Hussman Funds, John Hussman, Lower Taxes, Partisan Lines, Policy Environment, Public Balance, Right Solutions, Scarce Capital, Speculative Bubbles, Treasury Bills
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The Spanish Bank Bailout Begins

Monday, May 7th, 2012

It was only a matter of time before the next bank bailout began despite all those promises to the contrary. Sure enough, as math always wins over rhetoric and policy, earlier this morning the shot across the Spanish bow was fired after PM Rajoy did a 180 on “no bank bailout” promises as recent as last week. From Dow Jones: “Spain may pump public funds into its banking system to revive lending and its recessionary economy, Prime Minister Mariano Rajoy said Monday, signalling a policy U-turn. The government had pledged to not give money to the banking industry that is struggling in the wake of a collapsed, decade-long, housing boom. “If it was necessary to reactivate credit, to save the Spanish financial system, I wouldn’t rule out injecting public funds, like all European countries have done,” Rajoy said in interview with Onda Cero radio stations. The weakness of Spain’s banks is weighing on the economy that contracted 0.3% in the first and fourth quarters, meeting most economists’ definition of a recession. The unemployment rate is at an 18-year high 24.4%, data showed April 27. Banks have sharply reined in credit in the face of rapidly growing bad debt and problems getting finance on international markets.” And explicitly we learn that Spain will inject EU7 bln of public funds via contingent-capital securities to support BFA-Bankia, El Confidencial reports, citing Economy Ministry officials it doesn’t name. It actually sounds cooler in the native: “El Estado inyectará 7.000 millones de dinero público para salvar BFA-Bankia.” So it begins. Which also means that the “Bad Bank” idea is about to be launched. So far so good… The only problem is that like the EFSF, like the ESM, like the IMF, all those “deus ex machina(e)” also had to find funding of their own… and failed: it is one thing to intend to rescue the system. It is another to find the cash to do it with.

In the meantime, the process has already commenced:

• BANKIA SHARES FALL 4.8% IN MADRID
• SPANISH PLAN FOR BANKIA TO BE ANNOUNCED IMMINENTLY
• SPAIN TO CLEAN UP BANKIA, CHANGE MANAGEMENT, OFFICIAL SAYS
• SPAIN IS WORKING ON PLAN FOR BANKIA, GOVT OFFICIAL SAYS

From Reuters:

Spanish Prime Minister said on Monday he would use public funds to rescue the country’s banks, but only as a last resort. He said an announcement on government plans for the banks would come on Friday.

Spain has already spent more than 18 billion euros ($23.61 billion) to clean up its banks, which were highly exposed to a property sector crash four years ago.

The banks have been forced into several waves of mergers and to recognize more than 50 billion euros in losses related to property lending and assets.

…

A Spanish government and Bank of Spain plan to reform Bankia will involve major changes at the bank’s management, government and Bank of Spain sources told Reuters on Monday.

“The plan is being finalised by the Economy Ministry and the Bank of Spain. It will include major changes in the management,” a government source said.

The source also said the Spanish government would approve on Friday the guidelines for setting up holding companies to park and sell off toxic real estate assets, including a framework to create 10- to 15-year “bad banks”.

A source from the Bank of Spain said that the plan for Bankia, which is likely to stick to its stand-alone strategy after the intervention, includes the possibility of asset sales.

“The possibility of strenghtening the balance sheet through asset sales is on the table,” the source said.

And more from DJ:

The ministry official added that the government and central bank are studying a specific clean-up plan for Bankia SA (BKIA.MC) and parent company Banco Financiero y de Ahorros SA, which could include a shake up of their management. Daily El Pais said Monday the government also plans an injection of state funds via convertible bonds with a rate of about 8%.

Bankia’s parent, considered one of the weakest banks in the Spanish financial sector, recently carried out a EUR2.75 billion write-down of the group’s assets by lowering the value of its real-estate holdings.

A Bankia spokesman declined to comment.

Spain’s central bank estimates the country’s banks’ total exposure to the country’s ailing real estate industry at EUR338 billion, of which it considers some EUR176 billion problematic.

In new evidence of a deepening downturn, the local statistics agency said Monday that industrial output fell by 7.5% in a calendar-adjusted annual rate in March, after falling by 5.3% in February and by 4.4% in January.

Translated: since this plan is a stillborn failure, the countdown is now officially on to the Spanish PSI. Only this time around, unlike in the case of Greece, one wonders how Merkel will spin the German funding in continent that no longer cares about “austerity”, i.e., deleveraging, and is all bout “growth”, i.e., ramping up debt issuance to the max.

Tags: Bad Debt, Bank Bailout, Banking Industry, Banking System, Bln, Capital Securities, Contingent Capital, Dow Jones, Economy Ministry, Efsf, El Confidencial, Esm, International Markets, Madrid Sp, Mariano Rajoy, Matter Of Time, Ministry Officials, Spanish Bank, Spanish Financial System, Unemployment Rate
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Jim Chanos Debunks The Myth Of China As The World’s “White Knight”

Wednesday, September 21st, 2011

One of the recurring themes on Zero Hedge in the past several months has been the continued mockery of the seemingly global conventional idiocy that China can bail out the world, when it itself is on the verge of a huge credit bubble popping and requiring the rescue of China itself by the rest of the global pyramid scheme (which however will be far too busy monetizing its own debt by then). Why, we vividly recall this quote from July 4, “So let’s get this straight: a country which has 10% of its GDP in the form of bad debt, is somehow expected to be credible enough to buy not only Greek debt, but the EURUSD each and every day? Mmmmk. In the meantime, Dagong downgrades the US to junk status in 5, 4, 3…” Well, Dagong did since downgrade the US (as did S&P), although not to junk just yet, and somehow the world still continues to labor under the illusion that China (whose shadow banking system we also covered most recently here), is somehow healthy because it is far better than Europe (and the US) in hiding the true severity of its problems. Naturally, as long as that persists, the global ponzi will always have the benefit of pulling out a “white knight” whenever needed, regardless of just how ludicrous such an presumption has become. Today, famous China bear Jim Chanos appeared on Bloomberg TV and recapped his thesis which summarizes the bulk of these points, further extrapolating based on the Andy Lees analysis posted yesterday which estimates what a true economic growth rate is when one factors for bad debt and loss severities. His conclusion: “If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%.  Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.” And this stagnant, overlevered behemoth is somehow supposed to be… the world’s white knight?

Highlights:

On the Chinese government’s balance sheet:

“The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse.”

On how a Chinese property bubble will play out:

“I think that will be the surprise going into this year, and into 2012 – that it is not so strong. The property market is hitting the wall right now and things are decelerating. The CEO of Komatsu said last week that he is having trouble getting paid for his excavator sales in China. Developers are being squeezed. They’re turning to the black market for lending, this shadow banking system that is growing by leaps and bounds like everything in China.

“Regulators over there are really trying to get their hands around the problem. In the meantime, local governments have every incentive to just keep the game going. So they will continue with these projects, continuing to borrow as the central government tries to rein it in.”

Chanos on his long and short positions:

“We are short Chinese banks, the property developers, commodity companies that sell into China, anything related to property there is still a short.”

“We are long the Macau casinos. It’s our long corruption, short property play. We feel that there’s American management and American accounting. They are growing at a faster rate even than the property developers.”

On the IMF lowering growth estimates for China:

“A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%.  Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.”

Tags: Bad Debt, Banking System, China Bear, Credit Bubble, Downgrades, Economic Growth Rate, GDP, Idiocy, Illusion, Jim Chanos, July 4, Junk Status, Mockery, Myth, Ponzi, Presumption, Pyramid Scheme, Severity, Verge, White Knight
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