Rosenberg Defines European Insanity

Wednesday, June 13th, 2012

The situation in Europe goes from bad to worse. Gluskin Sheff’s David Rosenberg is back to his bearish roots as he remind us that ‘throwing more debt after bad debts ends up meaning more debt‘. As he notes, the definition of insanity is (via Bloomberg TV):

When you realize that of the potential $100 billion to spend, 22% of that has to be provided by Italy and their lending to Spain is at 3% but Italy has to borrow at 6%. They have to lend to Spain $22bn at 3% – it is just madness. Everybody is getting worried again. The solution that they seem to have come up with seems to be worse than the problem in the first place.

As we have pointed out vociferously over the past few days, even though the assistance is being earmarked for the banks, the Spanish government assumes the responsibility and so this once ‘low national debt’ sovereign is following in Ireland’s footsteps as its debt/GDP takes a 10pt jump to 89% (based on the government’s data) and much higher in reality (when guarantees and contingencies are accounted for). As Rosie explains succinctly, this is right at the Reinhart-Rogoff limit of 90% at which debt begins to erode the nation’s economic fabric.

It is probably not long before this credit – two notches away from junk and having to raise money at 6.75% when its economy is contracting at nearly a 2% annual rate – is going to require external assistance as it follows Ireland onto the sidelines.

The situation in Europe indeed goes from bad to worse.

Tags: Bad Debts, Contingencies, David Rosenberg, Definition Of Insanity, Economic Fabric, External Assistance, Few Days, Footsteps, GDP, Gluskin Sheff, Guarantees, Madness, National Debt, Notches, Roots, Rosie, S David, Sidelines, Sovereign, Spanish Government
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One Sided Balance Sheet and Solvenquidity (Tchir)

Wednesday, June 13th, 2012

One Sided Balance Sheets

I’m seeing a lot of negative headlines about how much more debt Spain is adding. How much subordination there is going to be for existing creditors. That is in spite of a lack of detail. I’m not here to cheerlead this deal, but at the same time, falling prey to the easy headlines is dangerous.

No one seems to be talking about the “asset” side of this program. The FROB will borrow money and it will buy assets. The proceeds from either repayment or sale of those assets would be used to pay back FROB’s borrowing. If everything FROB buys is worthless, than yes, the Kingdom of Spain will owe a lot of money under those guarantees. If the FROB made great investments, all the debt could be repaid by the investment and no claim ever made under the guarantee.

Once again, the answer is likely to be in between. The U.S. has done okay on TARP. Since the U.S. forced some of the better banks to take on money, the recovery/repayment rate is artificially high but at least worth looking at. The IMF involvement is a good sign here. If Spain was completely in control of investing FROB’s money, I would quickly assume the assets would wind up with no value. That might be unfair to Spain, but I would not for a second trust them to make decent investments with the FROB money. The IMF, I will grudgingly admit, does seem to actually try and run numbers and make sane decisions. They seem less likely to lose all the FROB money.

When I see everyone talking about all the great points of the deal, I will reconsider my view, but right now, I see simple headlines and negative reactions to those simplistic headlines. I don’t see this deal as a game changer on its own, but I don’t think it is as bad as some are pitching it right now, and more importantly, am very scared as a potential bear that there are more ideas and programs in the global pipeline.

Solvenquidity

Solvency and Liquidity are usually two different concepts.

A “liquidity” problem is when a solid borrower who for some reason cannot get access to money at a particular point in time. There is usually some reason that the company cannot borrow, and it has less to do with the creditworthiness of the borrower than on the market as a whole.

A “solvency” problem is when a creditor is so weak, overleveraged, that they have no way to borrow because they are on the verge of default.

Typically those two situations are different. If some entity tried to address a solvency problem by lending more and more, they could do that, but eventually they would run out of money as the market would stop lending to them. If A is a horrible credit, B can choose to lend to B so long as B has money. If B is willing to lend cheaply and in ever increasing size, A can continue to avoid default. It is the doubling down on an unlimited table theory in blackjack. In the real world, B will start having trouble getting money to lend to A because its creditors will see how stupid it is behaving. That mechanism is what separates solvency from liquidity.

What happens when the lender can print its own limitless supply of money? If you can print money and are willing to continue to print money you can use liquidity to avoid solvency for a very long time. I don’t condone that. I think it is horrible in the long run. I think we should have let more entities go bankrupt, starting with Bear Stearns back in 2008, and Greece in 2010, but for whatever reason the politicians have been petrified to do that.

Will they finally step up and let failure and bloated balance sheets run their course? I hope so, but I doubt it. I think we will see more activity, and for all the talk that you can’t solve a solvency issue with liquidity, you are right, but sadly a lender with virtually unlimited access to cheap money (since he prints it) can provide enough liquidity to address solvency for a long time. The end result is likely to be ugly, but that doesn’t mean the central bankers won’t try.

Tags: Assets, Balance Sheet, Balance Sheets, Creditors, Different Concepts, Frob, Global Pipeline, Guarantees, Imf Involvement, Kingdom Of Spain, Liquidi, liquidity, Negative Headlines, Prey, Proceeds, Repayment Rate, Solvency, Spite, Subordination, Tarp
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Is Needing EU Help a Good Thing? I Really Cannot Remember.

Wednesday, March 28th, 2012

by Peter Tchir, TF Advisors

Markets are up a little this morning, basically getting back the late day fade.  S&P Futures up 4.  IG18 is ¾ of a bp tighter.

In Europe, bonds in Spain and Italy are better after an initial round of weakness.  As far as I can tell, they both bounced on rumors that the EU was going to help out the Spanish banks.  Maybe it’s too early today, but I’m beginning to have trouble seeing the logic of rallying sovereign debt on a story that the banks need help.  I continue to be a little surprised that Italy is back to moving up and down in lock-step with Spain, as I think Spain is doing a lot to distinguish itself – and not in a good way.  Italian 5 yr CDS is actually 4 bps wider on the day at 371 while Spanish 5 yr CDS is 2 tighter at 423.

I will dig into the Spanish debt issuance and budget issues in more detail, but yesterday’s news should scare investors.  The deficit in the first two months of the year was worse than expected, and worse than last year because they transferred money to various regions and municipalities.  Now they will just guarantee debt of those regions, so no transfer, and improved deficit.  All fixed?  Hardly, just accounting games and another sign that somehow Europe does not understand that guarantees count.

Yesterday in fixed income ETF’s, we saw gains across the board, but with treasury related assets outperforming credit assets.  Junk bond ETF’s had the smallest gains, but that was a bit of catch up from the prior day, and the reality is that they are running out of room for any significant upside, which is why we still like HY17 vs HYG.  HY17 is back to 99 and does seem to be benefitting from the roll.  We are also finally seeing some “compression” as HY outperformed IG.  That trade has been hurting people as the “compression” story has been compelling, but the market hasn’t played nice with that trade.  Looking at it now, but not yet in it.  IG18 still seems like a reasonable short.  Even with creeping back into 88.75 this morning, it feels like the market is underhedged and even a bit long and it has failed to come back to its tights of 85.5 in spite of a spirited stock market.

Durable goods orders have a chance to break the trend of weak data, but that series is so volatile, I’m not sure a positive reading does much.  My guess is that we miss this number as well, but in this day and age of central banks dominating market moves, that miss might not do much.

VIX and TVIX (trading with almost no premium again) both bounced.  Stocks leaked, but the reality is that everyone is still digesting Monday’s move and really trying to figure out if all that matters is central bank liquidity.  I think that has its limits, and we have had sell-offs with big central bank policies in place, but even my faith was shaken on Monday as Ben seemed almost single-minded in his pursuit of more ways to “accommodate” the market, in spite of our concerns that he may be doing more harm than good to the economy, both in the short run and in the long run.

Copyright © TF Advisors

Tags: Accounting, Amp, Assets, Bonds, Bp, Bps, Budget Issues, Debt Issuance, Fixed Income, Futures, Guarantees, Ig, Junk Bond, Logic, Months Of The Year, Municipalities, Sovereign Debt, Spanish Banks, Tf, Treasury
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Bill Gross Investing in Long-Dated Treasuries

Tuesday, September 29th, 2009

Bloomberg reports that PIMCO’s Bill Gross is exchanging his corporate bonds for longer-dated government securities out of concern for deflation. This is a theme that we have written extensively about during the course of the year.

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said he’s been buying longer maturity Treasuries in recent weeks amid a re-emergence of deflation concern.

“We’ve exchanged our mortgages for the government’s check” as the Federal Reserve winds down purchases of agency debt, Gross said in an interview from Newport Beach, California, with Bloomberg Radio.

Gross boosted the $177.5 billion Total Return Fund’s investment in government-related bonds to 44 percent of assets, the most since August 2004, from 25 percent in July, according data released earlier this month on Pimco’s Web site. The fund cut mortgage debt to 38 percent from 47 percent.

This is very interesting if you’ve been following Bill Gross’ calls during the course of the year. Late last year and early this year, Gross was a huge investor in corporate debt, particular the debt of financials that received support from the government in the form of guarantees. Gross’ main thesis was and continues to be “Shake hands with the Government.” By the way, corporate debt has outperformed its equity peers during the course of the year, and was considered by many large investors as the superior bet given the option to invest in equities. The strategy of buying corporate debt (which was regarded as a lower risk than equities earlier this year) is one that eluded most retail investors because the credit market is generally perceived as out of reach or sophisticated.

Much of the “easy” money has already been made in corporate debt, and its likely now that investors, who are still for the most part sitting in record levels of cash, may stay there, or be lured into the equity market by the powerful rally seen the last two quarters.

If, on the other hand if you’re in the same camp as Gross, that deflation is still something to worry about, then longer dated governments may be the way to go. In Gross’ “New Normal” de-leveraging, de-globalization, and re-regulation are three dominant themes that flatten out the yield curve, which remains steep, and a flattening yield curve means short term rates rise while long term rates fall. The short term rates will be a little while in rising as it may be a little premature for the Fed to touch them, but the long term rates will come down as the market continues down the deleveraging path Gross and a few others are counting on, as assets get substituted for cash on institutional balance sheets. For the large institutions who continue to target their balance sheets, this ‘recovered’ equity market is a perfect opportunity to sell some reflated assets, and that means that a large amount of cash will be used to retire debt  and/or refinance Option ARM mortgages for that matter.

Long term rates are likely to fall on this development.

Read the whole article here.

Tags: Bill Gross, Bloomberg Radio, Bond Fund, Corporate Bonds, Corporate Debt, Deflation, Easy Money, Emergence, ETF, Federal Reserve, Government Bonds, government securities, Guarantees, Investment Bonds, Investment Management, Maturity, Mortgage Debt, Newport Beach California, Pacific Investment Management Co, Peers, Retail Investors, Treasuries
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