A Final Note Regarding PIIGS Debt

I want to issue a clarification on the statements I made yesterday and Saturday. I am in no way saying these bonds are good purchases or that the fiscal situations in these countries are OK. Austerity measures will probably hurt recoveries, people who's benefits are cut are going to be pissed, and politicians are going to have to do some very unpopular things. A good place to look for inspiration, as The Economist noted, is Eastern Europe. My point was that the problems these nations are facing, particularly Greece, are deep problems that have been long ignored. Greece's issue is not that it's facing unfavorable refinancing rates, it's that it needs to finance debt service, something that David Merkel very eloquently covered with his post You Can't Cheat an Honest Man.

With that said, I'll leave you with a little excerpt from Hyman Minsky's wikipedia page:

For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments

More on the PIIGS Debt Coming Due

Yesterday I wondered about whether all of this PIIGS debt panic was warranted. I don't contest that there is debt problems that need to be fixed (and not just in Southern Europe), but I also don't think that there's any reason to be alarmed over the debt coming due in the next couple of months. If you would, however, want to be alarmed by the debt coming due in 2012, I'd completely understand. The reason I'm not alarmed is because those euros have to go *somewhere* once these bonds start coming due and while there may be some movement away from Greece, it's not like liquidity is going to suddenly dry up for sovereign issues and Euro area countries are going to be stuck, unable to refinance their debt. Yeah, they might have to refinance it at higher yields, but they will refinance it. Considering how low interest rates are right now, I wouldn't be surprised if the debt they are retiring is going to be refinanced at lower rates, reducing the debt service expense. I'm working on this last point right now, but it's very labor intensive.

Regardless of how many bad things you hear about these countries in the media, it's still sovereign debt, not corporate junk. It's not low-rated, you can repo it at the ECB and, most importantly, the other European banks are buying it. And you know what? As long as they can be repod for liquidity, the banks will keep buying these bonds and strolling carefree down the meadows of borrow short, lend long. Yields may or may not accurately reflect default risk, I do not know, but barring a huge, sudden jump in interest rates, this is just not that big of a deal. And since I don't see inflation in our near future, I'm not too concerned about that.

In the mean time, a weaker Euro will probably help support tourism and give a boost to manufacturing, buying everyone a little more time.

PIIGS Debt Coming Due: Is it really an issue?

Der Spiegel published the following graph as part as the ongoing Portugal / Greece / Italy / Ireland / Spain crisis porn.

Let's not all just freak out just yet. Let's do our homework:

As of this writing the PIIGS are borrowing ta the following rates (Economist 3/20 -3/26):

• Portugal: ??
• Ireland: ??
• Italy: 3m @ 64bp and 10y @ 390bp
• Greece: 3m @64bp and 10y @594bp
• Spain: 3m @ 66bp and 10y @ 384bp

The economist also tells us that the average maturity of this debt stands as follows

• Portugal: 6.5 years
• Ireland: 6.8 years
  
• Italy: 7.2 years
• Greece: 7.7 years
  
• Spain: 6.7 years

Now, what I'd like to know is when this debt coming due was issued and at what cost to the government. If the yield at issue was higher than their current borrowing rates, well, that's not really a problem. Second, who owns all this debt? The local banks? foreign banks? regular people? If it's mostly local banks that hold this debt, i don't imagine the refinancing is going to be much of an issue, after all, the banks have to do something with that cash. Could rates move up as the supply of debt overwhelms the demand? Yes. Do I think this is as big of a deal as it is being painted to be? Hell no.

A note about securitized loans

CLOs pool loans and slice them into securities of varying risk intended to provide higher returns than similarly-rated investments.

-- via Bloomberg CLOs to End 12-Month Drought in Citigroup Deal


Uhm. This is what is wrong with everyone. Have these people never heard of conservation of probability? Slicing and dicing loans doesn't improve the quality of the underlying, it just redistributes risk across tranches and security holders to reduce the variance. Without so much as touching on David Merkel's great point about lower quality in originate-to-securitize loans, the overhead needed to securitize these loans effectively reduces the aggregate return on the whole pool as well as lower the probability adjusted return of the pool.

A Closer Look at Retail Sales

Well, we got new retail sales numbers from the Census Bureau. Calculated Risk reported an increase but, just like last month, these numbers are a little less bright when adjusted for population changes. Please take in mind this is a census year, and we'll have a new population estimate soon, but if the gap between the 1990 and 2000 estimates is any indication, the difference shouldn't that large. While we continue to see minor weakness in the population-adjusted sales, it's starting to look like we are just moving sideways, which is not good news, but it's better than bad news.

One of the items that I find discouraging is the percentage of sales volume that is gasoline sales. While sales numbers are moving roughly sideways, the amount of money spent on gasoline has been increasing. The increasing sales volume of an item with a low short-run elasticity of demand just means people's income are increasingly tied up in covering the necessities and their disposable incomes are shrinking. That is not good news for the consumer. Where are all those gasoline savings Cash4Clunkers was supposed to bring us?

I also added a chart including per-employee retail sales, which show us some tremendous improvement in the retail sector. It looks like retail was able to adjust employee-levels quickly and the per-employee sales number is actually very close to the peak levels.

Chinese Money Supply: Record Low Reserves (17%)

To see the latest data please see the label Chinese Money Supply

Note that the numbers available from the PBC only go from Jan2004-Dec 2009. As soon as the 2010 numbers are available I'll post an update. Also, if you are perplexed by that spike in reserves, there is a very simple explanation: Chinese New Year.

Traditionally, Red envelopes or red packets ... are passed out during the Chinese New Year's celebrations, from married couples or the elderly to unmarried juniors ... Red packets almost always contain money, usually varying from a couple of dollars to several hundred.

Wikipedia: Chinese New Year

Feb 2010 Unemployment

We have unemployment, yes we do! We have unemployment, how ‘bout you?!

How’s a young man gonna meet his financial responsibilities workin’ at a motherfuckin’ Burger King? He ain’t!

This is not Progress: Transaction Taxes

There have been many calls for a transaction tax. I oppose all of them. I am not a free-market fundamentalist, but intervention here will help nobody. I understand the desire to tax speculator's trading activities, they can often be seen as value extracting instead of value creating activities, but at the end of the day, they do add liquidity and lead to tighter spreads, even if the liquidity is of low quality. The problem here is regulatory arbitrage, the transaction tax can easily be circumvented by moving transactions off-shore. I understand that is not trivial, but all the large  operations, the ones that can really affect the financial system, are big enough to be able to move the taxable operations because the cost of moving the operation will be less than the cost of paying the tax. Meanwhile, all the smaller players will be stuck paying the tax.

There is a lot of legitimate transactions that would end up burdened by the tax, from a small airline hedging fuel costs to a farming operation locking-in a price on a harvest, to a municipal water company hedging their energy costs (you'd be surprised at how much electricity those pumps need). The media has called it a "Robin Hood" tax and the politicians are throwing numbers like "0.25 percent" around. They just don't get it. First of all, this would mean bye-bye to the money market mutual fund industry and it's associated returns for holders of cash. Secondly, it would wreak havoc in the Fx markets and inevitably lead small money-changers to go into the black market since the tax would be bigger than the current bid-ask spreads. Finally, the tax would just end up being paid by consumers in the form of higher prices. I won't even touch the subject of market makers, whether official or de facto.
We need to fix problems, not symptoms! This is not progress.

1.) http://www.guardian.co.uk/business/2010/feb/09/tobin-tax-nighy-curtis-film
2.) http://www.bloomberg.com/apps/news?pid=20601103&sid=anYlPWIEm6gE
3.) http://www.lexology.com/library/detail.aspx?g=de4f41cb-2d89-410b-88ed-696853e482ec