Financial Review

February 14, 2012

DOW + 4 = 12,878
SPX – 1 = 1350
NAS +0.44 = 2931
10 YR YLD -.07 = 1.92%
OIL +.29 = 101.20
GOLD – .80 = 1722.10
SILV – .14 = 33.68
PLAT – 26.00 = 1635.00
Over the weekend, the unelected technocrat Greek Prime Minister warned that if the terms of the second Greek bailout were not approved, there would be a “disorderly bankruptcy that would create conditions of economic chaos and social explosion. The savings of the citizens would be at risk. The state would be unable to pay salaries, pensions, and cover basic functions, such as hospitals and schools, and … the country – public and private sector alike – would lose all access to borrowing and liquidity would shrink. The living standards of Greeks would collapse. The country would drift into a long spiral of recession, instability, unemployment and prolonged misery. These developments would lead, sooner or later, to exit from the euro.”
And so the Greek parliament voted to accept a plan to impose austerity on the already austere Greek economy in exchange for a 130-billion euro bailout needed to pay 14-billion in bonds that are set to be redeemed in March.  If there is a default on the bonds, it would likely start a process of national bankruptcy which in the first order would mean state pensions, wages, contracts and medical bills not being paid. From there, the insolvency would multiply outwards into the already deeply impaired private sector, where many businesses would find it impossible to stay afloat.
To exit the euro would further wipe out the private savings market through a combination of devaluation and waves of bankruptcy. Then there would be an  economic contraction, followed in short order by heavy duty inflation, really nasty inflation, because Greece imports most of what it needs to get by. Devaluing the currency would lead to inflation, then people who are still working would demand better wage compensation and that would result in another wave of inflation and then central bankers would emerge from under their bridge to monetize the deficits.
And so, faced with these prospects, the Greek government decided to submit to the austerity program in exchange for bailout money. But the money doesn’t go to the Greeks, it goes into a fund to pay the bankers. And so the Greek people have been protesting. There have been riots. They burned buildings. The police fired back with tear gas. The ordinary Greeks are being punished for the mismanagement and corruption of the politicians and the banksters and the business elite.
And the European paymasters, mainly Germany, keep making the deal tougher and tougher on the ordinary Greek citizen. Late today, the Greek parliament defied violent street protests and voted for even more austerity, but fully implementing the measures is likely to prove an impossible task given the political divisions and deep-seated social unrest. The package includes public sector layoffs, sharply cutting the minimum wage and already dwindling pensions, as well as widespread tax increases.
But late today, there was word the Greek government signed off on the austerity measure, and then later the euro ministers said the paperwork had not yet been received and there was more technical details to be worked out and more assurances were required from the Greek politicians.
The question we still have to ask is if the markets have already priced in a Greek default, and the possible contagion, or if the market is still living in a land of make believe. Today, Moody’s Investors Service cut the debt ratings of six European countries including Italy, Spain and Portugal and revised its outlook on the U.K.’s and France’s top Aaa ratings to “negative”.There had been no indication the U.K.’s outlook was necessarily in danger based on how other ratings firms view U.K.’s debt. Both S&P and Fitch have a stable outlook on their U.K. rating.
Spain was downgraded to A3 from A1 with a negative outlook, Italy was downgraded to A3 from A2 with a negative outlook and Portugal was downgraded to Ba3 from Ba2 with a negative outlook. Moody’s also reduced the ratings of Slovakia, Slovenia and Malta.
What Greece has in essence committed itself to is an internal devaluation lasting years, if not decades into the future. There is no discernible end to the austerity; year after year, it grinds remorselessly on. Even if everything goes according to plan, which seems unlikely, it takes until 2020 to reduce the national debt to 120% of GDP, a level still far too high to be remotely sustainable.
Greece also faces a massive hit to wages and living standards as it seeks to impose competitiveness on an economy. There is not a hope of Greece growing its way back to debt sustainability while still in the euro. Even if that were the right thing to be doing from an economic perspective, it seems intolerable from a political and social one, as we are already seeing from the mini-revolution on the streets of Athens. Public support for the political establishment is going up in flames. The euro is destroying Greek democracy.
There is a long history of countries that have defaulted on their debt; most recently Iceland and Argentina and other countries that have both devalued and defaulted; the result is an economic shock that is relatively short lived. Once competitiveness has been restored by devaluation and default, growth prospects improve dramatically. This is probably a better path for Greece than to become the whipping boy of Europe.
As Greece struggles to meet Europe’s strict terms for receiving its next round of bailout money, the lesson of Portugal might bear watching. Unlike Greece, Portugal is a debtor nation that has done everything that the European Union and the International Monetary Fund have asked it to, in exchange for the 78 billion euro (about $103 billion) bailout Lisbon received last May.
And yet, by the broadest measure of a country’s ability to repay its debts, Portugal is going deeper into the hole.
The ratio of Portugal’s debt to its overall economy, or gross domestic product, was 107 percent when it received the bailout. But the ratio has grown since then, and by next year is expected to reach 118 percent.
That’s not necessarily because Portugal’s overall debt is growing, but because its economy is shrinking. And economists say the same vicious circle could be taking hold elsewhere in Europe.
Two other closely watched countries on the debt list, Spain and Italy, now also have rising debt-to-G.D.P. ratios — even though they, like Portugal, have adopted the budget-slashing and tax-raising measures that the European officials and the I.M.F. continue to prescribe.
And on Tuesday, new figures showed that the Greek economy shrank even more than expected last year, as Greece struggles under ever heavier austerity demands by its European lenders.
Without growth, reducing debt levels becomes nearly impossible. It is akin to trying to pay down a large credit card balance after taking a pay cut. You can cut expenses, but with lower earnings it is hard to set aside money to pay off debt.
Mario Monti, the Italian prime minister, has warned of the dangers of pushing governments too far, and fearing contagion to his own country, has asked for Europe to go easy on Greece. The Euro-powers-that-be argue that there is no alternative, they must impose harsh discipline on Greece. And if contagion does spread through Europe, it will be well deserved because there is always an alternative. Right now the Euro-zone economy is being run by and for the bankers. There was a time when Europe was torn apart by war, and after the war, the victors rebuilt the vanquished. Economics without compassion is a losing game.
Yesterday was the last day to submit comments on the Volker Rule No less than Paul Volcker himself was roused from 25 years of slumber to submit his own comment, and while he was up he laid a gleeful smackdown on European governments. You may recall that some clients had some concerns about the Volcker Rule reducing liquidity, with some of those concerns being less sympathetic than others, and foreign sovereigns were among the noisiest complainers. Volcker is having exactly none of it:
“There is a certain irony in what I read. In Europe, there are plans to introduce a financial transaction tax, justified in part by officials because it puts “sand in the wheels” of overly liquid, speculation-prone securities markets. … How often have we heard complaints by European governments about speculative trading in their securities, particularly when markets are under pressure?”
The financial services industry wants to revise the “Volcker Rule.” I know, it’s shocking. The Securities Industry and Financial Markets Association, or SIFMA, teamed up with the American Bankers Association, the Financial Services Roundtable and the Clearing House Association to deliver a 173 page letter detailing their objections to the Volker Ruleand how it goes about setting up the ban on proprietary trading. The groups, the major trade associations for the financial world, also filed separate letters on other aspects of the rule.
The trade groups write:“The potential costs to the financial markets, investors and corporate issuers from incorrectly implementing the Volcker Rule are enormous.”  I doubt it, but just to refresh my memory, what was the cost to allowing the banksters to take crazy risks and nearly drive the entire global financial system over the edge and into a dark abyss? How many trillions were paid out in the form of bailouts, and free money? And how much of that money has been spent to lobby for even less regulation for a broken system?
Just curious.

The California Public Employees’ Retirement System, or CALPERS has about $234 billion under management. The pension fund estimates that it has about 75 percent of the money it needs to cover promised benefits. That differs from a Stanford University report that said Calpers was only 58 percent funded. That’s a pretty significant difference. And to come up with those conclusions they have to make certain assumptions. CALPERS assumes they can earn 7.75% on the funds. Stanford assumes that CALPERS can only earn 6.2%.

About 2 weeks ago, The California State Teachers’ Retirement System,  with $133 billion of assets, agreed to lower its assumed returns to 7.5 percent from 7.75 percent. The teacher’s fund had 71 percent of what it needs to pay future benefits as of June 30, 2010. The lower rate added $5.9 billion to a $56 billion shortfall projected at the time  So, now you’re thinking Calpers is crazy for making such aggressive assumptions, or maybe they are pretty good at investing. Which is it?
In the fiscal year ended June 30, Calpers earned 20.7 percent, its best result in 14 years, led by stocks and private equity. Since then, the fund has dropped 4.5 percent. It lost almost a quarter of its value in 2009 as the global recession dragged down stock prices and real-estate values. Through Dec. 31, Calpers earned almost 5.1 percent over a decade and 7.5 percent the past 20 years. hat 20-year return will rise to 8.36 percent when results through June 30, 2011, are included. The fund uses such fiscal year results in its calculation of employer contributions.
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