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  • eton97
    Senior Member
    • Dec 2008
    • 922

    The state of the economy.....

    Spain part 1:

    Contagion very much one of the buzz words of the day as details of the Irish Bailout get released and the market likely moves its attention to Portugal and Spain. The outlook for Spain remains the most important in terms of the wider European economy and the EUR as any bailout would test the limits of available resources in the EU/IMF. We continue to believe Spain will develop along a path where debt dynamics remain sustainable over the medium term, though I fully acknowledge the market has little confidence in this outcome (and has the ability to make this situation self-perpetuating!).


    So what is really going on in Spain and why is it important?


    Why is Spain important?

    * Its economy is substantially bigger than Greece, Ireland and Portugal combined.
    * A bailout of Spain would require essentially full use of resources available from EU/, IMF and other sources, putting the back-stop infrastructure to the test.

    * The potential losses involved in a restructuring of Spanish debt could trigger a eurozone-wide banking crisis.

    But it is not a question of liquidity in Spain......
    * The underlying issue is whether the Kingdom of Spain is solvent.
    * It is not a question of liquidity given that Spain does not have any large pending bond debt maturities and given that the ECB has an obligation to provide liquidity to solvent Spanish banks (and has proven willing to do so earlier this year).
    * But the market is currently pricing in an increasing probability that the Kingdom of Spain will ultimately have to default on its debts in some form. Using a standard recovery rate assumption of 40%, the 10Y CDS for Spain is now pricing a default probability of 42% for Spain, up from 27% in the beginning of August and 20% at the beginning of this year.
    * This deterioration is understandable in the context of contagion from Ireland, but it is not immediately logical in the context of domestic developments in Spain - aggressive fiscal tightening measures over the last six months, somewhat better than expected growth, and robust earnings among the biggest Spanish banks.


    Are the debt dynamics in Spain sustainable?
    There are three key elements of uncertainty in the outlook for Spain and its debt sustainability:
    1. Costs linked to banking system recapitalization;
    2. Risk of further significant declines in house prices;
    3. Underlying fiscal dynamics.

    1) The Banking System

    * Investors fear that the cost of contingent liabilities in Spain could be of a similar magnitude to Ireland. This view is based on the fact Spain has seen comparable increases in house prices and domestic credit as well as a similar construction booms. There has also been a comparable spikes in unemployment in Ireland and Spain since 2007.


    * But there are also some big differences :
    - The Irish banking system was much bigger, with banking assets to GDP in excess of 1,000%, compared to less than 500% for Spain.
    - Lending standards appear to have been better in Spain.
    - Spanish banks (unlike Irish banks) did not have large problematic external exposure to the UK and US markets. Instead they had soundly performing assets in Latin America.

    * Total risk weighted assets of Spanish banks (all major institutions) amounts to €1,914bn (179% of GDP), based on end 2009 numbers from the bank stress test from June. Santander and BBVA, the two biggest banks in Spain, account for 47.6% of total risk weighted assets. The remaining 52.4% of risk weighted assets in the Spanish banking system, or €1,002bn are held by a combination of other commercial banks, and the savings banks (Cajas).


    * Separating Santander and BBVA from the overall asset pool makes sense, because it is hard to construct scenarios where Santander and BBVA are likely to need new capital. The basic reason being that both institutions are generating strong pre-provision profits, including from their business outside Spain. Consistent with this, Santander and BBVA have consistently been able to access wholesale funding markets, even during May this year. That said, CDS spreads for Santander and BBVA have widened out last week to levels similar to what we saw during the panic of May, illustrating that even the most robust institutions are not immune to current sentiment.


    * In the stress test, the ‘worst bank' was DIADA, which according to the stress test would see losses of 10% of risk-weighted assets. If we apply this percentage to the entire risk weighted assets outside of Santander and BBVA, then we get losses of €100bn (10% of €1,002bn). Some of this will be absorbed in profits and existing provisions, leaving a smaller amount left for recapitalization. Importantly, the stress test's growth assumptions of -1.4 in 2010 and -1.2% in 2011, do not look overly optimistic, with 2010 GDP likely to come in close to flat y-o-y.


    * Another way to look at the potential for loan losses is to focus on exposures linked to the housing market and real estate more broadly. Whilst delinquencies on residential mortgages remain below 3%, the total exposure to real estate development and construction is €445bn, of which €250bn are held within the savings banks (Cajas). The Bank of Spain has argued that only €165bn of this exposure is troubled, as other parts are to sound projects (such as airports, utilities, as well as developments outside Spain). Moreover, provisions of €42bn have already been made for the troubled part of the loan portfolio. In terms of exposures, which have not been provisioned for Cajas may have €225bn and commercial banks around €180bn (of which Santander and BBVA account for around €80bn). In any case, if we assume losses of 40% on the entire portfolio of real estate development and construction loans, we get to a loss figure of €178bn, for which at least €42bn of provisions has been made. A part of this gap of around €130bn in additional potential losses would be absorbed in profits, but could see a need for recapitalization of perhaps €75-95bn.


    * With nominal GDP at €1,066bn, it is hard to argue that a recapitalization need of around €80-120bn (or around 8-12% of GDP) would by itself alter the debt dynamics (as has been the case in Ireland). It would be important to pin down what could be ‘too optimistic' about these calculations. Clearly, a restructuring of sovereign debt in the eurozone is one such risk. Another risk would be a significant rise in delinquencies on residential mortgages, linked to significant further declines in housing prices and continued rises in unemployment.
    Last edited by eton97; 11-30-2010, 02:22 PM.
    you can't polish a turd, but you can roll it in glitter...
  • eton97
    Senior Member
    • Dec 2008
    • 922

    #2
    Spain part 2.....

    2) Housing Market: How much downside risk?
    * Another issue is that the house prices could go down more than currently feared. The stress test assumes a 9% decline in house prices this year, and a further 15% decline next year. Compared to the current pace of declines, of 3.5% y-o-y, the stress-test assumptions for 2010 is clearly more severe, and the assumption of a 15% decline in 2011 does seem to be a valid benchmark for the worst case (at least for declines within that time frame).


    * Relative to the dramatic declines we have seen in the US and in Ireland (30-40%), these assumptions, may seem optimistic. But a number of valuation metrics do suggest that the likely adjustment for house prices in Spain from here is more likely to be in the 10-15% range, rather than the +20% magnitude.

    · Our economists have estimated that the ratio of house prices to income is currently 17% above its historical average. Assuming a cumulative 2% annual income growth over the next two years, that would suggest that nominal house prices have another 13% to fall to reach the historical norm relative to income.

    · It is also common to calculate current house prices relative to rents. But there is only short times series of rent data available in Spain. However, we can use the price to rent ratio in 2003 (ahead of the housing boom) as a benchmark. The current price to rent ratio is currently 10% above its 2003 level.

    · The IMF has calculated so-called house-price gaps, which measure the component of house price increases from 1997-2007 which could not be accounted for by fundamentals. In Spain, the house price gap is calculated to be 15.8%, compared to a gap of 31.9% in Ireland. And some of the gap has already been corrected (even taking into account that fundamentals have also deteriorated).

    * Such valuation metrics are dependent on the overall macroeconomic situation. A significant rise in unemployment or fall in incomes would pose additional downside risk. However, there are also structural factors at play. Compared to the US, it is worth noting that mortgages are not ‘non-recourse' in Spain, implying that borrowers are personally liable for the full loan amount regardless of collateral value of the house.

    * Moreover, lending standards appear to have been more conservative in Spain (better banking regulation) and average loan to value ratios for mortgages in Spain are low (currently at 63%) and well below the norms in the UK, US or Ireland. Consistent with more conservative standards, it appears that doubtful assets in the residential mortgage space are actually declining from 3% a year ago to 2.5% currently. If this pattern is maintained, it means that additional supply from foreclosed properties is likely to remain low, potentially reducing a significant downside risk for the market.

    * In a scenario where Spanish house prices reach levels close to fair value by declining 10-15% over the next 2-3 years, the implied losses for banks are likely to be within the ranges discussed above (assuming that incomes stabilize also). And various basic valuation metrics for house prices suggest that this may be the central case, although it would be foolish to rule out further declines, including as a function of ‘undershooting'.

    3) The Underlying Budget Performance
    Debt to GDP ratio is set to reach almost 80% by end 2012 driven primarily by still large primary deficits in 2010-2012. Such a level of debt would clearly exceed the 60% Maastricht limit, but it would still be well within the range of other eurozone countries, and no bigger than the current debt level of France. Beyond the need for bank recapitalization, three key uncertainties remain:


    1. Achieving budget targets:

    With respect to this year's budget target, the austerity measures (the bulk of which took effect on July 1), appear on track to secure this year's general government deficit target of 9.3% of GDP. Recent budget figures, which are up-to-date to October, show that the budget is responding well to the measures taken, especially in the revenue side, and the November-December numbers should look favourable based on base effects relating to elevated government investments expenditure in Nov-Dec 2009.


    Turning to the 2011, achieving the general government target of 6%, is clearly not going to be easy. In particular, the growth assumption is 1.3%, which appears to be on the optimistic side (We are at: 0.3%). That said, Prime Minister Zapatero's government has recently negotiated a pact with the Basque party (PNV) which gives the government a much more secure base from which to deliver on budget promises. In addition, there is still room to raise VAT (currently 18%) and excise taxes, given their low starting point compared to the rest of the eurozone. In any case, securing the 6% of GDP budget target will be instrumental in building market confidence, and any slippage on that front, including within regional governments, is likely to have a clear negative impact on the market.


    2.Growth Performance.
    Recent economic data is mixed, GDP is up marginally (+0.2%) in y-o-y terms as of Q3 2010, and unemployment continues to edge higher, although at moderating speed. This outcome is clearly falling short of the performance seen in Germany (+3.9% y-o-y). But it is far better than the outcomes in Greece (-4.5% y-o-y) and Ireland (-1.8% y-o-y). In addition, GDP has actually come in slightly better than projected by the IMF this year, despite the drag from the extraordinary austerity measures implemented in July.


    3. Debt Servicing

    Debt servicing cost. Recent rises in Spanish government bond yields clearly pose a challenge in this regard, as higher debt servicing costs will make the debt dynamics more challenging. At this point, however, Spain has covered is immediate financing needs for 2010 and government debt maturities are moderate in early 2011. Moreover, we still have a backstop in place from EU/IMF, with broadly sufficient capacity to support Spain in the next two years.

    Conclusion

    In the short-run, the details of the Irish bailout, which cemented that the package was of the expected size (€85bn) and that there will be no immediate hair-cuts for private sector bond holders (including holders of senior Irish bank debt), could lead to a rally in peripheral sovereign spreads and some easing of tensions around eurozone banks.

    But the real issue remains broad-based contagion effects, including to Portugal and Spain. A bailout of Portugal would likely require around €50bn, which is well within the capacity of the EU/IMF backstop. But the additional resources needed to fund Spain in a scenario where Spain lost market access would test the limits of the capacity available from the EU/IMF (around €385bn). This is the reason Spain is pivotal to the outlook for the euro.

    While there were very good reasons to view Greece's debt dynamics as unsustainable earlier this year, Spain's situation is not the same and not comparable to Ireland's either, based on:


    1. The 6% of GDP fiscal deficit target for 2011 will be approximately achieved,
    2. Banking sector restructuring costs will not meaningfully exceed 8% of GDP,
    3. Average growth in 2011/2012 will not be worse than 0.5%.

    Based on those assumptions, Spain's debt to GDP ratio will not significantly exceed 80% by end-2012 and can be stabilized around 90% or below in the following years. There are risks to the key assumptions, perhaps especially to the growth assumption, given the need for fiscal tightening. But our central case would still be that these assumptions are more likely to play out than not.

    From a currency point of view we estimate the range on the EUR/USD of 1.50 (should sovereign risks be eliminated) and 1.23 (Should Spanish spreads widen to 435bp, implying a 60% probability of default). The current risk premium implied in the EUR (11%) can only be expected to come down significantly when fiscal consolidation programs show meaningful progress, which will happen around mid-2011 at the earliest. In the mean-time, the risk premium is likely to fluctuate in line with news about fiscal measured and performance, external support commitments, ratings news, and banking sector tensions.
    you can't polish a turd, but you can roll it in glitter...

    Comment

    • eton97
      Senior Member
      • Dec 2008
      • 922

      #3
      a must see to truly understand what has caused the financial crisis.....

      its the first video of the bunch 'the million dollar question'


      Video: Australian TV personalities Clarke & Dawe on the INSANITY of European Debt Guarante...
      Last edited by eton97; 11-30-2010, 04:43 PM.
      you can't polish a turd, but you can roll it in glitter...

      Comment

      • uL7iMa
        Member
        • Oct 2010
        • 57

        #4
        Thanks for the interesting read!

        I'm currently doing a degree in Economics, and this kind of articles really intrigue me!

        Comment

        • snafu
          Senior Member
          • Apr 2008
          • 2135

          #5
          eton did you see Britain's trillion pound horror story ?
          .

          Comment

          • doldrums
            Senior Member
            • Dec 2008
            • 500

            #6
            Awesome bit.




            Originally posted by eton97 View Post
            a must see to truly understand what has caused the financial crisis.....

            its the first video of the bunch 'the million dollar question'


            http://dailybail.com/home/brilliant-...ropean-de.html

            Comment

            • eton97
              Senior Member
              • Dec 2008
              • 922

              #7
              it aint over yet ....the rides just started

              an interesting article i was reading that is a short but very clear reminder that nothing much has changed since the financial crisis, and the outlook remains very bearish.....

              1 – Overall, the issues leading to the 2007-09 crises are still present, and are even worsening in some places. Namely very large global, regional, sectoral and national imbalances (in areas such as incomes, earnings, wealth, trade and financial health); excessive levels of, and excessively narrow concentrations of, debt primarily in Western
              economies; and significant fat tail risks in the market when it comes to the price of and the levels of assumed volatility. It seems that collectively we learnt nothing from the 2007-09 experience, and the apparent solution to the crisis has been to implement more of the same policies that caused the mess in the first place.

              2 – Therefore, we think the key drivers of markets and economies are still the cost of capital (CoC) and balance sheet (BS) strength/financial health.
              The rising CoC over 2006-09 led to exactly what it always leads to: slower growth, weaker earnings and incomes, and ultimately a default cycle and poor risk asset performance. Since early 2009, primarily through quantitative easing (QE), the CoC fell and has been artificially mispriced in our view since then. This lower CoC also had the usual consequences: more leverage, more debt, and artificially supported, or mispriced, (risky) asset valuations.

              3 – the key current global macro themes occupying the market are still:
              A – In emerging markets (EM) will there be a soft or a hard landing? There is no doubt that a landing is needed in order to address inflation problems, excessive and speculative asset bubbles, approaching cyclical capex peaks, and very real labour squeezes/positive output gaps. But what sort of landing this will be remains to be seen.
              B – In developed markets (DM) we expect, for the next few years, lower trend growth rates. Already excessive debt levels have worsened, and we continue to expect a weak U-shaped recovery in domestic sectors overlaid by a temporary and highly cyclical super-cycle in manufacturing based largely on demand from the big three EM nations, the BICs (Brazil, India and China).
              C – In Europe, although we do eventually expect a credible and sustainable solution to Europe‟s excessive debt/insufficient equity problem, we expect the crisis to continue for a while yet.
              To the above three themes we can now add two more.
              Firstly, the outlook for Japan after the tragedy, and how it may impact the global economy and any global asset allocation. Second, Arabic unrest/oil price spikes and how such price moves are affecting growth and inflation in both the DM (where growth is the bigger risk), and the EM world (where, in energy and food, inflation is the bigger risk).

              .....................In summary, the key driver of market returns right now and since early 2009 has been the Fed and its “intentional” mispricing of the true CoC through QE, but we think the Fed is fast approaching the limits of its credibility. We think the Fed is asking investors:
              A - to lever up at the wrong price;
              B - to take on risk at the wrong price; and
              C - to do this at precisely the wrong time in the business cycle.

              For this to succeed, the Fed needs to convince investors it can keep the QE-fed Ponzi growing forever, permanently misprice the true CoC without any negative or unintended consequences. The US housing market seems quite clearly to be rejecting this proposition, but the equity market in particular has not. History shows no successful precedent, so under the hard landing path, when the CoC and pricing of risk normalise, as we would fully expect them to, asset prices, especially equities, should be hit very hard. We see this starting in Q3 2011, and likely lasting through 2012/2013 and maybe even into 2014, with QE3 becoming the central risk/problem, rather than the apparent solution.
              In this significant down move we should expect new lows in weak BS DM and EM equities (not strong BS countries) as in these weak BS nations policymakers, especially the Fed, would likely have little/no credibility and no/extremely limited policy options left (we see QE3 as the Fed‟s last big stand). And all it will have achieved in our view, since QE1 and especially QE2 was flagged, is to have encouraged many more investors to wrongly load up on risk, at the wrong price and at the wrong time.
              Assuming that the QE3 option is eventually exercised (as we do under the hard landing outcome) and assuming it does what we fear to the credibility and status of the US, the US dollar and US Treasuries, then we think the result, most likely at some point between 2012 and 2014, will be major fx regime changes and significant paradigm shifts in global fx markets.
              As these changes and shifts occur, gold could perform very well, as could other scarce physical assets (possibly super prime real estate). And the highest quality (by BS strength) nominal corporate assets – top quality equities in other words – may at least on a relative basis (if not absolute) perform fairly well.
              Last edited by eton97; 04-21-2011, 06:39 AM.
              you can't polish a turd, but you can roll it in glitter...

              Comment

              • Faust
                kitsch killer
                • Sep 2006
                • 37852

                #8
                This is depressing, eton. :( What's your take on it?

                What scares me most is that if this comes to pass, the idiot Americans will continue blaming the Democrats for this and will vote in Republicans, who will be more than happy to continue running the country into the ground while depriving us of civil liberties.
                Fashion is a form of ugliness so intolerable that we have to alter it every six months - Oscar Wilde

                StyleZeitgeist Magazine

                Comment

                • ES3K
                  Senior Member
                  • Oct 2008
                  • 530

                  #9
                  In this context, does anybody know how good (or bad) the summer collections at Luisa, Barneys et al are performing? at least the menswear brands (including Rick and Balmain) I'm monitoring at eshops aren't moving as they used to past seasons. Even in SZ classifides (to me) it seems that supply exceeds demand currently.

                  Comment

                  • quiet noise
                    Banned
                    • Dec 2008
                    • 425

                    #10
                    i think its really fascinating that most people in this world doesnt realize that their precious money is nothing but a fake debt, and that it all began in the 18th century when the rothschilds convinced the inbred, alchololic monarchs of europe to borrow money from their family bank, and so the nations would be forever tainted with government debt.

                    I also think its fucking terrifying how they dont teach ecnomomist students how the monetary system actually works. One of my best friends is in his 5th year at Handelshögskolan (the "best" economic education avaible in scandinavia) and he didnt know that the federal reserve was a private, non-governmental organization.

                    Comment

                    • sam_tem
                      Senior Member
                      • Apr 2007
                      • 650

                      #11
                      Originally posted by eton97 View Post
                      Assuming that the QE3 option is eventually exercised (as we do under the hard landing outcome) and assuming it does what we fear to the credibility and status of the US, the US dollar and US Treasuries, then we think the result, most likely at some point between 2012 and 2014, will be major fx regime changes and significant paradigm shifts in global fx markets.
                      so what exactly are they talking about here becuase as far as i could tell from this last recession any faltering in the american economy is still enough to ruin teh global economy. if america falters who exactly do they think is next in line to pick up the slack? i think china's future is way too intertwined with US right now, we know where Japan stands, depressed oil prices would bring Brazil to a halt and start severely crippling others and India will never be able to take off until Pakistan gets under control.

                      i'm just trying to decide if i'm going to dump it all into cash at the end of QE2 but still continue making equity purchases as per usual plan or just keep it all in throughout the rough periods. i think the last drop proves most everyone should stay in regardless because the number of individual investors that missed the run-up appears to be quite staggering. yes, we'll know when QE3 will probably start by then so theoretically there should be some kind of clear buy signal but i doubt it will work that way.

                      edit: damn, just saw QE2 is expected to end in June, i thought it wasn't until this fall sometime. i guess we gotta be on our toes this summer.
                      Last edited by sam_tem; 04-21-2011, 12:03 PM.

                      Comment

                      • sam_tem
                        Senior Member
                        • Apr 2007
                        • 650

                        #12
                        oh, and houses. hopefully the gov't gets it butt in gear and starts fixing the distorted housing market in the next few years. i like the idea of using it to try and fix the inter-generational theft going on right now. the gov't needs to simply remove itself from housing altogether along with mortgage interest deduction which is such a huge waste of money and steers investment into low/zero growth oppurtunities and watch it sink. old folks would lose wealth to make up for the medicare/SS they're receiving and never paid in full that younger generations are paying for and the younger folks get to buy homes much cheaper in return.

                        this would of course have to go in very slow-motion so as not to destroy city revenues, but either way it's something that needs to happen already and we need to start fixing the gov't revenue intake so this budget battle crap going on doesn't ruin this country even more.

                        i'm just worried in that i expect to have my current home paid off in about 6 years and i'm going to be looking for a nice place at that time. if the gov't doesn't fix the market by then i'm still worried housing could take a huge fall in the future once the boomers start trying to pass off all their homes (these are the folks that own rental units, vacation homes, 2nd homes, etc.).

                        Comment

                        • Faust
                          kitsch killer
                          • Sep 2006
                          • 37852

                          #13
                          Originally posted by quiet noise View Post
                          i think its really fascinating that most people in this world doesnt realize that their precious money is nothing but a fake debt, and that it all began in the 18th century when the rothschilds convinced the inbred, alchololic monarchs of europe to borrow money from their family bank, and so the nations would be forever tainted with government debt.

                          I also think its fucking terrifying how they dont teach ecnomomist students how the monetary system actually works. One of my best friends is in his 5th year at Handelshögskolan (the "best" economic education avaible in scandinavia) and he didnt know that the federal reserve was a private, non-governmental organization.
                          Sounds like you are into conspiracy theories. Probably one of those Zeitgeist youtube fans.

                          The Fed is only partially privately owned, and the board is appointed by the President, and it calls the shots. Not to say they are not in cahoots with Wall St.
                          Fashion is a form of ugliness so intolerable that we have to alter it every six months - Oscar Wilde

                          StyleZeitgeist Magazine

                          Comment

                          • quiet noise
                            Banned
                            • Dec 2008
                            • 425

                            #14
                            thats not a conspiracy theory, Faust. I have never seen Zeitgeist, but i study Economic history and the rise of the Rothschilds is one of the core chapters of the course. Their role in the global capitalistic market is undeniable, altough possibly slightly off-topic.

                            Why should a state like the USA be forced to borrow 100% of their money from a private bank? and how are you supposed to pay back your debt with more borrowed money? thats like trying to get out of a pit by digging yourself deeper down the mud.

                            Nations should be able to create debt-free money, period.

                            Comment

                            • eton97
                              Senior Member
                              • Dec 2008
                              • 922

                              #15
                              The way I see it, QE3 is going to be unavoidable when we finally see a significant slowdown in global growth in 2H (driven by an emerging slowdown and a slowdown in the global manufacturing super-cycle).....once the slowdown occurs it will become evident that:
                              - asset valuations are too high, only supported by overly optimistic growth expectations
                              - the fed has destroyed its credibility
                              - there is nowhere near enough sustainable growth in the US or DM

                              QE3 = policy mistake = all-out debasement and monetisation = a serious risk to the 'safe haven/risk-free' status of the US, the $ and US treasuries = $ no longer being viewed as any useful store of value.

                              $ should weaken vs Eur and sterling, especially if eurozone solves it problems over the rest of the year (big ask).....but we all remember $2/£ around lehman bankrupcy....

                              S&P500 could hit 1400, but by year end could be below 1000
                              you can't polish a turd, but you can roll it in glitter...

                              Comment

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