Week in Review Part I: Europe, Washington and Wall Street

Greece officially gets its second, 130 billion euro bailout, 174 billion when combined with part of the first bailout package that remains, as the International Monetary Fund approved 18 billion of the 130bn, or 28bn of the 174bn. I’m telling you this is kind of confusing, but let’s stick with the second package of 130 billion.

This means 18 billion coughed up by the IMF, 112 billion by the European Union. Now recall you first had the European Financial Stability Facility [EFSF] as the original firewall for Greece, Ireland and Portugal, and then the European Stability Mechanism [ESM] consists of 500 billion euro ostensibly to backstop Italy and Spain.

Portugal, at an estimated 100 billion, and Ireland, 80 billion, are funded out of the 250 billion remaining in the EFSF, along with the 112 billion for Greece. Yes, it doesn’t exactly add up but it’s hoped Portugal and Ireland won’t have to use all of theirs.

Or they might need more…Greece as well.And even though we’ve seen the credit market situation improve markedly for Italy and Spain, they can still have all manner of issues if their economies don’t improve, and soon, and in that case you all know by now, 500 billion euro isn’t enough for these two.

Which is why the IMF is adamant Germany, in particular, back a further increase in the ESM, or at least combine the EFSF with the ESM, but Germany doesn’t want to because it believes the five nations just mentioned wouldn’t then have the incentive to implement their austerity programs.

As for the IMF, one of its directors, Paulo Nogueira Batista, who represents Brazil and eight of the governments, abstained – the traditional way of showing dissent at the board, saying, “I remain deeply uneasy about the Greece program. For the past two years, Europe has taken a Panglossian view of Greece’s likely growth while the economy has continued to contract.”

Batista told the Financial Times that the restructuring of Greek sovereign bonds held by private sector creditors was “too little, too late….They have gained some breathing space but I don’t think that the medium-term prospects for the country have fundamentally been altered for the better.”

With Greece getting the bailout package, though, it now has to accept four European Commission officials permanently stationed in Athens, along with representatives of the IMF and European Central Bank, who will be constantly looking over the shoulders of Greece’s monetary officials.

Meanwhile, in Spain, with an unemployment rate of 22.8%, 50% for young people, house prices fell 11.2% last year, with prices in Madrid down 15.7% in the fourth quarter, year-over-year.

Eurozone finance ministers, still reeling from Spain’s announcement that its deficit would be 5.8% rather than the previously agreed upon 4.4%, cut Spain some slack to 5.3% as a target for 2012, but this requires even more draconian cuts. Ollie Rehn, the EU’s most senior economic official, said the EU couldn’t do more given the fact Spain’s deficit for 2011 came in at 8.5%, 2.5 percentage points higher than it was supposed to.

Now do you see why an increased firewall for the ESM is necessary? Oh, sure. Spain and Italy have 10-year bond yields that have come down to roughly 5% for each vs.

7.50% for Italy at its recent peak and 6.67% for Spain. That is good. But to beat a dead horse, or slaughter a bull in the case of Spain, they need growth. Both are in recession.

Mohamed El-Erian / Financial Times

“Many investors wish to wave a final goodbye to the disruption the Greek debt crisis has had on market valuations. Meanwhile, European policymakers are already trying to move away from the dramas on the periphery and focus on restoring growth in Europe. Both impulses are understandable. Unfortunately, they are premature….

“What last week’s debt reduction deal really delivers is a bit more time for others to reposition for the next, more disruptive, act in this unfolding Greek drama. For European policymakers, this means even more urgent building of firewalls to protect countries such as Italy and Spain, continuing to strengthen the core through better fiscal and political integration, and forcing banks to raise capital. For investors, it is about reducing their exposure not only to another default by Greece, but also the risk of the country’s exit from the euro.

“If this were to happen, the latest agreement would end up being characterized in history books as more than just a costly failure.”

And on the ECB’s recent longer-term refinancing operations (LTROs) that stabilized the debt markets in the eurozone by injecting massive amounts of liquidity into the banking system, economist Paul De Grauwe, in an op-ed for the Financial Times:

“(It) can now be said (the LTROs) were ill-designed, making it probable that the ECB will have to discontinue them….

“(The) ECB chose not to intervene at the source of the problem – the sovereign bond markets. It delegated the power to buy government bonds to the banks, trusting they would obey. But the banks themselves were and still are in a state of fear.

“The decision to delegate to panicky bankers has had three unfortunate consequences that will become clear now the central bank has completed its second liquidity injection. First, because banks channeled only a fraction of the liquidity they obtained from the ECB into the government bond markets, the ECB had to pour much more liquidity into the system than if it had decided to intervene itself.

“Second, new waves of panic may grip the banks again, leading them to sell off government bonds. The risk that this may happen undermines the credibility of the whole operation, and can quickly lead to a new crisis in the bond markets. Will the ECB then again increase its lending to these banks in the hope that frightened bankers will resume their bond purchases?

“Third, and most importantly, the liquidity injections in the banking system create moral hazard problems that are more dangerous than those resulting from direct intervention in the sovereign bond markets.

“Banks have been given unlimited sources of funding to make easy profits. This reduces their incentives to restructure their balance sheets, which would make them more resilient in the future….

“The LTRO program has relieved the pressure in the sovereign debt markets of the eurozone. But this is only temporary. The peripheral eurozone countries are now pushed into a deep recession that will exacerbate their fiscal problems and will create renewed distrust in financial markets.

“As a result the sovereign debt crisis will explode again, forcing the ECB to make hard choices. Either it will stick to its indirect LTRO approach, giving cheap money to trembling banks with all the problems this entails. Or the ECB will become pragmatic and intervene directly with a steady hand in the government bond markets.”

Of course as Paul De Grauwe concludes, on this last point Germany will never accept direct interventions.

Bottom line, sports fans…it ain’t over ‘til it’s over.

One last item. Appearing before a rally of some 100,000 in Budapest, Hungarian Prime Minister Viktor Orban blasted the European Union for suspending funding for Hungary over its high budget deficit, with Orban saying:

“We will not be a colony. As a European nation, we demand equal treatment. We will not be second-class European citizens.”

That’s why they call it ghoulash.

Washington and Wall Street

The Federal Reserve’s Open Market Committee met to discuss the latest on interest rates and the economy and emerged with no change on the former, as expected, but a bit more enthusiasm for the pace of growth, even as it reiterated it would keep rates at zero into 2014 due to the fact housing remains depressed, Europe is still a concern, and high oil prices normally aren’t a good thing.

The Fed also released the results of its latest stress tests. 15 of the 19 largest financial institutions passed, with the four failures being MetLife, SunTrust Bank, Ally Financial, and Citigroup. Citi was ticked, saying it would have passed were it not for its request to increase its dividend.

“The Federal Reserve advised Citi that it has no objection to our continuing the existing dividend levels on our preferred stock and our common stock, and we plan to do so,” the bank said in a statement.

The stress tests assumed an equity market plunge of 50%, further home price declines of 21% and unemployment levels of 13%, up from the current 8.3%. It also threw into the equation an asteroid striking Earth and unemployed dinosaurs from the recently canceled Fox program, “Terra Nova,” wreaking havoc.

But no doubt, the Fed deserves a lot of credit for stabilizing the banking system at the height of the financial crisis, not that it didn’t hit up taxpayers at the same time, and America’s banks are in far better shape than Europe’s, and it’s not even close. So Chairman Ben Bernanke gets a gold star for his notebook. But he gets two black marks for holding rates at zero way longer than appropriate and thus killing savers, and all pension funds for that matter.

And, in case you missed it this week, the Federal budget deficit for February came in at a cool $230 billion. One month. $231.7 billion, to be exact. Nice job, Mr. President. Or as Church Lady would say, “Now isn’t that spe-cial.”

The Wall Street Journal editorialized:

“If only someone would now test where the next ‘stress’ is most likely to occur – in the government….

“The Treasury is still rolling out $1.3 trillion deficits, three years into a recovery, and the Federal Reserve is still holding interest rates at near-zero and has tripled its own balance sheet.

“Neither institution – much less the White House or Congress – seems to have an exit strategy worth the name. The White House says a big tax increase next year will solve any fiscal woes, and Fed Chairman Ben Bernanke says, well, trust him.

“Earlier this week we described the Treasury’s financial pickle if interest rates rise even 200-300 basis points. What we don’t know, but would like to, is what would happen to the Fed’s balance sheet if interest rates rose rapidly, say, to their historic modern norm of about 5%? What really needs a stress test is the government.”

Meanwhile, a funny thing happened to President Obama’s approval ratings. They have distinctly plateaued, and, in the case of one poll in particular, plummeted.

Surveys from Reuters/Ipsos and Pew Research Center show the president with a 50% rating, which is where all of them have settled the last six weeks or so, owing to the improving economy and falling unemployment rate, but then the Washington Post/ABC News poll had him at 46% (57% disapproval among key independents), and the shocker of them all, a 41% approval rating from the New York Times/CBS News survey, which just one month earlier had Obama at 50%.

What happened? I suspect it’s an aberration, but there is no doubt that high prices for gasoline at the pump are hurting Obama.

Here’s the deal. When the history of this year is written, in terms of the economy, weather will have played a huge role, at least for January thru March, and judging from the long-range forecast for the second quarter, April thru June as well.

You cannot discount the impact of great weather on retail sales, auto sales, and construction activity.

At the same time, while gasoline prices have soared to a national average of $3.82 as I write, 1/3rd of drivers in America are paying over $4.00.

Yes, I know. Americans have saved huge sums on heating costs (especially assuming you have natural gas), and cars are far more fuel efficient, so you aren’t filling up as much if you have a relatively new vehicle, but $4.00 irks you. And if we have to use our A/C a lot sooner than normal, and begin to burn up these humongous natural gas inventories and get back to pricing normality, the hit to the wallet from $4.00 gas will be substantial.

And to those who think we are going to catch a break on gasoline, NFW [no functional way], until the Iranian situation resolves itself.

So the president is going to get the blame on this one, whether he deserves it or not, and that’s all part of the approval rating.

Lastly, the GDP figure for the first quarter is going to be in the 2% range, if consensus is correct, though Morgan Stanley lowered it to 1% this week, and that’s a come down from Q4’s 3%, so that trend isn’t going to help the president, it would seem.

But I said in predicting what would happen this year that foreign policy would overwhelm the White House and I believe that more than ever. Suffice it to say, those who think the president has done a good job on this front are mentally challenged. Let me help you. History will show him to be a disaster.

And a word on China. I discuss the political machinations of the nation down below. On the economy, in his last major appearance as premier before the National People’s Congress and the press conference after, Wen Jiabao said there would be no short-term easing of measures on the property sector, this as foreign direct investment fell in February for a fourth consecutive month. A ministry spokesman said the outlook was “grim,” owing to “slack” external demand.

JPMorgan Chase economist Adrian Mowat, who is said to have a good track record, though I haven’t followed the lad, proclaimed that China’s economy is in the midst of a “hard landing.”

“If you look at the Chinese data [Ed. I reported on a slew of it last week, if you want to check the archives to refresh your memory], you should stop debating about a hard landing. China is in a hard landing. Car sales are down, cement production is down, steel production is down, construction stocks are down. It’s not a debate anymore, it’s a fact.”

Well, my main man, economist Stephen Roach, said the week before that talk of China having a hard landing is nothing but a bunch of “exaggerations.” The banking system will not collapse, nor will there be a true property bubble burst.

Mowat doesn’t see a pickup in property demand sopping up the inventory.

But lower growth, assuming there’s no hard landing, keeps inflation under control and in terms of keeping the masses quiet, this is what’s most important.

Jim O’Neill / Goldman Sachs…in an op-ed for the Financial Times:

“Much of China’s slowing is neither unexpected nor undesired. Premier Wen’s forecast was not news to those who follow developments in the country closely. In the 12th five-year plan released about a year ago, the leadership had already said that it expected real GDP growth of 7.5 percent. It was seen at the time as confirmation that Beijing was no longer pursuing as fast a rate of GDP growth as possible….While actual GDP growth has consistently exceeded expected growth for many years, this didn’t stop Beijing from lowering their stated and assumed target….

“But let’s get things in perspective. A real growth rate of 7.5%, if it occurs, along with 4% inflation will still see China’s GDP, in U.S. dollar terms, close to doubling in five years so long as the currency doesn’t nosedive. By early next decade China’s economy would near $15 trillion and be on track to surpass the U.S. For the rest of the world, 7.5% growth in China is effectively the same as U.S. growth of around 4%. As I have become fond of saying, China today creates the equivalent of another Greek economy every eleven and a half weeks, and one-tenth of another eurozone economy every year.”
2012, but this requires even more draconian cuts. Ollie Rehn, the EU’s most senior economic official, said the EU couldn’t do more given the fact Spain’s deficit for 2011 came in at 8.5%, 2.5 percentage points higher than it was supposed to.
Now do you see why an increased firewall for the ESM is necessary? Oh, sure. Spain and Italy have 10-year bond yields that have come down to roughly 5% for each vs. 7.50% for Italy at its recent peak and 6.67% for Spain. That is good. But to beat a dead horse, or slaughter a bull in the case of Spain, they need growth. Both are in recession.