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

What a week, beginning with the votes in France and Greece last Sunday and the continued unraveling in Spain.

We’ll take the easy one, first…France. Socialist Francois Hollande will be sworn in on May 15 as his nation’s next president, having defeated incumbent Nicolas Sarkozy 52-48, a little tighter than expected. Clearly, Sarkozy was hurt by the non-endorsement of National Front leader Marine Le Pen and he was unable to pick up enough support from the right to counter Hollande’s leftist coalition (plus many in France were simply tired of Sarkozy’s act). Hollande will be meeting soon with German Chancellor Angela Merkel for what promises to be an interesting chat. On May 15, Hollande not only is inaugurated but France’s first-quarter GDP figure is released and it’s expected to be flat at best, further pointing out the problems he faces with his socialist agenda.

Make no mistake, though. Despite some of his tax proposals which are already driving out France’s wealthy and entrepreneurs, he will prove to be not so radical when it comes to actual enactment. And while he has little high-level experience, he understands that France still has to cut spending and rein in its debt. But he’ll also be attempting to promote growth and there’s just no way France’s debt doesn’t continue to explode.  Nonetheless, Hollande will insist the eurozone’s “fiskalpakt” be renegotiated, which was the central plank in his platform.

As for Merkel, she has ruled out any renegotiation of the compact that would enforce budgetary discipline that all but two of 27 EU nations agreed to.

“Growth through structural reforms is sensible, important and necessary. Growth on credit would just push us right back to the beginning of the crisis, and that is why we should not and will not do it.”

Turning to Spain, I’ve been writing for years that it continues to underestimate the severity of their banking crisis owing to the real estate crash that is still unfolding. For example, the government is now asking lenders to increase provisions for bad debt by 50 billion euro, or enough to cover losses of 50% on loans to developers and construction firms, but there are also more than 1.4 trillion euros of home loans and corporate debt, according to Yalman Onaran of Bloomberg. The Center for European Policy Studies, out of Brussels, estimates banks really need to increase bad loan provisions by as much as five times what the government is recommending. Ergo, as Dick Vitale would say, again, “Its bailout city, Baby!”

This week the Spanish government essentially nationalized the nation’s third-largest bank, Bankia, taking a 45% controlling stake while supplying “strictly necessary” capital. Bankia has 38 billion euro in real estate assets, more than any other bank.

The other banks, with capital restrictions such as the above now in play, or needed further, are hoarding all the cash they can get their hands on just to survive.

So to beat a dead horse of the past few years in this column, how the heck do you grow when the banks are in no position, or at least are too paralyzed, to lend?

Well the European Commission (which reiterated this week that Spain’s economy will shrink 1.8% in 2012) is prepared to cut Spain some slack on its budget deficit targets, but only if Madrid agrees to all sorts of demands, including the hiring of outside auditors to verify bank stress tests.

This coming week, Spain will be receiving mandated budgets from its 17 autonomous regions, which have been set strict deficit reduction targets. Of course it’s the regions where all the massive corruption has taken place and where there is zero transparency when it comes to the books.

Which brings me to Greece. More than 70% of Greeks want to stay in the euro, according to the polls, but then when they actually vote, as they did last Sunday, they give more than 60% to all manner of parties that want to bail on the austerity demanded in the very bailout that would ensure they remain in the union.

The centrist parties that have been running Greece for decades received 149 of 300 seats in parliament, including a crazy 50-seat bonus awarded to the first-place finisher, but they still couldn’t muster two more seats for a 151-seat majority. The second-place finisher, the Radical Left Coalition (Syriza) led by Alexis Tsipras, a former Communist who is just 37, also wasn’t able to form a new government. Tsipras said from the start that the 130 billion euro rescue plan had been rejected by the Greek people.

“With their vote, Greek people gave their mandate for a new day in our country, without the cruel bailout measures. They want solidarity and justice.”

Syriza’s economic coordinator told the London Times, “Our position is that we want to stay in the eurozone because we believe we can fulfill our targets much better when we are members of the eurozone. It would be very destructive if we returned to the drachma. However, we are in favor of a radical break with the structure of the eurozone.”

Syriza would like to see the European Central Bank pump money into the economy and to guarantee the issue of Eurobonds, which is a major no-go with the Germans.

Guido Westerwelle, the German foreign minister, warned Greece that unless the country implements new austerity measures of about $15 billion in June, the flow of aid under the bailout will stop, which would cause a collapse of public services and send the state spiraling into bankruptcy and depressing chaos.

“Germany would like to keep Greece in the eurozone, but Greece’s fate is now in its own hands.”

Klaus-Peter Willsch, the chairman of the German parliament’s budget committee, which has a veto over EU bailouts, said, “We should offer Greece a controlled exit from the eurozone, without withdrawing from the EU.”
Philip Stephens / Financial Times

“You can see why so many backed Mr. Tsipras. New Democracy and Pasok [Ed. the two centrist parties] commanded the corrupt and clientelist system that has ruined the economy and disfigured Greek society. For all the jibes in Berlin and beyond about Greeks retiring at 50 or refusing to pay taxes, austerity has already taken a heavy toll. Public spending has been slashed and wages and pensions have fallen by 25%. Greece has lost a fifth of its economic output. Featherbedding has been replaced by sackcloth.

“Public rage, however, does not provide answers. Greece can say no to Brussels and Berlin. It can thumb its nose at the apparatchiks of the IMF. If it so chooses, it can unshackle itself from the euro. What it cannot do is escape a reckoning. Inside or outside the euro, Greece cannot avoid the brutal adjustments needed to repair its public finances and restore international competitiveness. Simply writing off its debts and reclaiming the drachma would trigger economic collapse.

“Greek politicians may be betting that the country’s creditors are bluffing: that, however much they insist otherwise, the EU and IMF could not afford an uncontrolled default in Greece. The latest cracks in the Spanish banking system have provided a timely reminder of the dangers of contagion to the eurozone periphery. The single currency’s firewall is still only half-built. Would Germany’s Angela Merkel really take the risk of a Greek exit that could herald the break-up of the eurozone?...

“Yet my sense from many conversations with dispassionate European officials and politicians is that Greece would delude itself were it to imagine that the new rhetoric of growth will allow it to put aside its commitments to fiscal rectitude and structural reform. The rest of the EU has run out of patience. Its dealings with policy makers in Athens are marked by a complete absence of trust and a deep pessimism about the capacity of the Greek state to reform itself….

“All roads lead to austerity. For Greece, though, there is more at stake than economics. The tragedy of its membership of the EU has been its failure to defy geography and redefine itself as a modern European state. Now, it is hard to imagine how Greece can remain in the single currency. But does it want to return to the Balkans?”

Noted economist Kenneth Rogoff said this week, “A Greek exit would underscore that there’s no realistic long-term plan for Europe, and it would lead to a chaotic endgame for the rest of the eurozone.”

So we’re headed for another election it would seem, probably on June 17, and Alexis Tsipras’ Syriza party could do even better.

At the same time Greece is due to receive 39.4 billion in bailout funding before the end of June, but only if it has committed to the mandated austerity cuts.

Economist Nouriel Roubini called the situation in Europe a “slow-motion train wreck.” He’s wrong. Europe is like two trains about to hit head on at 200 mph.

As for the neo-Nazi Golden Dawn movement, it picked up 438,910 votes in Sunday’s election, 7%, despite Greece’s traditional hatred for Nazi occupation during World War II.  Golden Dawn thus won 21 seats in parliament. No doubt it is one of the most extreme of Europe’s far-Right groups.

“These parties use violence to fulfill their political aims or at least they don’t exclude the use of political violence in their actions,” said Vassiliki Georgiadou, a professor of politics at Athens Panteion University. “They are not only against, but also aggressive to immigrants; they support racist ideas with cultural or with biological connotations too, and they are irredentist, denying the geographical borders of the postwar nation states.” [London Times]

It seems a lot of Greeks really didn’t know what Golden Dawn was all about until now. Like one newly elected MP is facing trial for allegedly lending his car for an assault on a left-wing university lecturer. Now the guy will benefit from parliamentary immunity.

And just who is Golden Dawn’s leader? It’s Nikolaos Michaloliakos, who the night of the election told reporters, “Greece is only the beginning.”

Michaloliakos, 55, is a mathematician with a prison record. Citing Julius Caesar, he declared: “Veni, Vidi, Vici…The Time for fear has come for those who betrayed this homeland. We are coming.” [He was flanked at the podium by “musclebound supporters”; one picture of which was rather scary.]

Golden Dawn, with its swastika-like Ancient Greek symbol believes in throwing out all illegal immigrants and putting landmines on the border to stop any from coming back in.

The party is also sometimes compared to Hamas and Hizbullah because of its social outreach. It is taking over Athens’ slum areas, for example, and becoming the source for food.

And what did Mr. Michaloliakos serve prison time for as a young man? Possession of explosives.
Editorial / Wall Street Journal

“As for the rise of the extremist fringes, this should serve as a warning of what happens in countries where mainstream parties fail. It’s too soon to start making comparisons to the interwar years of the last century when Fascism, Communism and Nazism all found their political footholds. But that’s the scenario Europe may someday risk again if its centrist parties continue to fail.”
--EU Bits

Not for nothing, but Ireland is still slated to hold a referendum on the EU fiscal compact, May 31. Friday, June 1, could thus be another hairy day in the global markets should the Irish vote it down, and they are highly unpredictable on such matters.

Germany’s exports rose 0.9% in March over February when a decline had been forecast. Factory orders and industrial production also rose in the month.

Retail sales for the month of April in the U.K. were down 3.3% from a year earlier, owing to the wettest April on record.

Portugal is taking austerity to a new level in scrapping four of 14 public holidays.

Angela Merkel’s Christian Democrats scored only 31% in the northern state of Schleswig-Holstein, its lowest tally in the state in 50 years. Sunday, Merkel faces another test in Germany’s most populous state, North-Rhine Westphalia.

British Prime Minister David Cameron said with regards to his austerity program, “There can be no going back on our carefully judged strategy for restoring the public finances. I don’t hide from the scale of that challenge.”

But Cameron is under increasing scrutiny for his friendship with former News International chief executive Rebekah Brooks, who on Friday detailed her close relationship with Cameron, former Prime Minister Tony Blair and their families in testimony to the country’s inquiry into media ethics. Brooks acknowledged that she used her access to lobby the British government over News Corp.’s planned takeover of British Sky Broadcasting. Rather messy for No. 10 Downing Street.

And in Serbia, the Serbian Progressive Party headed by Tomislav Nikolic, a former ultranationalist ally of Slobodan Milosevic, will go against pro-Western President Boris Tadic in a presidential run-off May 20, Nikolic outpolling Tadic in the first round of voting, 25% to 22%. In the run-off, however, Tadic is expected to prevail. At stake is whether Serbia will continue on a path to EU membership or fall back into Russia’s orbit.

As for Washington and Wall Street, there was little economic news on the week, with a non-inflationary report on producer prices the highlight, down 0.2% for April and up 1.9% year-over-year (up 2.7% ex-food and energy the past 12 months), as well as a solid consumer confidence number. Oil hit its lowest levels since the first week in February and the price of gasoline is edging down, though Iran could quickly be back on the table at a moment’s notice…see below.

But the news from the major retailers has been weak lately and on the tech front, Cisco Systems issued a gloomy forecast, guiding revenue lower vs. analysts’ expectations as CEO John Chambers cited the ongoing uncertainty in Europe and a lack of leadership in Washington that is adding to Corporate America’s cautious outlook; as in customers are delaying purchases until the fog lifts. As Chambers put it, “Clearly, they’re keeping their powder dry.”

Meanwhile, PIMCO’s Bill Gross and Goldman Sachs economist Jan Hatzius are among those predicting the Federal Reserve will launch QE3, or more bond buying, to spur what is definitely a slowing economy. The Fed’s meeting in June would seem to be the right time to make such an announcement, unless global markets mandate action earlier (like bank runs in Greece and Spain).

On the federal budget deficit front, the Treasury Department said Thursday that the government in April recorded its first surplus in 43 months - $59.1 billion, which in itself isn’t unusual with tax returns rolling in, plus the Congressional Budget Office said the figure was inflated by timing shifts of certain payments; so adjusted for those the surplus in April would have been more like $27 billion.

Bottom line, the U.S. deficit for the first seven months of the fiscal year ending Sept. 30 is $719 billion; on track to exceed $1 trillion for the fourth straight year. As for the going over the “fiscal cliff” talk, I’ll give it a rest for a week. But it’s coming. Another debt-ceiling debate is also coming sooner than later to a theatre near you.

Lastly, we have the “King of Wall Street,” JPMorgan Chase & Co. CEO Jamie Dimon, who suffered a major black eye at the worst possible time with the revelation JPM had suffered at least $2 billion in trading losses, stemming from bad bets in the bank’s Chief Investment Office that manages risk for the company. Dimon called the ‘hedging’ mistake “egregious, self-inflicted,” and said: “We will admit it, we will fix it and move on.” The actual loss, however, could be far more, or less, after its wound down. Dimon added, JPM’s strategy was “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”

The timing of the JPM announcement could not have been worse as Congress and the banks fight over new regulations designed to rein in such trading, i.e., the Volcker rule, to which Dimon said, “This doesn’t violate the Volcker rule, but it violates the Dimon principle.”

It was the Wall Street Journal a month ago that first called into question the activities of a London-based JPM trader dubbed “the whale,” French-born Bruno Michel Iksil, who was roiling the debt market with oversized trades back then. When queried in April, Dimon said the whale’s trading was “a complete tempest in a teapot.” Only after he made this comment on an earnings call, April 13, did he learn otherwise.

Whether or not this kind of trading falls under the purview of the Volcker rule, Democratic Sen. Carl Levin was ready to pounce, calling JPM’s announcement “just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making.”

But as the Wall Street Journal editorial board points out, not only is there no precise definition of the Volcker rule, no one knows when it takes effect, whatever ‘it’ is.

Back to Dimon, asked if he thought that other banks engaged in such risky derivative trades, he responded: “Just because we’re stupid doesn’t mean everybody else is.”
The Financial Times editorialized:

“If JPMorgan was a pure investment bank such as Goldman Sachs or Morgan Stanley this mess would be no business of Paul Volcker. It is crazy that even these two banks have to get rid of desks that had nothing to do with the financial crisis. But the Volcker rule is on firmer ground for the JPMorgans and Barclays of the world, which mix being subsidized instruments of government savings policy on one side and risk-taking investment banks on the other. Cue the wailing.”

The SEC opened a preliminary investigation into JPMorgan’s accounting practices and public disclosures about the trades. Fitch Ratings lowered its credit grade one notch and S&P threatened to do the same.