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

Greece received its second bailout this week of 130 billion euro or $170 billion. Including the first bailout worth 110 billion euro ($145 billion), the new deal means every Greek man, woman and child will owe the eurozone and the International Monetary Fund about 22,000 euro ($29,000). Greece averted a nightmare, but for how long is still up in the air. Many a headline says Greece bought itself more time, but we could just be talking weeks, not years.

The respective parliaments in the euro-17 have to vote to approve the bailout and on Monday, it is expected Germany’s will weigh in. Chancellor Angela Merkel is receiving a lot of credit for acting like Margaret Thatcher and being the leader to hold the eurozone together, but she is rightfully concerned with public opinion, which is tired of the Greeks and sending money down a rat-hole. Most Germans, for example, don’t want an increase in the firewalls, though that is what is needed to backstop Italy and Spain, even as the rest of the eurozone wants them increased. Merkel herself has two key state elections later in the year as she sets herself up for her re-election fight in 2013.

On the debt-restructuring topic in Greece, private bondholders have accepted a ‘voluntary’ deal with a haircut of 53.5% [70% net present value] in order to pare down $100 billion in debt owed to the creditors, but the actual bond swap doesn’t take place until March 9, so there is always a danger attitudes change in the interim.

An election in Greece is scheduled for April and opinion polls suggest that the two parties in the coalition, which currently dominate parliament, are facing huge losses, while parties on the far left and far right are set to make big gains, they being opposed to the bailout deal. That same month, you have a critical presidential election in France (a run-off in May), and the leader in the polls, a socialist, wants to renegotiate the bailout and other recently agreed to eurozone treaties. [French President Nicolas Sarkozy said if he pulled off the upset, he would put the eurozone’s fiscal accord to a referendum, always dangerous.] So politics will play a huge role in May Day activities, if you catch my drift.

Meanwhile, the IMF said it would decide in the second week of March just how much of the 130 billion euro for the latest Greek bailout it is willing to pony up. It’s indicated it would contribute less than the one-third it provided in previous rescue efforts.

And as for the economic picture across both the European Union and the 17-nation eurozone, the European Commission lowered its forecasts, projecting flat growth for the full 27-nation EU and a contraction in 2012 of 0.3% for the euro-17 after last projecting growth of 0.5%. Greece is slated to decline another 4.3%, its fifth year of recession/depression; Spain is now expected to decline 1% after the EC had predicted a rise in GDP in 2012, so its political leaders are pressing the Commission for a break when it comes to its budget deficit target for this year. How can they lower their deficit to 4.4% from 8% when the economy is contracting, they are arguing?
But bottom line, at least as of today, Greece is set to be able to meet its 14.5 billion euro debt payment on March 20, which was the reason behind the recent rush to get a deal done.

As for the Greek people, they face another round of brutal cuts to wages, jobs, pensions and privileges; plus they lose more of their sovereignty, the real killer to many, as one of the demands of the northern European nations was that there be permanent surveillance in Athens by auditors from the EU, the ECB and the IMF…a total humiliation, even if warranted.

Greece’s finance minister, Evangelos Venizelos, said a “nightmare scenario” had been avoided. “This was a significant development that gives our country a new opportunity, and we need to make the most of this opportunity,” he said as he urged citizens to “put behind us this sense of misery and despair and build a new national social contract.”

But as if all the above isn’t bad enough, a confidential analysis by the IMF, first leaked to the Financial Times, concludes there is no way Greece’s debt will ever reach the 2020 target of 120% of GDP and that it would be more like 160%, so a third bailout would be required at some point of at least another 100 billion euro.

Right now, however, Greece has just days, until Wednesday, to complete to the EU’s satisfaction a checklist of 38 demands; specific changes to the country’s tax, wage and spending policies, which is why I said at the top, the deal really isn’t completed as most have been led to believe.

Editorial / Financial Times

“As Ferrari says to Victor Laszlo in Casablanca, ‘Might as well be frank, Monsieur. It would take a miracle to get you out of Casablanca, and the Germans have outlawed miracles.’ It is the same with Greece. A miracle is required to get Athens to meet the almost impossible targets it has been set by its friends in Brussels and Berlin.

 The central assumption in the latest bail-out is that the country’s debt ratio will fall to 120% of gross domestic product by 2020 if it implements swinging austerity measures. How likely is it that this miracle will occur?

“The best that can be said about the 130bn euro bailout – and it is not a small thing – is that it adds another layer to the firewall behind which Greece is now quarantined. Other vulnerable eurozone countries may breathe a little easier. In Greece, however, the bailout is likely to do more harm than good.”

Editorial / Wall Street Journal

‘The good news about the latest Greek bailout is that it is much less consequential to Europe or the global economy than the first bailout two years ago. The tragedy is that the cost will be the crushing of the Greek economy and the diminishing of democracy – in its Athens birthplace, no less.

“More than saving Greece, the last two years have been mainly about insulating the rest of Europe from Greece. This Europe has gradually done. Tuesday’s bailout takes another such step by protecting the European Central Bank from taking losses on its Greek bonds, while forcing private bondholders to take losses of as much as 70% in net present value….

“A better outcome would have been a steeper haircut and greater debt reduction, but that would have hurt the European banks that lent so much money to Greece. It also might have made the banks less eager to lend to other European countries….

“Under the burden of debt and austerity policies, the Greek economy won’t recover for years….

“Most striking in this deal is the damage to Greek self-government. The EU’s price for this bailout were assurances from Greece’s two biggest parties – Pasok on the center-left and New Democracy on the center-right – that they maintain current policies after elections this spring. Party leaders swallowed that pill to get the bailout, but Greek voters are understandably dismayed….

“It would have been far better had Europe let Greece default two years ago, reducing its debt to manageable levels and confronting the economic pain of reform earlier. The rest of Europe may congratulate itself this week on one more example of its ‘solidarity.’ But two years later, everything is worse for Greece. This is not the glory that the founders of the euro project imagined.”

Howard Davies / Financial Times

“The first question is – can the Greek government retain control of the streets? So far they have done so, but the mood in Athens and elsewhere is volatile.

“The second is – what kind of government will be elected in April? Wolfgang Schauble, the German finance minister, betrayed his anxiety about the election outcome when he suggested an Italian-style technocratic administration. That was always unlikely, but Mr. Schauble has made it impossible. So next month’s elections will be crucial, and there are signs that the parties that have distanced themselves from the negotiations will do well. But a fragile coalition may not be able to deliver the dramatic spending cuts the deal implies.

“Only the third and final question is economic in nature. Will the Greek economy pull out of its free fall and begin to stabilize this year?...Unless there is a return to growth before too long, the debt mountain will continue to grow more rapidly than the Troika can shovel it away.”

Philip Stephens / Financial Times

“Two things are needed if Greece is to avoid catastrophic economic and social collapse. They apply whether it stays in or leaves the euro. The first is sufficient political resolve within Greece to reform radically the state and economy; the second is a reciprocal willingness among other Europeans to foot a sizable bill for the failures and fraud of past Greek governments….

“Behind the name-calling that marks out Greece’s relationship with its eurozone partners lies a complete breakdown of trust. Many Europeans – and I am not talking only about Germans – do not believe that politicians in Athens will keep their promises; many Greeks think that the draconian austerity demanded as the price of debt relief is calculated to punish rather than rehabilitate. A fair observer would probably say that both sides have a point.”

Wolfgang Munchau / Financial Times

“When Wolfgang Schauble proposed that Greece should postpone its elections as a condition for further help, I knew that the game would soon be up. We are at the point where success is no longer compatible with democracy. The German finance minister wants to prevent a ‘wrong’ democratic choice. Similar to this is the suggestion to let the elections go ahead, but to have a grand coalition irrespective of the outcome. The eurozone wants to impose its choice of government on Greece – the eurozone’s first colony….

“A senior German official has told me that his preference is to force Greece into an immediate default. I can therefore only make sense of Mr. Schauble’s proposal to postpone elections as a targeted provocation intended to illicit an extreme reaction from Athens. If that was the goal, it seems to be working. Karolos Papoulias, the Greek president, fired back at Mr. Schauble’s ‘insults.’ Evangelos Venizelos, finance minister, said certain elements wanted to push Greece out of the eurozone.

Conspiracy theories abound. Hardly a day passes by without a cartoon in the Greek press of Angela Merkel and Mr. Schauble in Nazi uniforms. German MPs expressed outrage at the Greek outrage. Bild, the German mass-market daily, is calling for Greece to be ‘kicked out’ of the eurozone. I shudder at the thought of an act of violence committed against Germans in Greece or Greeks in Germany. This is the kind of conflict that could easily escalate….

“The reason the current system is breaking down is the loss of mutual trust. It narrows the political options of crisis resolution. Mistrust is the reason why the Greek rescue package has been delayed until the latest possible moment, and why the latest proposals contain so many poison pills: implementation deadlines, the escrow account, and a permanent representation of creditors and the International Monetary Fund. Soon there will be yet more austerity. At some point, somebody will snap.
“The German strategy seems to be to make life so unbearable that the Greeks themselves will want to leave the eurozone. Ms. Merkel certainly does not want to be caught with a smoking gun in her hand. It is a strategy of assisted suicide, and one that is extremely dangerous and irresponsible.”

Finally, on Feb. 29, the European Central Bank will launch phase two of its long-term refinancing operation, LTRO, that is to have the impact of the 2008 TARP bailout; a mechanism that staves off disaster among the banks. Phase I, last Dec. 8, by most accounts has been a huge success. We were on the verge, as I was writing at the time, of a systemic failure in the European banking system and there was no telling where it would go once the first bank run commenced and panic set in.

Instead, the ECB lent out 489 billion euro ($640 billion) to 523 banks, a far larger sum than anticipated. The money was lent at 1% for three years and there was no stigma attached. The banks are expected to take anywhere from 400 billion to 680 billion euro in round two. If it’s the larger sum, that means the collective borrowings under the LTRO would surpass the amount lent out during TARP.

But here’s the thing. There is zero evidence whatsoever the European banks are taking the funds and then lending them out to business and consumers. Instead they are either refinancing their own debt, using the proceeds to buy sovereign bonds yielding far more than the 1% they borrowed at, or sticking it back in the ECB’s overnight lending facility until they need it. Goldman Sachs did a survey of investors and only 4% said they thought the proceeds would be used to increase lending to customers, compared with 56% who thought it would be used to refinance maturing debt and 26% who said it would be invested in sovereign bonds.

Well it’s not all bad to invest in sovereign bonds. That no doubt has helped reduce the yields on Italian paper, for example. And that’s a good thing.

But, again, this eventual 1.2 trillion euro or so isn’t going to the consumer or corporations, at the very time Europe needs growth. Yes, Spain and Italy, in particular, need to be able to refinance their humongous debt loads at reasonable rates to avoid requiring bailouts of their own, that’s one piece of the puzzle, but the other side of the equation is crying out for help, too.

At the same time, think about how the LTRO funds are designed to encourage the banks to buy the sovereign debt that the central bank can’t. As Andrew Stuttaford wrote in the Feb. 13 issue of The Weekly Standard:

“Pause for a moment…to think through this money-laundering. Banks that have been weakened by their exposure to dodgy European sovereign debt were being encouraged to use loans (secured by similar debt, and worse) from an already highly leveraged central bank (underwritten by increasingly restive taxpayers) that was itself heavily exposed to identical crumbling borrowers, to buy even more of the same poison. Ponzi himself would have blanched. Nicolas Sarkozy, however, thought it was a great idea. ‘Each state,’ he said, ‘can turn to its banks’ to buy its bonds. Because thanks to the LTRO, the banks ‘will have liquidity at their disposal.’….

“The fundamental flaw of the euro was, and is, that this one-size currency does not fit all. All the liquidity in the world will not change that. Europe’s monetary union was assembled on the basis of political fiat rather than economic reality, and the economics and politics have both turned sour.  And not just sour: They have combined into a murderous cocktail. Understandably enough, the looted taxpayers of the north want to see budgetary discipline imposed on the dysfunctional south….But too much austerity too soon is draining the ability of the PIIGS to generate the growth that is the only way out of their burning sty. More dangerously still, it is reaching the limits of the politically possible. Shuttered businesses, soaring unemployment, and the prospect of years of stagnation to come are not the stuff of social stability. If insults like the recent draft German proposals that would have ground into dust the last shards of Greece’s economic sovereignty (and much of what remains of its self-respect) are then added to the mix, an explosion is unlikely to be far behind.”

I’ve been saying the explosion is as likely in Eastern Europe as it is in the southern tier.

Washington

When it comes to the topic of oil, one of the true know-nothings on the planet is Fox News’ Bill O’Reilly. Every time the price at the pump rises, he totally gets the fundamentals wrong. The other night he was insisting that the reason why gas is headed to a nationwide average of $4.00 a gallon is because Big Oil is selling its surplus overseas, to China and India, and not keeping it here. Good lord. For starters, half of all U.S. gasoline is refined from overseas oil and that price has generally been $15 to $20 a barrel more than what I quote at the end of this column each week, which is West Texas Intermediate, out of a key storage hub in Cushing, Oklahoma. The price for West Texas ended the week shy of $110. But Brent Crude from overseas closed at $125!

There is one reason, and one reason only, why the oil price has spiked as it has the past few weeks, and thus the price of gasoline. Iran. There are other tangential reasons, such as a low refinery operating rate in America, and to a lesser extent talk of a stronger economic picture worldwide, which is frankly just talk. I mean there were those this week who said the Greek bailout agreement was cause for optimism with regards to European growth and thus higher energy demand. If that was the case, then why did the European Commission lower its growth outlook? I also get a kick out of those who actually touted rising consumer and business confidence in Germany, or here in the U.S. Puhleeze…oil doesn’t trade on that, at least not more than $0.50 or so a barrel.

I mean Bloomberg had a story on Thursday that started out thusly:

“Oil rose to the highest level in more than nine months as jobless claims held at a four-year low in the U.S. and German business confidence surpassed forecasts, signs fuel consumption may improve.” Nothing on Iran until about the fifteenth paragraph, and then only in passing.

It’s Iran and, yes, speculators. What’s clear is that until there is a resolution of the Iranian nuclear crisis, one way or another, President Obama has a real problem on his hands if he wants to hang out at the White House for another four years beyond next January.

I also got a kick out of those, like CNBC’s Jim Cramer, who said something is different this time. We don’t seem too upset about rising oil prices as some restaurant chains aren’t getting hit like they normally do when oil is spiking.

It’s the weather. Geezuz. In case you haven’t noticed, we’ve had no winter! When the roads are icy and the windchill is zero, you aren’t as likely to go out to dinner as when it’s 50 and you just got off the golf course. And, yes, the overall economy has shown some improvement.

But if we get to $4.00 and stay there ($5.00 in some areas), it will have an impact and gives the Republican presidential candidate a terrific talking point this fall, assuming they don’t blow it, the surviving candidates being a most dysfunctional lot. In all honesty, the price of gas is all I hear people talking about in my neck of the woods. [Currently about $3.70 at the three stations I use.]

I discuss Iran in depth down below (as I have for the 13 years of this column…I think I’ve covered it all about sixteen times over by now, and to digress, if we had talked to Rafsanjani like I suggested years ago we wouldn’t be in this mess today). For now just know that on Friday afternoon, the International Atomic Energy Agency said Iran is making significant advancements in its enrichment of uranium.

As for tapping the Strategic Petroleum Reserve as a way of lowering prices, that would be the stupidest move, at least today. We are lucky past leaders had the foresight to build it out, but it is to be used for national emergencies, and we don’t have one, yet. If Iran successfully closed the Strait of Hormuz for a decent length of time, then it’s a different story, but for now the oil is flowing and the SPR should be left untouched.

Meanwhile, President Obama, beginning to feel the heat on the topic, seeing as how the price at the gas pump when he took office was 50% lower than today, says he’s not to blame. Energy production is up in this country, but as the Wall Street Journal correctly editorializes:

“The reality is that most of the increase in U.S. oil and gas production has come despite the Obama administration. It is flowing from the shale boom, which is the result of private technological advances and investment. Mr. Obama has seen the energy sun rise and is crowing like a rooster that he made it happen.

“Mr. Obama (Thursday) also repeated his proposal that now is the time to raise taxes on oil and gas companies, as if doing so will make them more likely to drill. He must not believe the economic truism that when you tax something you get less of it, including fewer of the new jobs they’ve created.

“We’d almost feel sorry for Mr. Obama’s gas-price predicament if it weren’t a case of rough justice. The President has deliberately sought to raise the price of energy throughout the economy via his cap-and-trade agenda. He is now getting his wish, albeit a little too overtly for political comfort. Mr. Obama has also spent three years blaming George W. Bush for every economic ill. If Mr. Obama now feels frustrated by economic events beyond his control, perhaps he should call Mr. Bush for consolation.”

President Obama was in the news over his new corporate tax plan as well this week, as alluded to in the Journal editorial, whereby he would lower the corporate rate from 35% to 28% (lower for manufacturers) while closing loopholes. But while I would love to see a lower corporate rate, and the elimination of every single freakin’ loophole around, as would most corporations themselves, truth be told, Obama’s picking and choosing who would benefit and who would suffer (i.e., the oil and gas industry regarding the latter), is once again falling into the trap of picking the outcome in his “Winning the Future” dogma. You’d think he would have learned otherwise with Solyndra.

But last week I talked of how the lame duck session of Congress following next November’s election is going to be historic, and one helluva fight, and I thought Lori Montgomery of the Washington Post summed it up better than I did. To wit:

“On Dec. 31, the George W. Bush-era tax cuts are scheduled to expire, raising rates on investment income, estates and gifts, and earnings at all levels. Overnight, the marriage penalty for joint filers will spring back to life, the value of the child credit will drop from $1,000 to $500, and the rate everyone pays on the first $8,700 of wages will jump from 10 percent to 15 percent.

“The Social Security payroll tax will pop back up to 6.2 percent from 4.2 percent under the deal approved Friday (Feb. 17) by Congress. And new Medicare taxes enacted as part of President Obama’s health-care initiative will for the first time strike high-income households.

“The potential shock to the nation’s pocketbook is so enormous, congressional aides have dubbed it ‘Taxmageddon.’ Some economists say it could push the fragile U.S. economy back into recession, particularly if automatic cuts to federal agencies, also set for January, are permitted to take effect….

“(Both) sides are bracing for another epic showdown in the weeks after the November election, as Democrats prepare to use Taxmageddon to break the partisan impasse over taxes that has blocked action on an array of issues, from modernizing the nation’s infrastructure to taming the national debt.”

Some say it will be a time to put divisiveness behind them, referring to our fearless elected officials, with such a hard deadline ahead of them. You’ll also either have a president who is crowing and putting on his ghetto voice with the southern twang, or he’ll be fuming.

One thing he should do in the interim, however, is sit down with Republicans on a corporate tax overhaul. Each side has an incentive to act in the best interests of the country, while still protecting their flank for November.