Week In Review Part I: Europe, Washington And Wall Street

Regarding the euro debt crisis, I haven’t changed my opinion one iota, including writing in this space on 1/1/2011, 17 months ago, that the crisis would be with us “well into 2012.” I have also issued constant warnings on a topic that everyone seems to be ignoring. This is the Balkans, when it comes to Greece. I’ve specifically written that one needs to watch Kosovo and Serbia, and last weekend we had a surprise outcome in Serbia’s presidential election, a nationalist winning out over the incumbent pro-Western president. Not good in a nasty land with massive unemployment and debt where neighbors detest each other unlike nowhere else in the world, including the Middle East.

The point being that when the inevitable bank runs start in earnest in Greece, as seems imminent, and within hours spread to Spain (panic as opposed to the slow bleed we are seeing in both today), you will see reactions elsewhere, like in Bulgaria and Romania, two EU nations that never should have been allowed into the eurozone in the first place, as my personal reporting from there years ago concluded.

So this financial crisis on the European continent will morph into a violent one sooner than later. The people can’t take it anymore, and they have new outlets, the extremists, from radical Socialists to neo-Nazis.

Thomas Mayer, chief economist at Deutsche Bank, was quoted in the London Times this week as saying that a full-blown exit by Greece could amount to a “social and political catastrophe… with unforeseeable consequences for Europe and possibly the world.”

For now you have a confluence of events, including outside the region, that will all hit at once.

June 16-17…the Egyptian presidential run-off wherein the Muslim Brotherhood’s candidate could emerge victorious with dire consequences for Israel and the peace treaty between the two.

June 17…the second Greek election, a revote, a referendum on whether the Greeks stay in the euro, since a government that goes back on previously agreed to austerity measures gets cut off from any further installments of the 240 billion euros in aid pledged in Greek Bailouts I and II.

June 18…another round of talks on Iran’s suspected nuclear weapons program in Moscow, almost certainly the last, one way or another.

June 28-29…another formal EU summit that will either spell the end of Greece, if this hasn’t happened sooner, or provide it, and Spain, a final lifeline.

North Korea could test everyone’s nerves by conducting its third nuclear weapons test in this rough time frame as well.

And there is a simmering issue between China and the Philippines in the South China Sea that mandates cooler heads prevail, though this is not a certainty.

I could go on and on…and I do to a large extent further below, particularly in the “Foreign Affairs” section, but for now we focus on the situation in Greece and Spain.

All are in agreement that the odds of Greece leaving the euro, the so-called “Grexit,” rose sharply this week. And at an informal EU summit in Brussels (No. 18 in the last two years), participants issued a statement that said in part:

“We want Greece to remain in the euro area while respecting its commitments. We expect that after the elections, the new Greek government will make that choice.”

Italian Prime Minister Mario Monti said he could help persuade Germany to support Europe’s “common good” and back the call for euro-area bonds, saying a majority of EU leaders supported the proposal.

But Luxembourg Prime Minister Jean-Claude Juncker said, whaddya mean there was a lot of support? He told reporters the idea of joint debt sales “didn’t find much support,” particularly in the German-speaking area.

Monti said, “A united Europe is in Germany’s interest. We’ll have euro bonds in the euro area, and therefore Germany will want them.”

But German Chancellor Angela Merkel said she has “huge difficulties” with euro bonds. For starters, aside from throwing massive liabilities onto the backs of taxpayers, it would raise German borrowing costs and dilute its creditworthiness.

But all are in agreement the Greek government must live up to its bailout pledges and that there can be no easing of the terms or that creates a moral-hazard issue, i.e., everyone else, such as Ireland and Portugal, will want easier terms as well and then the whole fiscal compact, recently negotiated, breaks down.

European Central Bank president Mario Draghi called on governments to take a “courageous leap” of political imagination to safeguard the future of the eurozone. Draghi said it was up to the banks, and especially governments, to take their own decisive action.

“We are living a crucial moment in the history of the EU,” he said, as various manufacturing data for the region revealed more doom and gloom. Key business surveys showed private sector companies pulling back, new orders shriveling up, leading to talk of a new round of layoffs. The downturn is occurring in Germany and France, as well.

The eurozone composite PMI, a combination of the services and manufacturing indexes, fell to 45.9 this month, down from April’s 46.7 and the lowest reading since June 2009. [50 being the dividing line between growth and contraction.]

Germany issued a blunt warning to Greece, some would say putting a gun to its head as it prepares for the critical June 17 vote. The Bundesbank said a Greek withdrawal from the eurozone would be disruptive but “manageable,” an attempt to undermine the claims of anti-austerity Greek leader Alexis Tsipras that Europe wouldn’t dare pull the plug.

“When the euro system provided Greece with large amounts of liquidity, it trusted that the programs would be implemented and thereby ultimately assumed considerable risks. In the light of the current situation, it should not significantly increase these risks,” so said the Bundesbank, which earlier said with regards to easing Greece’s bailout terms, it “would damage confidence in all euro-area agreements and treaties and strongly weaken incentives for national reform and consolidation measures.”

French President Francois Hollande stated firmly that “France and Europe want Greece to stay in the eurozone. We want you to respect your commitments but we want to take steps to show you that we want to restore hope. That is in the interests of Greece, the eurozone and the global economy.”

If there is a stopgap solution to the crisis, it would be a guarantee of bank deposits backed by all remaining eurozone members which would prevent bank runs following a Greek exit from the euro.

At the Brussels summit this week, talk focused on growth measures and Greece. There was zero talk of Spain and its humongous problems, a “triple threat” of recession, rapidly rising debts and a banking system with over $230 billion in problem assets.

The Spanish government has made one futile attempt after another to shore up the banks and on Friday there was talk of a further injection into the most troubled lender, Bankia, of 19 billion euros, this after the government pumped in 4.5 billion just one week earlier to effectively nationalize it. With the new capital funding, the state would own up to 90% of the institution.

I’ve written tons on the situation with Spain’s banks and its 17 regions, the latter comprising 50% of the nation’s GDP, and it’s clear the government is going to require a bailout, but it doesn’t want to do so, a la Greece, because then it would be giving up some of its sovereignty.
But check this out…from BBC News’ Laurence Knight:

Total lending by Spain’s central bank to the Spanish banks has increased from 50 billion euro nine months ago to 264 billion euro in March…and counting (pre-Bankia, for starters). “Spain’s central bank in turn borrows most of this money from the ECB. It now owes the ECB 285 billion euros, or 27% of Spain’s GDP….

“ Italy’s central bank has borrowed 279 billion euro from the ECB, or 18% of Italy’s GDP, while those of France, Greece and the Irish Republic have taken about 100 billion each. And where has the ECB been getting all this money from? The answer is mainly from Germany’s central bank, the Bundesbank.” 644 billion euros by April.

The yield on Spain’s 10-year bond closed the week at around 6.30%, an extra cost that Prime Minister Mariano Rajoy says will nullify any savings derived from the austerity measures that are being enacted.

Jin Liqun, the chairman of China’s $440 billion sovereign wealth fund, perhaps best summed up the mess in the region.

“The debt crisis is actually much less devastating than the handling of the debt crisis,” he said, in warning political gridlock was driving the eurozone deeper into the woods.

“Too much time has been wasted on endless bargaining on terms and conditions for piecemeal bailouts,” he continued, adapting a Shakespearean quote to add: “Frailty, thy name is leadership.” [London Times]
Eurobits

--The Organization for Economic Cooperation and Development (OECD), in its semi-annual forecast, said eurozone GDP will decline 0.1% in 2012 and rise 0.9% in 2013. Germany’s GDP will rise 1.2% this year and 2.0% next.

--Greece owes over 400 billion euros to the ECB, euro governments, the International Monetary Fund, foreign holders of Greek government bonds and on Greek corporate debt.

--78% of Greeks want to stay in the eurozone, but at the same time anti-austerity Syriza is gaining in the polls.

--GDP in the U.K. fell 0.3% in the first quarter vs. a previous estimate of minus 0.2%. In a Populus poll for the London Times, 49% of Brits back the coalition’s deficit reduction plan, while 51% say the government of David Cameron should slow the pace of cuts.

--Consumer confidence in Italy is at its lowest level in 15 years as its recession deepens.

--France’s comp PMI was a mere 44.7 in April, while Germany’s was 49.6.

--The OECD warned that Ireland’s economic recovery risked being derailed by the fallout from the eurozone debt crisis, with GDP now expected to expand just 0.6% this year, which is off from the OECD’s November forecast of 1.5%. Unemployment is expected to hold steady at 14.5%, with government and private consumption predicted to fall.

--Not for nothing but Ireland has its referendum on the fiscal compact May 31. Should the Irish pull a surprise and vote it down, they would lose all further EU financing.

Turning to Washington and Wall Street…

The above-referenced OECD forecast has the U.S. growing at 2.4% this year and 2.6% in 2013. Frankly, that would be great given what is transpiring in Europe and the slowdown in China and Asia.

Regarding the “fiscal cliff,” the yearend combination of expiring tax cuts and mandated reductions in spending, the Congressional Budget Office said were such a scenario to come to pass the economy could go back into recession first half of 2013.

But the CBO also notes that any extension of the expiring tax cuts, plus a reversal on spending would explode the deficit anew.

Economist Martin Feldstein was on CNBC and said he expected a six-month extension of the tax cuts and a moratorium on spending reductions right after the November election, thereby creating a new deadline of April 2013 to work things out, but can you imagine what a mess that would be in terms of corporate planning, let alone for the IRS?

Then again, each scenario you throw out there, knowing that Congress will do nothing until it’s forced to, leads to my Crash scenario. Senate Minority Leader Mitch McConnell (R-Ky.) said on CBS’ “Face the Nation,” President Obama “needs to become the adult” in discussions with congressional leaders on spending and debt.

“The Speaker and I have been the adults in the room, arguing that we ought to do something about the nation’s most serious long-term problem,” in echoing House Speaker John Boehner’s call for cuts to government spending as part of any plan to raise the debt ceiling.

But McConnell differs with Boehner on the issue of timing. Boehner wants discussions before the November vote, while McConnell basically believes Obama won’t engage in good faith until after November anyway.

At least the housing market is showing signs of life. April existing home sales rose and the median home price had its biggest year-over-year gain since January 2006. I said last month that I wanted to wait until April’s figures came in before commenting on my now three-year-old forecast, from end of 2008, that we’d bottom in terms of the median home price in April 2009 and then “just sit there.”

And so we have…the median home price in April ’09 was $166,500. April 2010…$172,300. April 2011…$161,100. And now April 2012…$177,400, up from March’s $164,800.

So seeing as how prices almost always rise further in May and June, before beginning to slide back the remainder of the year, just classic seasonality, the temptation is to say we bottomed and that we will not revisit the April ’09 figure of $166,500. I can’t wimp out on this. My original call worked beautifully for three years. I’m just worried that my predicted market crash could send us back in the soup but I think this would just be temporary.

But I do have to point out that the April existing home sales number came in at 4.62 million on an annualized basis, off the low of 4.11 million in 2008.

The peak annualized rate, however, was 7.11 million in 2005.

[New home sales for April were also up over March and builder confidence is at a 5-year high, though it’s fragile given the persistent headwinds.]

And despite the better news on housing, according to Zillow, more than 30% of borrowers, 16 million homeowners, remain underwater on their mortgage; though 9 out of 10 underwater borrowers are current on their payments.