Trader’s Review of the Week; 11 and 12 June 2011

[private] Saturday 11th Germany versus the ECB re Greece – mind blowing issues aired in public

I’m truly gobsmacked. The unseemly public airing of conflicting views by Germany, though supported by Finland, Austria, Holland etc on the one hand and the ECB (supported by France, though the French, for once, have (sensibly) been relatively silent – maybe because the French Finance Minister, Christine Lagarde, is pushing for the IMF job and does not want to negatively affect her chances, by upsetting Germany) is mind blowing.

In a fit of peek, Mr Trichet stated that if there is a Greek “credit event”, the ECB may not accept Greek bonds as collateral for emergency funding to Greek banks. This statement is unbelievable, especially when it’s made in public. If I was a depositor in a Greek bank I would certainly withdraw my money – I would have withdrawn my money ages ago in reality.

However, Mr Trichet and his colleagues, I would argue, by stating that the ECB may not accept Greek bonds as collateral (i.e. the Greek banks will run out of money), post a credit event, are effectively encouraging a run on Greek banks, particularly as the chances of a Greek “credit event” occurring is the most likely outcome.

There is no other conclusion you can draw. This is the European Central Bank. I still can’t believe it. Indeed, you can take this argument one step further and speculate that Portuguese, Irish etc depositors should withdraw their deposits from their banks, as the possibility of a “credit event”/default in these countries must be high.

Why stop there – what about Spain … A fine mess you have potentially got Europe into Mr Trichet and he’s the Head of the 2nd most important Central Bank in the world.

The ratings agencies (Fitch and Moody’s) have stated that anything, other than a totally voluntary roll over of debt, (which Moody’s rightly says will not work), may well be deemed a “credit event”.

By pushing for a vote in the German lower house, the Bunderstag, and supporting the motion that was passed (OK, a non binding vote), namely that Germany would provide Greece with more aid. Though only on the condition that there is “an appropriate participation of private creditors”, it is virtually impossible for the Germans

(Merkel/Schaeuble) to do a U turn now.

Mrs Merkel and Mr Schaeuble’s credibility will be shot to pieces if they tried i.e. their political futures would be as dead as a dodo. Trichet must know this and therefore I am dumbfounded as to his and his colleagues’ attitude.

Germany is Europe’s paymaster – the ECB, assuming a Greek credit event is bankrupt – unless they print money (that will be amusing). How can the ECB think they will win this one? In a punch up between Germany and the ECB, Germany will win.

Does Trichet honestly think he is more powerful than the most important State in the Euro Zone, indeed the EU? Indeed, Mr Trichet is effectively saying that he knows what’s best for the Euro Zone, rather than the German parliament, public, the voters and the markets.

Minister Schaueble also states that he requires the ECB to agree with the final decision adopted by the Euro Zone – he has arranged for a committee to be formed (comprising the EU/ECB/IMF) to come up with an agreed plan – how does that work? Minister Schaeuble is proposing a 7 year extension of maturing Greek debt.

Another key issue is the German Constitutional Court in Karlsruhe, who will be considering a number of issues relating to bail outs (imminently), which have been raised by a number of prominent German economists and politicians, who oppose the bail outs. There is a risk that the Court could require the German Government to amend the Lisbon Treaty, not possible in 2 weeks clearly, which unravels everything.

Trichet must have been furious with his Vice President, Mr Vitor Constancio, who last Friday (initially) seemed to suggest that Trichet/the ECB may be more flexible on private sector participation in existing Greek debt. His office released a subsequent statement – I quote

“The ECB’s Vice President Vitor Constancio replaces his earlier statement of today regarding possible private sector involvement in the Greek adjustment programme with the following.

President Trichet made it clear that the ECB’s Governing Council excludes all concepts that are not purely voluntary or have an element of compulsion, that entail any credit event or that entail any default or selective default”.

The statement went on to say “Mr Constancio also recalls that President Trichet stated whatever happens, it is not the ECB’s decision, but the responsibility of the Government’s. The ECB will apply its rules and framework as regards the soundness of counter parties for monetary policy operations and the quality of the collateral accepted in such operations”.

Clearly Mr Constancio got a thorough spanking by Headmaster Trichet following his initial statement and had to recant.

The reality is that Trichet is really interested in his legacy – he retires this October and therefore the attitude of not on my watch is his over riding concern. However, even though I do not and have never supported the EU/Euro etc, for him and the ECB to act in this manner is beyond belief.

Maybe he should resign and we can move on. After all, we know that Draghi is his successor – interestingly Draghi has (sensibly) been silent – so he has no baggage to carry and therefore in a position to be “more flexible”.

The risk of contagion spreading to Portugal and Ireland, but also to Spain etc is now sky high. Remember that in the next few weeks or so, there is a strong possibility of reports emerging from Spain as to black holes in provincial finances; now that the opposition party controls so many of these municipalities, following the recent elections.

What happens then? Spanish Government bond yields are rising rapidly in response to this crisis. Will depositors start withdrawing money from Spanish banks? Somewhat less likely, I expect, but you just can’t play around with this stuff.

The threat of further withdrawals of deposits from banks is really acute in Portugal and Ireland, which means they will seek more ECB emergency funding, whereas the ECB wants to reduce the dependency of its liquidity from the “addicted” (mainly peripheral Euro Zone) banks.

Whilst I have always believed that a restructuring of Greek debt is inevitable, the means by which we are getting there is now so alarming, that an orderly restructuring, without serious contagion effects, looks a more and more remote possibility.

Everyone is forgetting the Greeks – very dangerous, given their past, indeed even recent, history. They have the capability of making a bad situation much, much worse. For example, will they exit the Euro? Horrendous consequences, but they can just go Greek and default – after all, Greece has been in default for more than 50% of the time in the last 100+ years, so this will be nothing new.

We then have the issue of the public in Germany (but also in Finland, Austria, Holland etc) saying no more bail outs with our money and, on the other hand, the Greeks and other PIIGS countries protesting against further austerity measures.

Somebody better get a grip of this situation as it looks as if it is spiralling completely out of control. My problem is that I don’t see where that much leadership needed will come from.

The Finns have not formed a coalition Government, having tried twice in the last 2 months – the party with the most votes (lead by Mr Katainen) will try a 3rd and final time to form a coalition. Though this suggests he has to talk to the anti bail out/Euro sceptic True Finns Party.

If he fails, the party with the 2nd highest votes will try. Whilst supportive of a bail out, they will also need the support of the True Finns Party (who are staunchly opposed to a bail out – they campaigned on precisely this issue and virtually nothing else). Who cares about the Finns you say – well, unfortunately we must care. The Greek bail out has to be approved by all 16 other Euro Zone countries, In Finland’s case they need Parliamentary approval.

As you all know, I have never been a fan of the EU/Euro/ECB etc, but not in even my wildest dreams, did even I expect this kind of shambolic and irresponsible behaviour. However, it just reconfirms my total mistrust of this (politically driven and economically suicidal) experiment.

Mr Trichet came out with the “strong vigilance” phrase at last Thursday’s ECB press conference – implying a 25 bps interest rate hike in July. It is, in my opinion, complete madness to contemplate an interest rate hike in these circumstances. However, the ECB is the ECB.

Not withstanding the “strong vigilance” phrase, I for one, am not at all convinced that the ECB can implement a rate increase at the next ECB meeting in July, particularly as a rate hike has a disproportionate negative impact on the peripheral countries i.e. higher mortgage costs for excessively leveraged people in the PIIGS countries and who are facing severe austerity measures i.e. lower income.

In addition, inflation seems to be declining in Euro land, which could be used as the excuse for holding off further rate rises. As a result, (assuming I am right), the Euro has further to fall, even if you ignore (though impossible to do so) the recent events regarding Greece/Germany/ECB.

So we will have a Greek “credit event” in all likelihood, quite possibly also in Portugal. It may also occur in Ireland, though there is just a chance that it will not. However, in Ireland, the Irish authorities will impose haircuts/debt equity swaps on secured bond holders, particularly if the ECB (who have totally opposed these measures in the past) lose to Germany re Greece.

That will be good news, but the cost of capital of European banks will increase, not a sector to be in.  What happens next? Well it’s all about the banks and the Europeans better get ready to recapitalise them rapidly and, at the same time, make sure that they force them to derisk from now on.

A further bank bail out will cause a public outcry, so the bankers, shareholders and debt holders will have to pay up first, this time around. No more concessions will be granted.

There is a possibility that Greece will withdraw from the Euro (still unlikely I suspect), but I’m always wary of the Greeks – pity the EU/ECB/IMF were not in the past.

The key dates are the 20th June (EcoFin meeting) and the 24th June (EU heads of State meeting).

For the US (assuming a credit event is triggered), there will be a huge payout on CDS’s, as it is likely that US institutions wrote the majority of the relevant CDS’s. I do not have an idea of the extent of the problems, but it could be significant.

In any event, US banks policy of pushing back on regulation isn’t going to work, if they get into trouble this time. That’s why I don’t like US financials either – in any case, they are facing lower income – most of the recent rises in profits have just been write backs of provisions, which I expect will have to be reversed.

This is going to be a tough one. Clearly, I’ve positioned myself for this, but I must say it still amazes me.

Sunday 14th Greek default will not destabilise the Euro – Jens Weidmann, Bundesbank President

In response to clashes with Chinese vessels, Vietnam has asked the US and other nations to help in resolving disputes as to territorial claims in the South China Seas. This will anger the Chinese intensely. Vietnam will shortly conduct live fire drills. this confrontation is escalating.

A further increase in food prices will result in inflation in India rising further, which makes the possibility of a further rate hike on the 16th June more of a possibility.

The AKP party is heading for victory in Turkey’s weekend elections, with PM Erdogan winning a 3rd term. Whilst gaining some 50% of the votes (representing 325 seats with most votes counted), the AKP is unlikely to reach the 330 votes necessary to make changes to the constitution that the PM wishes, without support from opposition parties.

This should be positive for markets. However, the release of economic data, which was postponed until after the elections, suggests that there will be negative news coming (inflation, current account, interest rate hikes etc).

Syrian government forces have taken control of a town in the North West of the country with a heavy death toll. The Turkish PM, Mr Erdogan, a long term ally of President Assad seems to be backing off, isolating Syria further. The situation in the region continues to deteriorate.

A French court has decided to postpone a trial to 8th July, which involves Christine Lagarde, the favourite to gain the IMF MD job – French judicial overload, you may say. The delay is particularly interesting when you realise that the decision as to the selection for the top IMF job is to be taken by end June. Pure coincidence?

However, what happens if the courts decide to launch a full judicial enquiry into Mrs Lagarde’s actions in resorting to arbitration involving Mr Tapie, who had helped – politically – Mrs Lagarde colleague and boss, President Sarkozy and which was particularly helpful to Mr Tapie? Particularly given the DSK issue, who, as you know, is also French.

Israeli Central Banker, Mr Stanley Fischer has thrown his name into the ring for the IMF role. Now he is a serious candidate, who clearly deserves the job, being the best candidate. However, the Europeans want a European head and won’t give up on this demand – difficult for the US to disagree.

Completely contradicting the ECB, Bundesbank President, Mr Jens Weidmann (who previously worked for former Bundesbank President Axel Weber and subsequently Mrs Merkel),  suggested that Euro Zone Governments go ahead with a bail out of Greece (presumably involving private sector burden sharing on existing Greek debt) without ECB support and only on the condition that Greece lives up to its commitments.

He added that the Euro would survive a Greek default – which, in my opinion, is true as a Greek exit would remove a weaker member. However, there is still the issue of recapitalising European banks that will take a hit – potentially big numbers and undoubtedly will require Government funding.

In addition, there are the other weaker Euro Zone countries to consider i.e. Portugal and Ireland and the biggie Spain. Other Euro Zone countries are also heavily indebted. The ECB position is that a Greek default will be similar to a “Lehman Brothers catastrophe”.

Mr Weidmann’s comments are at odds with Jean Claude Junker’s view (head of the EcoFin) who stated over the weekend that ECB support was necessary.

EPFR Global reports that retail and institutional investors have withdrawn more money out of US equity funds, since August 2010. Retail investors withdrew US$2.1bn in the w/e 8th June, having withdrawn some US$5.8bn over the last 7 weeks (source: FT).

The FED is to expand its capital planning program to 35 of the largest US banks. Banks with US$50bn and more in assets will be required to adopt “robust, forward looking capital planning processes that account for their unique risks” – basically a call for banks to raise more capital and derisk. Expect a significant amount of asset sales and fund raising in due course.


  • A pretty tough Friday for European and US markets, which closed near their lows. Fear is certainly superseding Greed. There are too many problems around to see a major rebound. However, with the Japanese supply chain issue almost resolved, economic data may surprise to the upside in coming months. If it does not, we are in for a rocky ride.
  • Still believe the Euro is heading lower. Oil, whilst off its recent highs, is still near US$119 – not a good sign and will impact consumption far more than current estimates in my view, particularly given weak earnings growth.
  • I’m afraid I remain bearish.


Trader X is a pseudonym. The author is a former senior corporate financier at a prominent London investment bank who now manages his own money from his homes in London and the West of Ireland. [/private]