Professional Documents
Culture Documents
June 2012
If you owe the bank $100, thats your problem. If you owe the bank $100 million, thats the banks problem. J. Paul Getty (1892-1976)
Germany Made Bad Loans but Still Wants its Money Back
German Bank Claims on Periphery Countries Plus TARGET 2 Balances
1,000
800
Public risks
Billions
600
400
Private risks
200
3. The Bundesbank has replaced the exposure to peripheral debt that the German banks reduced
Periphery debt is now the Federal Republic of Germanys problem
Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 BIS balance vis--vis periphery Target2 Balance
2. Rescue payouts
4. Fall in exports
The Cost to Save the Euro is Much Less Than to Let It Fall Apart, but Do the Germans Have the Political Will?
6
The Bundesbank has large exposures to the ECB and other central banks
TARGET2 Claims are Rising Quickly
1,200,000 R = 0.9628 1,000,000 Euros in Millions 800,000 600,000 400,000 200,000 0
German claims are on pace to increase from current amount of 657 billion to 1.1 trillion by end of 2012
If a member leaves the Euro the amount owed to the ECB becomes a loss for the remaining members
Polynomial Regression
2. Germanys Obligation for Rescue Programs Is 419 Billion and Could Increase
Germanys debt-to-GDP would reach 100%
100.0% 98.0% 96.0% 94.0%
Debt-to-GDP
Well above the 90% that Reinhart and Rogoff suggest as slowing GDP growth
92.0% 90.0% 88.0% 86.0% 84.0% 82.0% 80.0% Current Debt to GDP
(in trillions)
Any movements towards a fiscal not just monetary union will involve more explicit transfers
EFSM Exposure 18
Total
Debt
2,095
2,539
The 438 billion of exposure is still 40% greater than the estimated 310 billion of German bank equity As late as December 2011, German banks had 33 billion of exposure to Greece
This does not count the CDS on Greece that German Banks have written
Should the Eurozone split, German banks would likely suffer both large credit losses and currency losses
For the twelve months ending Jan 2012, Eurozone countries were 57% of net exports
This figure has been as high as 81%
Should the Euro dissolve, we would expect that net exports would fall to at least where they were at the beginning of the Euro (1999) Germany could become a net importer as exports become more expensive in neoPesetas or neo-Drachmas and imports in neo-Deutsche Marks fall in price Exports are currently ~40% of the German economy
Mar-08
Mar-09
Mar-10
Mar-11
Jun-08
Jun-09
Jun-10
Sep-08
Sep-09
Sep-10
Jun-11
Sep-11
Dec-07
Dec-08
Dec-09
Dec-10
10
Dec-11
125
110
400 Eurozone GDP Weighted Avg 300 France 200 China Germany 100 CAM Est for Germany (Euro integration) CAM Est for Germany (Euro collapse)
95
Iceland
80
65
50
0 40
US
UK
35
60
160
180
If bonds are redenominated into Deutsche Marks, currency gain can offset the yield loss
For the currency, we used the European Commissions own estimates of Real Effective Exchange Rates For liquidity, we examined the moves in the US Treasury post Lehman Brothers default For where rates should be, we used the Taylor rule
We added the average shape of the yield curve and made an adjustment for the need to keep the markets liquid
Bund yields can trade in this range given the markets fear of redenomination, liquity needs and desire for safe haven
-2
Source: Bloomberg. 12
100
150
200
250
50
13
Jan09 Mar09 May09 Jul09 Sep09 Nov09 Jan10 Mar10 May10 Jul10 Sep10 Nov10 Jan11 Mar11 May11 Jul11 Sep11 Nov11 Jan12 Mar12 May12 Jul12 Sep12 Nov12
Source: Bloomberg.
Purchasesof10yrCDS CAMestimatedtradingrange
Investment Summary
Rationale The market underestimates the risk to Germany posed by its exposure to periphery debt 10-year credit default on the Federal Republic of Germany (first purchased in June 2011) Our notional amount is much larger than our Spain CDS position Average of 0.8% of notional per annum effectively an option premium on the default of Germany during the next 10 years We expect that within a year, German CDS will widen to 200, which would provide a 2.2x return on the premium we have spent Even at current levels the return will be 1.4x
Instrument
Cost/Capital Commitment
Expected Return
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Appendix
Until 2007, German Savings Helped Build Projects in High Growth Areas
Spanish bank borrows from a German bank in the wholesale market; lends to the builder
German bank takes deposits from German savers and not finding interesting German investments, lends the money to a Spanish bank in the wholesale market
German saver takes his hard earned savings and puts it into a German bank
What is at risk If the project fails the developer loses his equity, but then it is owned by the bank Once the bank owns the property, losses beyond the equity of the bank are shared with the lenders 2007: 18x leverage (5.6% equity) Once the bank eats through its own equity, the losses should be shared with lenders Depositors are usually guaranteed by a deposit fund, which is funded by banks but backstopped by taxpayers (depositors) Simple example, but not that far from loss (~19% loss)
17
German banks lent directly into the asset bubbles in Spain and Ireland Lending to Italy was smaller than lending to Ireland despite the fact that Italys economy was 8x the size (2007 numbers) German private lenders realized their mistakes and have withdrawn 478bn from the GIIPS between June 2008 and December 2011
250
200
Euro in Billions
100
50
18
Mar.2000 Sep.2000 Mar.2001 Sep.2001 Mar.2002 Sep.2002 Mar.2003 Sep.2003 Mar.2004 Sep.2004 Mar.2005 Sep.2005 Mar.2006 Sep.2006 Mar.2007 Sep.2007 Mar.2008 Sep.2008 Mar.2009 Sep.2009 Mar.2010 Sep.2010 Mar.2011 Sep.2011
Greece Ireland Italy Portugal Spain
Spanish builder is having difficulty, gets extension on loan from Spanish bank
The German saver is unaware of what has happened Step 4: Simultaneously the NCBs borrow and lend from the ECB
Step 3: needing to replace financing, Spanish bank borrows from Banco de Espana
19
Step 1: German bank refuses to roll loan to Spanish bank returns to German bank
20
But when the interbank market stops functioning efficiently, TARGET2 balances build up
21
So long as the Euro remains in place these balances do not present a risk
But this is akin to saying that so long as my creditor keeps paying, I have no credit risk.
As countries exit the Union, the temptation to default on amounts owed to the ECB/EU/IMF will be high
Greece owed 104bn as of 3/31/12
BoG
BdE
ECB
NCB 4 NCB 5
NCB17
Key: BoG = Bank of Greece, BdE = Banco de Espaa, BUBA = Bundesbank, NCB = National Central Bank of which there a currently 17
24
There Have Been Many Rumors of a Grexit; Could This Be the First?
ECB Exposure to Greece
SourceofECBExposure SMP(Directpurchasesofbonds) GreekTARGET2Balance Total Amount 51,871,861,000 103,735,616,784 155,607,477,784 Asofdate 5/17/2012 3/31/2012 DataSource Bloomberg BankofGreece
We believe that the current number is higher as the last TARGET2 balance sheet date was almost a quarter ago
During this time Greek banks have experienced deposit flight
A Greek exit from the Eurozone would cost the ECB at least this amount
The Eurosystem as a whole has enough capital to bear this loss Germany losses would amount to 43bn which is 32% of the Bundesbanks capital
If this causes others to leave, recapitalizing the ECB would become harder, more expensive with more of the burden falling on Germany
25
If Greece Leaves, the Bundesbank Has to Rely More Heavily on Just the ECB
BoG
BUBA
Suddenly, the capital of the Eurosystem looks more like the capital of just the ECB, with limited ability to absorb losses
BdE
BoG
ECB
If the BoG leaves, the concept that no country can leave the Euro will be broken. NCBs of weaker countries will be called into question.
NCB 4 NCB 5
NCB17
Key: BoG = Bank of Greece, BdE = Banco de Espaa, BUBA = Bundesbank, NCB = National Central Bank of which there a currently 17
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What Starts to Be Horrific for Germany Is the Situation Where Multiple Countries Exit
BoG BdE
BUBA
Rather than being recapitalized, the ECB now becomes a debtor to the remaining countries Those debts are what the ECB owes from the TARGET2 system Far from being a worthy debtor, the ECB has no assets at this point
BoG
BdE
ECB
NCB 4 NCB 5
NCB17
NCB17
Recapping the ECB is supposed to be weighted by GDP, but only 4 countries lend to the ECB via Target2 the real risk lies on them
Key: BoG = Bank of Greece, BdE = Banco de Espaa, BUBA = Bundesbank, NCB = National Central Bank of which there a currently 17
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But in the case of German Customs Union (Zollverein), it ended with a single nation state What would a US of E look like economically?
Lots of pathways to these two endpoints 2011 Debt to GDP = 86.4% 2011 Budget Deficit = 4.1% Bank Assets to GDP = 3.1x Bank leverage =19.0x Breakup Full Union
France currently has almost these exact numbers Would the US of E trade about where France is now?
29
Stitching together a separated Germany was slow and expensive (1.4 trillion)
This despite strong cultural, even familial connections What will be the ultimate cost of holding Europe together?
30
Pan-European Deposit Scheme have the ECB or some other European body guarantee all the deposits of Eurozone banks
This might help banks that have been experiencing deposit flight for credit reasons (Spain) But unlikely to help those that are experiencing deposit flight because of fear currency redenomination (Greece)
Eurobonds bonds issued by a European body that are joint and severally liable
If the issuing body is to be given unlimited issuing power, we do not believe that this would pass under Germanys Federal Constitutional Court If it is limited, we do not see much difference to the current ESFM/EFSF/ESM system
31
A Marshall Plan for the periphery be it grants, loan forgiveness or write-offs a direct transfer of funds from creditor nations to debtor nations within the Eurozone
This is possible politically
The Marshall Plan was originally sold to the US body politic as a way to spur markets for their goods, which we think is reasonable in this case
But the ravages of war were clear in the late 1940s and the US also feared the rise of the Communist Party in Europe Currently, the debtor nations are seen as being profligate by the creditor nations and there is no ideological bogey man
32
Will a leader emerge in the current crisis to draw Europe together? Will it be possible without bloodshed?
33
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