The men who crashed the world

The new series on Al Jazeera explores in 4 episodes  how greed and recklessness led to financial collapse.

In the first episode of Meltdown, we hear about four men who brought down the global economy: a billionaire mortgage-seller who fooled millions; a high-rolling banker with a fatal weakness; a ferocious Wall Street predator; and the power behind the throne.
The crash of September 2008 brought the largest bankruptcies in world history, pushing more than 30 million people into unemployment and bringing many countries to the edge of insolvency. Wall Street turned back the clock to 1929.
But how did it all go so wrong?
Lack of government regulation; easy lending in the US housing market meant anyone could qualify for a home loan with no government regulations in place.
Also, London was competing with New York as the banking capital of the world. Gordon Brown, the British finance minister at the time, introduced 'light touch regulation' - giving bankers a free hand in the marketplace.
All this, and with key players making the wrong financial decisions, saw the world's biggest financial collapse.

Super-sized EFSF and Greece Default

Germany's economic elite has said it would agree to an EFSF expansion and hence installation of European firewall, but at a price: a "controlled" default by Greece and 50% haircuts for private bondholders (good for German banks who have already offloaded their Greek bonds).

This means that a second "Lehman" moment is indeed here!
So as part of this new strategy, here are the three key components of the plan to "firewall" contagion, via the Telegraph.

Sources said the plan would have to be released as a whole, as the elements would not work in isolation.

First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. The recapitalisation plan would go much further than the €2.5bn (£2.2bn) required by regulators following the European bank stress tests in July and crucially would include the under-pressure French lenders.

Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) – the eurozone’s €440bn bail-out scheme.

The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target.

The complex deal would see the EFSF provide a loss-bearing “equity” tranche of any bail-out fund and the ECB the rest in protected “debt”. If the EFSF bore the first 20pc of any loss, the fund’s warchest would effectively be bolstered to Eu2 trillion. If the EFSF bore the first 40pc of any loss, the fund would be able to deploy Eu1 trillion.

Using leverage in this way would allow governments substantially to increase the resources available to the EFSF without having to go back to national parliaments for approval, which in a number of eurozone countries would prove highly problematic.

The arrangement is similar to the proposal made by US Treasury Secretary Tim Geithner to the eurozone at the September 16 EcoFin meeting in Poland. Gathering turmoil in financial markets has convinced Germany to begin work of some kind of variant of the US plan, despite having initially rejected the notion as unworkable as threatening to compromise ECB independence.

 The proposal would be hugely sensitive in Germany as its parliament has yet to ratify the July 21 agreement to allow the EFSF to inject capital into banks and buy the sovereign debt of countries not under a European Union and International Monetary Fund restructuring programme. The vote is due on September 29.

As quid pro quo for an enhanced bail-out, the Germans are understood to be demanding a managed default by Greece but for the country to remain within the eurozone. Under the plan, private sector creditors would bear a loss of as much as 50pc – more than double the 21pc proposal currently on the table. A new bail-out programme would then be devised for Greece.

Europe's Dilemma: When to cut Greece out of the Eurozone

Finally, Greece default is no longer a taboo, but in the last days it has been finally given real consideration with plans being devised to try and make it as soft as possible.
Europe should have let Greece default 1 years ago and it would have been much less costly to the EU and maybe would have prevented a Domino effect.  The reality now is that Europe needs to abandon the existing perimeter and fall back to a more defensible position.  Europe doesn’t need to collapse, but it does need to retreat to a core, stronger position, where it can dig in its heels and defend itself, how deep the retreat will be is going to be defined by events in the following weeks.
Contagion was a concern back then in regards to Ireland and Portugal, now it is a reality.  Only the darkest of the doom and gloom crowd believed that contagion could really spread to Spain and Italy, yet now we have reached that point.

Italy and Spain are now trading almost where Portugal was a year ago before being bailed-out. Italy is the biggest loser in the recent turmoil and it is leading stock market losses with an incredible -33%.  How much easier would it have been for Italy to withstand a Greek default when it’s 5 year bonds were trading at Bunds + 134 instead of Bunds + 407. 
Let’s just admit it is gangrene and that it has already spread farther than is safe, but it is still better to cut off an arm to save the body.  If we keep waiting it may not be possible to save the patient.  The patient is getting weaker by the day, and being blind to that is just as big and just as dangerous as letting Greece default now.

Greece could default and leave the euro by March

Both the WSJ and Reuters reports that the second Greek bailout, following repeated and consistent disappointments by Greece which has resolutely refused to comply with the terms of its fiscal austerity program, has just collapsed.

"I expect a hard default definitely before March, maybe this year, and it could come with this program review," said a senior IMF economist who is keeping close tabs on the situation.

"The chances for a second program are slim."

It is not only Greece - Italy also thought it would sneak by with getting quid pro no and continue leeching off of Europe, or specifically Germany, indefinitely, at least until the ECB said that absent Berlusconi taking austerity seriously that implicit ECB support for Italian bonds would be cancelled, sending the second most indebted country in the world into a toxic debt tailspin.
From the WSJ:

Talks over new bailout funds for Greece were suspended Friday amid disagreements over how to fill a government-deficit gap that once again is veering off track, raising doubts about the country's future access to finance and triggering renewed nervousness in financial markets across Europe.
The suspension pushed yields on Greek government debt to levels indicating that investors see a default by Athens soon as a near certainty: Interest rates on one-year paper blew out past 70% and two-year yields rose close to 50%.
The continent's stock markets also retreated, with the French market down 3.6% and the German market down 3.4%.
The suspension of the talks in Athens between the government and a group of officials representing the providers of Greece's bailout cash came, officials said, amid a dispute about how to address new gaps opening up in the government budget deficit.
"The Greek side insisted the missed targets are the result of the recession. The troika said recession played a part, but Greece basically didn't keep up with its commitments, so more measures will be needed to make up for the lost ground," said a person with direct knowledge of the talks.
"There is a clear disagreement that can't be bridged today," the person added.
"I expect a hard default definitely before March, maybe this year, and it could come with this program review," said a senior IMF economist who is keeping close tabs on the situation. "The chances for a second program are slim."
Failure of Greece to meet its targets, growing reluctance by some euro members to continue lending and the fact that private-sector participation in a second bailout won't significantly alter Greece's debt profile are the primary factors, the IMF official said.

It gets worse: as Reuters confirms, the political turmoil has already spread to Germany, where all that is needed for wholesale conflagration that will sweep Merkel out of the cabinet is a tiny spark. This may just have been it:

Christian Lindner, general secretary of the Free Democrats, (FDP) junior coalition partners in Chancellor Angela Merkel's center-right government, said Athens was endangering European solidarity.
"The breakdown of talks between the Troika and Greece is a blow to the stability of the euro," he said at a news conference in Berlin.
Referring to Greece's failure to meet deficit targets set in exchange for a second bailout package, Lindner said Athens was shirking responsibilities to which it had agreed.
"This is not about non-binding statements of intent, but contractually secured reciprocity for the emergency loans," he said. "We insist these agreements are observed."
Separately, senior FDP official Hermann Otto Solms, a vice-president of the Bundestag and an economy committee member in parliament said since Greece could not handle its debt problem and it should consider leaving the euro.
"It should be considered whether a restructuring and exit from the euro would offer better perspectives for the currency union and Greece itself," he told Frankfurter Allgemeine Sonntagszeitung.
The pro-business FDP styles itself as a defender of the German taxpayer, a stance Lindner reiterated in his statement over Greece.
"Taxpayers in Northern Europe and especially Germany cannot accept inability or reluctance. In the eyes of the FDP, Greece must reaffirm its will for stability and reform."

A Greek departure from the Eurozone, which now seems inevitable, will have a major impact on Europe's financial institutions.

A new bailout looming: Cyprus downgraded and italy under pressure

And the hits keep coming! After the launch last week of the Great Euro Marshall Plan which was supposed to cure all economic diseases once for all, the bond tragedy has resumed relentless.
Yields on Italian 10-year bonds spiked to 5.8pc on Wednesday while Spanish yields punched through 6pc once again. Analysts remain perplexed by the decision of Italy's treasury to cancel bond auctions in mid August due to lack of liquidity and "reduced financing needs". Italy was expected to raise €68bn (£60bn) in August and September.
In the meanwhile there is a new entry in the bailout club.
Cyprus has been downgraded today two notches from A2 to BAA1 due to "fractious politics", exposure to Greece and the disaster of the energy crunch caused by the explosion and destruction of his main power plant on the 11th of July which destroyed 60% of Cyprus electricity output.

The darkening picture in Cyprus raises concerns that a fourth eurozone country might soon need some sort of rescue, exhausting bail-out tolerance in Germany, Holland, Finland and Slovakia, where a wing of the coalition has denounced the EU accord.

"The markets have started to see all the flaws in the summit deal," said David Owen, of Jefferies Fixed Income. "They know there has been no increase in the size of the European Financial Stability Facility (EFSF) and that it will not be in any position to intervene in the Spanish and Italian markets for quite some time because the changes have to be ratified by all parliaments."

"Unless the European Central Bank (ECB) steps in to buy bonds, this is going to be tested by markets over the summer. EU leaders have sent absolutely the wrong signal by thinking they have done the job and can now go on holiday," he added.
But the most interesting and scary piece of news today is the following:
Italian bank stocks fell sharply in Milan with Intesa down 5pc and Unicredit off 4pc.
Deutsche Bank said it had cut its exposure to Italian debt from €8bn to €1bn since the end of last year, mostly by purchasing credit default swaps (CDS). This suggest Europe's banks have been the main buyers of Italian CDS for hedging purposes, rather speculators as claimed by Italian leaders. It appears that core Europe started now for quite a while to dump the peripheral PIIGS.
The economic outlook continues to darken in Italy. The manufacturing index fell for a fourth month in July, dipping below the contraction line of 100. Italy's business lobby Confindustria said growth would be "almost nil" this quarter. The group's leader Emma Marcegaglia said Italy's political system was unravelling, leaving industry to its fate.

Net foreign liabilities in Italy have reached 26pc of GDP, the Italian government leitmotiv has been always that Italy is safe since most of the debt is owned by Italian families, this has not been the case since now for some time regardless of the Prime Minister's media propaganda.
Italy is cushioned for some months and the traditional summer shutdown will let the country slumber through till September unless of course a major event wreak havoc on the international markets.
September though will be torture for PIIGS.

Greece default: shutdown when needed

The grandiose plan to save Europe has been unveiled today and it is the same "kick-the-can-down-the-road" stuff this time designed to give Europe a little bit more time by allowing  Greece to default but just temporarily and selectively.
Even the ECB and Bank of Greece officers need an holiday in August so they decided to freeze the issue and the country just temporarily or selectively as they say.
So Greece is being allowed to selectively default, but this won’t harm Greek banks (nor their French owners) because the greek bonds will be guaranteed by an enhanced European Financial Stability Facility (EFSF) that can intervene in secondary markets amongst other new powers. Other debt-laden member states, including Ireland, will have access to cheaper funds from the uber-EFSF at longer maturities.

As for how to do it and what does it mean exactly well the cryptic EU bureaucracy managed again to be vague enough to allow lots of leeway should policy makers require it.

This is, after all, the tenth time EU leaders have met to sort the problems in Europe out once and for all.The composition of the new beefed up EFSF isn’t reported.
Is Italy, in its current fragile state, expected to keep its share of the EFSF up? If we look at the table on page 1 of this document from the EFSF showing the contributions of member states; Italy is expected to contribute up to 78 billion euros if required.
Italy just passed an 80 billion euros austerity package to cut its debt and stabilize its budget.
A useless austerity package then since the amount will not help the Italian economy at all but most probably will go straight to Greece in the following months.

Euro crisis: contagion talks ahead of EU meeting

Stock markets are up today, although given the following comments we can expect an interesting emergency meeting tomorrow:

The International Monetary Fund said there is now "serious risk" of eurozone contagion with "large" potential knock-on effects worldwide. "Market participants remain unconvinced that a sustainable solution is at hand," it said.

Suki Mann from Societe Generale caught the mood in a note to clients, asking whether it is "all over". "Eurozone politicians don't – or don't want to – understand that the eurozone as we know it is on the precipice. Greece appears beyond repair, Italy is on the brink, and the chances are that the euro might be no more very soon," he said.

RBS fears that Europe is on the cusp of "system-wide convulsion" after yields on Spanish 10-year bonds reached post-EMU records of 6.34pc this week, and Italian yields topped 6pc. "We believe that Spain has entered the danger zone for yield levels," said Harvender Sian, the bank's credit strategist, who fears the "point-of-no-return" may be 6.5pc. "Given that Spain [and likely soon Italy] has entered this territory, there is a growing risk that a large systemic risk event is plausible in the near term and if not then in a matter of weeks."

"We are approaching the endgame for this part of the European sovereign crises: the number of cans that now need kicking down the road would challenge the left foot of Lionel Messi," said Gary Jenkins from Evolution Securities. "The chances are that the EU will only take the step of fiscal union or common bond issuance at one minute to midnight on a weekend when it is clear that the system is close to collapse." 

The bond fund Pimco has its own idea of solving the Euro disaster: throwing Greece, Ireland and Portugal to the wolves, and concentrating €1 trillion in "overwhelming force" to defend Spain and Italy. That major players should utter such thoughts shows how fast events are moving.

Greece and the Eurozone Russian Roulette

A key week is starting tomorrow for Greece and regardless of the decisions that will take place in Athens the situation in the Eurozone is deteriorating by the day.
The reality is that Greece should have defaulted in May 2010 and avoid an austerity torture that is destroying the country and dragging the Euro to hell.

Had the May 2010 deal provided for debt writedown, the Greek crisis would be over by now. The crises in Ireland and Portugal would probably have happened anyway but would have been easier to handle and the European sovereign debt market would surely be less fragile.
Greece, Ireland and Portugal are small countries and a major disaster can be averted if the debt meltdown can be confined to these three. But if Spain goes under, threatening next-in-line Italy, the world financial crisis will enter a new and potentially disastrous phase.
There is a dangerous divide in the Eurozone which has been getting bigger in the last years and is widening up rapidly. While Ireland has some hope to get out of this mess thanks to its offshore companies' production provided will be able to disentangle itself from the burden of the irish banking system; the situation is appalling in Spain, Greece and Italy.

On Friday, the yield on Irish 10-year bonds reached 12 per cent, the highest level yet seen, with Portugal not far behind. But more ominously, yields on Spanish 10-year bonds have been creeping up and reached 5.7 per cent on Friday.
Ten-year yields for Italy, Europe's largest bond market, have shot back up towards five per cent, close to the danger zone, and one of the ratings agencies (Moody's) has threatened a downgrade.
There is a high risk of accident in the Spanish or Italian bond markets, or of an unexpected bank failure or a government collapsing somewhere. On Friday, Bank of England governor Mervyn King put it: "Providing liquidity can only be used to buy time."
As for the ECB we are not sure if they are trying to save the situation or complicate it.
Last week's Irish edition of The Sunday Times, quoted an unnamed ECB official saying: "In the meantime, we may have to come to the conclusion that it doesn't really make sense for the ECB to keep putting €100bn into Irish banks. What we are doing is actually illegal, but we have being doing it because we want to help Ireland. Maybe we might come to the conclusion that we should stop."

Der Spiegel pointed out correctly:


If the rest of Europe abandons Greece, the crisis could spin out of control, spreading from one weak euro-zone country to the next. Investors would have no guarantees that Europe would not withdraw its support from Portugal or Ireland, if push came to shove, and they would sell their government bonds. The prices of these bonds would fall and risk premiums would go up. Then these countries would only be able to drum up fresh capital by paying high interest rates, which would only augment their existing budget problems. It's possible that they would no longer be able to raise any money at all, in which case they would become insolvent.



And the cash is running out fast, disturbing news last week on the liquidity of European banks is that the number of banks tendering for ECB liquidity surged to 353: higher by 118 from the week earlier as the liquidity contagion spreads, the highest since September 2008, when 371 banks were rushing to suckle at the ECB's teat.

In the meanwhile Labour Unions in Greece decided to cut another 0.15% from Greek GDP by doing absolutely nothing. As a result, as Athens News reports, "according to the General Confederation of Workers of Greece (GSEE) and the civil servants' umbrella federation Adedy, the 48-hour strike is an escalation of their recent industrial action comprising 24-hour nationwide strikes in protest of the medium-term programme. A main demonstration will be held on Tuesday, June 28, at the Pedion tou Areos park in central Athens at 11am, while on Wednesday another demonstration will be held in downtown Klafthmonos Square."
As a reminder June 28, is the far more critical Greece austerity vote, which unlike the vote of confidence already has several PASOK members saying they will vote against it. 


This could explain why Le Figaro reports today that a working group of French banks led by BNP Paribas has proposed, and been agreed to by the French Treasury, that maturing debt would be rolled over into a a 30 year maturity piece, accounting for 50% of the total existing debt, and another 20% would go into a "zero coupon" fund focused on high quality stocks. Also according to Le Figaro, borrowings under the proposed scheme would pay an interest equivalent to what Greek "public" interest is plus a variable interest rate "likely to be linked to an economic Greek indicator such as GDP" (which being negative for years to come will likely means lower interest than prevailing).
The implied haircut for the Greek Treasury would be between 30% and 50%.
At least 30% of the rolling over debt would not come back to the issuing authority.
This funding avenue closure would commence the waterfall that triggers the liquidity cascade that culminate with every single European money market fund breaking the buck.

Greece default being invoked by the IMF

The International Monetary Fund believes Greece’s debt is unsustainable and that the country’s government should consider a restructuring as early as next year, the Wall Street Journal said, citing three unidentified people familiar with the situation. Senior IMF officials have told European Commission and euro-zone governments that a restructuring should be considered, the paper said. IMF, which hasn’t recommended a restructuring of all the country’s debt, has considered extending its loan repayment schedule, IMF spokesman William Murray told the paper.

Euro-zone officials, including finance ministers, have said it is necessary to restructure Greece’s debt and the European Central Bank responded by saying it didn’t want a public discussion, an unidentified official familiar with the situation told WSJ. A first step would be to substantially extend Greek bond maturities, another unidentified official said, according to the paper. That may include extending debt repayments by as much as 30 years, the official said.

Greece's central bank chief said Monday that a restructuring of the country's giant public debt would have "disastrous consequences," and called on the government to step up the pace of its reform program. "[A debt restructuring] is neither necessary nor desirable," Bank of Greece governor George Provopoulos said. "It would have disastrous consequences for the access of the government and of Greek enterprises to international financial markets, as well as very negative effects on the assets of pension funds, banks and individuals holding Greek government securities."


























In May last year, Greece narrowly avoided default with the help of a €110 billion bailout from the European Union and International Monetary Fund. In exchange for that loan, Greece has committed to a multiyear austerity program to fix its public finances and overhaul its economy. Since then the country has narrowed its budget gap by about a third, to around 10.6% of gross domestic product last year and is aiming to reduce it to 1% of GDP by 2015.

But many analysts say Greece's fiscal reforms aren't enough to tackle a debt burden expected to reach nearly 160% of GDP in 2013. In recent weeks, there has been growing speculation that Greece will need to proceed with some sort of debt restructuring to ease that burden. The central bank also sees inflation slowing to around 3.25% this year—down from an average rate of about 4.6% in 2010—but well above the government's 2.2% forecast for 2011.

Euro bailout explained

As It appears that Portugal will have to be saved by the EFSF, let us see what is the EFSF and how it works:

The EFSF practically does the following, it takes bad loans, and by putting them together, turns them into good loans. It uses a financial instrument similar to that used by institutions in the run-up to the 2008 financial meltdown - whereby subprime mortgages were bundled together with other loans and sold as one good loan. These instruments are known as collateralised debt obligations or CDO.
In February 2011 the Financial Times explained that, technically, the EFSF is not a collateralised debt obligation ‘but a special purpose vehicle that essentially pools guarantees and loans from stronger euro members to give it a top triple A credit rating.’
The economist Nouriel Roubini wrote in January 2011 that the EFSF was an instrument whereby ‘you take a bunch of dodgy less than AAA sovereigns (& some semi-insolvent) and try to package a vehicle that gets [an] AAA rating’. And it is this process of bundling bad debt into bonds which are guaranteed by good lenders which makes it akin to the ‘financial weapons of mass destruction’ which almost brought down the US and European banking systems.
The loans are still bad, the sovereign states are still distressed - it is only the guarantee that has changed. The bonds are valued not so much on the loans themselves, but on the guarantee which comes with them.
The risk has not gone away. It has merely shifted from one place to another, from bad lenders to good lenders as Germany. The main effect of this shift is to spread the cancer affecting one country to all the other countries of the EU. The reasons why the sovereign states find themselves distressed in the first place are not addressed in any shape or form.
If Portugal is forced to leave the money markets, as has happened to Greece and Ireland, ’the EFSF would then have to issue new debt on behalf of the remaining eurozone countries, to help Portugal’. In other words, 14 countries rasing money for three, until another defaults, then it’s 13 countries raising for four, and so on ‘until the bank of nations within the EFSF is so small that they cannot bear the burden of total debt on their shoulders.’

Portugal bailout due before April

Following in the footsteps of Greece and Ireland from 2010, Portugal is the next piece falling. 


Per Reuters: "European Union member states are increasingly concerned about Portugal's ability to fund itself in financial markets and believe Lisbon will have to seek a bailout by April, a euro zone source said on Thursday.


The EU has a rescue plan ready for Portugal, but it is dependent on Lisbon asking for the aid and making that request to both the EU and the International Monetary Fund. Portugal remains adamantly opposed to asking for assistance. "Portugal is drowning. It's not going to be able to hold on beyond the end of March," the euro zone source said. 

Ireland bail-out not enough according to IMF

The IMF’s report on the Irish deal projects cumulative general government deficits of €44.8 billion over the period 2011-2013.
Add in €16.4 billion to honour long-term bond redemptions and €9.3 billion for principal payments on promissory notes and you get €68.7 billion.
The EU-IMF programme provides €50 billion over the period 2011-2013 to fund budget deficits and other cash payments. This means that, based on the IMF’s own deficit projections, the Irish government will need to come up with an additional €18.7 billion to fund the state over the next three years and also honour comittments on bonds that it has issued.

Where is Ireland going to find 18.7 billions more needed to finance his debt?
This is if the current debt estimates for Irish banks are correct and assuming that no further hidden debt will pop out in the future.

A full PDF version of the IMF report is available HERE