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ETF 2010 Sovereign Debt Are We out of the Woods Yet?
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Sovereign Debt: Are We out of the Woods Yet?
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Moderator : Pat Bolland Senior Counsel Veritas Communications Panelists: Alex Jurshevski Founder Recovery Partners Beat Guldimann Founder Tribeca Consulting Group
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The Simple Answer: Not even close!
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Sovereign Debt Crises are not new; we have seen sovereign defaults and economic collapses of sovereign states over centuries, back into the times of the Greek and Roman empires.
What is different now is the prevalence and severity of interconnected events. Irresponsible ballooning of sovereign, corporate, personal and institutional (can you spell Social Security?) debt is global in nature and the traditional sources for bailouts (can you spell United States of America?) are in a state of indebtedness that makes it extremely difficult for the authorities to apply needed solutions. What is also different is demographics and the shift in economic output: The traditionally strong economies of the G8, most importantly the US and Germany are weakened by an aging population, a smaller workforce and less economic output. This is partly due to a relocation of skilled employment to China, India and other emerging markets. Recovery from the stress of 2008/2009 is proving to be much more difficult than the remarkable growth phase witnessed after WW2.
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Vicious cycle will be painful
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Structural deficits of the public purse exist everywhere, and well beyond the point where stimulus spending runs out Ageing demographics come with increasing funding gaps for social security, public pensions and health costs With a smaller portion of the population engaged in producing GDP in the real economy, those that produce income will have to be taxed more to support structural deficits that have not been taken care of and the part of the population that is drawing funds from the welfare state The private sector is not going to pick up fast enough to replenish the fiscal coffers. In order to survive, private enterprise will continue to increase efficiencies, migrate manufacturing to low cost jurisdictions, reduce workforce in saturated economies and write off the cost of restructuring. The result is depressed tax revenue from corporations and increased unemployment in Western economies that transform into pure service and consumer economies while Emerging Markets pick up the manufacturing jobs. Cutting the vicious cycle will be painful if not politically impossible: Strictly Confidential, Legally Privileged and Private
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Political Difficulties
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This leads to a picture of Western Economies continuing to pile up structural deficits with a depressed tax base and ballooning unfunded liabilities towards a rapidly ageing population. Sound sustainable? We think not. In contrast, Emerging Economies (including China) will benefit from lower current levels of debt and much lower expected future deficits while manufacturing all the goods that the virtually bankrupt economies in the West will have to buy from them. Sound sustainable? We think yes.
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Political Risks
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Europe will face political risk from the fact that a population that has grown accustomed to benefits from an unsustainable welfare system will be asked to suffer cuts in public sector wages and social security benefits. Implementing these changes is extremely difficult in a heavily unionized environment and in one that sees the gap between rich and poor increase. Social unrest such as seen in Greece and Spain are just a foretaste of what is in store. In the US, you can add already unprecedented unemployment levels, ethnic tensions, regional income gaps and the fact that the population has constitutionally supported easy access to firearms of all calibers to the mix. The spectre of social unrest turning into violent riots staged by heavily armed “discouraged workers” becomes more than just a remote possibility in this scenario. This kind of development has the potential to create a significant political crisis in the US, which in turn would have negative feedback effects on the Global economy. Strictly Confidential, Legally Privileged and Private
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Political Risks
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In one scenario, the US, currently the leading force in global politics will come under increased global pressure: former and current enemies (including Al Qaeda) will try to benefit from US domestic and international weakness; the US will have trouble maintaining its global military leadership role as they won’t be able to appropriately fund not only their military, but more importantly non-US bases; China in this scenario might step in to seek a deal with the US for Eastern Hemisphere control. All signs suggest that the “deck” holding the global balance of power is being re-shuffled in favor of what we today still so ironically call emerging economies… However, the biggest risk here is simply that it has proven very hard to sustain political support for fiscal consolidation plans over the timeframes required for these programs to work.
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The Track Record
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The markets have hailed the UK’s post-election budget and similar moves on the Continent as evidence that the Sovereign Debt crisis is receding and the appropriate solutions have been identified and are being applied. The reality is that there are only a handful of success stories among the more than 140 attempts at fiscal consolidation in the last few decades. Defining “success” as a consolidation that reduces Debt/GDP by at least 10%, something that is required for all of the Sovereign zombies, yields a list of only two countries, New Zealand and Canada that have done so in the past. To clarify this further, there has never been a successful effort mounted in a situation where numerous countries are attempting to achieve the same thing in the aftermath of a Global Financial Crisis (GFC). Strictly Confidential, Legally Privileged and Private
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Investment Implications
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Running for shelter will be difficult in a scenario where the public debt crisis spins further out of control, sovereign defaults and even bankruptcies of whole nations potentially become a wide spread occurrence rather than a possibility and civil unrest ensues as populations lose whatever confidence they had left in their governments. Buy-and-hold is definitely over; shorter-term trading is back. Absolute returns should be the yardstick, not market benchmarks. Keep durations short to manage interest rate risk Use stop-loss parameters to manage equity risks Structured products (issuer assumes the risk of future shock while capping yields) Physical bullion Exposure to emerging markets may well become a safer play than the NYSE Strictly Confidential, Legally Privileged and Private
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Charts and Tables
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Financial Market Conditions
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Condition of Banks
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Top 20 Financial Institutions 1999
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Top 20 Financial Institutions 2009
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Cross Border EU Sovereign Debt*
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(USD millions) Portugal
Ireland
Italy
Greece
Spain
Britain
$24
$189
$77
$15
$114
France
$45
$60
$511
$75
$220
Germany
$47
$184
$190
$45
$238
Total owed to “Big 3″
$116
$433
$778
$135
$572
Overall Total Debt
$286
$867
$1,400
$236
$1,100
Debt / GDP
75.2%
63.7%
115.2%
108.1%
* Countries in the top row owe the amounts to countries in the vertical column. debt to GDP ratios are in the two bottom rows.
59.5%
Gross debt and
Source: BIS Strictly Confidential, Legally Privileged and Private
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Sovereign Debt Ratings – The Red Zone Rank 1 2 3 4 5 6 7 8 9 10 11 16 17 18 19 20 22 23 25 26 Average
Country Zimbabwe Japan St Kitts and Nevis Lebanon Jamaica Singapore Italy Greece Sudan Iceland Belgium France Germany Portugal Hungary Canada United Kingdom Austria Malta Ireland World
Debt / GDP 304.3% 192.1% 185.0% 160.1% 131.7% 117.6% 115.2% 108.1% 104.5% 100.6% 99.0% 79.7% 77.2% 75.2% 72.4% 72.3% 68.5% 68.2% 66.2% 63.7% 53.6%
Moody's Not Rated Aaa Not Rated B2 B3 Aaa Aa2 A2 Not Rated Baa3 Aaa Aaa Aaa Aa2 Baa1 Aaa Aaa Aaa A2 Aa1 N/A
Rank 28 29 32 43 49 51 52 55 61 62 90 69 70 78 80 85 86 90 100 103 Average
Country Netherlands Norway Spain Cyprus Turkey Croatia Poland Finland Switzerland Sweden United States Denmark Slovakia Czech Republic Latvia Slovenia Lithuania New Zealand Bulgaria Romania World
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Moody's Aaa Aaa Aaa A2 Ba2 Baa3 A2 Aaa Aaa Aaa Aaa Aaa A1 A1 Baa3 A2 Baa1 Aaa Baa3 Baa3 N/A
Notes: Japan’s Public sector debt is very high. However, Japan has a high savings rate which makes it easier for the government to finance the debt. 90% of Japanese debt is owned by Japanese individuals. Nevertheless the National Debt of Japan is a real burden for the economy. The US has a low savings ratio and 25% of US debt is owned by foreigners. The numbers for the US also do not include off-balance sheet obligations. An important factor is not just cumulative national debt, but, the annual budget deficit. This annual deficit determines the rate of deterioration in the public sector debt Source: CIA World Factbook (https://www.cia.gov/library/publications/the-world-factbook/)
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Spending Patterns by Age Group
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Demographics
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Demographics
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Demographics
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Food Stamp Recipients
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Industrial Production Index
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US Retail Sales
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US Housing Starts
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Housing Permits
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Civilian Unemployment Rate
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Unemployment
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Employment Falling
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Civilian Unemployed - 15 weeks and over
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Civilian Unemployed
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Median Duration of Unemployment
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Gross Federal Debt
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Foreign Holdings of US Domestic Debt
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Interest on Public Debt
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Household Debt Service
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Total US Revolving Credit
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Commercial Loan Net Charge-Offs
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Industrial Production
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US Home Vacancy Rate
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US Consumer Credit
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US Total Bank Credit
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US Total C&I Loans
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Net Loan Losses % of Total Loans
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Loan Losses Reserves
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Net Interest Margin US Banks
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Bank Failures and the FDIC
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Failures and Assistance Transactions United States and Other Areas (Dollar amounts in thousands) 1990-2007
2008-2010
Number of Bank Failures
949
249
Nominal Value of Defaulted Assets
$403,130,565
$296,467,735
Average Size of Failed Bank
$424,795
$1,235,282
Losses to Insurance Fund(s)
$43,464,818
$73,462,832
Average Loss per Failure
$45,801
$304,825
Weighted Average Loss (%)
10.58%
26.29%
Annual Failure Rate (during Peak)
293
118
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Canada – NPLs and Bankruptcies
16000
8000
14000
7500 7000
12000
6500
10000
6000
8000
5500
6000
5000 4500
4000
4000
2000
3500
0
3000 2007
2008
2009
2010
Years
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# of Filings (Blue Line)
CAD Billions (Red Bar)
Comparing Business Bankruptcies and Loan Losses
Big 5 Loan Losses (E) Number of Business Bankruptcies
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Contact Details RECOVERY PARTNERS CANADA LIMITED Suite 2500, 120 Adelaide Street West Toronto, Ontario M5H 1T1 office: (866) 889 7882 email:
[email protected] web: www.recoverypartners.biz
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Notes:
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