Sovereign debt bubble thread

[Admiral Yi]

What do you mean?

Greece throwing the deal under the bus, Ireland poised to, Spain blowing off the fiscal target, Hollande making socialist noises.

[Iormlund]

What do you mean?

Greece throwing the deal under the bus, Ireland poised to, Spain blowing off the fiscal target, Hollande making socialist noises.

No sane person has invested in the periphery lately. Whether you follow austerity or not doesn't make a difference. If you don't, they won't buy because of the deficit. If you do, they won't buy because the economy tanks and you won't be able to repay.

As Sheilbh says, the only remaining question is whether Germany will make a move when Greece exits or Spain is about to come crashing down. And how much will it cost by then.

[Admiral Yi]

No sane person has invested in the periphery lately. Whether you follow austerity or not doesn't make a difference. If you don't, they won't buy because of the deficit. If you do, they won't buy because the economy tanks and you won't be able to repay.

That doesn't seem to describe Italy.

And someone is lending money to Spain at 6%.

[Sheilbh]

Hollande's noises are exactly the same as Monti has made - and Rajoy has made.

The Spanish said they were going to miss their fiscal target.  Then Brussels forced them to walk that back.  Here's the FT BrusselsBlog on S&P's response:

Spain, S&P and the austerty-growth debate
April 27, 2012 11:18 am by Peter Spiegel

The recent turn in market sentiment against Spain has led to a somewhat unanswerable debate in European policy circles about what, exactly, the markets are worried about: Is it that the new Rajoy government tried to break from tough EU-mandated deficit limits last month...or the fact they eventually agreed to stick to next year's stringent target?

If Standard & Poor's downgrade of Spanish debt last night is any indication, it appears the markets are more concerned about the latter than the former.

Most senior EU officials have a different view, arguing that by unilaterally declaring he was going to ignore the EU-mandated 4.4 per cent debt-to-gross domestic target for 2012, prime minister Mariano Rajoy spooked the bond market by signalling Spain had lost its sense of discipline.

But S&P makes a different argument.

After his rebellious flourish, Rajoy reversed course and agreed at EU urging to reduce the deficit to 3 per cent of GDP by the end of next year – a huge undertaking, considering Spain's deficit was at 8.5 per cent at the end of last year. By front-loading severe austerity measures, the credit rating agency argues, Spain's already shrinking economy is likely to suffer an even more severe recession, making current debt projections look overly rosy:

In light of the rapid rise in public debt since 2008, we expect the Spanish government to implement a sustained budgetary consolidation effort – including strengthening fiscal surveillance frameworks at the regional government level – aimed at gradually reducing the government's net financing needs. Balancing this commitment to stabilising public finances with policymakers' clear interest in preventing an acceleration of the economic downturn will be challenging in the absence of fiscal transfers from abroad, or private-sector credit creation at home. At the same time, we believe front-loaded fiscal austerity in Spain will likely exacerbate the numerous risks to growth over the medium term, highlighting the importance of offsetting stimulus through labour market and structural reform.

[Their highlighting]

The Spanish government's response to the downgrade has been to insist that S&P hasn't taken into account the growth-oriented reforms that have accompanied Rajoy's new austerity push. But, in fact, S&P did take them into consideration – and praised them with great enthusiasm. The agency just doesn't think such restructuring will have an immediate impact on growth, something most European officials have long acknowledged:

Despite the unfavourable economic conditions, we believe that the new government has been front-loading and implementing a comprehensive set of structural reforms, which should support economic growth over the longer term. In particular, authorities have implemented a comprehensive reform of the Spanish labour market, which we believe could significantly reduce many of the existing structural rigidities and improve the flexibility in wage setting.... At the same time, we do not believe the labour market reform measures will create net employment in the near term. As a consequence, the already-high unemployment rate – especially among the young – will likely worsen until a sustainable recovery sets in.

[Their highlighting]

Apart from the growth-vs-austerity debate, S&P warns that there are two other things weighing on their minds. The first is the worry shared by most analysts and officials who think about Spain: it's shaky banking sector. S&P expects further shoring up of banks to add another 3.75 per cent of GDP to Spain's already burgeoning sovereign debt.

But perhaps more interestingly, S&P once again – much like it did during a swath of downgrades earlier this year – takes a whack at the eurozone's collective crisis response, saying that even Spain's good work on economic reform and financial sector restructuring could be washed out by ineffectual decisions made in Brussels. The lack of a firm response two years into the crisis, S&P argues, has led to rising borrowing costs, further threatening Spain's ability to invest and grow its economy:

In our view, the strategy to manage the European sovereign debt crisis continues to lack effectiveness. We think credit conditions, and hence the economic outlook for Spain, could now deteriorate further than we anticipated earlier this year unless offsetting eurozone policy measures are implemented to support investor confidence and stabilise capital flows with the rest of the world.

European leaders have spent much of the last week proposing ideas to stimulate growth. But S&P clearly views many of these ideas – including those put forward this week by France's François Hollande, the front-running Socialist in next week's presidential vote – as inadequate.

For S&P, the steps that need to be taken are things that have gained little traction or have been outright blocked in Brussels. One idea they advocate is "greater pooling of financial resources and obligations", a thinly veiled reference to eurozone bonds, which have been blocked by Berlin. Another is "direct bank support mechanisms to weaken the sovereign-bank link," an apparent reference to allowing the eurozone's €500bn rescue system to inject capital directly into struggling banks – again, a policy resisted in Berlin.

S&P makes clear that the gloomy road ahead for such measures is part of the reason for keeping Spain's long-term outlook as "negative". Only if economic growth returns, and the bond market becomes more willing to lend Madrid cash at more reasonable levels, will S&P change its mind. At this point, neither looks likely.

But I still think a real problem is that the Eurozone hasn't actually addressed the crisis - as I say I think the fiscal pact could be a long-term solution but there's no short or medium term solution.  Every summit we hear a new figure for the Eurozone bailout fund, normally it's somewhere between 1 and 3 trillion Euros.  Every summit they announce the same €500 billion (which is mostly taken up by Portugal, Ireland and Greece) and the rest will be made up by the IMF and Chinese.  Then it's a wonder that a serious economy like Spain or Italy get in trouble.

The socialists, the technocrats, the markets, the Economist, the Guardian, Paul Krugman and the Telegraph are pointing in broadly the same direction.

I agree that Greece is worrying.  Polls so far show the Irish supporting the fiscal pact but it's difficult to predict - I imagine the 'no' side will be far more enthusiastic.  But Greece's GDP is the same as Dallas-Fort Worth, the only reason it's an issue is because the Eurozone still hasn't developed an answer to the crisis and it's still unclear how far the Eurozone states will go to save their currency.  This is possible - they've got a lower deficit and debt, in the aggregate, than the US or the UK.

Edit:  Incidentally I still think it would have been cheaper for Germany and other creditor nations if they'd bailed out Greece and set up an enormous Eurozone bailout fund (a bazooka you don't need to use as Cameron put it) right at the start.  As it is the crisis is just constantly moved along with the Eurozone doing just enough to avert collapse but never enough to actually save the Euro.  So another make-or-break summit happens every 3-6-9 months. 

[mongers]

Of course France is one of the worries.
Either Hollande, or Merkel, (or both) must retreat from their stance and lose political face back home, or their disagreement on wether more spending will save you from overspending will disable, and then destroy the eurozone.

Yeah, but traders can read polls.  They've been expecting a socialist victory and an Hollande victory, with all that entails, for the past six months.  That's expected and I think has largely been priced in.  The market perhaps would have responded to a Sarko victory.

The surprises are that over 60% of Greeks voted for anti-bailout parties and the country's now bordering on the ungovernable, the severity of the economic decline in Spain and the effect that will have on Spanish banks (who would have to be recapitalised by the Spanish state, putting further strain on Spain's fiscal situation).

It wasn't a surprise to many, it was in part what I was trying to explain about the Respect Party's success in Bradford; it went a lot future than the racial, religious explanation some in the media have painted as. 

As things stand, the UK, being very small 'c' is still lacking in 'credible' rejectionist parties on the left and the right, but give austerity time and who knows what may emerge.

[Iormlund]

That doesn't seem to describe Italy.

And someone is lending money to Spain at 6%.

Italy is a very peculiar case. They've got a primary surplus, low private debt, a strong industry and healthy exports. The only reason it is in this mess is the absurdly huge amount of debt, which is mostly held by Italians themselves.

As for Spain, the ones lending us money are our own distressed financial institutions, with cheap ECB credit. Healthy banks like Santander are no longer buying our bonds.

[Admiral Yi]

Shelf: Who's Peter Spegel?  His generalizations don't fit his citations.

Iormlund: the ECB money ran out, which is why Spain's yield rose from 4%.  Apparently someone out there is lending at 6.

[Sheilbh]

Shelf: Who's Peter Spegel?  His generalizations don't fit his citations.

FT's Brussels Bureau Chief.

Edit: 

As for Spain, the ones lending us money are our own distressed financial institutions, with cheap ECB credit. Healthy banks like Santander are no longer buying our bonds.

Which is precisely the sovereign-bank link which is a huge problem for Spain.

[Iormlund]

Iormlund: the ECB money ran out, which is why Spain's yield rose from 4%.  Apparently someone out there is lending at 6.

It hasn't run out entirely. According to a RBS study, Spanish banks still hold on to over half their LTRO loot.

In the first quarter foreigner participation in Spanish debt fell from 50% to 37%. Spanish banks almost doubled their exposure from 16% to 29%

[Admiral Yi]

37% is a lot of someone.

[alfred russel]

germany is not going to pay for the union. cause that is what bonds would be atm.

That's not how Eurobonds work.

But this is what the markets still don't know - which is the biggest problem with all of the 'solutions' the Eurozone's gone through - is how far will Europe (mainly Germany) go to save its currency. 

Another indication that France isn't the problem is that their bond yields dropped today.  There was a flight to safety towards, not from M. Hollande.  I think that's an indication of the risks in the rest of the Eurozone.

I agree with you that Hollande was priced in and isn't really the cause of the trouble.

But I think the case that he is the cause isn't that Hollande is unsafe for France, but that he will break the Merkozy hardline regarding Southern Europe insisting on austerity and at least strong resistance to debt restructuring.

[Iormlund]

37% is a lot of someone.

Not when it was 50% very recently. No matter how you spin it the drop in foreign involvement in a single quarter is huge. And it's pretty clear who's "making up for it". I bet you a gazillion internet dollars that the trend continues in the next auctions.

[alfred russel]

But I still think a real problem is that the Eurozone hasn't actually addressed the crisis - as I say I think the fiscal pact could be a long-term solution but there's no short or medium term solution.  Every summit we hear a new figure for the Eurozone bailout fund, normally it's somewhere between 1 and 3 trillion Euros.  Every summit they announce the same €500 billion (which is mostly taken up by Portugal, Ireland and Greece) and the rest will be made up by the IMF and Chinese.  Then it's a wonder that a serious economy like Spain or Italy get in trouble.
.

If years of this crap could have been averted by 1 trillion euro, Europeans should lose any rights to criticize American government for the next decade. Even Bush knew to get the bailouts rolling when it hit the fan.

[alfred russel]

I bet you a gazillion internet dollars that the trend continues in the next auctions.

Careful, by the next auctions those may be worth more than a gazillion euro.

[Sheilbh]

His generalizations don't fit his citations.

I think I've found the S&P report cited.  Other relevant bits:

Overview

We believe that the Kingdom of Spain's budget trajectory will likely deteriorate against a background of economic contraction in contrast with our previous projections.

At the same time, we see an increasing likelihood that Spain's government will need to provide further fiscal support to the banking sector.

As a consequence, we believe there are heightened risks that Spain's net general government debt could rise further.
We are therefore lowering our long- and short-term sovereign credit ratings on Spain to 'BBB+/A-2' from 'A/A-1'.

The negative outlook on the long-term rating reflects our view of the significant risks to Spain's economic growth and budgetary performance, and the impact we believe this will likely have on the sovereign's creditworthiness.
...
Rationale

The downgrade reflects our view of mounting risks to Spain's net general government debt as a share of GDP in light of the contracting economy, in particular due to:
• The deterioration in the budget deficit trajectory for 2011-2015, in contrast with our previous projections, and
• The increasing likelihood that the government will need to provide further fiscal support to the banking sector.

Consequently, we think risks are rising to fiscal performance and flexibility, and to the sovereign debt burden, particularly in light of the increased contingent liabilities that could materialize on the government's balance sheet.

...

We had previously forecast real GDP growth of 0.3pc in 2012 and 1pc in 2013.

We believe that negative drags on GDP include:
• Declining disposable incomes;
• Private-sector deleveraging;
• Implementation of the government's front-loaded fiscal consolidation plan; and
• The uncertain outlook for external demand in many of Spain's key trading partners.

...

Despite the unfavorable economic conditions, we believe that the new government has been front-loading and implementing a comprehensive set of structural reforms, which should support economic growth over the longer term.

In particular, authorities have implemented a comprehensive reform of the Spanish labor market, which we believe could significantly reduce many of the existing structural rigidities and improve the flexibility in wage setting.

Even if, in our opinion, the reform is unlikely to eliminate the structural duality in the Spanish labor market, we believe it will ultimately benefit employment growth once a sustainable recovery sets in. In the near term, increased labor market flexibility is likely to accelerate the necessary wage adjustment and reduce the pace of job-shedding. At the same time, we do not believe the labor reform measures will create net employment in the near term.

As a consequence, the already high unemployment rate - especially among the young - will likely worsen until a sustainable recovery sets in.

...

We believe the ECB's recent long-term repurchase operations (LTROs) have significantly reduced the risks the Spanish banking sector faced in refinancing its medium-term external debt and its short-term interbank liabilities maturing in the first half of 2012. The LTRO also helped banks to finance their government debt portfolios cheaply. Nevertheless, we do not view the provision of liquidity support by the monetary authorities as a substitute for financial sector restructuring and economic rebalancing.

In our view, the strategy to manage the European sovereign debt crisis continues to lack effectiveness. We think credit conditions, and hence the economic outlook for Spain, could now deteriorate further than we anticipated earlier this year unless offsetting eurozone policy measures are implemented to support investor confidence and stabilize capital flows with the rest of the world. Such measures at the eurozone level could include a greater pooling of fiscal resources and obligations, possibly direct bank support mechanisms to weaken the sovereign-bank links, and a consolidation of banking supervision or a greater harmonization of labor and wage policies.

In light of the rapid rise in public debt since 2008, we expect the Spanish government to implement a sustained budgetary consolidation effort - including strengthening fiscal surveillance frameworks at the regional government level - aimed at gradually reducing the government's net financing needs.

Balancing this commitment to stabilizing public finances with policymakers' clear interest in preventing an acceleration of the economic downturn will be challenging in the absence of fiscal transfers from abroad, or private-sector credit creation at home. At the same time, we believe front-loaded fiscal austerity in Spain will likely exacerbate the numerous risks to growth over the medium term, highlighting the importance of offsetting stimulus through labor market and structural reforms.

Following budgetary slippage of 2.5pc of GDP in 2011 beyond the 6pc target, the government has committed to a target of 5.3pc of GDP in 2012 and 3pc in 2013. In our opinion, these targets are currently unlikely to be met given the economic and financial environment. We forecast a budget deficit of 6.2pc of GDP in 2012 and 4.8pc in 2013 (our previous forecasts were 5.1pc and 4.4pc). We also believe the delay to adopting the 2012 budget could reduce the government's capacity to prevent deviations from its budget plans.

Given the significant and regular budgetary slippages at the regional level - the main contributor to the deviations from the government's targets - the national government's willingness to fully enforce its new budget will likely be tested as we expect the regions to post a shortfall of around 0.4pc of GDP in 2012, above their 1.5pc of GDP 2012 target. Because of higher-than-previously-expected deficit projections, and other debt-increasing items such as arrears resolutions (estimated at 3.9pc of GDP in 2012), we forecast net general government debt at 76.6pc of GDP in 2014, against our previous projection of 64.6pc of GDP. State guarantees to the European Financial Stability Fund, the European Stability Mechanism, and the Electricity Deficit Amortization Fund, which are included in the government's own debt projections, are not part of our debt estimate and are instead classified with other state guarantees.

In line with the increasing risks we see to Spain's recovery, we have also considered a downside scenario that, if it were to eventuate, could lead us to lower the ratings again. This downside scenario assumes a deeper recession in
Spain this year, as a result of weaker external and domestic demand, with real GDP declining by 4pc in real terms, followed by a contraction of 1pc in 2013 and a weak recovery thereafter. Under this downside scenario, the current account would adjust faster, but the general government deficit trajectory would deteriorate further. The net general government debt ratio would breach 80pc of GDP.

...

We could also consider a downgrade if political support for the current reform agenda were to wane.

Moreover, we could lower the ratings if we see that Spain's external position worsens or its competitiveness does not continue to approach that of its trading partners, a key factor for Spain to return to sustainable economic and employment growth.

We could revise the outlook to stable if we see that risks to external financing conditions subside and Spain's economic growth prospects improve, enabling the net government debt ratio to stabilize below 80pc of GDP.

That seems broadly congruent with what Spiegel described:
http://www.telegraph.co.uk/finance/financialcrisis/9230382/SandP-downgrades-Spain-the-full-document.html

If years of this crap could have been averted by 1 trillion euro, Europeans should lose any rights to criticize American government for the next decade. Even Bush knew to get the bailouts rolling when it hit the fan.

I agree.  I think that's the comparison.  It's as if instead of actually bailing out the banks, with implicit bailout for the rest of the financial sector, the US had allowed each bank to individually almost-collapse then provide enough funding to keep them going for a few years while they sort out their balance sheet.  They've done nothing to address confidence in the Eurozone.

But I think the case that he is the cause isn't that Hollande is unsafe for France, but that he will break the Merkozy hardline regarding Southern Europe insisting on austerity and at least strong resistance to debt restructuring.

I agree, but France is the next country that could come under threat if the Euro-debt crisis continues to deteriorate.