Doom News

It would appear that European leaders are back at their usual table.

Speaking at the Bookings Institute before meeting with the US
administration, Greek Prime Minister George Papandreou blamed
“unprincipled speculators” and “ill-regulated” financial markets for
pushing Greece to the brink of financial ruin and dragging down the
euro.  Along the way he convinced France’s Nicholas Sarkozy, that
another financial crisis is around the corner if the CDS market is not
curtailed.  Sadly, we agree with the conclusion, but many European
“leaders” are confusing cause and effect.  Keith McCullough, at
Hedgeye, explained it best yesterday when he said, “markets don’t lie;
politicians do . . . hearing politicians talk about markets is like
watching a southern belle try to ice fish.”

So let’s set the
record straight.  CDS trades are not the cause of Greece’s problems. 
Profligate government spending is the 800 pound gorilla jumping up and
down in the center of the Parthenon.  We wonder how Mr. Papandreou
would respond if asked to imagine that the Greek public debt ratio was
50% instead of 135% and the Greek budget deficit was 5% or 6% (or even a
surplus heaven forbid) rather than 12.8%.  Would insurance against a
Greek default cost north of 300 bps and would Greek government interest
rates be trading at elevated levels and rising in this unfathomable
scenario?  We think not.

We’d like to briefly review our
“principles” for the benefit of Greece’s PM.  We are a small family
office in North Carolina, entrusted with protecting family wealth and
growing it prudently for future generations.  We are also
fortunate enough to do the same for a few other families that share the
same objectives and same values.  Believe it or not, when we lend (i.e.
invest) our money to businesses – and governments – we expect to get
it back (and occasionally earn a respectable return over time).  We
have a fiduciary obligation to look after the pool of capital entrusted
to us and work hard to earn our investors a consistent rate of
return.  As Papandreou and Company go cup in hand on their global PR
tour blaming “unprincipled speculators” for their own fiscal
recklessness, we ask how many of these so-called, evil investment
managers have been bailed out with tax-payer dollars during this Global
Recession.  And we’d encourage Mr. Papandreou to consider the
following “principles” as Greek actions speak louder than words:

• As
  early as 2001, just after Greece was admitted to Europe’s monetary
  union, Goldman helped the government quietly borrow billions, hidden
  from public view because it was treated as a currency trade rather than
  a loan.  This allowed Athens to meet Europe’s deficit rules while
  continuing to spend beyond its means.
• Greece entered the
  monetary union with bigger deficits than permitted under the treaty
  that created the currency. Rather than raise taxes or reduce spending,
  the Greek government artificially reduced their deficits with
  derivatives.  Ironic how the same politicians are blaming derivatives
  for the problems they created.
• Aeolos, a legal entity created
  in 2001, helped Greece reduce the debt on its balance sheet. As part of
  the deal, Greece got cash upfront in return for pledging future
  landing fees at the country’s airports. A similar deal in 2000 called
  Ariadne devoured the revenue that the government collected from its
  national lottery. Greece, however, classified those transactions as
  sales, not loans, despite doubts by many critics.
• Then in 2002,
  accounting disclosure was required for many entities like Aeolos and
  Ariadne that did not appear on nations’ balance sheets, prompting
  governments to restate such deals as loans rather than sales.
• After
  numerous downward budget revisions, the recently appointed “Committee
  on the Reliability Of Statistics” uncovered $40 billion of previously
  hidden debt.  Per Zero Hedge, “the findings
  indicate that the possibility of political interference is mainly
  associated with the close relationship of NSS with the Ministry of
  Finance and the inability of the General Accounting Office to work
  independently and responsibly.”

George, George,
George.  We wonder exactly what  is “principled” about levering-up your
country’s balance sheet to 135% debt to GDP, with a 12.8% deficit and
them blaming others for your problems?  Take a look at the recent piece
by GaveKal which clearly demonstrates
that markets are, indeed, efficiently pricing the risk in government
balance sheets.  There is nothing speculative about it.

The
reality is that, politicians having failed at the task, financial
markets have now become the best ally of the Euro’s founding fathers. Indeed,
since the beginning of the year, sovereign spreads have been nearly
perfectly aligned with the level of fiscal constraint imposed by the
Maastricht Treaty to each country of the Eurozone. In other words, the
market is doing the job that policymakers could not tackle.

The fiscal data
presented on the table above helps us to understand the current
structure of bond yields in the Eurozone. Working with publicly
available official data rather than with potentially opaque in-house
assumptions, we obtain a very good fit (97% correlation) between actual
bond yields and a small number of key variables. Thus, for all of the
complaints about market manipulation, it seems that the hierarchy of
spreads over German Bunds has followed, since the beginning of this
year, a pretty rational walk. Actual debt levels and short-term
pressure on government accounts have systematically explained more than
85% of yield spreads. When a liquidity risk premium is applied,
the explaining power of our model rises to above 95%.

While visiting US President
Barack Obama this week, Papandreou urged that “Europe and America must
say ‘enough is enough’ to those speculators who only place value on
immediate returns, with utter disregard for the consequences on the
larger economic system.”  We can almost visualize those cynical
speculators letting it all roll.  Yet, we’d much rather invest for
long-term returns, with a focus on capital preservation, than bet on
the politicized strategy of piling debt, upon debt, upon debt.  Believe
it or not, it appears that White House officials sent George packing,
recommending that Greece focus on righting its economy and dealing with
its own debt problems.  There is hope!