G3 Recap 5-9-11

Main Items:

  • Fannie Mae (FNMA) reports huge loss for the Q, in contrast to Freddie’s improved results; Fannie seeks $8.5B injection from the Treasury – after the close Fri reported a net loss of $6.5 billion in the first quarter of 2011, compared to net income of $73 million in the fourth quarter of 2010. The change to a net loss in the first quarter of 2011 from net income in the fourth quarter was due to an increase in credit-related expenses, primarily driven by a decline in home prices during the quarter. Upon receipt of those funds, the company’s total obligation to Treasury for its senior preferred stock will be $99.7 billion. FNM
  • The Bahrain government said it would be lifting martial law on June 1, 2.5 months after first imposing the order. The action could signal that the government feels it was weakened opposition groups to such an extent that they no longer pose a threat. WSJ


  • EU Sentix Investor Confidence declined to 10.9 in May vs 13.8 expected and 14.2 previously
  • AU NAB Business Confidence declined to 7 in April from 9 in March.


  • S&P cut Greece’s rating to B from BB-, and indicated that it may be cut further. It also said that the rating means an estimated 30-50% recovery upon default
  • The Greek Finance Minister has been asked by his European counterparts at the informal meeting in Luxembourg on Friday to increase the target of privatization program to €15b for 2012, in order to initiate any discussion of increasing the country’s loan to €150b from €110b. If the proposal, which seems to be promoted by the four strongest European economies, is approved at the Eurogroup meeting on May 16, then it will be forwarded to the European Summit in June. Meanwhile, Wolfgang Schäuble raised the issue of a partial “voluntary agreement” between Greece and holders of bonds that mature in 2012-2013, but his proposal has not been rejected so far. Capital.gr
  • JPM Greece Restructuring Impacts:
  1. ECB has 200bn notional exposure and is protected for a haircut of up to 30%
  2. For Greek banks, a haircut of 50% for example, would create losses of around €25bn, leaving only €4bn of equity (or 1% of assets) for the Greek banking system. But Greek banks would see half the above loss if a Greek debt restructuring were to take place in mid 2013 as their bond holdings mature.
  3. Other European banks hold a manageable €50bn of Greek government bonds, but they look more vulnerable when adding the €115bn of private sector exposure.


  • The recent Greece headlines underscores the fact that trade competitiveness within the EU remains unbalanced. German Trade balance in March printed 18.9bn vs 11.8bn expected. This takes the 12m average to 13.1bn, which is even higher than levels prevailing when Greek default headlines first hit the market a year ago:

    Looking across EU countries, it appears that while Greek, Portugal, and Spain Current Account deficits have improved over the past year, it has come at the expense of France and Italy. As the latter two countries are much larger, the change in their current account as a percent of GDP is small. Nevertheless, this is not a sustainable way to rebalance EU trade flows:

  • Insurance companies are apparently now creating SIVs and hiding negative value assets in them. NYT. Has anyone had a good look at the impact of baby boomer demographics on US Insurance company asset-liability management? Reader responses appreciated.

8 thoughts on “G3 Recap 5-9-11

  1. Eurozone is structurally unbalanced – adjusting trade imbalances through wage depressions and changes in price levels is much more painful, much longer and much less efficient then adjusting them through currency devaluations, not to mention much less politically plausible. Basically, whatever advantage Germany and other core countries have because of the euro, they will have to give up through state loans to the periphery, otherwise the investments of their banks and pension system, which necessarily have to flow to said periphery in the good years (because without these flows situation quickly degrades to its current form), will go bust.

    I doubt this situation is sustainable in the long-run, even with all the misguided political commitment to euro in its current form. Most likely, at some point (maybe 5 years from now, maybe a bit more) we will see either an orderly restructuring of the Eurozone – a two-tier currency system perhaps, or a return to national currencies while keeping euro as a sort of international currency – or its disorderly dissolution.

    1. tend to agree with you sid; longer terms there seems to be the need for 2 currencies within what is now the Euro as 2 very different economic/cultural models. meanwhile, its a question of buying time to recapitalize banks to allow defaults. i just don’t see greece or ireland being able to dig themselves out of their specific holes not to mention portugal.

      as for the impact of retirement of baby-boomers on insurance asset mix … well the lessons from europe is that we should have and will continue to see some de-risking to produce cash flow streams that match liabilities (or annuity streams). i know scott peng wrote a lot on the topic a few years ago whilst at citi but that may have been a bit more geared towards pension funds. conclusion basically is curve flattener on duration grab or at least capping of long end yields absent a serious fiscal shock…

      specifically, you have national accounting standards that dictate how liabilities are measures, international regulators that try to provide guidance on asset mix (solvency 2) and within the US, it seems insurance is regulated on a state by state basis (similar to countries in Europe). but i think, that given the concentration of policies within a few insurance companies that are listed, one should be able to do a bottom up assessment of what the guys need to do to balance sheets (ie equity analysts) rather than the usual top down structural reform analysis fi analysts conducted here in europe.

      in short, i dunno what work still has to be done in the US but i would imagine the mix also contained all sorts of products with a yield pickup (either credit extension or vol selling) to increase operating margins … hmm given where credit spreads are and how vol has behaved over the past 2 years, one would tend to think switching out of any crap and into some of these higher yielding back end vanilla forwards would make sense.

  2. Definitely agree that we need to see a restructuring… I’m less sure that a 2 currency system will work over the long run though. In the absence of the periphery, Italy or France may start running the same type of deficits that got the periphery into trouble. In fact, that’s what the data appears to suggest has been happening over the past year. It appears there needs to be either fiscal unification or some sort of mechanism that allows orderly restructurings. Ultimately, the basel accords and 0 risk weighting of sovereign debt exacerbated this economic inevitability.
    This ponzi game the EU is playing with the periphery will end the way ponzi games end… when the sucker (EU) stops paying!

    Thanks for your comment on insurance liability Bert. That insurance co’s are using the SIVs to increase leverage and/or hide losses like the Times article is suggesting along with the need to pay out a steady stream as boomers hit retirement seems like a very toxic mix. Should this result in insurance company insolvencies, they will no doubt again be too big to fail. But the path to bailout will probably be just as bad as we saw in 2008. Is anyone else getting nervous about this? I haven’t read anything about this elsewhere.

    1. “It appears there needs to be either fiscal unification or some sort of mechanism that allows orderly restructurings.”
      In the absence of proper common labor market (whose existence is hindered by language, cultural etc. differences), both amount to redistribution from surplus countries to deficit ones – basically, this is the current situation. But you’re right, 2 currency system would probably be plagued with same problems as the current one. Probably, a return to national currencies with euro left for international transactions (and with possibility of gradual adoption of it by countries with same productivity levels and with economic ties that resemble those for parts of one state, like US states for example) would be the best approach.

      “along with the need to pay out a steady stream as boomers hit retirement”
      I haven’t done the maths, but judging from the EDR data provided by UN we’re unlikely to see major problems coming from that direction until at least 2020. Until 2015 the rise is not significant enough, the inflow of new clients will compensate for the accumulation of payouts.

      1. Thanks for your comments, Sid. I didn’t know that the problems are that far off, nor sure where to get the data.
        I’d just like to add though, that if the US Treasury credit or inflation risk premium were to reset appreciably higher, insurance companies may be the weakest link in the system. As they are certainly too big to fail, and Federal government assistance may be impaired, the risk is for a scenario potentially worse than Lehman.

        Levered financial entities with massive off balance sheet liabilities were the a cause of the last recession, and the culprits – the banks – are now better capitalized. Insurance co’s were also massively exposed, but were saved by being able to mark their assets as held to maturity. AIG only went down because it faced a liquidity crisis.

        I need to look at this further, although I’m not sure how deep I can get given that a lot of these off balance sheet vehicles are opaque.

      2. You should probably try modeling the industry’s inflows and outflows then. On macro-scale you can probably just take some fixed average yearly outflow per pensioner and fixed yearly inflow per client, this should give you some idea about nearest mismatches. If the problems lie farther away then 5 years, I doubt it’s worth bothering now.

        You can get the data here – http://www.gapminder.org/data – it’s easier then navigating UN’s crazy databases.

  3. in my opinion, lots of insurers are near desperate for yield these days, their asset managers are reaching for any/all paper that fits their mandate … also, perhaps some of the worst kind of style drift …

    off balance sheet – well, don’t forget China, local govt land sales, unit investment trusts promising 2x deposit rate, state bank/state corp combo

    we live in nervous times

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