Bundesbank President Jens Weidmann does not mean to alarm you, but he thinks that Europe’s, um, difficulties could take a while to resolve. Read more »
Europe
German Central Bank Chief Hopes You’re Not Banking On That European Recovery Any Time Soon
By Jon ShazarPerhaps it would like to do something about that? Read more »
Things in Cyprus: kinda bad. There are better places than here to read about it; I particularly recommend Joseph Cotterill here and here, pseudo-Paweł Morski here and here, Mohammed El-Erian here, the FT’s coverage here and here, the Journal’s round-up of analyst reaction here, etc.
The basic story is that Cyprus’s government and banks are both massively overindebted and need a bailout, and the EU and IMF will provide a €10bn bailout, but they demanded that Cyprus chip in some €7bn, which it has decided to do by means of a tax on deposits in Cypriot banks of 6.75% for up to €100,000 and 9.9% above €100,000. (Is that rate on bigger deposits marginal or absolute? No one knows!) Those numbers are being renegotiated and may end up not being approved by Cyprus’s parliament.
The various reasons to object to this boil down to its violations of absolute priority; the way things are supposed to work is more or less: Read more »
It’s probably good news that “European Union finance ministers reached a landmark deal early Thursday that would bring many of the continent’s banks under a single supervisor,” but of course it wouldn’t be Europe without some self-evidently bad ideas for financial regulation, so today we also get this:
Bankers’ bonuses in Europe would be capped at two times fixed salary under a tentative EU agreement that would mark the most severe crackdown on pay since the 2008 financial crisis.
The European parliament and negotiators for member states drafted a deal in Strasbourg on Thursday that imposes a 1:1 bonus to salary ratio, which can be increased to 2:1 with the backing of a supermajority of shareholders.
Still being negotiated, can change, etc. One could perhaps imagine that once there’s a single eurozone banking supervisor, the warm glow of supervision will shield eurozone banks from this sort of chaotic meddling from the European parliament. Or not, who knows.1
This is mostly bad for the usual reasons: keying bonuses to base salary, without capping base salary, increases fixed costs and thus risk, while reducing bankers’ incentives to actually do a good job at whatever they’re supposed to be doing. A first-best comp scheme would probably involve huge bonuses to reward bankers for doing the things you want them to do; smaller bonuses is perhaps a better scheme than huge bonuses to reward bankers for doing the thing you don’t want them to do, but it’s not a particularly impressive approach. Read more »
Here are two tiny little puzzles about Moody’s's’s downgrade of the European Financial Stability Facility from Aaa to Aa1 just now. But first, here is some math on EFSF guarantees; basically every €100 of EFSF bonds has €165 of member guarantees, of which €103ish were Aaa-rated and €62ish were not. Until Moody’s downgraded France last week. Now it appears that each €100 EFSF bond has only €67 of Aaa guarantees, €36 of Aa1, and €62 of … various lesser things.
So the puzzles: first, this thing – the EFSF – is basically a structured credit product that is roughly two-thirds guaranteed by a Aaa thing, one-third guaranteed by an Aa1 thing, and roughly another two-thirds guaranteed by an assorted lower-rated miscellany that you can safely ignore. Should that make it (1) Aaa, (2) Aa1, or (4) other? S&P, as it happens, has a mechanism to sort of solve this, which is to say that a bond is rated by its probability of defaulting. Discarding the cats and dogs (and ignoring correlation questions), something that is 1/3 AA+ and 2/3 AAA has about an AA+ chance of defaulting: even if those AAAs are rock-solid, a default by that AA+ counts 100% as a default. Moody’s doesn’t have that – they, in theory, rate structured products1 based on expected loss, not just chances that there will be a default. So something that is two-thirds Aaa and one-third Aa1 is … at least arithmetically closer to Aaa than Aa1, is it not? (Especially if you assume the cats and dogs add a little bit of recovery.) But here you are stuck in a granular world: a thing that is two-thirds Germany and one-third France may be better than France, but I guess it’s also worse than Germany, so you gotta pick one or the other and I suppose pessimism is always a good look.
But a second and possibly related puzzle: if you were the EFSF, would you be bummed about being downgraded? Here is a weird fact2 (via Alea): Read more »
Europe is doing various terrible things about short selling today, and go talk about them in the comments, but this whole thing is really boring isn’t it? It’s like the “price gouging is grrreat” arguments that spring up like weeds after natural disasters;1 there’s the thing that politicians do to Convey Emotion and then we over here in the blogs are all “aha that thing is emotional but wrong!” and we all feel good and rational. So let’s, there’s nothing to stop us, we are in fact good and rational and the politicians are in fact emotional and wrong, as we and they always are, so there’s nothing wrong with patting ourselves on the back a bit when it’s demonstrated particularly clearly. I guess.
So, yes, Spain is continuing its ban on short sales of stock for another three months, to reduce volatility, though it seems to have increased volatility,2 because that is how you pantomime “deep concern” to … someone … and “blind panic” to the financial markets. And Europe more broadly has a ban on (1) naked shorting of stock and (2) naked CDS positions that goes into effect today; some things to think about that include:
- The regulation is a mess and is causing freakouts among banks, hedge funds, lawyers, etc.,
- it is hard to imagine it not being bad for the European government bond market, and
- the word “naked” has two different values in that sentence.
One slightly different read of the pan-EU rules is that they are less about their ostensible emotional purpose – “don’t anybody say anything mean about European governments or banks” – and more about market-structural stability. Read more »
UBS is said to be embarking on a “fresh round of cuts” in the investment bank, starting with employees big and small in Europe. Read more »
Every time I talk about Europe I begin by saying “Europe is all better,” because Europe these days operates on big-bang fixes followed by long slow decays, repeated indefinitely, so I guess you should sell the news and buy the quiet. Anyway, Europe is all better, since Mario Draghi announced today that the ECB will be buying unlimited quantities of European government debt, subject to a series of footnotes to which I tip my hat as a fellow connoisseur. Like me, the ECB likes its footnotes suggestive rather than exhaustive,* so the details are a little vague but will include “conditionality” in which the subject governments need to sign up for EFSF bailouts and adhere to their conditions. Without many details you can pick lots of nits; a good one is the ECB’s attitude to the seniority of its purchases, which is ably picked here.
The analyst reaction is mostly of the too-cool-for-this, everyone-expected-it variety but then there’s this:
So either “the market has gotten ahead of itself,” or “expected” comes with some variance, or I guess both why not.
Anyway, this is the internet, you can’t just be like “the ECB is buying lots of bonds,” you need a theory; two worthwhile ones are: Read more »
I liked that the two top articles in Money & Investing in the Journal today were (1) that European banks are buying bonds, and that’s bad, and (2) that American corporates are selling bonds, and that’s bad. And: probably!
The European banks are behaving sensibly:
With the European crisis knocking down the value of banks’ longer-term debt, some are taking advantage by buying back their debt from investors at a discount from the original value. Banks can book the difference in price as an accounting gain, adding to their bottom line — and their ability to withstand losses.
There’s enough opacity in European banking that you could be forgiven for assuming that “accounting gain” means “fake gain.” And indeed one can have an accounting gain merely by having the price of one’s debt drop, and that looks fake-ish. That’s not what’s happening here though: these banks are taking the critical extra step of actually saving money by taking advantage of that price drop. If I sell you a bond for €100 and then buy it back for €90, I have no debt and €10 more than I used to have, so that looks like gain, and also is gain.
Does it look like capital, or as the Journal puts it “ability to withstand losses”? Sure, I mean, money’s money and more of it is better than less. But the Journal and friends are probably not totally wrong to worry. My perhaps idiosyncratic view of bank capital is: you should want your banks to have a relatively long average duration of funding, and be sad if they’re almost exclusively funded via skittish overnight markets, and so (perpetual, fully loss-absorbing) common equity capital is a super way to bring up the average duration but you shouldn’t sneeze at 30-year bonds either, because when the world gets all Bear Stearns on you you don’t have to pay back the thirty-year bonds either.* Read more »
No human can realistically be expected to understand or focus on the constant stream of Eurozone gyrations and in fact humans increasingly don’t, with the half-life of blather-driven euphoria declining rapidly. The latest gyration seems to be that Germany is contemplating letting the Eurozone collective rescue funds think about maybe one day putting up for discussion the possibility of considering buying bonds of distressed countries directly to try to drive down funding costs for those countries.
This seems to have helped Spanish yields more than did the announcement earlier this month that those funds might consider giving Spain €100bn in special senior debt to get its banks sorted, for sort of obvious reasons. If the EFSFSMCBFFFFF is buying hundreds of billions worth of Spanish bonds right alongside whatever brave dopes are buying them already, that buying pressure should push up prices and push down Spanish borrowing costs and improve Spanish sustainability in a virtuous circle etc. etc. If the EFSFSMCBFFFFF is instead putting in its money at a more senior level than those bondholders, then those bondholders are subordinated and, empirically, sad about it.
One weird thing though is that there is little assurance that “EFSFSMCBFFFFF buying the same bonds that everyone else is buying” is actually the same thing as “EFSFSMCBFFFFF ending up with the same bonds that everyone else is buying.” The (not yet ratified!) ESM treaty maybe requires the ESM to be senior to market creditors (maybe!), but also maybe allows it to buy market bonds, which generally are not senior to themselves. Seniority is ordinarily a matter of contract: if you buy one of a series of totally fungible publicly traded bonds, you generally expect to be treated pari passu with the rest of those publicly traded bonds.
Ordinarily! Read more »
You would think that European regulators have a lot to worry about with their banks but they’ve got time for a surprising distraction: finalizing a plan to cap bankers’ bonuses at 1x base compensation*:
Bankers’ bonuses across the European Union are set to be limited by law, with many bank lobbyists admitting in private that they have lost the fight against a European Parliament initiative to limit the size of bonuses relative to salary.
Some banks still hope to increase the proposed ratio from 1:1 to 2:1 or beyond, while others are trying to limit the restriction to upfront cash bonuses, excluding deferred payouts. But many bankers now accept the principle of a ratio as inevitable.
“It’s dawning on many banks that this is game over,” said one senior lobbyist. “Many are now resigned to the 1:1 ratio.”
Assuming – as is currently the case – that the caps will be only on the ratio, not the amount, this is a somewhat weird move. Banks in Europe, as you may have heard, are somewhat undercapitalized. They also continue to need to employ bankers, and the going rate for senior bankers in Europe seems to be around 2.5x their current base salaries,** which are already up due to previous noise (and action) about bonus caps. A cap like this should push them up further, increasing banks’ fixed costs at exactly the moment they can’t afford to pay them.
But of course the regulators know that and view it as an acceptable trade-off for the benefit of the bonus cap, which mainly to nudge banks’ culture away from levered risk-taking and toward … I’m gonna say bureaucracy? Read more »
- Use the Bloomberg command
NH BLG_DEALBREAKER <GO>
to access Dealbreaker
