2017/08/02 Commentary: Summer? Must Be Kool-Aid Time!
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Commentary: Wednesday, August 2, 2017
Summer? Must Be Kool-Aid Time!
It is the height of summer, and there’s plenty of Kool-Aid on offer once again. Yet it’s kind of bitter to the Kool-Aid drinkers who have bought into the false precepts which have pervaded previous events. That is because their faith in various assumptions is being proven misguided. [For more on that ‘Kool-Aid drinkers’ reference see our January 14, 2017 Commentary: America’s Kool-Aid Crisis with its full explanation of the origination of that phrase to designate blind belief, often in false ideas or their prophets.] And there are three flavors on offer now for a good reason. There are three recent or current situations that have either called for and received blind belief, or have seen the risk in previous blind belief exposed.
The most recent is the imbroglio over Trump Jr. accepting a meeting with a Russian lawyer that was ostensibly for the worst sort of election subterfuge. The second is the recent Italian bank bailout that violated the protocols to which European banking authorities, the Italian government, the ECB and others had committed. Those two are not of any real concern to the markets right now, yet one may be.
That flavor is the long available IMF (International Monetary Fund)-Greece Kool-Aid which has suddenly been served up again in large volumes. That also means in a way that might elevate the Greek Bailout Crisis to meaningful market disruption levels once again after a lengthy hiatus. How could this be? Simply because someone in an oversight role at the IMF has finally pulled the covers off behavior in the Greek Crisis that is wholly inconsistent with the IMF’s mandate.
And when we say ‘pull the covers off’ this grimly depressing affair it is only a metaphor: there was in fact no secret as to what was going on over the very public objections of the non-European members of the IMF board. Possibly there being a next (albeit contingent) round of IMF funding for Greece in the pipeline finally caused someone there to say, “Enough European creditor-nation Kool-Aid already! Stop the Madness!”
In IMF protocol terms it has been indeed nothing less than insane because...
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NOTE: Given the likelihood the US economy will now get the structural reform that we (along with Mario Draghi and others) have been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015, we need to adjust our view that a potential economic and equity market failure is coming. We previously referred you back to our December 8, 2015 post for our major Extended Perspective Commentary. That reviewed a broad array of factors to consider Will 2016 be 2007 Redux? While a continued regime of higher taxes and more regulation (i.e. under Clinton) might have fomented a continued weak or even weaker US economy, the tax and regulation changes proposed by the Trump administration will hopefully still be approved by the Republican Congress and diminish the similar fears we had to what transpired in 2007-2008.
▪ …as draconian as many of the IMF financial and economic programs have been for many countries over the decades, most of them ultimately yielded a positive result. And one of the key aspects of that has always been returning the previously wayward country to a sustainable debt management plan. That substantially included having the banks that had lent too much money to a government that (at some point) was clearly going to be unable to service the debt take losses on their loan portfolios.
But the European creditor nations convinced the IMF that the 2008-2008 Crisis created a special Greek situation that required the cash infusions to stabilize it to avoid contagion spreading to the rest of the Euro-zone and ultimately global financial system. Much like the initial Fed Quantitative Easing (QE), at the time a single infusion might have been justified as part of that stabilization. Yet the multiple capital infusions from the IMF that violated its lending and reform protocols were clearly not justified.
Going back to the beginning of the entire affair and lack of any substantial write-downs of those bad loans (i.e. the extensive purchases of Greek government bonds) by the mostly German and French banks, there never was a ‘Greek bailout’. It was a Euro-zone bank bailout through the vehicle of Greece being loaned the money (i.e. putting it further into debt) to pay off the government bonds being held by those French and German banks.
Original Greek ‘Kool-Aid’ Sin
As we have noted at many previous points, bailing out the Euro-zone banks while getting all involved (except the Greeks and few other informed observers) to characterize it as a bailout for Greece was a pure canard… the ‘original sin’ of the subsequent mess for the IMF and others who were bamboozled by European creditor nation pleadings.
And it also had a ‘hubris’ element (as these things almost always do) in Europe’s effort to cover for its banks. The last thing the Euro-zone powers-that-be wanted to admit after roundly criticizing the US for the Mortgage Backed Securities (MBS) and other derivative instrument excesses of the Americans was that their banks had been as big a bunch of idiots as the Americans.
And their sin was on a much less sophisticated and obscure level than the Americans belief in the price of US housing never coming down to any great degree. The European banks were simply buying government debt instruments with an ever increasing yield (always a danger sign for any prudent investor) under an equally specious assumption:
As no European government had defaulted on its debt since the creation of the euro currency, surely some entity (European Union, ECB, etc.) would make the Greek bonds whole if Greece itself could not.
Hole in the IMF
And the IMF’s complicity in buying into consistently overly optimistic European estimates of future Greek GDP growth as a way to justify participation in serial bailout loans did not just blow a hole in its balance sheet… it also blew a hole in its standing as an effective assessor of the future prospects of bailout recipients economic and financial prospects.
And as noted above, this happened through the European faction at the IMF repeatedly overriding the concerns of the non-Europeans on the IMF board. As we have covered that at length in previous posts, we will simply refer you back to those for the context that we (and others) as informed observers understood was the case. Those go back to our February 15th Commentary: Greece (again)? European Kool-Aid post that first touched on the idea the IMF might refuse to provide more loans unless there was further debt relief.
That implied there might be an overall failure to extend Greece additional bailout funding, as noted in that post, “The risk is that the IMF will refuse to participate in any further financial aid if the debt forgiveness is not forthcoming. In turn, the Germans have said they will not proceed without the IMF involvement.”
There were then additional posts across the next few months on the evolution of that from of European Kool-Aid. And as early as February 26th our WEEKEND: European Kool-Aid Redux post we noted, “…the EU and Euro-zone are edging incrementally closer to drifting ‘through the looking glass’ once again.” That was on their additional misguided serial upbeat Greek GDP estimates.
And we cited the IMF “…blowing off a self-imposed deadline to reach agreement last Monday…” in order to study the situation further. That was nothing more than a ‘fudge’ to prevent a confrontation with the Europeans when additional weak Greek growth numbers would support the non-European IMF faction’s position demanding additional debt relief. So over five months ago all of the informed observers already knew that the European creditor nation’s specious assertions were coming apart.
Our additional posts following up on this European Kool-Aid were the March 19th WEEKEND: Black Swans(?): Italy & Greece post (that also visited the Italian bank bailout risks we revisit below), and (among others) more recently the May 24th Commentary: Hysterical Headline Hiatus, Greece and Peace? post update on the temporary stall on the Greek loans issue coming home to roost as Greek economic data remained weak.
More Pressure on IMF Now
That last post also revisited the idea that the US (a major IMF funding source) new administration would not be as amenable to more IMF loans to Greece without sustainability as the oblivious Obama administration.
Yet to placate its non-European faction as well as return to its traditional protocols, the IMF also found it belatedly necessary to demand more Greek loan forgiveness as the price for its recent agreement to participate in further Greek loan funding.
So this round’s ‘fudge’ is for it to only commit to a very limited amount of funding, with the larger necessary loans only coming once the European creditor nations agree to the far more extensive debt relief. And in addition to pressure from the non-European faction at the IMF and the Americans, the recent UK Telegraph article by Ambrose Evans-Pritchard IMF admits disastrous love affair with the euro and apologises for the immolation of Greece sums up an internal IMF assessment in its opening…
“The International Monetary Fund’s top staff misled their own board, made a series of calamitous misjudgments in Greece, became euphoric cheerleaders for the euro project, ignored warning signs of impending crisis, and collectively failed to grasp an elemental concept of currency theory.” That’s quite a damning indictment of an organization which is supposed to be at the forefront of effective country economic analysis, and financial engineering able to get wayward countries back on a sustainable funding track.
Yet the ‘immolation’ of Greece is exactly what the informed observers were aware was going on all along. We (along with others) have long noted that handing Greece ‘bailout’ funding at the same time as imposing serial draconian cuts on its state sector and taxes on its individuals and businesses was a recipe for disaster… or at least the overly optimistic growth projections having no chance of coming to fruition.
And as such, that was going to drive the Greek fiscal situation into further depths of unsustainability that somehow the IMF was unwilling to challenge until just recently. However, the articles in the Telegraph and many other media outlets are based upon the IMF’s own Independent Evaluation Office report from July 28, 2016!! As that is some fairly thick reading, we suggest a thorough review of the Telegraph article first (or instead.)
It not only distills the bottom line on many of the key issues; it also includes some very easy to understand graphs on the most relevant aspects. The sheer Brobdingnagian size of the Greek loans along with their over the top percentages compared to previous IMF programs is very interesting. And the serial downward revisions to the Greek growth projections out of 2010 into 2015 (which we have included in previous posts) are still a relevant sign of what went wrong, and how badly the IMF was bamboozled by the European creditor nations on previous growth assertions.
As the Telegraph article notes, “The eurozone had no firewall against contagion, and its banks were tottering. The European Central Bank had not yet stepped up to the plate as lender of last resort. It was deemed too dangerous to push for a debt restructuring in Greece.” And further, “While the fund’s actions were understandable in the white heat of the crisis, the harsh truth is the bailout sacrificed Greece in a ‘holding action’ to save the euro and north European banks. Greece endured the traditional IMF shock of austerity, without the offsetting IMF cure of debt relief and devaluation to restore viability.”
So no wonder the Non-European faction on the IMF board has finally been demanding that the European organizations now holding the Greek debt (ECB and others) must take the loan write-downs, which should have been taken by their banks in the first place back in 2009 and 2010 prior to the first IMF loans to Greece. It is going to be very interesting.
Merkel Irony
And one of the folks who has had among the largest vested interests in blaming the Greeks solely for what was a binary failure along with the northern European banks has been German Chancellor Angela Merkel. She certainly was not going to advocate a policy that was so totally opposite the entire German political class’ backing of their misguidedly profligate banks as victims in this whole exercise. Along with that, about one of the last things she was going to suggest was that the Greek debt writedown should be funded by the Euro-zone taxpayers.
That would have been the case had the German and French banks needed to be recapitalized by Euro-zone taxpayers to prevent their collapse under the weight of the bad Greek government bond purchases. And the continuing rounds of bailout funding for Greece that included IMF participation have been a convenient way to sweep the whole thing under the rug while keeping the Euro-zone contribution to as low an amount as possible into early this year.
However, with IMF Chair Christine Lagarde now embarrassed by the revelations from last year’s IEO report, the major US funder of the IMF becoming much more aggressive on it returning to its protocols (especially debt relief as way back to sustainable debt levels) and the IMF’s non-European faction becoming more aggressive about no further Greek loans without that requisite debt relief, things are coming to a head after the June ‘fudge’.
That was the agreement by which the IMF agreed to provide an additional $2.0 billion, but only if the specific Greek debt relief is provided at some future date. This is problematic on two fronts. The first is that the Germans are still against any debt relief, and secondly that they are still opposed to moving forward without IMF involvement. So the IMF commitment is so far only ‘in principle’. This is that much more problematic in light of IMF Chair Lagarde’s statement at the time, “…that the €320-billion Greek debt - 180 percent of the country's GDP - was not sustainable, and that Europeans will have to come up with more detailed proposals for relief in the coming months.”
“Coming months”? Sounds like another exercise in ‘kicking the can down the road’ to us. The question is whether this is capable of delaying the next real crisis out beyond the German election, or will it come back to haunt Chancellor Merkel just as her election looked assured? We shall see. Yet at some point the Greek situation does have the potential to create some real disruption in the recently renewed upbeat European economic and market psychology.
Italian Bank Kool-Aid
This can be very much briefer than the Greek situation assessment, because it looks like this situation has stabilized. Yet it has done so on the backs of Italian taxpayers, which is just what the Italian and Euro-zone authorities had promised would not be the case. It was a major issue that was also swirling around earlier this year, and there were various devices that were suggested to avoid any cost the Italian public. Yet as we also pointed out in our February 26th WEEKEND: European Kool-Aid Redux post (along with Greek shenanigans), a potentially far more risky Italian plan was under consideration.
That was for a ‘bail-in’ of depositors. As bad as the taxpayer bailout for the major Banca Monte dei Paschi di Sienna SpA (MPS) and two smaller banks might be, the bail-in had some extreme risks attached to it. This is also a bit of a mea culpa on being wrong about the potential crisis in Italy based on that alternative, which has been eliminated by the also far from ideal taxpayer bailout.
The Bail-In Protocol
As noted in that post, under the recently updated Euro-zone rules, “…a bank which is in trouble must receive some funding from a percentage of funds in depositors’ savings accounts along with losses of bond holders to qualify for state aid.” And our observation at time was, “???!!!” and, “Are you kidding?!”
We shortly went on to note, ”The real question should be what happens to the depositor base of an already ailing institution if the retail depositors suddenly feel their funds are not safe.” Note that we did not end that with a question mark. It was a rhetorical question insofar as it is actually a recipe for a bank run, not stabilization.
That went on to discuss the “Small Number Kool-Aid” where limited success of a given financial finesse (and the previous bail-ins even had very limited success) is then applied to much broader efforts that are in fact very risky. The MBS failure that fueled the Credit and Housing Bubble in the US got started with success in a very limited number of blended debt securities.
As we noted back in February, “And on current form the European bank regulation and state supervised rescue organizations seem to be counting on no really negative broader result coming from what have been very limited bail-ins. That would support their idea this can be applied to a Monte dei Paschi di Sienna… Italy’s third largest bank.”
As bad as a taxpayer bailout might have been (and presumably will be in future cases), at least the folly of the Bail-In Kool-Aid was deflected timely to avoid a larger problem. Should the European powers-that-be ever announce they are actually going to apply the bail-in to any substantial lending institution, we have a friendly piece of investment advice: But the shares of European mattress and safe manufacturers.
Trump Kool-Aid
It might seem a bit redundant to point out there is quite a bit of Trump Kool-Aid being consumed by his acolytes. Yet the situation we reviewed previous on our July 12th Commentary: ‘Normalization Bias’ NOT Back!! post on the misstep by Donald Trump Jr. in accepting a meeting with a Russian lawyer continues to churn along with typical Washington DC dysfunction.
The Trump Kool-Aid drinkers are clear that the meeting ended up being about US family adoption of Russian orphans. Oh, how sweet, and no cause for alarm on any nefarious behavior on the part of Trump Jr. or Paul Manafort or Jared Kushner who he had convinced to join him in this meeting. Yet that is far removed from the point, which is that Trump Jr. (and by extension the other two) were responding to indications that the meeting was ostensibly to received damning evidence on Hillary Clinton. And that was to be from a source close to the Russian government that wanted to assist Trump Sr.
As we have already reviewed the implications of the real Russian incentives behind the outreach to Trump Jr. in that July 12th post, were refer you back to that for more details. Suffice to say this was Russian and FSB ‘business as usual’. The point for the Kool-Aid drinkers on both sides of the US political divide is that the Left is going to continue to cast Trump Jr.’s agreement to meet (at least somewhat rightfully) as an attempt at collusion with a foreign entity.
The Trump Kool-Aid drinkers will be equally as adamant that because nothing came of the meeting, there was no collusion and therefore no reason for concern. This is a small slice of how the continued pro- and con-Trump Kool-Aid drinking in Washington DC continues, and may still yet have implications for the markets in how little is actually getting dome in the US Congress.
As a nonpartisan point on this, the Senate Democrats are still demanding a full 30 hours of testimony for any Trump cabinet appointees; even lower level ones that have already been previously vetted for those positions. As such, even if the high profile department heads have been confirmed, the extended staff to implement any new legislation (still very sparse at present) or regulatory changes are lacking.
This is part of the Left’s ‘Resist’ movement that is looking to stall any policy initiatives within the US government. That is in the wake of their continued disbelief that Donald Trump won the election, and their disdain for the man.
▪ The Extended Trend Assessment with full Market Observations will be updated after Thursday’s Close to fully assess how various markets perform from key technical areas in the wake of Thursday’s more prominent economic data (global Services PMI’s and other) along with the Bank of England Inflation Report and press conference.
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