Archive for January, 2012
The Continuing European Debt Crisis
Posted by Jody Eisenman | Filed under Uncategorized
Although I have written about this issue previously, I wish to focus on how we got here and what, if any, are possible solutions. Dubai, (also known as the City of Gold) was considered the jewel of the Arab world in terms of growth and modernity. However in 2009, mostly due to a recession and dropping property values, the Dubai World conglomerate stunned the world by announcing that they needed a six month moratorium on payments for $60 billion in loans. Investors began to focus on the sovereign debt of other countries. First Greece needed a short term bailout. Then came Portugal and Ireland. However, it is important to note that these bailouts were only short term in nature, meaning that no one was addressing the fact that increasing debt burdens were going to overwhelm these countries eventually. By mid-2011, Greece faced another huge crisis, which was addressed via a “voluntary” haircut. The theory was that these countries would eventually grow enough to pay these ever increasing debt loads. The reality is much starker. First of all, most economists do not believe these countries could ever grow their way out of the debt, especially in a recessionary environment. Second of all, the insurance on these bonds ultimately fall to a great extent upon European banks. As many of these banks are leveraged at 20 or even 30-1, even relatively small losses will doom these banks. Now, die to fancy accounting, you can keep these balls juggling in the air for a while. The straw that could break the camels’ back would be a drop in liquidity. In other words, as long as investors are willing to put up money, you can keep this charade going. If that were to stop, the music could end quickly. This is pretty much what happened with Lehman Brothers and Bear Stearns. Incidentally, this why European sovereign debt yields matter so much. As yields rise, it increases the countries debt service (the amount of money they must pay just in interest) and more importantly, is a sign that a liquidity crisis could be coming. In addition, every loan increase is met by further austerity measures, which are none too popular with the workers who must bear the brunt of increased hours, lower pay, and layoffs. Greek ten year paper yields over 30%. Portugal has gone from 7% this past May to over 15% currently. Countries are getting downgraded by the ratings agencies as well. Where is the Eurozone going? What will be the effect of the world economy? As always, be cautious.
The End of an Era? Europe’s Sovereign Debt Problem
Posted by Jody Eisenman | Filed under Uncategorized
As history has shown us beyond a shadow of a doubt, no empire, no matter how great, will last forever. We have seen the collapse of the once great Egyptian, Persian, Greek, and Roman dynasties. More recently, we have seen the collapse of the British, Ottoman and Russian empires. Although all these countries (Persia is basically Iran and Iraq, and the Ottomans survive via Turkey) still exist, they are only a fraction of their former size and glory. Meanwhile, the continent of Europe has dominated the world for the past two thousand years. During the vast majority of this time, countries were at war with each other, jockeying for wealth and power. Finally, after two catastrophic world wars, the European Union was formed. In 1999, a uniform currency called the Euro was created. Although the Euro currency initially trade weakly in the foreign exchange markets (it traded as low as $.81 in January 2002), the euro then climbed rapidly and actually reached a peak of almost $1.60 in the summer of 2008. However, due the current economic problems in Europe, the euro has dropped rapidly. From a high of $1.48 last January, it has now plunged to $1.26. The problem, as usual, is debt.
On Friday, S & P downgraded nine countries sovereign debt, with France and Austria being the most prominent. Today, S & P further downgraded the ESFS (European Financial Stability Facility) to AA+. The ESFS is the primary lending arm for euro zone countries in trouble. As such, this will probably lead to a cost increase in the bonds they issue. In some perverse way it may not matter. If Italy or Spain will actually require a bailout, the amount of money required is perhaps as much as one trillion euros (that’s a 1 with nine zeros!), which is far beyond their current capability. However, even this problem is dwarfed by the sovereign default protection issue. It is believed that the largest European banks have hundreds of millions of dollars in sovereign risk exposure. In order to somewhat mitigate these risks, banks have purchased credit default swaps, which are insurance policies should a country default. However, many of these banks have sold these swaps to each other. In the case of the Italian and French banks (the largest exposure believed to be issued by UniCredit and Credit Agricole), it is difficult to see how they could possibly pay off these policies, as their balance sheets are already highly leveraged. Thus, should some of the PIGS (Portugal, Ireland, Greece and Spain and perhaps Italy) actually default; it could lead to a domino effect that might leave Europe devastated. I don’t see how the countries could possibly bail out these banks in the case of failure. The next few months will be telling.
2011 Wrap Up
Posted by Jody Eisenman | Filed under Uncategorized
Although it would seem that 2011 was basically a non-event for stocks, it would seem that the swings really hurt many professional investors. Returns for a few key indexes were as follows:
DJIA +5.5%
NASDAQ -1.8%
S & P FLAT
Russell 2000 -5.5%
Anecdotal stories among brokers and investors indicate to me that most people lost money. I believe the reason why was because the market was sort of trendless. Just when you thought we were in an uptrend, we would selloff. Then, when it looked like the market was falling apart, we would rally. I think a lot of people got whipsawed in and out and it cost them plenty of money. According to Hedge Fund Research most funds lost money, including some notable names like Bill Gross and John Paulson. On the plus side, James Simons from Renaissance and Ray Dalio from Bridgewater had excellent years. Speaking of Bridgewater (which manages over $120BB); they remain quite bearish for 2012. They have done well for investors by maintaining a bearish stance on the global economy. On the other hand, Citicorp believes that we are now in a ten year secular bull market. Opinions are like brains, everyone’s got some.
Finally, in a sign of the times, it seems that 131 year old Eastman Kodak may be on the verge on bankruptcy. EK launched its’ first camera at the end of the nineteenth century and went on to dominate the film industry. As late as 1997, shares traded as high as $90/share. Today, will everything moving to digital film, EK no longer has much of a business. EK shares closed yesterday at 47 cents. This is the nature of the world, with new industries being created to replace obsolete ones. However, there is no question that change is accelerating at a rapid rate. I like to tell my employees that virtually everything I use in my office (wireless, fax, personal computer, email, digital TV, etc) barely existed 20 years ago. If you want to read an excellent book on this trend, please read (maybe on your Kindle!) Future Shock by Alvin Toffler. The book was originally written in 1984, and it is all the more true today. I highly recommend it!
