Where the Wildest Things Are

Today, your California editor will pay homage to the classic picture books of our generation – Where the Wild Things Are, Green Eggs and Ham and Goodnight Moon – with a special “Financial World in Pictures” edition of The Daily Reckoning.

As it turns out, not all of the world’s wild things are in Max’s bedroom. Some of the wildest things of all are in the accounting ledgers of various national governments. Greek finances, for example, aren’t just wild; they’re scary too.

Greek Debt, Recession and Investor Confidence

The Greeks are short of cash, plain and simple. But a variety of European leaders and finance officials refuse to see it that way. They want to imagine, like Max, that they can become “king of all wild things” and tame the savage debt crisis that’s prowling around in the euro zone… But we doubt the finance ministers will fare as well as Max. The Greek debt monster will not return to the closet without mauling a few bondholders along the way.

Financial markets around the globe rallied yesterday on the “good news” that the European Union and the IMF would continue bailing out Greece. Never mind that last year’s $157 billion bailout failed to make the insolvent Greeks solvent, the EU pooh-bahs are cobbling together a new $60 billion bailout which, as Joel Bowman pointed out yesterday, “does little more than to give false hope to a doomed scenario.”

“If the medicine isn’t working, increase the dose. That, at least, is the treatment plan being pursued by the saviors of the euro in Brussels,” Germany’s Der Spiegel cynically observes. “Hardly anyone believes anymore that Greece can avoid a restructuring, or a debt haircut. Its mountain of debts has grown to more than 150 percent of gross domestic product this year. Meanwhile, the economy is shrinking, partly because of the austerity measures.

“The country is stuck in a vicious circle,” Der Spiegel continues. “Investors refuse to lend Greece money at affordable interest rates because they are convinced that Greece is over-indebted. This forces the government to accept bailout loans from its partner countries, which further increases debt levels while reducing creditworthiness.”

Greek finances have entered the hopeless stage – a fact that is obvious to the Man on the Street, but opaque to the men and women in the conference rooms of Northern Europe. “A total restructuring of Greek debt is not an option and nobody is planning it,” Luxembourg Prime Minister Jean-Claude Juncker reiterated yesterday. A few days earlier, the French Finance Minister, Christine Lagarde, declared, “A restructuring of Greek debts is absolutely out of the question.” Likewise, German Finance Minister, Wolfgang Schäuble, is on the record saying, “A debt restructuring is not under consideration and is completely speculative.”

These vehement official declarations can mean only one thing: A debt restructuring is absolutely certain and everybody should be planning on it.

“The question is no longer whether Greece will restructure its debt, but when.” says Peer Steinbrück, the predecessor of Germany’s current Finance Minister. Oxford economist, Clemens Fuest, agrees, “Europe’s governments must face reality. [They] cannot keep behaving as if Greece were not insolvent, while constantly imposing new burdens on taxpayers for the bailout.”

Despite these self-evident observations, the EU will continue fighting against the inevitable for a while longer. “We will try to solve the Greek problem by the end of June,” says Juncker. Conveniently, Juncker specified only the month, but not the year.

A solution will certainly arrive, but it will certainly not look anything like the solution EU finance ministers are implementing…and it will certainly not be painless.

“Large segments of the [Greek] population favor a quick fix, like the one Vassilis Sarantopoulos, 50, the head of a small Greek publishing company, recommends,” Der Spiegel relates. “The ‘solution’ to Greece’s debt crisis is obvious, says Sarantopoulos: ‘Withdrawal from the euro zone, return to the drachma, non-recognition of the government debt.’… Sarantopoulos is one of the advocates of a new movement in Greece called ‘I Won’t Pay.’ The name speaks for itself.”

Yes it does. But this “new movement” is as old as the Caveman’s first IOU. “I won’t pay” isn’t painless, but it is an elegantly simple solution…and it always works. It always solves insolvency.

Alas, Greece’s feeble finances are not the only wild things roaming around in the financial markets “roaring their terrible roars, gnashing their terrible teeth” and “showing their terrible claws.”

The US housing market is also looking pretty scary. The Case-Shiller 20-City Index of home prices has dropped to its lowest level since mid-2003. After adjusting for inflation, the index has tumbled to 1999 levels. “Prices have now fallen further since the bubble burst than they did during the Great Depression,” the Associate Press reports. “It took 19 years for the housing market to regain its losses after the Depression ended.”

Case Shiller National US Home Price Index, 1988-2011

Apparently, no one wants to buy a house. In a recent survey, 92% of all homeowners said they believe it is a bad time to sell a house. Visibly, an even higher percentage of folks – like about 100% – believe it is a bad time to buy house. The pace of new home sales has plunged to the lowest level since JFK was sharing afternoon teas with Marilyn Monroe. Folks are simply too fearful or too credit-strapped to buy a home.

They do not want to buy a house.

They will not buy one with a mouse.

They will not buy one with a spouse.

They do not like home prices that fall. They do not like these things at all.

Home prices seem destined to continue falling for a while. Pending home sales plunged 12% in April, according to the National Association of Realtors. Meanwhile, foreclosed inventory continues flooding into the market. CoreLogic estimates that 1.8 million mortgages are more than 90 days delinquent, in foreclosure or bank-owned. This “shadow inventory” will swell the number of unsold homes by nearly 50%!

The housing mega-bust is no mystery, of course. Folks without jobs or savings tend to buy very few homes. Americans, by and large, are in the retrenchment stage. They are trying to solidify their shaky finances by shopping less and saving more…or saving anything. They are struggling to re-pay debt the old-fashion way – by defaulting and/or curtailing consumption relative to incomes.

Total Revolving Credit and Mortgage Debt Per US Laborer

The Greek government will get there eventually…and when it does, the repercussions will certainly extend beyond its borders. French and German banks, to name two obvious victims, will suffer blows to their balance sheets. But who knows how far and wide the repercussions might spread?

Perhaps the resulting trauma will cross the Atlantic and wound a few financial institutions on our own shores. Already, Goldman Sachs is exhibiting some uncharacteristic frailty. For the first time in recent history (and probably ever) the cost of insuring Goldman’s debt against default is more expensive than the cost of insuring Citigroup’s debt against default.

Price of a 5-Year CDS on Goldman Debt vs. 5-Year CDS on Citigroup Debt

In other words, professional investors are saying that Goldman is riskier than Citi. Why? Perhaps it’s because the Justice Department is sniffing around in Goldman’s books and records; perhaps it’s because an ex-Goldman guy is no longer Treasury Secretary; perhaps it’s because Goldman’s profitability remains hyper-vulnerable to financial market distress, like that kind of distress that could result from the simultaneous defaults of two million American homeowners and two or three European governments.

At that point, it would be time to say, “Good night.”

Good night Greek banks.

Good night banks that hold Greek bonds.

Good night US housing market.

Good night banks that hold mortgage-backed securities.

Good night quantitative easing.

Good night Ben Bernanke.

Good night global bond markets.

Good night financial firms that receive federal indictments for lying to clients.

Good night Goldman Sachs.


Eric J. Fry
for The Daily Reckoning

The Daily Reckoning