Kyle Bass on The Euro-Zone Crisis

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Kyle Bass on The Euro-Zone Crisis

The US equity market down sharply. the u.s. treasury marketrallying sharply. that ten-year yield. and europe financial quandary, it continues to worsen. welcome to strategy session.i’m david faber along garrett kaminsky. we’ll talk debt downgrades and treasuries and bank of america. we also will have our friend with us very shortly but i want to start with you on bank of america, the aforementioned down almost 14% today.we heard kate talking about the aig story. there are different stories behind what is a meltdown in the stock down 50% for the year. we want to be careful in terms of what is story and what is fact. kate is a reporter on this lawsuit. i think what we have here is a traditional debt holders versus equity holders warfare. what do i mean by that? this is a situation that we sawin years past. let’s be careful about this. there are a lot of people who want the company to raise equity. the company says we don’t need to raise equity right now. until you get to true book value what it may or may be or maybe not, these debates willcontinue. i’m reflected back to something i said in 2008 that ended up saying something that stood with me which is when dilution is your solution, you’re not at a bottom. for bond holders, that’s ringing true here today in terms of what is really happening. they’re not going to do an equity offering as $7 a share unless they were up against the wall which it’s not clear they are in any way. there’s talk of asset sales and spin outs of certain value businesses. stock down 14% on the day. 28% in two weeks. all right. one thing i can tell you bank of america employees got a slug equity a couple years back vesting this week. i want to get to our top story with one of our top voices as i said. kyle bass, since this show began in june of last year has consistently provided invaluable insight when it comes to what he believes are europe’s financial problems. kyle joins us on the phone. we haven’t spoken to you for a few months. we know what’s going on to a certain extent in europe. tell me your latest thoughts in terms of ecb and willingness to buy spanish and italian bonds and it would appear at least and perhaps you disagree, the willingness of germany to go with that. i think that what the market is seeing today is looking at the core and you see the stress really show itself in italy today. there’s a realization in the marketplace that a bailout of this side required for italy and spain will cost france and germany their aaa ratings. remember when italy was a different story do to highdomestic ownership and now italy is in a crisis. think about the world in which we live in. the enormity of the debts that have been taken on and the country’s subsequent ability to pay those debts. you move from stability to cr s crisis in 200 basis points.we see cans kicked down the road in europe. several countries have failed into solvency years ago. the u.s. isn’t in that zone. for our viewers who haven’t listened in the past, what’s the zone of insolvency that you are discussing here? like at home when you can’t pay your bills. you have a situation with grief where they spend 15% of their sovereign government revenue on interest alone and on balance sheet borrowing at 4.5%. the bond in the marketplace, ten-year bonds today are yielding 15%. they are borrowing at 4% and spend 15% of sovereign revenue on interest. greece is insolvent. we’re looking at a complicated graphic on our screen which shows something you discussed in the past which is diminishing margin of the utility of so-called saves. each way along the course of the last couple years a new save comes out to bailout countries and say everything is safe and then yields continue to go up. is that what you expect will ultimately happen again here? i do. you have a scenario in which this is supposedly the sixth save for the euro zone and ihave seen the press report that now that this crisis is involved, let’s move on to the next problem. i think when you understand the mechanisms today it has 440 billion euros in lendingcapacity. they have to raise 780 billion euros in debt to fund this. the democratic parliament that are basically the membership of the euro zone have to vote to ratify these agreements that they are making. they haven’t even ratified thenew lending capacity. let me ask you three questions here. are we in a global recession? do the european banks have enough capital and number three, what about japan? you were very concerned about their debt levels. obviously not on the front page now. what’s your scenario now? the european banking system is three times levered. they haven’t recapitalized theirsystem because they don’t have lender of last resort like the fed and united states. u.s. banks are in much better shape than european banks and don’t have money to recap banks because they don’t have a mechanism to print money like we do. that’s question one. i forgot question two. are we in a global recession? if it means that growth is sub 2% for a couple quarters, yes. i think we are in a recession again. you have questions about the japanese market and how it’s sold and financed. what happens in japan and how does that effect a world that is looking to refinance itself? imagine a scenario in which you have the world’s second or third largest economy in japan and they have the largest on balance sheet sovereign debt in the world and worst democratic profile in the world running one of the highest fiscal deficits in the world and you have the inability to sell finance starting to show itself. think about italy. italy went from completely solvent and safe to unsafe overnight when rates moved 200 basis points. in japan, if rates move at all, they can’t pay their bills. they spend 50% of their sovereign revenue today on debt service. you’re going to see — a lot of people are asking today, what are the implications of the u.s. downgrade? the implication of the u.s. downgrade is it doesn’t take a genius to see in the u.s. when you bring in 2.3 trillion of revenue and spend 3.7 trillion, that maybe we’re not aaa. i want to come back to europe, kyle, before we say good-bye. you know, germany today cds, france up sharply. so their spreads widening. in italy and spain, they have seen a decrease in yields. a rather significant one over the short-term.what’s the end game here? you have said that the germans to fund 700 billion. germans and french additional beyond what’s in the sf. do you believe ultimately the german taxpayer will be there and politicians will bring them there in terms of taking on what they need to? i think french have to be in because the french are in more trouble than the united states in my opinion.the germans on the other hand publicly i would be doing exactly what merkel is doing. trying to show as much solidarity as i could. i would try to ratify the situation through dramaticausterity measures and cuts and i would be toting the publicline like they are with regard to keeping solidarity within theeuropean union. the day that the piece of paper is slid in front of them where the european periphery says you need to sign joint and severally liable with us, merkel won’t sign that piece of paper. you don’t think they’ll do it? no way. then what happens? then you have restructuring. think about the crisis we went through in 2008. what did we do? we pretended it didn’t happen. we smoothed the volatility by printing money. we didn’t delever. the only delevering that went on was forced delevering through foreclosure. the governments have now relevered that and more. so now total credit market debt to gdp is higher than three years ago. so what has to happen here is we just need to delever and delevering will be voluntary or involuntary and what we’ve seen throughout the world is it will have to be involuntary and violent oppose std to voluntaryd measured. what are you doing in terms of your portfolio to position yourself for what you expect. it’s really tough. even maintaining this view of the world for the last few years has been really tough. we’re invested mostly in the united states. we’re about 60% of our portfolioinvested in fixed income credit and you know, we don’t thinkeurope is going to be able to make its way through this so we’re hedging by using european instruments and then in japan, you know, it’s interesting at a point in time in which the underlying instruments meaning their bonds are the riskiest they’ve ever been in their history, the price on interest rates is the cheapest it’s ever been given the structuring is used. it’s a very complicated answer to a very difficult question. understood.kyle, appreciate your insights. look forward to seeing you inperson in about a month or so. in terms of the market with s&pdown 3.4% approaching lows of the day again, you’ve beenthrough these difficult periods. i don’t want to call it a panic but certainly it’s one that is typified by a lot of mass selling and concern. what do you give in terms of advice having weathered the housing bubble, the dotcom bubble and any other periodssimilar nature. we never call anything a panic. i said last week it was orderly and if you had been paying attention to certain signs that you and i have been paying attention to for several weeks it might have seemed violent last week, there were othersigns that sort of teld old us equity markets were disconnectedfrom credit markets. we put together what to do. as you know, we’ve known each other for 20 plus years. we did raise capital and predid p protect a lot of money. you heard me say sleep well and eat well. what does that mean? everyone should come to the conclusion that they feel comfortable with a certain level of capital. i don’t use the word catsh. capital that is liquid they can sleep well at night. this is your age and how much you should have in stocks. how much you should have in bonds.forget that. sleep well. don’t worry about eating well, worry about sleeping well. remember all analysts, strategists, economists,everybody including myself, nobody knows exactly what’s going to happen and so when you listen to predictions in terms of the economy in the second half, 2012, early part of 2013, recognize that these are moving targets and don’t lock yourself into something because somebody said it. number three, if we have not made this point on strategy session then shoot me right here in the head. bond markets are smarter than stock markets. if you have been paying attention to what was happening in high yield market in early july you would not have been surprised to see what’s happened here. focus on credit default swaps and as kyle said watch what’s happening with the debt of the european banks and not necessarily the equities and number four, a portfolio strategy is that i’ve alwaysendorsed here is look through your portfolio right now. if you have a short-term capital loss and taxable account, you can sell it here and harvest that tax loss. i don’t think in the next 31 days you’ll be able to reallocate that capital back. it’s not necessarily don’t make a strategy, decide that it’s in stone and not be flexible when we’re in violent times and you have to be heard gary say it.

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