I wrote an article titled, The Real Reason Corporations Are Not Hiring in May 2011, before Euro-crisis 2.0. I pointed out that corporations have more liquid balance sheets, since a larger percentage of their assets are in cash and s/t investments. However corporations also held a record amount of debt on their balance sheets. Therefore corporate balance sheets were not really as strong as the media portrays them.
John Hussman of GMO makes the same points below, in his latest weekly commentary.
John P. Hussman, Ph.D.
ValueWalk's Raul Panganiban interviews Joseph Cioffi, Author of Credit Chronometer and Partner at Davis + Gilbert where he is Chair of the Insolvency, Creditor’s Rights & Financial Products Practice Group. In the interview, we discuss the findings of the 3rd Annual report. Q2 2021 hedge fund letters, conferences and more The following is a computer Read More
Let’s begin with a few notes on continuing credit strains in Europe and elsewhere. The Greek 1 year yield shot to 270% last week, with Greek debt of every maturity trading at 35% of face value or less. The prospect of limiting writedowns to 50% is increasingly unlikely, which I suspect will put much greater strain on European bank capital than anyone is willing to admit. As expected, we’re beginning to see negotiations pushing for deeper restructuring than 50%. On Friday, Reuters reported: “Greece is demanding harsh conditions from its creditors as it starts talks with lenders about a proposed bond swap, a key part of Europe’s plan to reduce its debt pile and save the euro… The Greeks are demanding that the new bonds’ Net Present Value — a measure of the current worth of their future cash flows — be cut to 25 percent… a far harsher measure than a number in the high 40s the banks have in mind… It is increasingly likely that Greece will force bondholders who do not voluntarily take part in the bond swap to accept the same terms and conditions, something that is possible because most of the bonds are written under Greek law.” Should we care? Given the extremely high leverage ratios of European banks, it appears doubtful that it will be possible to obtain adequate capital through new share issuance, as they would essentially have to duplicate the existing float. For that reason, I suspect that before this is all over, much of the European banking system will be nationalized, much of the existing debt of the European banking system will be restructured, and those banks will gradually be recapitalized, post-restructuring and at much smaller leverage ratios, through new IPOs to the market. That’s how to properly manage a restructuring – you keep what is essential to the economy, but you don’t reward the existing stock and bondholders – it’s essentially what we did with General Motors. That outcome is not something to be feared (unless you’re a bank stockholder or bondholder), but is actually something that we should hope for if the global economy is to be unchained from the bad debts that were enabled by financial institutions that took on imponderably high levels of leverage. Notably, credit default swaps are blowing out even in the U.S., despite leverage ratios that are substantially lower (in the 10-12 range, versus 30-40 in Europe). As of last week, CDS spreads on U.S. financials were approaching and in some cases exceeding 2009 levels. Bank stocks are also plumbing their 2009 depths, but with a striking degree of calm about it, and a definite tendency for scorching rallies on short-covering and “buy-the-dip” sentiment. There is a strong mood on Wall Street that we should take these developments in stride. I’m not convinced. Our own measures remain defensive about the prospective return/risk tradeoff in the stock market. As for expectations of using the ECB to backstop the euro, as I noted last week ( Why the ECB Won’t, and Shouldn’t, Just Print ), we will not just all wake up one day to some surprise announcement that the ECB has started buying distressed European debt. If there is any potential at all to engage the ECB, the first thing to look for will be a concerted but unpopular change in EU treaties to subordinate the fiscal policies of each European country to one centralized fiscal body for all of Europe. In effect, the next step in the process will be an attempt to trade greater ECB flexibility in return for centralized fiscal control. We’ll probably see the phrases “cede sovereignty” and “fiscal union” quite a bit in the coming weeks. Late last week, after a meeting between Merkel (Germany), Sarkozy (France) and Monti (Italy), the three leaders squashed market expectations that they would ask the ECB to intervene. Instead, they announced “propositions for the modification of treaties” that would have nothing to do with the ECB. The best chance to resolve the crisis, in Merkel’s words, is to “make clear that we must take steps toward a fiscal union; to express the conviction that we know policies must be more closely coordinated if you have a common, stable currency.” Full article here-http://www.hussman.net/wmc/wmc111128.htm