March 26, 2023

DealBook Column: One Wall Street Seer Says the Greek Tragedy Is Near

The markets had a tepid response to Greece's pivotal election.Simela Pantzartzi/European Pressphoto AgencyThe markets had a tepid response to Greece’s pivotal election.

If you want to be scared, truly terrified, listen to Mark J. Grant. He might be right.

For the last two years, Mr. Grant, a managing director based in Florida at a regional investment bank, has been predicting the bankruptcy of Greece and a cascade of chaos across the global economy, attracting quite a following on Wall Street in the process.

“Greece will be forced to return to the drachma and devalue, and the default will cause bank runs and money flowing into Germany and the United States as the only viable safe haven bets,” he declared the day before Sunday’s Greek elections, irrespective of which party would win. “Greece will default because there is no other choice regardless of anyone’s politics.”

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He then walked through the falling dominoes: “It will hit the (European Central Bank), the banks on the other side of the derivatives contracts, all of the Greek banks who are really in default at present and being carried by Europe as well as the nation, and the Greek default will spread the infection in many places that we cannot imagine because so much is hidden and tucked away in the European financial system.”

Welcome to Doomsday, brought to you by Mr. Grant. He says he doesn’t think of it as such; he calls it “reality.” He told me on Monday, almost hopelessly, “There’s only so much money to go around.”

In a Jan. 13, 2010, report, Mr. Grant forecast that Greece would default on its government debts, one of the first to publish such a prognostication.

Mr. Grant could be the Nouriel Roubini (Dr. Doom) of the European crisis. Mr. Roubini, the New York University economist, said the subprime-debt sky was falling for a long time before it fell. Few people listened, in part, because nobody had ever heard of him. Then, of course, the sky fell. Now everybody has heard of him. Time will tell, but soon everybody could know Mr. Grant.

The January 2010 report, written two years before Greece did indeed default, has made him the go-to forecaster of Europe’s collapse for some of the world’s largest investors. Nicknamed the Wizard, Mr. Grant, who works for Southwest Securities, sends out a daily report, often frightening in its detail and matter-of-factness, by e-mail to a who’s who of the world’s biggest institutions, hedge funds and sovereign wealth funds. Subscribers like Bill Gross, a founder of Pimco, the world’s largest bond fund, pay thousands of dollars a year to receive Mr. Grant’s views in their in-boxes.

Never one to sugarcoat his views, his success is partly a function of his plain-spoken way of making complex ideas simple.

“There is only one way out of this mess and that is if Europe keeps handing Greece money like one does to some aged aunt that cannot support herself, but that is a family decision,” he wrote. But, he argues, “Greece requires 16 other family members to support her jointly and the politics in many of these nations, including Germany, is making it difficult for the charade to continue.”

His view of European officials’ effort to “fire-wall” the problem countries is equally simple: “This whole subject is a ruse in my opinion. Think of horses in a corral. The rancher keeps trying to build a higher and higher fence around his horses but for what purpose? For the rancher it is to keep the wolves out.”

Mr. Grant, who loves to mix metaphors, takes his rancher metaphor further: “The real problem is that the horses are sick, infected and that the disease of fiscal mismanagement has spread to virtually every horse in the corral except one and do not expect that one, Germany, to remain disease-free much longer.”

Layering on another metaphor, he adds: “You can call cancer a cold if you like but it changes nothing; not one thing.”

Sadly, Mr. Grant is not predicting the default of just Greece, he’s already on to Spain (he reached that conclusion before many others, too).

“The country cannot afford to pay off their regional debt, their bank debt,” he wrote on Monday, “and various schemes to avoid the Men in Black from taking over will not work nor will the pleas for ‘more Europe’ as the words mouthed by Germany are meant for placation only and will not find implementation in any kind of timeline that will make any difference.”

He has convinced himself that Germany, the only country in a position to help, will not come to the rescue. “You can bank on one thing if nothing else; the Germans will not allow their cost of funding to rise or their standard of living to decline to help the nations that have gotten themselves in trouble. You can count on this!” he wrote.

As we were talking on Monday, he said he wanted to make clear that he did not believe Armageddon was upon us. And it’s not as if Mr. Grant is wishing this to happen, despite his boat in Fort Lauderdale, named “Wishes Granted.”

“I don’t think the world is going to hell,” he said. “It’s very negative. What’s going on is serious. It will have a whole slew of negative consequences.” But he insisted, “I don’t think it’s going to get to the 1930s.”

More likely, he said, we are headed for a bad recession with lots “of shocks to the system.” He says this will likely happen in the next four months unless “there is debt forgiveness or Europe keeps handing them money like they are a ward of the state.”

“Or,” he warned, “it could come sooner.”

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DealBook: In Europe, a Conflict Over Bank Capital

UniCredit headquarters in Milan. Banks in Europe need to find $147 billion to raise their Tier 1 capital ratios.Luca Bruno/Associated PressUniCredit headquarters in Milan. Banks in Europe need to find $147 billion to raise their Tier 1 capital ratios.

LONDON — Europe’s banks and regulators are at odds about how financial institutions should increase their capital reserves.

Authorities want European banks to tap existing shareholders and reduce employee bonuses to find a combined $147 billion to increase their core Tier 1 ratios, a measure of a firm’s ability to weather financial shocks, to 9 percent by June. Citigroup estimates that Europe’s financial institutions, minus the Greek banks, had raised at least 40 billion euros, or $51 billion, as of the fourth quarter of 2011.

Banks, however, would prefer to sell or write down unprofitable operations, as well as adjust their balance sheets, to free up cash to meet the new requirements.

One solution could be to increase capital reserves through rights offerings, which allow existing shareholders to buy new stock at a discount. But volatility in the financial markets amid Europe’s sovereign debt crisis has damped investor interest.

Many banks are waiting on the outcome of the Italian bank UniCredit’s 7.5 billion euro rights issue, which closes at the end of this week. After initial investor skepticism, market participants say the Milan-based bank, which must raise almost 8 billion euros by June, is now expected to gain shareholder backing for the multibillion-euro capital increase.

“Everyone is looking at the UniCredit deal as a litmus test for future capital raisings,” said a senior investment banker from a leading bank in Europe, who spoke on the condition of anonymity because he was not authorized to talk publicly.

If other options are not attractive, some banks may eventually turn to local governments for a helping hand. Last year, the European Union created the European Financial Stability Facility, a 440 billion euro fund that can be used to shore up firms’ capital reserves.

Banks will soon find out what regulators think of their plans. Financial institutions, including Deutsche Bank of Germany and BNP Paribas of France, had to submit their recapitalization strategies to national regulators by Friday. The European Banking Authority will review the plans in early February, and regulators have the power to veto any capital-raising plan they don’t agree with.

Much of Europe is expected to enter recession this year, so authorities are likely to reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy.

The banking authority has called on banks to raise the money through cuts in shareholder dividends and issuance of new stock. It has warned that the sale of any operation, particularly in banks’ home markets, that hurts business lending won’t be allowed.

“Regulators are asking for the impossible,” said Etay Katz, a banking regulatory partner at the law firm Allen Overy in London. “They want banks to keep lending to the real economy, and there’s an expectation banks will have to swallow the bitter pill of offering new equity at times when investors’ appetite is negative.”

Nonetheless, some banks have been following authorities’ demands. Société Générale must raise 2.1 billion euros, and announced last November it was slashing bonuses and scrapping its 2011 shareholder dividend to meet the new regulatory requirements. It also plans to cut almost 1,600 jobs in its investment bank unit and has offloaded billions of euros of sovereign bonds to reduce its exposure to euro zone debt. As of the end of September, Société Générale’s core Tier 1 ratio stood at 9.5 percent.

Not every European bank, however, can rely on its own earnings. Many midsize banks, especially in Southern Europe, face deteriorating local economic conditions and rising customer defaults. In Spain, for example, authorities say the ratio of bad loans to bank lending has hit a 17-year high. And the European Union expects the country’s economy to grow a mere 0.7 percent this year, compared with 1.5 percent for the United States.

“The outlook is mostly negative for banks in countries like Spain, Italy and Portugal,” said James Longsdon, managing director in Fitch Ratings’ financial institutions group, in London.

Other banks are hoping the sale of so-called noncore assets in overseas markets will help to increase their capital reserves. The fire sale could be enormous. The European financial sector is expected to sell or write down more than $1.8 trillion in loan assets during the next decade, according to the consulting firm PricewaterhouseCoopers. That compares with just $97 billion from 2003 to 2010.

Last week, the Royal Bank of Scotland, which already has met the European Banking Authority’s capital requirements, sold its aircraft leasing business to a consortium of Japanese companies for $7.3 billion. Ireland’s nationalized Anglo Irish Bank also has offloaded $3.3 billion in commercial real estate loans in the United States to Wells Fargo. In all, the Irish bank wants to cut nearly $10 billion in American loans as part of a government requirement to reduce its assets and trim its operations.

Potential buyers, including American private equity firms, are lining up to take advantage, though analysts say the amount of assets up for sale will depress prices. That could reduce the impact on banks’ capital reserves. Local European politicians also may block deals that they believe will hurt domestic consumers.

“Banks may be restricted on deleveraging within Europe,” said Simon McGeary, managing director for European new products at Citigroup in London.

Banks also are restructuring their balance sheets to squeeze out extra capital. In a move known as liability management, banks can improve capital levels without raising additional funds. The strategy involves buying back or exchanging hybrid securities — investments that pay dividends like bonds, but can be converted into equity — at a discount from investors.

Under accounting rules, financial institutions can then book the difference between the original face value of the securities and the current discounted price as a profit toward core Tier 1 equity.

The strategy has been popular. Morgan Stanley estimates financial institutions, including Commerzbank of Germany and the Lloyds Banking Group of Britain, will raise a combined 8.7 billion euros by buying back, or exchanging, hybrid securities from investors.

The adjusting of companies’ balance sheets also includes so-called capital optimization, which involves tweaking banks’ back-office systems to free up funds to meet the capital requirements. Credit Suisse estimates that Spanish banks, which must raise a combined 26.1 billion euros, could free up more than 3 billion euros by fine-tuning how they use capital without raising any new funds.

“The only way for banks to succeed is to be more efficient with the limited capital available,” said Steve Culp, global managing director of the risk management practice at the consulting firm Accenture in London.

Banks, particularly in struggling southern European economies, may eventually have to turn to government bailouts. Deals already have been announced. In December, the National Bank of Greece and its local rival Piraeus Bank sold a combined 1.4 billion euros of shares to the government to increase their core Tier 1 ratios.

“There’s no magic bullet to this problem,” said Karl Goggin, a banking analyst at NCB Stockbrokers in Dublin. “The market has a finite appetite for banking stocks, so governments may have to step in.”

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Greece Feels Push Toward Euro Exit

In fact, that is the sentiment a growing number of reputable economists and other commentators, particularly from fully liquid Germany, have been expressing lately.

Greece, they say, should leave the euro zone for its own good, as well as the Continent’s. Some German economists argue that other members of the 17-nation currency union, like Portugal or even Italy, might need to leave as well.

“It is better for all concerned, in particular for Greece, if the country leaves the euro temporarily,” Hans-Werner Sinn, president of the influential Ifo Institute at Ludwig Maximilian University in Munich, wrote in an essay published two weeks ago.

Continuing to throw money at Greece will only reduce incentives for the country to restructure its economy, he and other experts say, while pushing Europe toward a so-called transfer union where the stronger countries are required to prop up the weaker ones.

As it turns out, there is no provision in E.U. law for a member to be ejected, according to legal experts. Greece would have to withdraw voluntarily. But if the other countries cut off aid, it might have little choice.

Among European economists outside Germany, the idea that a country should be put under pressure to leave the euro zone is regarded as reckless and cruel. Greek banks would fail, the country would default on its debt and would lack a credible currency with which to buy essential imported goods like oil or even food. The whole euro area would suffer as investors feared the disintegration of the currency union and perhaps even the European Union itself.

“It’s very risky,” said Silvio Peruzzo, an economist in London for Royal Bank of Scotland. “It would set a precedent for other countries leaving the region, and the market would start to flirt with the idea that the euro as a whole doesn’t make sense.”

But in Germany, with its embedded fear of inflation and insistence that individuals should suffer the consequences of their actions, the idea that Greece should just leave is gaining wider currency, even in elite circles.

Otmar Issing, a former chief economist of the European Central Bank and one of the architects of the common currency, has implied that Greece should exit.

Asked about his position by e-mail, Mr. Issing answered indirectly, saying that countries that break the rules of monetary union — as Greece did — should have to fend for themselves.

“If a country does not comply with the conditions agreed on, it should not get further financial aid,” he said. “A country which does not get further support has to decide what to do.”

Mr. Issing and Mr. Sinn are both extremely influential, and their thinking provides an intellectual foundation for opinions widely held by ordinary Germans. Chancellor Angela Merkel is facing intense pressure within her own center-right party, some of whose members are pushing for a special party congress to discuss the debt crisis.

Meanwhile, such German attitudes get plenty of publicity in Greece and other stricken euro countries, where they feed stereotypes of arrogant, domineering Germans and stoke the resentments that are already deeply straining European unity.

Greeks, it seems, are as fed up with Germany as Germans are with Greece. As plumes of tear gas bathed the streets of Athens in June, for example, many protesters volunteered that they wanted the drachma back.

“We don’t care about staying in the euro,” said one protester, who gave his name only as Dimitris. “It would be costly, but at least with the drachma we would be able to control our own currency and our own future.”

Greeks have still not gotten over a cover of the German magazine Focus last year that depicted the Venus de Milo raising a middle finger. “Cheats in our euro family,” said the headline, a reference clearly aimed at Greece.

“People believe Greeks don’t pay our taxes and we don’t want to work,” said Christos Manolas, a Greek businessman. “That’s a myth perpetuated by the Germans.”

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News Analysis: E.C.B. May Be Winner in Debt Talks

The E.C.B. lost the battle to prevent European leaders from precipitating a partial default of Greek debt. But, after meeting with Ms. Merkel and other leaders in Brussels Thursday, Mr. Trichet appeared to have won on a more important issue: getting governments to reclaim the task of preventing collapse of the Greek economy, as well as wider responsibility for fiscal performance of the euro area.

“Have they backed down?” Peter Westaway, chief European economist at Nomura International, said of the E.C.B. “To an extent they have.” But in the process, he and other economists said, the central bank extracted concessions that allow it to spend less time saving Greece and concentrate on its day job, overseeing monetary policy.

“The E.C.B. is trying to resist anything that makes it look like monetary authorities are taking on a role that governments should be taking on,” Mr. Westaway said.

Mr. Trichet won commitments from governments in Brussels on another longstanding demand. Political leaders agreed to take more concrete steps to reduce their debt and ensure that the Greek disaster does not repeat itself in some other corner of the euro area. Euro area countries promised to cut their budget deficits to below 3 percent by 2013, in line with limits set by treaty but widely violated.

The European countries also agreed to support Greek banks, another task that has been handled primarily by the E.C.B. And the leaders will do more to help Greece fix its dysfunctional economy.

“The decision of member states and of the commission to mobilize all resources necessary in order to provide exceptional assistance to help Greece in implementing its reforms is very, very important,” Mr. Trichet said in Brussels on Thursday, according to Reuters.

A high-ranking monetary policy official, who could not be quoted by name because of the sensitivity of the matter, said, “We got what we wanted.“

Since the debt crisis began last year, there has been a strong temptation for Ms. Merkel, President Nicolas Sarkozy of France and other leaders to let the E.C.B. do the heavy lifting. Unlike the politicians, Mr. Trichet and his colleagues on the governing council cannot be voted out of office and were able to act more decisively. The E.C.B. also has extensive financial resources and does not need an act of Parliament to deploy them — though it always took pains to avoid any appearance that it was printing money.

But, though Mr. Trichet always framed the E.C.B.’s actions in terms of monetary policy, he faced increasing criticism that the bank had compromised its sacred independence from politics. He was clearly annoyed at political leaders for their lack of stronger action. During a meeting last year, he even got into a shouting match with Mr. Sarkozy, according to several people present.

The package announced in Brussels late Thursday shifts responsibility for a number of key tasks from the E.C.B. to governments. For example, the European Financial Stability Fund will have the power to buy government bonds on open markets to stabilize prices, allowing the central bank to wind down its own highly controversial bond-buying program. The decision in May 2010 by the E.C.B. to begin buying Greek, Portuguese and Irish bonds split the bank’s governing council and has left the bank with billions in distressed debt.

“It is no longer necessary for the E.C.B. to do this job, which is a plus for the E.C.B.,” Jörg Krämer, chief economist at Commerzbank, said in Frankfurt.

European leaders will also guarantee the quality of Greek bonds even if some ratings agencies declare the country to be in partial default. Fitch Ratings said Friday that the plan to extract a contribution from bond investors would in fact constitute a restricted default.

The European Union guarantees mean that the E.C.B. can continue to accept Greek bonds as collateral for short-term loans, maintaining the flow of E.C.B. funds to Greek banks which are shut out of international money markets.

“In our view this is a very important sign of institutional respect from Europe to the E.C.B.,” analysts at Royal Bank of Scotland said in a note Friday.

Analysts cautioned that the rescue plan, outlined in a four-page statement by European leaders Thursday, was short on detail. It is not clear, for example, if the euro area countries are committing enough money to support the Greek banks, Mr. Krämer of Commerzbank said.

He was also skeptical of promises by leaders to do a better job policing each other’s fiscal discipline. “I have heard this for 15 years,” Mr. Krämer said. “I don’t believe it. The E.U. is a consensus driven club. You can’t force other coutnries to do this or that.”

Jens Weidmann, president of the German Bundesbank and a member of the E.C.B. governing council, implicitly greeted the greater willingness by leaders to take more responsibility.

“It is decisive for monetary policy during this sovereign debt crisis that no further risk be transferred to the Eurosystem, and that the separation between monetary and financial policy not be further weakened,” Mr. Weidmann said in a statement, referring to the network of European central banks.

But, in a sign that not all members of the governing council are happy with the agreement, Mr. Weidmann also criticized what he said was a major step toward collective responsibility for the mistakes of individual states.

“This weakens the fundament of a monetary union built on individual fiscal responsibility,” Mr. Weidmann said in a statement. “In the future it will be even more difficult to maintain incentives for solid financial policy.”

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