A plan that works

Nomura has initiated coverage of the newest listed members of the Spanish banking community - Bankia, CaixaBank and the much smaller Banca Cívica. Faithfully reporting respective ratings of 'reduce', 'neutral' and 'buy', the English-language press seems, nonetheless, to be lacking a certain amount of detail. Spanish investors, however, have not failed to note that the last of the three was assigned a target price of 4.40 euros by the Japanese brokerage. With the stock trading a touch shy of 2.30 at the time, that represents a projected upside of about 90 percent.

We congratulate the principals, led by Caja Navarra, of this fusion of ex-cajas de ahorros because - and this might be of interest to investors that give some weight to less formal information - they were the only grouping of savings banks that was not dragged, kicking and screaming, through the door that turned them into listed banks. They were the first to announce that they were going public, the first to demote the importance of their regional components behind the banner of the new bank and the first to devise a marketing plan as a reborn entity. That there was a considerable delay in coming to the market was because other cajas continued to sign on to the program - under the same conditions.

They deserve the recommendation if for nothing else than their seriousness.

Compare this admission of failure and determination to find a solution to any of the others - including Bankia, which was plagued with internal power struggles right up to its IPO date. Or NovaCaixaGalicia which can't accept that their books don't balance and whose rotating presidency plan (not to mention its unpronounceable name), meant to calm local jealousies, is a loser. Or CAM - now intervened and soon to be auctioned off by the FROB - financial arm of the provincial fiefdom of Alicante (controlled by one PP politician and one large builder), which to the moment of its death could not comprehend that the mushroom model of business practice just didn't cut it any more.

----------------------------

Doth Fritz protest too much?

As bad as we'd imagined

Economics Intelligence puts it succinctly:

It takes a Nobel laureate to talk about banks, hedge funds and financial intermediation for half an hour without even mentioning the current financial crisis. Myron Scholes, the creator of the Black-Scholes formula who received the prize in 1997, accomplished this amazing achievement last week in Lindau, Germany.

Stiglitz's presentation is worth half an hour of the reader's life, however. The high point is possibly when he points out that the Federal Reserve Board's model of the American financial system does not include an input for the banks.

----------------------------

In a subjunctive state of mind

Used primarily in modern times to provide the emotional underpinnings of boleros and Johnny Hartman ballads, the subjunctive mood fell into near total disuse in the English language over the course of the twentieth century. One of the regrettable results of this loss of communicative precision is that it has become seductively and irresistibly easy to present purely hypothetical proofs as if they were factual. Had it never taken place the human race might have ended up not being subjected to an unending barrage of contrafactual non-events posing as evidence supporting various indisputable tenets of finance and economics.

The uproar raised by the folks pictured above when, on August 12th, a number of eurozone countries temporarily banned the short sale of financial stocks and derivatives provides a pertinent example. The Millionth Monkey puts it best:

There are those who say the upcoming short selling ban in all stocks in Italy and France, which according to CNBC will take place as soon as after the close today, or in one hour, will be beneficial to stocks. Then there are facts. To those who may have forgotten, on September 18 (ed. 2008), the SEC banned the shorting of all financials here in the US. Below is a chart of the carnage that ensued... The same chart is coming to Europe first. End result: 48% drop in under a month.

Lacking the grammatical tools necessary for the task, what the intellectually challenged (and incredibly confused about the temporal order in which arguments are presented) writer of that piece is attempting to claim is that if the SEC were not to have banned short sales on financials three years ago that the outcome with respect to US banking stocks would not have been materially different. It’s that simple – the SEC kicked out the hyperthyroidic short specs and the market crashed anyway. Kindly, for its part, nature has recently provided us with a second opinion on that relationship – the Europe to which their chart is ‘coming to’.

Assuming, correctly we believe, that the effect of the directive can be measured from the moment that the rumour mill declared it a done deal and the shorts started covering in earnest – the lows of August 11th – the following lists the performance of various Eurostoxx banks affected by the ban through this Friday’s close.

Santander - +8.5%
BBVA - +6.9%
BNP Paribas - +2%
Credit Agricole - +10%
Intesa - +5%
Societe Generale - +6%
Unicredit - +1%

German Banks, however, were not subjected to the indignity of a prohibition.

Deutsche Bank - -3%
Commerzbank - 0%

We’ll take all this resultant calmness in the market as an incipient proof of the point we made the day after the ban was implemented – that the short position statistics, at least in the case of Spanish banks, indicated that ‘real’ money was not participating in the sell-off. Under circumstances like these, in other words, the strategy works.

Had the ban not been implemented, and were the banks to have ceased to fall further regardless, then the other possibility would have been that the market authorities have entered into the game of market timing by hiring a CTA to bolster their staff. The chart on the left shows the Eurostoxx 50 support level at which the intervention was effected.

Nice play, guys.



----------------------------

The big pow-wow

In recognition of this week's celebration of the economics version of the Nobel Laureate Meetings at Lindau, we present a statement uttered by Friedrich Hayek in his acceptance speech for the 1974 Nobel (from Wikipedia):

In his speech at the 1974 Nobel Banquet Friedrich Hayek stated that if he had been consulted whether to establish a Nobel Prize in economics he would "have decidedly advised against it" primarily because "the Nobel Prize confers on an individual an authority which in economics no man ought to possess... This does not matter in the natural sciences. Here the influence exercised by an individual is chiefly an influence on his fellow experts; and they will soon cut him down to size if he exceeds his competence. But the influence of the economist that mainly matters is an influence over laymen: politicians, journalists, civil servants and the public generally."

Aside from the above noted position of influence attained by, and the one million euros currently presented to, a winner of this award, it appears that another benefit conferred by the prize is that the average lifespan of a Nobel laureate is no less than 1.4 years greater than that of his or her immediate peers. The curative powers of an inflated ego, it seems, is the cause.

The event should be good. Price-as-God cheerleaders Myron Scholes and William Sharpe being forced to endure a Joseph Stiglitz rant on the failure of economics.

----------------------------

Trading Places

Finally catching on to a point that Ibex Salad has been making for a long time, El Pais yesterday published an article* on the fairly remarkable progression of Spanish exports over the course of the current recession. The title says it all (translation ours) - 'For the first time, Spain sells more to the EU than it imports'. A glance at the chart on the left confirms this general trend. The number has been positive with respect to the eurozone countries - those with which Spain is presumed to be a weaker partner in a common currency death dance - for 7 of the 9 months leading up to June. Currently at 493 million euros, the improvement since the low of the 3 months ending December 2007 is no less than 12 billion euros. Turning positive for the first time, the balance with respect to the OECD nations has turned around to the tune of 16 billion since the same date.

There are those, however, who would have it that the trade balance figures are primarily a relic of a flat, or recessionary, Spanish domestic economy consuming fewer imported goods. Certainly not irrelevant, but the pictures on the left of actual exports might put paid to that notion. Sales to the EU 17 made an all-time high in May. To the OECD, surpassed the April, 2008 record last March - and remain above through June.

Just for a bit of colour we add two countries with which Spain registers a trade deficit. Exports to Japan are at all time maxima, but the case of China is certainly worth noting. Total exports to that great devourer of the world's current accounts have nearly doubled since the 2009 depths of the crisis.

Of course, we couldn't possibly post a piece on external trade without taking another shot at that most dangerously useless of economics constructs - the real effective exchange rate. According to the Bank for International Settlements' disclaimer to their REER series:

Looking carefully at all the different measures of competitiveness cannot but instil a good deal of reticence about basing strong conclusions on any one measure.

As if to prove their point, the BIS July, 2011 calculations for Spain, Germany and China report, respectively (and keeping in mind that a higher value implies lower competitiveness), figures of 101.73, 95.45 and 117.86. We sincerely hope that the Chinese government has taken note of the imminent demise of its economic model.

*Those who don't read Spanish will have to cut the Google Translate version a whole lot of slack. It's terrible - and for no good reason.

----------------------------

Is that clear then?

What better than an election - an early election - to add some confusion to a situation. On the heels of the Spanish opposition PP's promise to reintroduce the principal residence tax deduction (worth maybe 400 euros a year to most home owners and abolished only in January) the governing PSOE has now decided to reduce the value-added tax rate on purchases of new homes, which they raised from 7 to 8 percent a year ago, to 4 percent. Long sentence. Have we got all that?

In point form...

July, 2010 - PSOE guv raises new home VAT from 7 to 8 percent;

January, 2011 - PSOE eliminates income tax deduction for principal residence for most owners;

July, 2011 - opposition PP (almost a shoe-in to win November elections) promises to reinstate said deduction;

August, 2011 - PSOE lowers VAT to 4 percent.

Real estate promoters and builders seem to like this plan. The degree to which it helps out banks which own repossessed homes is not entirely clear. The Spanish legal definition of a new home is that which is described as obra nueva in the deed. Repossessions that actually were recorded as a change in ownership in the property registries will not be able to avail themselves of the new regime. Those that were transferred prior to their first registration will.

We suppose it will bring some buyers out of the woodwork, but nothing works as well as the expectation of higher prices in the future - and it will be a long time before it gets to that along the Mediterranean coast.

For those with an immediate interest, the new measure is already in effect.

----------------------------

The trend continues

Markets are still a long way off last week's intraday lows, but today's big ugly continued to improve the outperformance of Spanish banks. Now at +14.5% with respect to a basket of German, Italian and French large banks, the spread is 2.5 points wider than last Friday.

For readers who don't have time to read the whole, very good article, a quick look at the tables and charts in an August 12 post at Logic of Finance might go some way to explaining what, to some, may be an anomaly.

Great publication, btw, for those who don't have some sort of moral objection to people who do their own research - before coming to conclusions.

----------------------------

All risks, all the time

If any phrase were to describe the editorial policy of FT Alphaville it might be, 'All risks, all the time'. So we were more than slightly surprised to find them this morning touting a blog post by Eric Falkenstein entitled, 'A Perennial Risk Problem', in which the writer complains that merely reporting everything that might go wrong, without any attempt to prioritize by cost and probability of occurrence '...is quite useless and not profound'. The take-home sentence from the piece is:

'Enumerating a long list of disparate things that may happen, without any probabilities, may work for Nouriel Roubini, but he's a charlatan'.

An apt explanation as to why Ibex Salad has transformed itself from being a quaint expression of its writer's parochial interests (if not his grotesquely inflated self-image) to actually having an entry category entitled 'Press and blogs'. Readers seeking to assign blame for this transformation could do worse than spend a couple of hours on a fog-bound day going through Edward Hugh's 'Spain Economy Watch'.

Let there be no misunderstanding here - we are not meaning to imply that FTAV or its writers are no more than a collection of mountebanks. But, just as investors are required in many jurisdictions to disclose whether they hold investment positions in securities mentioned in a given piece, perhaps some public admission that they and the grand part of the world's 'information' providers - due to the sociology that determines readership share and, thus, content and profitability - currently hold massive long positions on disaster would be in order.

We can think of various ways to do this, but would be more than satisfied if the disclaimer attached to any article were a mere 'If it bleeds, it leads'. In the case of the Spanish press, they could add, 'Si un anglo lo dice, se lo repite'... for example.

----------------------------

Spanish home sales stats

We don't know if we're being passé or merely retro, but here's our now less-than-regular glimpse at Spanish home sale statistics. Most notable, of course, is the continuing effect of spikes in activity last year - both related to changes in the tax treatment of purchases. In one year, we have consequently seen two multi-year highs - and two series lows. Mariano Rajoy, for his part, is now adding to the confusion by promising that the PP, if elected November 20, will reinstate the income tax deduction for a principal residence - with retroactive effect. Knowing politicians and their promises, exactly who is going to sink their money into a new home until he makes good on his word? Or fails to.

Meanwhile, trailing 12-month sales continue their downward drift. Currently at 422 thousand, we can imagine them hitting 400 before Rajoy clears the air on this matter and banks solve their reported liquidity problems.

Long time readers will remember when we railed and ranted about the inadequacy of using the unadorned American-style house price-to-income ratio to measure the affordability of Spanish homes (newer victims might poke around the 'real estate economy' category for the autumn-winter of 2009-2010). With regard to our incessantly repeated point that home ownership costs not related to purchase price or financing were so much higher in the U.S. than in Spain that they rendered any analysis based on price alone utterly inane.

Those familiar with Spanish carrying costs (and still interested in the matter) should take a look at this NPR article on what American banks are financially up against with their stocks of foreclosed residences. Or they could go and look at Credit Sesame's interactive map showing average property taxes in all 50 U.S. states. Placing the mouse pointer over any state produces statistics to the right of the map.

Louisiana is the state in which annual taxes as a percent of house value, for example, most approximate the same in Spain.

----------------------------

Fascists in the faculty

We are, admittedly, not very big fans of the indignados movement that took over Madrid’s Puerta del Sol in the lead-up to May elections. We think that what we privately refer to as the 'Gravy Train Revolution' is making the ruinous decision to attempt to parlay a misdiagnosis of the malaise from which we currently suffer into a wholly inadequate cure. Nonetheless, we were impressed by the pacific and civic manner in which they expressed their grievances. So we’re going to do these people who were so quick to rightly dissociate themselves from the coincident violence that took place at the investiture of the new government of Catalonia a favour – and point out exactly how a recent, widely-circulated publication by two Pompeu Fabra economists describes their demonstrations as being equivalent to both riots and assassinations.

The piece, published in précis form last week by VoxEU (and since sleepily making the August rounds in the noise-o-sphere) and entitled ‘How much will they hate it? Unrest and budget cuts over the long run’, posits that a statistical analysis its writers have performed reveals a significant correlation between government cutbacks and social strife since the end of World War I. Penned by Jacopo Ponticelli and Hans-Joachim Voth, it’s a pretty curious piece of work.

At face value simply one of the millions of publish-or-perish studies that clog up the creative arteries of social science departments (Oops! We seem to be including economists) everywhere with attempts to render into numbers the comings and goings of the human parade, the article reveals a disconcerting ideological tendency.

A few quotes...

August 2011 has seen days of rioting in London and other cities in the UK. In Spain, demonstrators known as indignados recently occupied town squares and demanded a full-scale change of the political system.

What drives such outbursts of violence against property and people, leading to buildings and vehicles burned, confidence in civic institutions and the police severely dented, and ultimately lives lost?

We look at five different types of instability – anti-government demonstrations, riots, assassinations, general strikes, and attempted revolutions – in Europe over the period 1919-2009.

As expenditure cuts start to bite, the number of anti-government demonstrations, riots, general strikes, attempts to overthrow the established order, and political assassinations increases dramatically.

Are we the only ones to notice that two legally-guaranteed, democratic expressions of political will – the general strike and the demonstration - are thrown in the same insidious basket with armed rebellions, killings and incidents of mob rule?

Were Franco still alive, the generalísimo would be awarding these two authoritarian apologists a medal – not to mention tenure and a statue in some town square.

-----------------------

When the piece first appeared on August 10, it contained a phrase indicating that the correlation had ceased to be significant from the early 1990's. It seems to have since disappeared, but as the writers note on page 17 of the full-study pdf:

The fall of the Berlin wall saw the spread of Western-style democracy
eastwards. The overall connection between austerity and social instability now
changes sign, and becomes in (sic) insignificant.

----------------------------

A good trade, with reservations

What is fairly typical following a bout of panic selling and voracious shorting is that, when it is over, the names most castigated also rebound harder. Why, given that they were the least punished of most eurozone banks, the two Spanish international banks, BBVA and Santander, managed to continue to outperform their brethren - even on the reversal (adding another 1 percent to the spread, pushing it up to +12 since July 1) - is partly answered by a late Friday piece in FT Alphaville.



Written mostly in defense of their editorial stance against both the necessity and utility of the short sale restrictions put in place in four European countries, the post shows the readers the charts on the left showing the actual short interest (as a percent of float) for stocks placed in the no-fly zone. Among the details to be gleaned are...

First, as is Joseph Cotterill's main point, the shorts - especially in the case of the French market - were by no means all over these companies.

Second, Spanish stocks, which displayed the highest maximum short interest of all, saw their detractors increase their stake rapidly over the first three weeks of July before tailing off to some degree. French and Italian positions were already established before the breakdown, from which they marginally decreased.



Third, the large Spanish banks showed an average 22 percent decline from July 1 to August 13. The French and Italian (no chart for Germany included) banks, 36. A 14 point spread.

Fourth, this difference seems to show that 'real money' selling, accompanied by scarce replacement buyers, was a significant factor behind the Italian and French declines. In the case of BBVA and SAN, it seems that long term investors did not bail out en masse or that other buyers of the same ilk were glad to take up the offer. The heavy lifting here was done by that doubling of the short interest over three weeks - with apparently scant assistance from those with a more measured view of things. A stress test if there ever was one.

Money was likely made, but managers looking back on their bets will at least note the overly large opportunity cost of that concentrated bet.

Readers should note that the person who prepared the charts seems to have reversed the colour scheme in the Spanish version.

----------------------------

Leap of Faith

Circled on the liturgical calendar since the early years of Christianity, August the 15th marks the day on which legend has it that the Virgin Mary – with no lack of vitriolic dispute among the experts as to whether alive or dead at the time – was teleported from the earthly realm to her deserved place in the afterlife. Many Europeans, as well as all South Americans and the grateful folk that populate the Philipines, will be taking Monday off work to celebrate this event which, thanks to its elevation to the unimpugnable status of infallible dogma by Pope Pius XII, also honours the labours of economists throughout history – The Feast of the Assumption.

Perhaps, on this one day of the year that the coldly calculating practitioners of the dismal science (sic) might allow themselves to indulge in the mystical raptures more the turf of pneumatologists and return on Tuesday and reveal to the world exactly how the calculation of the real effective exchange rate manages to assign 116 to China – with its 22 billion euro trade surplus with Germany - and 95 to this latter.

Those not reborn by their religious experience will, rightly, answer that ‘it’s only an index measuring rate of change’. The chosen few, however, will actually come to question what in heaven’s name the REER is actually good for.

------------------

As for reading material for this long weekend, we recommend a piece by an essayist who really knows how to use a metaphorical hook to seduce the reader into reading ostensibly dry material. Writing in the most recent Vanity Fair, Michael Lewis weaves a tale that takes the reader from an anthropologist’s study of German folklore into the more current matter of how many of Germany’s banks were disastrously duped into buying repackaged American mortgages (and Greek government debt). It’s seventeen pages long and worth every minute devoted to it.

Readers, for their part, might note the point in which an interviewee describes Germans as people who do not think the other party to an interaction is lying – and imagine what domestic mayhem can break loose when they find themselves married to a culture that has not the slightest expectation that the counterparty to even the most banal of street corner conversations is actually telling the truth. Forget Greek economic competitiveness, Spanish labour market rigidity or any of the myriad other assessments of the dilemma. This is the unbridgeable divide that separates the north from the south of Europe.

----------------------------

Random rubble observations

The chart is a continuation of the point we made about sovereign risks as perceived by the stock market 3 weeks ago.

On a similar tack, the ECB bond buying program, put into effect on Monday, has succeeded in bringing yields at 10 years and under back into the lower part of the range set by Angela Merkel's burden-sharing proposal. If it were accompanied by spreads under 200, we'd think it successful. But 270 seems to be the number for the Spain 10-year. They're going to have to throw more money at the problem.

Interestingly, longer-dated yields have crashed right through that barrier. Reports, however, have it that the ECB has been buying 5's and 10's.

Have readers noticed how many public commentators are touting this rout as a buy opportunity? When the mainstream press and the pro's both simultaneously agree that dividends are the play - beware. There's something wrong with that picture.

----------------------------

Party over?

A short note on the risks of spending too much time entertained by brightly coloured figures moving about on one's hand-held device whilst riding a bicycle.

The market's five-week long fixation on headlines emanating from Brussels, Frankfurt, Madrid, Rome or Washington came to an end on Wednesday with the sudden realization that it had managed, in its rapture, to blindly pedal from the credit crisis fairground on to the economy autobahn. The result is obvious on the left.

The industry-stacked Dax underperformed the bank-heavy Ibex 35 by about 3.2 percent over the course of the mayhem.

Of course, this may all be an irrelevant sideshow, what with a certain palpable sense of panic in the air with respect to Monday morning.

----------------------------

Rolling Over

With a 3- and a 3 & 1/2-year (an off-the-run 5 from 2010, actually) being auctioned tomorrow by the Tesoro as secondary market yields spike, it might be interesting to look at what it would cost them to roll various terms - this morning at 8:55, say*. Using average yearly yields taken from their statistics site and Bloomberg.

In the event that high rates continue for the next couple of years, the 3-year roll would be about 150 bps more costly in 2012 and 2013, the 5- about 55 cheaper, and the 10- about 100 bps more expensive by 2013.

*On the other hand, we could have done this at 9:50 and shaved 20 basis points off the whole thing. Was there an announcement, or something?

----------------------------