Mark J. Grant
November 8, 2012

While the citizens of Athens rioted and threw Molotov Cocktails outside of their Parliament the elected officials narrowly passed the new austerity measures demanded by the Troika last night. They have a budget vote left, likely to be passed, and then the focus will shift to the IMF and the European Union and whether they will fund and how it will be done. The Greek government says it will run out of money on November 16 and the country has debt payments to be made on November 21. Last night’s vote in Athens was only the first page in the current chapter and there are a number of open questions left. Prepare for the European ‘fiscal cliff’…

Will the IMF fund?

The International Monetary Fund has said that they will not unless it appears that the Greeks can pay back their debt. With an actual debt to GDP ratio now around 800% I think it can be said with certainty that the task is impossible even as the Troika says the same ratio is 190%. The difference between my number and their number is just what is counted. I count in exactly the same fashion as IBM or GE tallies up their balance sheet. I include all of the liabilities of the nation and then divide by them by their steeply declining GDP or revenues. I include the direct sovereign debt, bank debt guaranteed by Greece which is mostly used as collateral at the ECB. I count their $90 billion in guaranteed derivatives and I include the corporate debt in Greece that is guaranteed by the country along with their regional debt that is Federally backed. When all is said and done you arrive at my number by simple arithmetic and then division. The IMF has suggested that the ECB and the EU should take losses on their holdings, which both have refused to do to date,  and so the IMF may refuse to fund either their part of the next tranche or provide any new money for the two year extension that has been asked for by Greece.

Will the European Union Fund?

Several countries such as Austria, Finland and the Netherlands have stated publically that they will not use any more of their country’s money for Greece. We shall see. Then there is the two year extension of payments asked for by Athens which would require another $40-50 billion in additional money and who is going to pick up this bill remains an open question. We may have reached the point in the road where new debt to pay off old debt coupled with a total increase in the debt burden is no longer politically acceptable to some nations and so gets quashed as Freya and Athena are locked in mortal combat. The tranche payments plus the extension payment total $78-88 billion and I expect a significant pushback from a number of nations. The PSI card has been played, the shove it under the rug card has been played, the hide the bacon card has been played, the band of brother’s card has been waved around and now, like at the end of a long drawn out dinner; who is going to pick up the tab?

Cliff Hanging

Make no mistake; we are caught between three cliffs at present. Each of them presents a systemic challenge. The first is Greece because with a total of $1.5 trillion in debts a default would be cataclysmic. The next abyss is labeled “Spain” because they will be forced to the wall and the total price tag will amount to around $400-500 billion in my estimation. This includes bank debt guaranteed by the nation, their sovereign debt plus the regional debt that has been guaranteed by the nation. The actual debt to GDP ratio for Spain is about 245% and not the 90% number concocted by the EU to give the illusion of a prettier party dress. So much for all of the pledged money in the ESM fund; all gone and thanks for all the fish. Finally we have the “Fiscal Cliff” in the United States where some combination of entitlement’s reduction and new taxes will get implemented hopefully. These three and quite clear “Cliffs” should be bringing you back to Grant’s Rules 1-10: “Preservation of Capital” because if anything goes amiss on any of these dangerous walks then systemic shock could develop and your portfolios could take massive losses. Coupling the “Cliffs” with a stark recession in Europe and its contagion, a significant slow-down in China, declining earnings in America and you can begin to see the seriousness of our economic and markets position now; a lot of risk!

“There she stood discussing financial prudence with the Munchkins. The road did not need to be yellow and money could be saved by leaving the bricks in their natural state. The Lollipop Guild did not need to have any more galas and the Lullaby League needed to cancel their annual dinner. She was shouting and waving her wand like the silly scarecrow trying to ward off the crows and then Dorothy’s house fell on her head. Had she only looked up; the Wicked Witch of the East would have been alive today. Always remember to look up!”

                     -The Wizard

A Simple Solution

I am a conservative fellow by nature; my Kansas City roots I suppose. I am good with some risk positions but I also want to go to bed at night without undue worries spilling over into my sleep and creating unpleasant dreams. I will forego certain opportunities to achieve a good night’s sleep. No matter which way we turn now we are faced by three rocky cliffs that cannot be ignored and any one of them could send the equity markets into a tizzy which is why I suggest bonds and senior debt as a much more comfortable place to park your cash. We have seen a tremendous compression in bonds by the way during the last four months so that the combination of the coupon and the appreciation has performed equally well, if not better, than the performance of the stock markets. In the case of America there is also the possibility and the odds are at about 90% here that many people and perhaps institutions are going to be faced with higher taxes. If you consider this carefully and toss in the comparison of “A” to “AAA” rated securities on an apples-to-apples basis then you have to look at Municipal Bonds as maybe the best answer to the use of money now as many yield significantly more than their taxable counterparts even without including the tax implications. There is decent liquidity in the Muni Markets and some of the balance sheets, especially of the States, are far superior to the balance sheet of the nation. If the $600 billion “Fiscal Cliff” of the United States is to be solved then I think you will see a substantial amount of compression in Municipal Bonds as people and institutions recognize the significant value of their safety and of their yield. Think what you like but present circumstances force the quote from the Wizard of Oz:

“Toto, I’ve got a feeling we aren’t in Kansas anymore.”


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