Some details of Basel III were explained this morning by Barclays Research:

“… The Group of Governors and Heads of Supervision – the oversight body of the Basel Committee on Banking supervision – announced the final version of the Liquidity Coverage Ratio (LCR), one of the new measures which is a key part of the global framework on liquidity regulation in Basel III . Basically, under the LCR banks will be forced to hold enough high quality liquid assets to survive a 30-day funding squeeze. The final version is more flexible with respect to the draft announced in 2010 as it widens the range of the assets eligible as high quality liquid assets in the computation of the ratio (it also includes equities and certain residential mortgage-backed securities, with proper rating limits and haircuts), and some easing in the rules for the computation of the net liquidity outflow. The timetable for the phase-in period was revised as well. While the introduction on 1 January 2015 was confirmed, a more gradual approach will be followed, as the minimum requirement will be 60% in the first year and then will increase by annual steps of 10% to reach 100% on 1 January 2019. Less strict liquidity rules should reduce pressure on banks, thus helping provide a further boost to confidence and the real economic growth, all else being equal. Also, this should ease the expected impact of the introduction of the LCR on money market functioning, in terms of lower bank participation in the very short-term interbank market, and particularly in the EONIA market”

Today, the Spanish government has announced that it will not revalue pension payments by the full amount due.  Just as I anticipated exactly one-month earlier on the backs of regional elections in Galicia and Basque Country, President Rajoy’s administration failed to fulfill the promise that it would not touch pension payments.

Come November, Spain’s pensions, which are tied to inflation, are reviewed annually and adjusted to the year-on-year Consumer Price Index (CPI).  Considering the preliminary reading of 2.9% for November out this morning, Spain’s pensions were supposed to be revalued by that amount if confirmed in the final CPI reading.  Instead, Spain has decided to increase pensions below €1,000 by 2% and others by 1% in order to be able to reign in costs and meet the deficit target.

The decision has made it evident that the announcement in the 2013 budget presentation to increase pensions by 1% was just a ploy ahead of the elections.  While the decision sounds like a popular move on paper, it conveniently left out what I consider to be the intentional scrapping of pension revaluations due in November.

As I mentioned would happen, Spain has simply revoked its practice of tying pensions to inflation, something that the European Union has long been recommending.  This would also help meet the terms of a potential bailout package.

A couple of months back, Reuters cited a source familiar with the government who suggested that officials were possibly preparing for this already.  “He just said that he would not cut the pensions. But did you hear anything else? We both know that there are several ways of cutting. One is to simply leave them steady against inflation,” the source said. ¹

One is forced to wonder why politicians can’t just come clean with those who voted them into office in the first place.  All we know is that the population’s most vulnerable continue to foot the bill.  Pension beneficiaries have just learned that they will continue to fall behind to rising standard of living costs.

^{1. http://uk.reuters.com/article/2012/09/21/uk-spain-pensions-idUKBRE88K07Z20120921}

Polls had been showing Rajoy lose support amidst massive demonstrations and the social unrest produced by his drive for spending cuts and tax increases. Remarkably, the victory in Galicia by incumbent Alberto Nuñez Feijó, fellow party member and Galician president since 2009, gave the party an additional 3 seats since the previous elections.

Election results in Galicia may have many scratching their heads because they do not appear to reflect growing protests over the unpopular spending cuts and tax hikes. However, the PP was re-elected thanks to a strong foothold in the region ever since the party was founded by another Galician, Manuel Fraga, who had strong ties with Franco’s dictatorship and aided the country’s transition into democracy. Galicia’s aging population is a party constituent with unwavering support that could be partially engraved in their DNA. They may see the party as a centerpiece to the country’s young era of democracy. Whatever the psychology is, PP voters appear to be the most loyal to their party.

Galicia’s aging society together with a slightly lower voter turnout and PSOE’s failure to unite the opposition votes may have handed the PP their landslide victory. The PSOE failed to profile itself as the main opposition party and instead lost votes to nationalist parties. Even the traditional nationalist party BNG failed to build on its voter base. The newly formed alternative nationalist party AGI, led by the eccentric Jose Manuel Beiras, picked up more seats than BNG. Beiras went as far as blaming Feijó for killing more people with his spending cuts than any terrorist group in Spain.

Many analysts saw these regional elections as a roadblock to a potential bailout request by President Rajoy. It was widely thought that Rajoy would put off a bailout request until after the regional elections in order to prevent backlash from additional demonstrations that were sure to follow. In fact, Rajoy has consistently held off critical decisions until elections in order to show that he counts on voter support. Galicia’s early elections (they were not due until May of 2013) are reminiscent of Andalucia’s elections last March when Rajoy postponed a budget presentation with deep spending cuts until after the elections.

But the mass media has failed to recognize that there is another critical decision that the elections were intended to preclude. PP ‘s “older crowd” supporters may have decided to give the party a vote of confidence after Rajoy comforted them with their single most important issue: pension plans. After all, Rajoy and his cabinet members decided to include a 1% increase to pensions in the 2013 budget presentation. What these pension beneficiaries fail to know is that the pay increase is a likely cover-up to an upcoming pension reform. Pension payments in Spain are tied to inflation and due for revaluation in November. Do not be surprised if Rajoy decides to obey the European Union’s long-advised recommendation to no longer adjust pensions for inflation. What was once an increase to pensions will quickly turn into effective pension cuts. On top of the higher standard-of-living costs driven by austerity measures, pensions will no longer keep up with prices.

Part of the overwhelming PP victory can be attributed to PSOE’s failure to unite most of the opposition votes. The appearance of a new left-wing nationalist party has scraped enough votes away from PSOE and BNG to become a major player. Voters scatted across these three camps are surely to feel even more frustrated than before. Street demonstrations and other protest movements seem to have suddenly lost credibility.

Finally, lots of credit must be attributed to the PP as well. Rajoy’s constant praise of Feijó and Galicia for having its financial house in order seems to be part of a reciprocal relationship that many Galicians hope will benefit them. Rajoy has consistently told them that Galicia’s relatively low regional debt was thanks to austerity efforts put in place by Feijó since taking office in 2009, well ahead of his own austerity drive when elected in late 2011. Meanwhile, Feijó put enough distance between himself and Rajoy, who only attended one campaign rally in Galicia. Feijó steered attention away from Rajoy’s unpopular measures with the campaign slogan “Galicia first”.

Things were a tad different in Basque Country. Regional elections there, on the same day, gave the victory to PNV, a nationalist party. Although its 27 seats fall short of the 38 needed to rule with absolute majority, an alliance with a smaller party will be enough to oust the current ruling coalition party, a rare alliance between the People’s Party and Socialist party. Coming in second place was EH Bildu, a pro-independence party that grew out of the political arm of terrorist group ETA. It also embraces parties that stood against violence. It will be interesting to see whether PNV will join with EH Bildu or non-nationalist parties in order to rule.

Although Rajoy will feel the comfort of strong backing from his home region, the results from Basque Country may be an indication of more separatist efforts to come on the backs of uprisings and calls for independence from Catalonia. On the other hand, Galicia’s results are deemed to be more indicative of sentiment country-wide than the results in Basque Country and Catalonia due to their history of separatist movements. Nonetheless, Galicia saw its own increase in nationalist support to the detriment of PSOE.

Partly due to wise politicking from the PP, albeit somewhat misleading, Rajoy has full sway to go ahead with the additional unpopular measures that may be attached to a bailout programme, at least in the short-term. By playing to his loyal voting base and having opposition split three-way, Galicia’s election results provided Rajoy with the justification that he wanted. But the protests and the social unrest will not let up.

Details of France’s 2013 budget are out and as expected the focus appears to be on the revenue side.

France will be increasing taxes on the 10% wealthiest individauls and on the largest companies.

Again, what matters is that France is confident about reaching its deficit targets…

The biggest concern about these budgets is that both France and Spain’s economic growth forecasts are being seen as overly optimistic.  The problem is that the announced austerity plans will not be enough if economic growth falls short.  Spain is expecting a -0.5% contraction for 2013 and France is expecting 0.8% growth, figures that some analysts say are too optimistic.

Early Morning

Judging by the market’s reactions, Spain’s budget was good enough to keep investors satisfied. With the controversy of increased taxes during a recession well documented by now, markets are perhaps taking their consolance from the Spanish government’s conviction that it will meet its deficit targets.

Continued skepticism over the use of austerity during a downturn is just more of the same. As such, there are really no surprises, what matters right now is meeting the deficit targets….

In regards to the 2013 budget, it did not remain clear from last night’s presentation whether pensions will continue to be adjusted for inflation. The +1% increase approved by Spain in all likelihood will mean that pensions will not be adjusted for inflation when they are up for review in November. In fact, this has been a European Union recommendation: not to tie pensions to inflation. The 1% increase may sound good to pension holders but in fact it may translate into a spending cut because it will reverse the CPI-adjustment policy and pension payments will fall short of the increase in standard of living costs. Spain’s CPI is around 2.7%. So don’t be misled by the headline, Spain will be saving 1.7% on its pension costs.

Next up today: We will see where France decides to get its savings from. While Spain announced that it adjustment focus was on the spending side.. France is more likely to fill its budget gap through tax increases…

“The first impression is good, heading towards a major adjustment in spending rather than in revenues,” said Jose Luis Martinez of Citigroup, in Madrid.

“However, we see as too optimistic the macroeconomic assumption of 0.5 percent recession for the next year. We see a scenario with a deeper recession and if this were the case, further spending cuts will be needed”.

8:03 Q&A session:

Montoro: 2012 budget deficit will be met yes and yes

18:00

De Guindos: measures are taken aimed at stimulating economic growth,

De Guindos: measures go beyond EU recommendations.

De Guindos: measures for job training and education.. for youth employment

De Guindos: improving human capital is essential to encourage economic growth.

De Guindos: Pension system sustainability is a priority for the government.

De Guindos: Changes will be made to early retirement plans.

De Guindos: Measures to improve efficient and quality of public spending.

De Guindos:  Liberty of merchandise transportation, homogenous legislation across regions

De Guindos: Encourage business spirit, reduce administrative work for small businesses

De Guindos: Will look to provide alternative financing options for small business, enourage acess to alternative markets (MAB)

17:49

Montoro: Total Ministry spending will fall below €40bn.

Montoro: Sizable cuts are not being applied to social program spending

Luis de Guindos now speaks….

17:40

Montoro: Spain will be closing the trade deficit gap…

Montoro:  Is confident about reaching the 2012 deficit target of 6.3%

Montoro: 2012 budget revenue estimates will be reached.

Montoro: New 20% tax on lottery winnings above €2.500.

Montoro: Taxes on short-term capital gains to discourage speculation.

Montoro: Large interest expenses on debt, €10bn interest expense as a result of spiraling debt situation that govt aims to prevent.

17: 20 Madrid time

Measures for small business/entrepreneurs..

liberalization of some key sectors in Spanish economy, such as services, telecom, education…

43 new laws to be approved or in process in congress..

More adjustment on the spending side than on the revenue side…

A subsidy for purchase of lower fuel-emission vehicles to dinamize the auto sector and lower gas emissions…

Soraya now turns to Montoro..

Montoro: 2013 budget is an extension of the fiscal adjust process started in 2012..

17:08

Representatives from Spain’s Council of Ministers have stepped up to the podium to give their press conference, an event that the global markets have been anticipating….

Deputy prime minister Soraya Saenz de Santamaria, finance minister De Guindos, and budget minister Montoro will be speaking…

63.5% of budget is social program spending…

Targeted 2012 revenue will be reached…

Budget calls on collective efforts to get out of the crisis…

Creation of an independent agency to monitor that budget targets are reached…

Measures to continue on the path of fiscal consolidation…

16:47

Some ‘mixed’ macroeconomic references have been released in the United States today. Most notably, weekly jobless claims came in slightly better than expected although durable goods orders for August were moderately weak.

US equity have opened with slight gains and on top of the jobless claims, the gains may be buoyed by speculation that China may approve new economic stimulus.

On the European side of things, Monti told Bloomberg that he does not rule out running for a second term in next spring’s elections: Monti Says He Won’t Preclude Second Term as Prime Minister

Spain is now expected to give an announcement on its 2013 budget at 17:00 Madrid time (16:00 in London)

14:48

More news out of Spain, now Castilla La Mancha is expected to ask for a €800m bailout from the country’s regional bailout fund. This leaves the fund with €2bn remaining for future bailouts.

13:44

The markets are waiting for the controversial 2013 budget to be presented by Spain’s Council of Ministers today.  Early reports say that Rajoy will freeze salaries for government workers but will give back the Christmas paychecks characteristic of the Spanish job market, where may employees see their annual pay split into 14 installments with two “extras” to coincide with the Christmas and summer vacations.  Rajoy eliminated the Christmas “extra” in 2012, having effectively passed a 7% pay cut for public workers.

And so, the 2013 austerity budget will soon be presented after two days of intense protests in the Spanish capital.

Bail-in before a Bail-out

A bailout, by definition, injects capital into a business and prevents it from filing bankruptcy, saving creditors. However, in this EU-backed bailout of Spanish banks, “the MOU indicates that preference shares and subordinated debt will be subject to significant burden sharing after allocating losses to equity holders,” reported Fitch Ratings on Thursday. “Burden sharing is increasingly common in recapitalisations of this type, but it has previously mainly affected institutional clients. This time it is likely to hit some of the banks’ retail customers, who were sold these instruments as a way to make better returns than through a deposit account.”

“Four banks classified as Group 1 under the MOU and which are already owned by the Spanish state’s Fund for Orderly Bank Restructuring (FROB) are particularly exposed. The total outstanding preference shares and subordinated debt at Banco Financiero y de Ahorros, (Bankia’s parent), Banco de Valencia,NCG Banco, and Catalunya Banc is around EUR13bn,” added Fitch Ratings.

“European authorities are pressing Spain to inflict billions of euros of losses on small investors by wiping out certain types of bank debt before its financial institutions are recapitalised using Eurozone rescue funds,” Financial Times wrote.

In this bailout condition, the European Union is forcing the more severely damaged banks to “bail in” before they are bailed out. “The reason it’s been so rare for the holders of senior unsecured bank debt to take losses is that normally they’ve ranked pari passu with a bank’s depositors in bankruptcy. Governments have tried to pick their way around that problem,” Joseph Cotterill wrote for Financial Times. Spanish banks are in a peculiar situation. Since bank depositors were commercialized these financial products, they are in effect ranked below senior debt.

Spanish bank customers are already feeling the pain

Spanish banks have already been inflicting losses on their depositors by offering them to exchange their preference shares into more liquid common shares as a way to meet capital requirements. These common shares were usually offered through new capital increases, diluting shareholder value. In one example, Banco Sabadell (which acquired Spanish ‘caja’ CAM) will offer to exchange CAM preference shares for Sabadell common shares at a price of €2.31 although they are actually trading around €1.40 in the stock market. That is a big haircut off their investments. These CAM investors, mostly bank customers who were misled into thinking that they were opening deposit accounts, now feel forced to accept the offer because the unwinding of CAM deems the preference shares worthless.

A similar situation has occurred at other Spanish banks, where preference shares issued among loyal customers were later exchanged for common stock, only to be diluted through capital increases. Similarly, Bankia decided to raise capital through an initial public offering, promoting the shares strongly among its customers while institutional backing was not very strong. The shares were priced at €3.75 during floatation. Today, the shares are in a free-fall, dropping below €0.65, an all-time low.

Senior bondholders may not be spared

Although the MOU appears to indicate that senior bondholders will be spared like in the Irish bailout, it is reported that the European Central bank may be shifting its view. “The European Central Bank, in a sharp turnaround, advocated imposing losses on holders of senior bonds issued by the most severely damaged Spanish savings banks—though finance ministers have for now rejected the approach, according to people familiar with discussions,” The Wall Street Journal reports.

Bank customers feel the pain

The MOU reveals that the European Union has made a strong move to limit costs to taxpayers. They are imposing a strong bail-in as a condition for the bailout. As a consequence, bank customers will continue to feel the pain that Spain has already begun to inflict on them.

Jose Pineiro

Such a scenario might provide Ireland, which has not yet returned to borrowing on the financial markets, a door out of the euro if it does not access funds elsewhere. Therefore, we can make the argument that there is a greater chance of a dismantling euro beginning with Ireland rather than Greece, which is undertaking special efforts to abide by Europe’s imposition.

A lot must still happen before arriving to a situation where Ireland decides to leave the euro. Also reducing that chance is the fact that Ireland’s economy makes up a small piece of the Eurozone puzzle. Observing the extension of the European credit crisis, nothing seems too far-fetched.

Otros analistas apuntan a estos datos débiles en un contexto de política fiscal.  Hay debate entre la necesidad de responsabilidad fiscal y la necesidad de gastos públicos para seguir estimulando la economía.  Uno de los partidarios más conocidos por insistir en que los gobiernos tienen que aumentar sus gastos es Paul Krugman, el premio nobel de economía en 2008.  El opina que sería un error grande recortar gastos durante un periodo de desempleo masivo.  Krugman es partidario de la teoría económica que dice que el gasto público es necesario durante la recesión para compensar por la caída del sector privado. Según él, las preocupaciones recientes sobre la deuda soberana fueron exageradas y opina que el estimulo tiene prioridad para el corto plazo.  También en estas líneas, opina que la Reserva Federal debe mantener los tipos de interés lo más bajo posible durante los próximos dos años como mínimo.  Como argumento a favor, Krugman cita a los datos de bajo inflación (otra área de debate son los riesgos inflacionistas).

Finalmente, mencionamos a un analista anónimo en SeekingAlpha.  El cita una grafica que muestra las diferencias en la distribución de la riqueza, lo cual indica que la diferencia entre los ingresos personales de los más ricos y de los más pobres esta en lo más alto desde la gran depresión.  Como indica el y otros analistas, la recuperación que estamos viendo no es de lo más sostenible.  Argumentan que las medidas fiscales se realizaron mayormente a través de rescates de las entidades grandes y que solo se beneficiaron unos pocos.  Este analista anónimo argumenta que la prosperidad económica no viene de los que están entre el 1% más ricos, si no que tiene que venir de las masas consumidores.  Se realizó el rescate de grandes empresas como a AIG, BoA, Fannie Mae, y Freddie Mack pero el problema está en que la ayuda no llega al contribuyente.  Algunos analistas son altamente críticos con el gobierno por salvar a los “culpables” y a perjudicar al contribuyente.  Este analista anónimo llega a declarar que el contribuyente va a llegar a sus límites.  Llega a relacionar la posible pérdida de tolerancia de algunos con la avioneta que chocó con el edificio de la hacienda la semana pasada en Texas. También cita un informe que indica un aumento de amenazas contra los cobradores.  Y si nos permite ser un poco sensacionalistas y añadir leña al fuego, ¿qué nos dice el caso del hombre que demolió su casa antes de que lo llevara su banco?

Sin llegar a estos extremos y reconciliando las diferencias de muchos analistas, opino que lo que hace falta es aprobar reformas y gastar sensiblemente.  Se teme que muchos de los gastos fiscales fueron despreciados.  Solo con reformas se puede intentar a respectar la responsabilidad fiscal mientras invertimos en verdaderos locomotoras de la futura economía.

Fuentes:
http://seekingalpha.com/article/190274-consumer-confidence-and-the-upcoming-double-dip?source=feed

http://krugman.blogs.nytimes.com/2010/02/23/a-hawk-for-all-seasons/

http://seekingalpha.com/article/189649-wealth-disparities-in-u-s-approaching-1920s-levels?source=article_sb_popular

But of course, to get the most out of this education, we must know how to read into the stories that reach our screens and get to the bottom line of what is happening in the marketplace.

The public debt markets have caused panic.  This time, the stock market isn’t the main culprit.  When Greece had problems in covering its bond issuance, an alarm was sent to the rest of the world. The fact is that Greece has a large budget deficit and investors fear that the country might become insolvent.  The yield for Greek bonds and the spreads on sovereign debt CDS jumped higher.  The problem started there but given that we all run on our human emotions, fear was compounded exponentially and the main topic covering the news waves was that fiscal deficits must be controlled immediately.  All of a sudden, other countries were facing the same predicament, credit ratings were threatened, and even the integrity and unity of the European Union was threatened.

What is the bottom line that I am getting from all of this?  Well, the answer that I find, the true bottom line that I could gather is that the markets are signaling inflation.  Most likely, the debt markets have ran their course; they have provided all the liquidity that they can, and most likely, the market is starting to become flooded.  That is the signal that the Greek debt market has provided us!  Why Greece?  Well, it is obvious that pressure will begin at the weak spots.  The fiscal deficit is a true concern.  For Greece, the deficit is a large proportion of its GDP but the European Union requires it to fall to 3%.  Savvy investors now this and when it came time for Greece to issue their bonds, only a significant spike to yields would allow it to find enough buyers to cover its issuance.  It started with Greece but only because countries compete against each other in the bond market.  The “fiscal spending cuts” part of this cycle/crisis has arrived.  My conclusion: Bond yields will rise globally!

• -GDP growth not coming from consumers, coming from inventories buildup based on expectations of economic recovery.
• -Withdrawal of economic stimulus programs
• -High budget deficits and tendency towards cutting of government spending
• -Risk of inflation and rise of market interest rates
• -Tendency towards protectionism policies. Also, E.U. and its members under pressure.
• -Employment creation is lagging. High unemployment, which is very important for private consumption, is still a big factor.