Monday, 06 December 2010 20:29

The Truth Behind Portugal's Inevitable Default - Arithmetic Evidence Available Only Through BoomBustBlog ^Featured

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You don't need a "wikileaks.org" site to reveal much of the BS that is going on in the world today. A lot of revelation can be made simply by having motivated, knowledgeable experts scour through publicly available records. I'm about to make said point by showing that the proclamations of the ECB, IMF, the Portuguese government and all of those other governments that claim that Portugal will not default on their loans is simply total, unmitigated, uncut bullshit nonsense.

If you recall, I made a similar claim regarding the Irish government and posted proof of such, see Here’s Something That You Will Not Find Elsewhere – Proof That Ireland Will Have To Default… November 30th, 2010.

For those who wish to skip my market commentary and feel you may already understand how to interpret the output of the restructuring model, go straight to the haircut analysis by simply clicking this link and scroll to the bottom until you see the live spreadsheet. For the rest, let's start by looking at it from the German's perspective as reported in Bloomberg: Germany Snubs Pleas to Boost Aid, Sell Joint Bonds

Germany rejected calls to increase the European Union’s 750 billion-euro ($1 trillion) aid fund or introduce joint bond sales, signaling its refusal to bear extra costs to stamp out the debt crisis. With European finance ministers gathered in Brussels today for their monthly meeting, German Chancellor Angela Merkel rebuffed pleas from Belgium and central bankers to boost the emergency fund to save countries such as Portugal and Spain from falling prey to speculation. “Right now I see no need to expand the fund,” Merkel told reporters in Berlin. She said EU treaties bar joint bond sales, which might force up Germany’s borrowing costs, the lowest in the euro area. European political discord pushed down bonds in Spain and Italy today, reversing gains made last week after purchases by the European Central Bank briefly eased concern about the spreading crisis. The ECB bought the most bonds in a week since June, according to a statement today. The yield on Spain’s 10-year notes climbed 9 basis points to 5.08 percent as of 5 p.m. in London. Italy’s yield rose 7 basis points to 4.47 percent. The euro halted a three-session rally, dipping 1 percent to $1.3283.

The attempt to affect a global market in bonds long term by purchasing bonds short term is a futile effort and a total waste of resources - as we can all see.

‘No Credibility’
Europe has “no credibility” in ruling out debt restructurings, Kenneth Rogoff, a Harvard University professor and former International Monetary Fund chief economist, said in a Bloomberg Television interview broadcast today. “Greece will be very lucky to avoid restructuring, Ireland, Portugal -- they’re just in denial, saying it can’t happen. They really haven’t drawn clear lines, they haven’t really said what they wanted to do, they haven’t really made choices.”

Bingo! The professor is right on point. Thus far, it has been nothing but words that have been given as an indication that said states won't default. The market forces point to default. Their track record in terms of credibility point to default, as illustrated:

The numbers show default.

Only their proclamations say otherwise. Back to the Bloomberg article...

Under pressure to shield taxpayers in Europe’s largest economy, Merkel is drifting back into the role she played in the early stages of the crisis, when Germany held out against an aid package for Greece. The political standoff may saddle the ECB with more of the crisis-management burden, said Citigroup Inc. economists including Juergen Michels and Michael Saunders in London in a Dec. 3 e-mailed note. “Eventually the ECB will be forced to increase its contribution to the rescue packages substantially,” the economists wrote. “We expect that after another round of market tensions, the European fiscal policy makers will eventually come up with additional measures to fight the crisis.”

The inevitable truth of the matter is that several European states WILL default, and default they will. If Germany, or any other economy that still has its druthers to it decides to stand in front of said occurrence, it will likely be dragged down as well. The Germans apparently realize this. See this excerpt from our discussion on the topic regarding Ireland's prospects for default:

... from the post Ireland’s Bailout Is Finalized, The Indebted Gets More Debt As A Solution But The Fine Print Is Glossed Over – Caveat Emptor! wherein BoomBustBlogger Nick asked:

Reggie-

Do you have any reason as to why they are choosing 2013 as a deadline ? Seems like an arbitrary date.

Well, Nick, just follow the money or the lack thereof…

So, what debt raising and servicing that was unsustainable in 2010 was lent even more debt to become even more unsustainable. The chickens come home to roost in 2013, post IMF/EU/Bilateral state leveraged into Ireland loan/Pension fund raiding bailout! What Angela in Germany was alluding to was what all in the know, well… know, and that is that Ireland is already in default and those defaults have been purposely pushed out until 2013. Angela simply (and wisely from a local political perspective, although unwisely from a global geopolitical standpoint) admitted/suggested was that the defaults will be pre-packaged and managed ahead of time. The EU politbureau insists that politics rule the day, and no prepackaged structure be in place for the Irish defaults to be. This means the potential foe even more carnage through the pipelines of uncertainty!

And back to the article...

ECB Bond Purchases

The Frankfurt-based central bank said today it settled 1.965 billion euros of bond purchases last week. While the figure was the highest in 22 weeks, it didn’t include bonds bought between Dec. 1 and Dec. 3.

The bank is “actively” operating in the government bond market, Governing Council member Athanasios Orphanides said today in Nicosia. The ECB will act as necessary, said Orphanides, who heads the Cypriot central bank.

Greece won a 110 billion-euro EU-IMF rescue in May, leading the EU to create the three-year facility that was first tapped by Ireland with an 85 billion-euro program last month.

Both of these actions were clearly anticipated by BoomBustBlog research and analysis months ahead of time:

ECB President Jean-Claude Trichet indicated last week that EU governments might need to top up the emergency fund, a position echoed Dec. 4 by Belgian Finance Minister Didier Reynders.

Reynders said the IMF also wants the EU to put up more money and would boost its 250 billion-euro share. IMF spokesman William Murray declined to comment. Managing Director Dominique Strauss-Kahn is at tonight’s Brussels meeting.

All I can say is The ECB and the Potential Failure of Quantitative Easing, Euro Edition – In the Spotlight!

Re-Introducing the Not So Stylish Portuguese Haircut Analysis

Note: this is a repost of the information initially made available to subscribers in the summer of 2010

For those who feel that the simple application of arithmetic and math amounts to “Doomsday Scenarios”, Fear-mongering, and vultures in the market place, I present to you BoomBustBlog’s scenario analysis of the Portuguese Haircut.

You think those are ugly? You ain’t seen nothing yet!

The Mathematical Truth Concerning Portugal’s Debt Situation

Before I start, any individual or entity that disagrees with the information below is quite welcome to dispute it. I simply ask that you com with facts and analysis and have them grounded in reality so I cannot right another “Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!“. In other words, come with the truth, or at lease your closest simulacrum of it.

In preparing Portugal’s sovereign debt restructuring model through maturity extension, we followed the same methodology as the Greece’s sovereign debt maturity extension model and we have built three scenarios in which the restructuring can be done without taking a haircut on the principal amount.

Restructuring by Maturity Extension – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having same coupon rate but double the maturity. Under this type of restructuring, the decline in present value of cash flows to creditors is 3.3% while the cumulated funding requirements and cumulated new debt between 2010 and 2025 are not reduced substantially. The cumulated funding requirement between 2010 and 2025 reduces to 120.0% of GDP against 135.4% of GDP if there is no restructuring. The cumulated new debt raised is reduced marginally to 70.6% of GDP from 72.2% of GDP if there is no restructuring. Debt at the end of 2025 will be 104.8% of GDP against 106.1% if there is no restructuring
Restructuring by Maturity Extension & Coupon Reduction – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having half the coupon rate but double the maturity. The decline in the present value of the cash flows is 18.6%. The cumulated funding requirement between 2010 and 2025 reduces to a potentially sustainable 99.5% of GDP and the cumulated new debt raised will decline to 50.1% of GDP. Debt at the end of 2025 will be 88.6% of GDP (a potentially sustainable).
Restructuring by Zero Coupon Rollup – Under this scenario, the debt maturing between 2010 and 2020 will be rolled up into one bundle and exchanged against a single, self-amortizing 20-year bond with coupon equal to 50% of the average coupon rate of the converted bonds. The decline in the present value of the cash flows is 17.6%. The cumulated funding requirement between 2010 and 2025 reduces to 100.1% of GDP and the cumulated new debt raised will decline to 52.8% of GDP. Debt at the end of 2025 will be 90.9% of GDP (a potentially sustainable).

The scenarios above were also calculated using the haircuts necessary to bring debt to GDP below a pre-selected level (user selectable in the model, 80%, 85% or 90% - please keep in mind that a ceiling of 60% was necessary in order to gain admission into the Euro construct). We have also built in the impact of IMF/EU aid on the funding requirements and new debt raised from the market between 2010 and 2025 under all the scenarios.

A more realistic method of modeling for restructuring and haircuts

In the previously released Greece and Portugal models, we have built relatively moderate scenarios of maturity extension and coupon reduction which would be acceptable to a large proportion of creditors. However, these restructurings address the liquidity side of the problem rather than solvency issues which can be resolved only when the government debt ratios are restored to sustainable levels. The previous haircut estimation model was also based on the logic that the restructuring of debt should aim at bringing down the debt ratios and addition to debt ratios to more sustainable levels. In the earlier Greece maturity extension model, the government debt at the end of 2025 under restructuring 1, 2 and 3 is expected to stand at 154.4%, 123.7% and 147.0% of GDP which is unsustainably high.

Thus, the following additional spreadsheet scenarios have been built for more severe maturity extension and coupon reduction, or which will have the maturity extension and coupon reduction combined with the haircut on the principal amount. The following is professional level subscscription content only, but I would like to share with all readers the facts, as they play out mathematically, for Portugal. In all of the scenarios below, Portugal will need both EU/IMF funding packages (yes, in addition to the $1 trillion package fantasized for Greece), and will still have funding deficits by 2014, save one scenario. That scenario will punish bondholders severely, for they will have to stand behind the IMF in terms of seniority and liquidation (see How the US Has Perfected the Use of Economic Imperialism Through the European Union!) as well as take in excess of a 20% haircut in principal while suffering the added risk/duration/illiquidity of a substantive and very material increase in maturity. Of course, we can model this without the IMF/EU package (which I am sure will be a political nightmare after Greece), but we will be recasting the “The Great Global Macro Experiment, Revisited” in and attempt to forge a New Argentina (see A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina).

Here is graphical representation of exactly how deep one must dig Portugal out of the Doo Doo in order to achieve a sustainable fiscal situation. The following chart is a depiction of Portugal’s funding requirements from the market before restructuring…

This is the same country’s funding requirements after a restructuring using the "Restructuring by Maturity Extension″ scenario described above…

And this is the depiction of new debt to be raised from the market before restructuring…

And after using the scenario “Restructuring by Maturity Extension″ described above… For all of you Americans who remember that government sponsored TV commercial, “This is your brain on drugs. Any Questions?“

The full spreadsheet behind all of the calculations, scenarios, bond holdings and calculations can be viewed online here (click this link and scroll to the bottom until you see the live spreadsheet) by anyone with the wherewithal to click the link. This product was formally available only to our professional subscribers, but I have decided to distribute it much more widely. Our Ireland, Greece and Spain (to be published within 72 hours) haircut models are available solely to professional and institutional subscribers. Click here to subscribe or upgrade.