Les Papillons Noirs

Les Papillons Noirs
David R. Kotok
May 29, 2011
www.cumber.com

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Arnaud Clement-Grandcourt and Jacques Janssen invoke the black butterfly in the newest edition of their book Gestion des risques financiers et papillons noirs. The publisher is Lavoisier, www.lavoisier.fr. Depending on the culture, the black butterfly symbolizes fear, death or risk. This is not a play on words as a metaphor for the “black swan” made famous by Nassim Taleb. Black butterfly is its own version of serious risk.

This book is in French. For me, it requires quality time and pushes my language skill to its outer limit. I personally thank Arnaud for giving me a copy.

The book places global bubbles in their historical context. Authors focus on the early stages of bubbles, when authorities think they can manage things. Subsequent results are clear. Waiting and hoping make things worse.

The black butterfly is in Greece.

Would things be different if the ECB had not waived its credit-quality requirement in the early stages of the Greek demise? This is similar to the question about the Fed waiving a rule to facilitate the Bank of America-Countrywide merger. Note that Countrywide was the first Fed primary dealer to get special treatment; then came Bear Stearns; the crash came with Lehman Brothers.

Will Roger’s adage applies: “If you find yourself in a hole, stop digging.” However, history shows that Will’s wisdom is rarely heeded. Greece is about to blow up. Black butterfly fear plagues the Eurozone’s banking system.

In this weekend’s Barron’s, Vito Racanelli took an unusual position for his journal. He wrote, “Europe should make Greece restructure its debt — swiftly.” Vito’s prescription is harsh. “It would require delaying interest payments and an orderly reduction of the total debt by 50%. With 327 billion euros outstanding, we don’t recommend this lightly.” Wrote Vito. “Usually, Barron’s staunchly advocates full repayment to bondholders. But the choice for Greece’s bondholders, as we see it, is to accept 50 cents on the euro now – or 30 cents or worse down the road.” Vito’s forecast is sobering. “Failure to restructure will also bring further societal and economic ruin. With Greece’s unemployment rate at 15%, biding time until an eventual default could throw the country into depression, incite more unrest and drag all of Europe into deep recession.”

Among the non-Greek Eurozone banks, BNP, Societe Generale, Deutsche Bank, and HSBC are the largest Greek sovereign debt holders (source Wall St. Journal). The Greek banks would lose most or all of their capital if they were reserved for losses on Greek debt.

There are legal issues to overcome if a restructuring is to occur. The Journal reports that technical studies are underway to determine how the Greeks can restructure without triggering a payment clause under credit default swap contracts. RBC Capital Markets reported these details on May 26.

Meanwhile, Greek and other depositors keep withdrawing their money from Greek banks. The ECB reports deposit changes in the Eurozone. For Greece, they are and have been negative double-digit numbers in a year–over–year calculation. Greek banks have been bleeding deposits for months. Ireland is the only other Eurozone country with negative deposit numbers. Who can blame a depositor? The Greek bank deposit scheme is a nationally guaranteed one. Therefore, the guarantee is only as good as the sovereign debt promise that secures it. The markets are valuing that promise at a 50% haircut in two years. (Strategas estimate, May 27)

The black butterfly flits upon the flowers at Delphi.

Greece is no longer just a liquidity problem. It is a solvency problem. It is the most indebted country to the IMF in both total debt ($20 billion) and per capita debt ($1778). Source: Dennis Gartman. Its GDP is contracting. Its commercial and residential property prices are falling. Gross public debt is about 150% of GDP. It has the highest Unit Labor Costs in the Eurozone and the lowest export share. Only Iceland has a worse net international investment position. Source: Barclays.

Greece requires the most fiscal tightening of any EU member country. Meanwhile, polls show that 80% the Greek population refuses to make any more sacrifices needed to obtain EU-IMF support. Moody’s warned that “Greek sovereign default could spark contagion as it would have major implications for the Eurozone.”

These are some of the reasons why Barron’s has taken this unusual position articulated by Vito Racanelli this weekend.

“Les papillons noirs symbolisent les craintes depressives,” wrote authors Clement-Grandcourt and Janssen. Today, Eurozone bankers fear they may be correct.

We are off to Helsinki this coming week for the Global Interdependence Center, www.interdependence.org, conference that will continue its study of sovereign debt and the European Union. Four central bankers are on the program. The GIC delegation is filled. The Bank of Finland will host and is collaborating with the GIC for this discussion.

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David R. Kotok, Chairman and Chief Investment Officer