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WAISC 2010
Sovereign Debt
Are We out of the Woods Yet?
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Sovereign Debt: Are We out of the Woods Yet?
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Moderator :
Pat Bolland
Senior Counsel
Veritas Communications
Panelists:
Alex Jurshevski
Founder
Recovery Partners
Beat Guldimann
Founder
Tribeca Consulting Group
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The Simple Answer: Not even close!
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Sovereign Debt Crises are not new; we have seen sovereign defaults and
economic collapses of sovereign states over centuries, back into the
times of the Greek and Roman empires.
What is different now is the prevalence and severity of interconnected
events. Irresponsible ballooning of sovereign, corporate, personal and
institutional (can you spell Social Security?) debt is global in nature
and the traditional sources for bailouts (can you spell United States of
America?) are in a state of indebtedness that makes it extremely
difficult for the authorities to apply needed solutions.
What is also different is demographics and the shift in economic output:
The traditionally strong economies of the G8, most importantly the US
and Germany are weakened by an aging population, a smaller
workforce and less economic output. This is partly due to a relocation
of skilled employment to China, India and other emerging markets.
Recovery from the stress of 2008/2009 is proving to be much more
difficult than the remarkable growth phase witnessed after WW2.
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Vicious cycle will be painful
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Structural deficits of the public purse exist everywhere, and well beyond
the point where stimulus spending runs out
Ageing demographics come with increasing funding gaps for social
security, public pensions and health costs
With a smaller portion of the population engaged in producing GDP in the
real economy, those that produce income will have to be taxed more to
support structural deficits that have not been taken care of and the
part of the population that is drawing funds from the welfare state
The private sector is not going to pick up fast enough to replenish the
fiscal coffers. In order to survive, private enterprise will continue to
increase efficiencies, migrate manufacturing to low cost jurisdictions,
reduce workforce in saturated economies and write off the cost of
restructuring.
The result is depressed tax revenue from corporations and increased
unemployment in Western economies that transform into pure service
and consumer economies while Emerging Markets pick up the
manufacturing jobs. Cutting the vicious cycle will be painful if not
politically impossible:
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Political Difficulties
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This leads to a picture of Western Economies continuing to pile up
structural deficits with a depressed tax base and ballooning
unfunded liabilities towards a rapidly ageing population.
Sound sustainable? We think not.
In contrast, Emerging Economies (including China) will benefit
from lower current levels of debt and much lower expected
future deficits while manufacturing all the goods that the
virtually bankrupt economies in the West will have to buy from
them. Sound sustainable? We think yes.
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Political Risks
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Europe will face political risk from the fact that a population that
has grown accustomed to benefits from an unsustainable
welfare system will be asked to suffer cuts in public sector
wages and social security benefits. Implementing these changes
is extremely difficult in a heavily unionized environment and in
one that sees the gap between rich and poor increase. Social
unrest such as seen in Greece and Spain are just a foretaste of
what is in store.
In the US, you can add already unprecedented unemployment
levels, ethnic tensions, regional income gaps and the fact that
the population has constitutionally supported easy access to
firearms of all calibers to the mix. The spectre of social unrest
turning into violent riots staged by heavily armed “discouraged
workers” becomes more than just a remote possibility in this
scenario. This kind of development has the potential to create a
significant political crisis in the US, which in turn would have
negative feedback effects on the Global economy.
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Political Risks
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In one scenario, the US, currently the leading force in global
politics will come under increased global pressure: former and
current enemies (including Al Qaeda) will try to benefit from
US domestic and international weakness; the US will have
trouble maintaining its global military leadership role as they
won’t be able to appropriately fund not only their military, but
more importantly non-US bases; China in this scenario might
step in to seek a deal with the US for Eastern Hemisphere
control. All signs suggest that the “deck” holding the global
balance of power is being re-shuffled in favor of what we today
still so ironically call emerging economies…
However, the biggest risk here is simply that it has proven very
hard to sustain political support for fiscal consolidation plans
over the timeframes required for these programs to work.
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The Track Record
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The markets have hailed the UK’s post-election budget and similar
moves on the Continent as evidence that the Sovereign Debt
crisis is receding and the appropriate solutions have been
identified and are being applied.
The reality is that there are only a handful of success stories
among the more than 140 attempts at fiscal consolidation in the
last few decades. Defining “success” as a consolidation that
reduces Debt/GDP by at least 10%, something that is required
for all of the Sovereign zombies, yields a list of only two
countries, New Zealand and Canada that have done so in the
past.
To clarify this further, there has never been a successful effort
mounted in a situation where numerous countries are
attempting to achieve the same thing in the aftermath of a
Global Financial Crisis (GFC).
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Investment Implications
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Running for shelter will be difficult in a scenario where the public
debt crisis spins further out of control, sovereign defaults and
even bankruptcies of whole nations potentially become a wide
spread occurrence rather than a possibility and civil unrest
ensues as populations lose whatever confidence they had left in
their governments.
Buy-and-hold is definitely over; shorter-term trading is back.
Absolute returns should be the yardstick, not market
benchmarks.
 Keep durations short to manage interest rate risk
 Use stop-loss parameters to manage equity risks
 Structured products (issuer assumes the risk of future shock
while capping yields)
 Physical bullion
 Exposure to emerging markets may well become a safer play
than the NYSE
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Charts and Tables
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Financial Market Conditions
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Condition of Banks
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Top 20 Financial Institutions 1999
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Top 20 Financial Institutions 2009
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Cross Border EU Sovereign Debt*
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(USD millions)
Portugal
Ireland
Italy
Greece
Spain
Britain
$24
$189
$77
$15
$114
France
$45
$60
$511
$75
$220
Germany
$47
$184
$190
$45
$238
Total owed to “Big 3″
$116
$433
$778
$135
$572
Overall Total Debt
$286
$867
$1,400
$236
$1,100
Debt / GDP
75.2%
63.7%
115.2%
108.1%
* Countries in the top row owe the amounts to countries in the vertical column.
debt to GDP ratios are in the two bottom rows.
59.5%
Gross debt and
Source: BIS
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Sovereign Debt Ratings – The Red Zone
Rank
1
2
3
4
5
6
7
8
9
10
11
16
17
18
19
20
22
23
25
26
Average
Country
Zimbabwe
Japan
St Kitts and Nevis
Lebanon
Jamaica
Singapore
Italy
Greece
Sudan
Iceland
Belgium
France
Germany
Portugal
Hungary
Canada
United Kingdom
Austria
Malta
Ireland
World
Debt / GDP
304.3%
192.1%
185.0%
160.1%
131.7%
117.6%
115.2%
108.1%
104.5%
100.6%
99.0%
79.7%
77.2%
75.2%
72.4%
72.3%
68.5%
68.2%
66.2%
63.7%
53.6%
Moody's
Not Rated
Aaa
Not Rated
B2
B3
Aaa
Aa2
A2
Not Rated
Baa3
Aaa
Aaa
Aaa
Aa2
Baa1
Aaa
Aaa
Aaa
A2
Aa1
N/A
Rank
28
29
32
43
49
51
52
55
61
62
90
69
70
78
80
85
86
90
100
103
Average
Country
Netherlands
Norway
Spain
Cyprus
Turkey
Croatia
Poland
Finland
Switzerland
Sweden
United States
Denmark
Slovakia
Czech Republic
Latvia
Slovenia
Lithuania
New Zealand
Bulgaria
Romania
World
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Debt / GDP
62.3%
60.2%
59.5%
52.4%
48.5%
47.7%
47.5%
46.6%
43.5%
43.2%
90.0%
38.1%
34.6%
32.8%
32.5%
31.4%
31.3%
29.3%
21.4%
20.0%
53.6%
Moody's
Aaa
Aaa
Aaa
A2
Ba2
Baa3
A2
Aaa
Aaa
Aaa
Aaa
Aaa
A1
A1
Baa3
A2
Baa1
Aaa
Baa3
Baa3
N/A
Notes: Japan’s Public sector debt is very high. However, Japan has a high savings rate which makes it easier
for the government to finance the debt. 90% of Japanese debt is owned by Japanese individuals.
Nevertheless the National Debt of Japan is a real burden for the economy. The US has a low savings ratio
and 25% of US debt is owned by foreigners. The numbers for the US also do not include off-balance sheet
obligations. An important factor is not just cumulative national debt, but, the annual budget deficit. This
annual deficit determines the rate of deterioration in the public sector debt
Source: CIA World Factbook (https://www.cia.gov/library/publications/the-world-factbook/)
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Spending Patterns by Age Group
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Demographics
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Demographics
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Demographics
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Food Stamp Recipients
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Industrial Production Index
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US Retail Sales
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US Housing Starts
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Housing Permits
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Civilian Unemployment Rate
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Unemployment
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Employment Falling
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Civilian Unemployed - 15 weeks and over
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Civilian Unemployed
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Median Duration of Unemployment
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Gross Federal Debt
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Foreign Holdings of US Domestic Debt
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Interest on Public Debt
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Household Debt Service
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Total US Revolving Credit
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Commercial Loan Net Charge-Offs
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Industrial Production
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US Home Vacancy Rate
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US Consumer Credit
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US Total Bank Credit
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US Total C&I Loans
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Net Loan Losses % of Total Loans
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Loan Losses Reserves
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Net Interest Margin US Banks
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Bank Failures and the FDIC
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Failures and Assistance Transactions
United States and Other Areas
(Dollar amounts in thousands)
1990-2007
2008-2010
Number of Bank Failures
949
249
Nominal Value of Defaulted Assets
$403,130,565
$296,467,735
Average Size of Failed Bank
$424,795
$1,235,282
Losses to Insurance Fund(s)
$43,464,818
$73,462,832
Average Loss per Failure
$45,801
$304,825
Weighted Average Loss (%)
10.58%
26.29%
Annual Failure Rate (during Peak)
293
118
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Canada – NPLs and Bankruptcies
16000
8000
14000
7500
7000
12000
6500
10000
6000
8000
5500
6000
5000
4500
4000
4000
2000
3500
0
3000
2007
2008
2009
2010
Years
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# of Filings (Blue Line)
CAD Billions (Red Bar)
Comparing Business Bankruptcies and Loan Losses
Big 5 Loan Losses (E)
Number of Business
Bankruptcies
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Contact Details
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Suite 2500, 120 Adelaide Street West
Toronto, Ontario M5H 1T1
office: (866) 889 7882
email: [email protected]
web: www.recoverypartners.biz
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Notes:
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