Randomly Noted

It’s hard to imagine how the European credit crisis that hit hard many of the banks there could have an effect on bondholders of a housing agency in the U.S. whose reason for being is to provide affordable loans for first time home buyers. But that’s what could play out for investors – likely Mom and Pop types – who hold some $3 billion of mortgage revenue bonds issued by the Ohio Housing Finance Agency.

The housing agency, and apparently many other municipalities, have invested some of their funds in guaranteed investment contracts issued by a company called Pallas Capital Corp. The Ohio agency has some $106 million tied up with the Pallas GICs.  Some investors look to GICs as a means to extract a little extra yield. It’s not known what these particular securities were yielding.

Pallas sold GICs and then invested those proceeds in reverser repurchase agreements that were collateralized by a pool of structured finance and corporate assets, according to Moody’s Investors Service Inc. Moody’s recently downgraded the Pallas GICs because “the GICs are a direct pass-through rating of the reverser repo counterparty, DEPFA Bank. You know what’s coming next – DEPFA was recently downgraded on its ability to pay back short term loans.

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It may have seemed like the financial crisis is Europe had stabilized. Greece has been somewhat quiet. Portugal hasn’t quite boiled over the way some thought it would. But now all eyes are back on Ireland and they aren’t smiling. The government announced today that it would need to pump additional cash into its struggling banking system to an extent that its budget deficit could stretch to a third of its entire economy. No other country in the eurozone has a deficit that bad.

It all started with the Central Bank of Ireland announcing Thursday that the state-owned Anglo Irish Bank would need close to a EUR30 billion infusion. Although the government and the European Union have ruled out a Greece-like bailout, that certainly must be on the mind of some investors.

Ireland wasn’t the only European country in the news for its fiscal problems Thursday. Spain saw its credit rating downgraded one notch to Aa1 by Moody’s Investors Service Inc. The ratings agency cited the country’s weak growth prospects.

The Bank for International Settlements released its triennial survey on the foreign exchange markets last night  and among the mounds of all of the interesting numbers (interesting to those of us who care about forex) were some trends worth noting. For starters, spot trading was up nearly 50% – and that was driven by the traditional trading between banks but even more so by trading by hedge funds, pension funds and mutual funds, among those characterized as “other financial institutions.”

So, proprietary trading was in full force at the banks – which we know has been a profit center in recent quarters for some firms. And we continue to see the larger role played by institutions like hedge funds.

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Greece is thousands of miles away. But the debt crisis of that country and others in the Euro-region have had implications for companies big and small here – especially those with low credit ratings. These companies have been unable to borrow money, either from banks or the public debt markets, because of the renewed concerns of leverage. Investors and banks worry about a borrowers ability to repay principal and make interest payments.

The chart above, which accompanies a story by Jodi Xu on Dow Jones Newswires, shows the drop off in issuance of new loans and bonds in the below-investment grade arena. As Xu noted in her story, just when confidence was returning to the markets earlier this year, along came the Greek debt concerns and the ripple effect touched here – even for companies with no link to what was going on in Greece.

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If we think about the financial crisis as coming in two distinct waves, this second and current wave highlighted by sovereign debt issues finds politicians around the world much less concerned about upsetting markets.

When the credit crisis settled into the scariest part of its first phase (financial sector distress) in late 2008, you’ll recall the U.S. Congress first saw fit not to pass the so-called TARP legislation that set aside vast sums of money to save banks and other financial institutions.

The U.S. stock market promptly swooned and the politicians collectively rethought their position. TARP passed and despite significant criticism the aid did the trick of keeping  a credit squeeze and deep recession from turning into something worse.

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This Dow 10,000 thing is getting very old.

The U.S. stock market slid below 10,000 as measured by the Dow Jones Industrial Average yet again. Piercing that level on the upswing happened for the first time back in 1999. That’s right, 1999.

Call me an optimist, but we’ll eventually again head through and above 10,000. Maybe even today, as the stock market slightly recovers from its worst intra-day levels.

The issue is Europe. First was the worry whether certain European countries, Greece prominently among them, would be able to to continue to sell debt  and repay outstanding sovereign debt in full.

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I am handing the quote of the day award to German Chancellor Angela Merkel, who was quoted by Dow Jones Newswires as follows:

“Speculators are our adversaries. First the banks asked for help, and now they are speculating against governments’ debts … I find that perfidious.”

Being accused of perfidy is strong stuff. I looked it up in the online Merriam-Webster dictionary. Synonyms include treachery and faithlessness.

Perhaps sovereign debt shouldn’t be subject to pure bet-placing, as is sometimes now the case, but blaming speculators and banks for the sovereign debt mess centered in Greece, but threatening to break out beyond that country’s borders, is a bit much.

Greece’s problems, a reasonable reader of the news is likely to conclude, is more the making of the country’s past elected officials and to a degree many of its citizens. Fiscal figures were in the past fudged. Tax payments rates are exceedingly low. Some civil servants enjoy(ed) pay and retirement perks that strikes an American, at least, as outrageous and clearly not affordable.

There also are the innate issues with the structure of the common European currency, the Euro, which creates a monetary union but not a political one with teeth to prevent a member nation’s fiscal profligacy.

And the leadership of Europe didn’t do itself any favors by dithering before getting serious about a Greek bailout. Many believe a debt restructuring will still be needed.

There’s plenty of fiscal profligacy to go around, including in the United States and United Kingdom.

Sure it’s true, markets have no collective conscience, but yelling at speculators is to avoid more basic problems. Yes, markets can quickly make a company’s or even a state’s financial situation unstable. But only if there was some fundamental shakiness to start.

In Berlin to try to secure Germany’s assent for a Greece bailout deal, IMF boss Dominique Strauss-Kahn said earlier today that we “shouldn’t believe too much in what rating agencies say.”

One has to agree – on a number of levels. Over the past decade, Moody’s, Standard & Poor’s and Fitch have proved time and again they can be fallible – and late – in identifying all manner of credit vulnerabilities.

Moreover, during the Greek crisis, the rating agencies have become prime actors rather than arbiters – issuing downgrades and decisions that principally shape markets’ direction (in a fairly brutal way) rather than enlighten and inform.

DSK may in fact hold rating agency industry in contempt. But today what he’s really trying to do is calm markets. The rating agency downgrades – of Greece, Portugal and Spain – over the past two days have pushed the euro down significantly and spurred stock market selloffs around the world.

Ask a child who broke a chair or drew on the walls or put cat food in shoes what happened, and they are liable to answer: “Dolly did it”.

Apparently dolly is also now to blame for what’s happening in Greece.

We have murmurings that Greece’s woes–the latest being the downgrade of its sovereign debt to junk by Standard & Poor’s amid worries about its financing risks and growth outlook–aren’t of its own making. It was the euro that did it.

Czech President Vaclav Klaus has been quoted in the German daily Frankfurter Allgemeine Zeitung as saying the real cause of Greece’s crisis lies in the euro and not the country’s economic policy. It is “the euro that causes this tragedy,” he’s cited as saying.

In a way it’s surprising that we haven’t heard more of this sooner. Greece’s problems, and the worries about others in the region, like Portugal and Spain, provide the perfect chance to hammer the euro-zone and the euro in particular.

Finance ministers in the euro-zone haven’t shied away in the past in complaining about the euro’s level. It’s either too strong, or too weak, but never just right. The European Central Bank has been much more relaxed about the euro’s level than individual countries, in part because its primary monetary policy objective is to maintain price stability; certainly it’s not indicated any inclination to intervene in the market to adjust the currency.

Finance ministers also tend to grumble about the difficulties of a unitary monetary policy system. Interest rates that suit one country may not suit another.

But that’s not what caused Greece to get into such a mess. Blaming the euro is like giving Greece a leave pass for all its silly mistakes.

Its problems came about in some measure at least because it fudged its fiscal position to gain entry to the euro-zone. That fudging continued after it joined, and allowed government officials for years to sweep the budgetary problems under the carpet and operate in an increasingly precarious position.

Greece ignored its own difficulties, no doubt hoping that if it closed its eyes it’d all magically disappear.

People can argue that an elevated euro hurt the country’s exports or that interest rates were too high (though the ECB has kept them low for some time), and this sorry episode has highlighted the issues of a union like the euro-zone where there is a one-size-fits-all currency and monetary policy, but the Greek tragedy is largely one of its own making.

As she discussed Friday her concerns about the credit-default swaps market, especially when it involves sovereign debt, France’s finance minister, Christine Lagarde, turned a well-worn market notion on its head.

“Now it’s all OTC,” Lagarde said of CDS trading, “which I call ‘under’ rather than ‘over’ the counter.”

In a lunch interview with The Wall Street Journal and Dow Jones Newswires on Friday, Lagarde said she was particularly concerned with the lack of clarity around CDS trading, especially CDS on sovereign debt. The latter she described as a narrow and illiquid market.

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