Ode to the missing envelopes...

If you look at income statistics, things are not so bleak in Spain. Wages are falling only a bit; GDP will contract by, maybe, 2-3% this year. And then you come across statistics like this one (hat tip to marketwatch). Retail sales in Spain are falling at a rate of 10% yoy. What is going on? Partly, precautionary savings. Partly, incomes are falling much faster than measured - in the boom, the black economy grew much more than the official one, and it is all those extra payments (in little envelopes) that companies used to make that are disappearing at a fast rate. In boom times, countries love to add the black economy to their GDP statistics. If we captured how quickly it is shrivelling now, GDP growth in Spain for this year would look a lot bleaker...

a good headline

is like a great paper title... worth its weight in gold. Remember the famous "Ford to City: Drop Dead" one by the Daily News, during the NYC budget crisis in the 1970s? Here is another contender for greatest headline (via downtownjoshbrown)

Maybe Mauricio Drelichman and I should have tried to write a paper called "Meet the Fuggers" (about the German banking family's dealings with Philip II...)

everything you need to know

about Spanish banks, lucidly explained, over at fist full of euros. The conclusions are cheerful:

Naturally the whole BFA/Bankia edifice is the first good example I will point to of the use of chewing gum and chicken wire in Spain, since it is hard to imagine a more complicated way of doing something that is almost guaranteed not to work. Basically BFA, the parent bank, was created as a bad bank, where the toxic property assets (largely land) of the seven participating savings banks were to be warehoused, supported by a mixture of preference shares, subordinated debt and own resources in terms of company shares, equity etc, plus a 4.5 billion euro “hybrid capital” loan from the government restructuring fund (FROB), which was to be paid 8% a year. Naturally the value of the toxic assets was bound to drop as time past, and I suppose the hope must have been to tranfer earnings from new (“better” – not “good”) bank Bankia to both offset losses and service the FROB loan. But things weren’t to work out that way (as could have been anticipated), since Bankia itself was created with its own property exposure (especially in the form of developer loans, many of which were on the point of “souring”) as there simply were not enough resources available to wharehouse everything. And when the new government introduced a law requiring more provisioning, well it was all over, bar the large injection of public money now needed to clean up the mess. Others were given the opportunity to kick the can a little further down the road by entering a merger, and thus offseting the write-downs against capital rather than having to charge them directly to profit and loss. But Bankia was already too big, and too about to fall over, to be able to find a “dancing partner”.

Going back to gum and chicken wire, I remember reading in the report on the Three Mile Island nuclear accident, that in the run-in to the problem maintenance had either been neglected or was completely ad hoc. The archetypal example for this was the discovery that a hole in a cooling pipe had been plugged using a basketball. There you go Mr de Guindos... go find a basketball!

fun paper of the week - snow and liquidity

finally, a fun finance paper with some really cool (!) identifying variation:

Based on a sample of highly leveraged Austrian ski hotels undergoing debt restructurings, we show that reducing a debt overhang leads to a significant improvement in operating performance. Changes in leverage in the debt restructurings are instrumented with Unexpected Snow, which captures the extent to which a ski hotel experienced unusually good or bad snow conditions prior to the debt restructuring. Unexpected Snow provides lending banks with the counterfactual of what would have been the ski hotel's operating performance in the absence of strategic default, allowing them to distinguish between ski hotels that are in distress due to negative demand shocks (“liquidity defaulters”) and those that are in distress due to debt overhang (“strategic defaulters”).

who said

that economists aren't working on real-world problems? Here is the abstract of a paper by Diamond and Rajan (QJE 2011):

Is there any need to clean up a banking system by closing some banks and forcing others to sell assets if the risk of a crisis becomes high? Impaired banks that may be forced to sell illiquid assets in the future have private incentives to hold, rather than sell, those assets. Anticipating a potential fire sale, liquid buyers expect high returns, reducing their incentive to lend. Privately optimal trading decisions therefore lead to a worse fire sale and a larger drop in lending than is necessary. We discuss alternative ways of cleaning up the system and the associated costs and benefits.

While one can't apply it 1:1 to the situation in Spain,  it's definitely food for thought...

ECB smoke signals

First came the news that Jens Weidmann is openly arguing for collateralizing TARGET balances in the Eurozone. If you don't breathe and live Eurobabble - in simple words: The head of the Bundesbank now thinks that the risk of a Euro breakup is so high that it wants more than just the word of the Banco de Espana, Bank of Italy, etc. that they will repay all the money they have stuffed into their banking systems. Hand over the assets; this only makes sense if the risk of exit for the Club Med is getting high, in the Bundesbank's view. Ouch.

Now it emerges that the ECB has drastically curtailed lending to Greek banks, partly as a reaction to the fact that the 25 billion € given to Greece to recapitalize banks has not been used for that purpose. Remember that Greeks withdrew about 700 million € last week, after the elections. Without ECB liquidity, the banks will implode. This, to my mind, means the writing is on the wall. The ECB's long-term liquidity program in December last year bought a bit of time for countries that run big current account deficits, but now that Spanish banks are virtually out of collateral that they can post, and with the ECB getting restrictive, everything is set for a rapid unravelling once another small shock or two occur... 

How culturally isolated are you?

Take Charles Murray's little online quiz and find out how far away you are from American "mainstream culture". Notice that the definition of American culture is singularly narrow... hunting, fishing, cheap beer, pick-up trucks. Miraculously, I managed to score not 0 but 4 out of 20 (where 20 is full engagement with US culture). But no worries - acc. to Murray, I still qualify as "your bubble is so thick you don't even know you are in one". (hat tip to CheapTalk)