November 30, 2011
“Men prefer a false promise to a flat refusal.”
‐Quintus Cicero
Imminent Defaults
We write to you today to provide our thoughts on the most likely path of global debt and the potential
consequences of a cluster of sovereign defaults. We see an interesting relationship between the dual
aspects of the situation – the quantitative and the qualitative. First, the quantitative data sets are
simple facts which are easily analyzable. Second, and much more open to debate, are the qualitative
thoughts and reactions of market participants to that data.
Often when there is a large and rapid change in a market dynamic to a new paradigm there is a chorus
of analysts proclaiming that “nothing has changed”, yet undeniably the market indicates it has. We
believe that in many cases the quantitative data leads the qualitative change in opinion to such a degree
that it may look like nothing has changed in the data to drive the change in opinion. In most cases this is
merely the market catching up with the fundamentals.
Once the quantitative data points get as bad as they are today in many nations, the qualitative beliefs
and actions of the participants can rapidly change a situation from benign or stable to full crisis (think
Italy). It is the beliefs of the participants that are most important in times like today. The data sets are
large and slow moving, but the qualitative interpretation of them is far more mercurial. We operate
under the assumption that most participants are educated and informed, and, therefore the
quantitative analysis should already be done. However, it is clear that some previously unquestioned
qualitative beliefs are hard to shake. One of the axioms that we have been developing at Hayman is a
more precise definition of debt sustainability. Debt sustainability is often defined as the ability of a
country to meet and service its debt obligations without requiring debt relief or accumulating arrears.
The non‐linearity of the relationship between expenses (primarily the delta in interest expense) and
revenues is a concept we spend a lot of time on. When a nation’s debts become many multiples of
central government revenues, a non‐linear relationship develops that becomes insurmountable because
expenses grow faster than revenues even in inflationary or growth environments. We believe the debts
of the following nations, among others, are not sustainable in the current economic environment:
Greece, Italy, Japan, Ireland, Iceland, Japan, Spain, Belgium, Japan, Portugal, France, and, have we
mentioned Japan? The United States is quickly approaching the zone of insolvency but can avoid it with
massive spending cuts and severe reductions in entitlements into the future (but don't hold your
breath).
While there are many inputs that are functionally relevant, we look for a couple of warning signs. We
move a nation out of the risk free category as soon as they spend more than 10% of their central
government revenues on interest alone. We also worry about debt loads that represent more than 5x
the revenue of the responsible government. When these and other characteristics are met or exceeded,
it can quickly move the country into checkmate.
Global Debt Saturation
Since 2002, total global credit market debt has grown at more than an 11% compound annual growth
rate (“CAGR”) from $80 trillion to approximately $200 trillion. Over the same time, global real GDP has
only grown at approximately a 4% CAGR.
Total Global Debt (Left Axis) and Global Debt/GDP (Right Axis)
($ in Trillions)
$220 350%
$200 340%
Total Global Debt (Trillions of Dollars)
$180 330%
$160 320%
Global Debt / GDP
$140 310%
$120 300%
$100 290%
$80 280%
$60 270%
$40 260%
$20 250%
$‐ 240%
2002 2003 2004 2005 2006 2007 2008 2009 2010
Public Debt Securities Private Debt Securities Bank Assets Debt/GDP (Right Axis)
As it stands today, total credit market debt is 310% of GDP. We are saddled with the largest
accumulation of peacetime debts without any playbook for what happens next. Throughout history,
whenever total credit market debt breached 200% of GDP, it was commonly due to deficit spending
fueled by borrowing as nations prepared for and then fought wars. To the victor went the spoils (and
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debt pay‐downs) and to the loser went defeat and default. Given the enormity of the debt burdens of
the PIIIGSBF (Portugal, Italy, Ireland, Iceland, Greece, Spain, Belgium and France) coupled with those of
Japan (and at some point the US), lending schemes designed to lend more into an intractable debt
problem are destined to fail miserably. There is no savior large enough with a magical pool of capital to
stave off this unfortunate conclusion to the global debt super cycle. We think hard defaults are
imminent.
For those of you that aren’t following European rates closely, please see the charts below. After
reviewing the history of rates in EMU member countries, one key takeaway is that the markets have told
participants that the EMU has ALREADY BROKEN UP.
Greek 2‐Year Government Bond Yield
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Portuguese 2‐Year Government Bond Yield
Italy‐Germany 10‐Year Government Bond Spread
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Many absolute levels as well as spread levels are higher and wider than pre‐Maastricht extremes. This
indicates something that the politicians, bankers, and regulators don’t want to acknowledge: They have
already lost control, and they will not be able to put this genie back into the bottle. It is already over for
the EMU, they just do not want to admit it. Below we compare Moody’s official sovereign ratings to the
implied default ratings derived from market trading levels of sovereign debts – the “marketplace
ratings”.
Country Moody's Rating CDS Implied Rating Notch Difference
Austria Aaa/Stable Baa3 Nine
Belgium Aa1/Rvw Dng Ba2 Ten
Cyprus Baa3/Rvw Dng B3 Six
Estonia A1 /Stable Baa2 Four
Finland Aaa/Stable Aa3 Three
France Aaa/Stable Baa3 Nine
Germany Aaa/Stable A2 Five
Greece Ca/Developing C One
Ireland Ba1/Negative B2 Four
Italy A2/Negative Ba2 Seven
Malta A2/Negative Ba1 Five
Netherlands Aaa/Stable A3 Six
Portugal Ba2/Negative B3 Four
Slovakia A1 /Stable Ba1 Six
Slovenia Aa3/Rvw Dng Ba2 Eight
Spain A1 /Negative Ba2 Seven
Needless to say, a seven‐notch differential prompted a three‐notch downgrade for Italy. When there is
a 10‐notch differential (Belgium) or even a 9‐notch differential (France), expect a multi‐notch
downgrade in the very near future.
The Mirage of the IMF and EFSF (and whatever the next vehicle is called)
Recently, rumors circulated in the press of a EUR 600 billion loan ($794 billion) being readied by the IMF
for Italy, which would (theoretically) provide the country with another 12‐18 months of runway to sort
out its intractable debt problems. I suppose it was only a matter of time – another “bazooka” with an
eye‐popping headline number put forth to calm the market participants. It is unconscionable that
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anyone thinks that lending more into this debt problem “solves” anything, but in the true spirit of
Keynes and White, Lagarde and Draghi are attempting to placate the market with optics. The problem is
that the optics have now broken down.
The optics of an EFSF levered CDO idea are collapsing as one of the largest guarantors of early EFSF
bonds – Italy – is now looking to be a recipient of aid. Recently, the EFSF had to purchase its own bonds
as there were no takers for 20% of a EUR 3 billion issue. Imagine how they will do when they attempt to
issue EUR 200 billion more (answer: poorly, if it happens at all). One other point to ponder is the fact
that sovereign bond managers take career risk by simply owning these toxic securities (therefore they
won’t do it). Again, there is a need to fully comprehend the enormity of the circular reference involved
with the IMF and EFSF schemes being contemplated. The EFSF is a combination of a handful of debtor
nations that are out of money. The mechanism is only as strong as its weakest link, and the links are
crumbling. How will EFSF bonds trade in the marketplace when, in the first issue, there are a group of
guarantors and a single recipient while in the second issue there will be differing guarantors and
recipients (where a prior guarantor is now a recipient)? For all intents and purposes, the EFSF
mechanism is dead on arrival. It is amazing to us that this idea continues to be pursued by the Eurocrats
in their 17th emergency summit on December 9th.
Now, let's discuss the IMF. Perhaps this would be a workable temporary mirage in the near‐term
assuming the IMF had the funds at its disposal to make such a promise. As it turns out, that assumption
is way off the mark. Currently, IMF resources fall significantly short of the rumored Italian loan amount,
and further increases to IMF funds exacerbate the circular‐reference problem of heavily indebted
nations providing money – that they do not have – to bail each other out. Even former IMF chief
economists agree that the IMF was never designed to make even a medium‐sized loan. The IMF was
designed to assist small third‐world countries with balance‐of‐payments problems. The IMF was not
designed to act as a lender of last resort for profligate debtor nations in Europe or Japan. It may seem
bizarre given some suggested IMF action, but the socialization of global losses run up by profligate
developed nations cannot be found in the IMF mission statement.
According to data provided on the IMF’s official website, there is only approximately $385 billion of
remaining firepower currently available to provide aid to member nations (referred to by the IMF as its
“forward commitment capacity”)1. In other words, a loan the magnitude of the rumored Italian loan
would exhaust currently available IMF resources more than twice over. Including total committed
capital under the IMF’s New Arrangements to Borrow (“NAB”) (assuming activation could be
expeditiously approved and funded), total forward commitment capacity would increase by $153 billion,
to approximately $538 billion (excludes commitments from Greece, Ireland and Italy). Even still, the
Italian loan would fully exhaust the committed (funded and unfunded) resources of the IMF and still
leave a hole of $256 billion.
We are reaching the point at which the amount of funds required to continue delaying the inevitable is
simply becoming too large. As more countries require aid and thus are unable to provide aid, the burden
1
http://www.imf.org/external/np/tre/liquid/2011/0911.htm
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on the remaining contributing nations grows. If Italy, currently the seventh largest contributor to the
IMF as measured by both its quota and its lending commitments under NAB, is too big to save, what is
to become of France (fourth in terms of quota and fifth in terms of NAB commitment)? Or worse yet,
Japan (second in terms of both quota and NAB commitment)?
Imagine a team of mountain climbers all strapped together for safety as they ascend a treacherous peak.
While they are all holding on to the mountain there is no additional strain placed on each other. Now
consider what happens if one climber, let’s call him Stavros, slips and loses his grip. He places added
strain on the remaining climbers. One climber might not make a difference, but as Seamus, Pablo and
Jose each lose their grip they not only add extra total dead weight to the team but also increase the
amount each other climber has to carry, until finally Francois, Luigi and Takehiro let go and poor Jurgen,
and Uncle Sam are left trying to keep the whole team on the mountain.
The IMF has already made a mockery of its own policies by making a commitment to Greece that was
3,200% of the Greek's SDR quota.2 With the Troika owning 40% of Greek sovereign debt, a 100% write‐
down (complete loss) of the remaining public sector debts will not bring Greece into "debt
sustainability". It appears to us that the IMF and the ECB might have to take a loss on their Greek debt
as well. Just think, the ECB has been purchasing Greek bonds in the open market since May 2010.
Greek 10yr rates were as low as 6.34% while the ECB was initially purchasing bonds. The ECB and IMF
now own 40% of the outstanding debt of Greece and Greek 10yr rates are now at ALL TIME HIGHS of
31.98%. If the ECB can't hold back Greek rates, what makes anyone believe they can do anything for
Italian rates (where Italy's debts are $3 trillion while Greece was a paltry $500 billion)?
The bill is due and payment time is now. The world sits with nearly $200 trillion of total credit market
debt (on balance sheet excluding contingent liabilities arising from social welfare programs and the like).
One more dollar worth of global credit market debt produces almost no additional utility via GDP
growth.
Below we present the largest contributors to both the IMF New Arrangements to Borrow and the EFSF
in order of total commitments, largest to smallest.
IMF New Arrangements to Borrow EFSF
United States Germany
Japan France
China Italy
Germany Spain
France Netherlands
United Kingdom Belgium
Italy Greece
How do the optics of these schemes look to you?
2
The commitment as a percentage of the quota fell to 2,400% this year after IMF raised its quota for Greece.
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IMF Facilities Committed and Outstanding as % of Countries’ Quotas
3000%
Total Committed
Total Outstanding and Committed Credit Lines as % of
Total Outstanding
Aggregate IMF Funding Capacity
2500%
Total Credit
Outstanding
7%
Total Undrawn
Commitments
2000% 22%
Arrangements
to Borrow Member
from Currencies,
Members, $414,900
$573,494
1500%
Draft
Contribution to
1000% Eurozone
35%
IMF Funding Sources ($ in millions)
500%
0%
Seychelles
Kenya
Macedonia
Georgia
Moldova
Armenia
Ghana
Djibouti
Burundi
Grenada
Guinea‐Bissau
Angola
Malawi
Nicaragua
Greece
Portugal
Iceland
Poland
Kosovo
Mauritania
Yemen
Zambia
Ukraine
Solomon Is.
Mali
Afghanistan
Bosnia
Congo, DR
Mexico
Antigua
Iraq
Liberia
Togo
Congo, Rep.
Maldives
Comoros
Ireland
Pakistan
Colombia
Romania
Honduras
Burkina Faso
Benin
Dom. Rep.
Latvia
Sri Lanka
Jamaica
El Salvador
Tajikistan
Cote d'Ivoire
Haiti
Sierra Leone
St. Kitts
Sao Tome
‐500%
Pre‐ or Post‐?
After perusing about as many opinions on the current debt crisis as is humanly possible, it becomes clear
that the consensus solution involves the idea that the ECB takes the gloves off and freely prints euros to
“solve” the debt problems of Europe. The consensus argues that when the pain becomes most acute
and unbearable (i.e. threatens the breakup of the EMU), the ECB will jump in and print money until all
problems go away. The qualitative inputs here have become predictable as we have all been
programmed to think that we will always be saved from default in a post‐Lehman world. The Eurocrats
know full‐well that they don’t have any spare capital to recapitalize their entire banking system in a
post‐default world, nor to adequately recapitalize them pre‐default. Instead, EU member nations know
that they will be required to print money in order to re‐capitalize their systems. The $18 trillion dollar3
question for the EMU periphery is: Should they (National Central Banks or the ECB) print before or after
a default? We think they print post‐default as they come to the realization that printing pre‐default
without addressing the toxic debt problem would rewind the clocks back to the days of Von Havenstein
and then you‐know‐who.
3
The total credit market in the European periphery is $18 trillion (source: IMF).
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The Importance of Psychology ‐ Self Deception
Whether it is Kahneman’s “availability heuristic” (wherein participants asses the probability of an event
based on whether relevant examples are cognitively “available”), the Pavlovian pro‐cyclicality of
thought, or the extraordinary delusions of groupthink, investors in today’s sovereign debt markets can't
seem to envision the consequences of a default. The psychology of the situation is crucial to
understanding why and how the gap between perception and reality can be so large. Participants
haven’t contemplated hard defaults (until most recently) because they have been conditioned to believe
they cannot occur because it is against the interests of too many powerful parties. They believe that
there is no upside to thinking this scenario all the way down through the logical steps due to the fact the
last few steps are so painful for everyone (both financial and non‐financial). Developed Western
sovereigns haven't defaulted since WWII and current generations have not experienced a cluster of
defaults or any developed default in their lifetime. However financial history has shown repeatedly that
waves of default are commonplace across a longer time horizon. As events transpire, investors will be
forced to accept developed defaults with enormous loss severities. The risk‐free rate won't be risk‐free
any longer. The very foundation of the collective financial education will be proven to be flawed. The
Value‐at‐Risk (VAR) models that Wall Street continues to use today will blow apart once again. The
models that currently provide us with some of the most mispriced anomalies in the history of finance
because of their reliance on historical implied volatility as substitute for true risk will be rendered
useless. It is analogous to driving a racecar using the rear‐view mirrors.
Japan Will Soon Be on the Front Page
Madoff's scheme collapsed for one primary reason – he had more investors exiting his scheme than
entering. As soon as this happened, it was over. According to the most recent census, the Japanese
population peaked within the last few years at 127.9 million and has since lost almost 3 million. Japan
has one of the most homogeneous – and some might even call it xenophobic – societies of any
developed nation in the world. It is no secret that there is no love lost between the Japanese and their
neighbors, and therefore, immigration is an unlikely answer to a dwindling populace. Even if
immigration was encouraged, such an influx would depress carefully balanced wages and would further
disrupt the three jewels of Japanese corporate culture (seniority based wages, employment for life, and
company unionism). It is indisputable that Japan has the worst on balance sheet debt burden in the
world (roughly 229% of GDP). Japan has the worst debt dynamic (total debt outstanding as a multiple of
central government revenues) of any country in the world (at a staggering 20X). They now have more
people leaving the workforce than entering. Soon they will have more people dis‐saving than saving.
Without re‐hashing our entire thesis here, the funding mechanism (including Japan's current account
surplus) is dwindling and in fact, we forecast the trade component of the current account to be negative
for FY2011. Personal savings of the Japanese population is forecast to be below zero by the middle of
2012. Their ability to fund themselves internally is coming to an end. We believe that Japan would have
a bond crisis of its own within the next two years without the current European debt crisis. The
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European debt crisis will simply act as an accelerant to the Japanese situation as it will most likely
change the qualitative thoughts of JGB investors. We believe that this sequence of events is set to begin
in the next few months (beginning with defaults in Europe). Attached, please find several recent articles
showing the initial stresses beginning to show in the JGB and swaps marketplace.
The Problems Between Kaiserville and Medland
Recently, Larry Lindsey, former Director of the US National Economic Council at the White House and a
trusted friend, penned a satirical piece that warrants inclusion into this letter. With Larry's permission,
we are pleased to share it with you.
Kaiser on the Hill
The European Finance Ministers’ meeting hardly qualified as King of the Hill, maybe Earl of the
Hill, and had it not been for the actions of the world’s central banks, equity markets would be
headed south today. The central bank action certainly qualifies as doing the urgent. Odds were
we were days from a major European bank collapse and heading that off was both urgent and
important. But the underlying sovereign debt crisis remains. Hopes now focus on a deal in which
centralized fiscal control is a quid pro quo for increased ECB purchases of peripheral debt. We
consider the underlying dynamics of this by examining what happened in Medland and
Kaiserville, who were locked in a currency union known as the Uberalles.
Medland’s economy was 60 percent private sector, 40 percent public sector. It financed its
public sector with a 25 percent income tax on all workers and a 20 percent VAT levied on the
private sector. The VAT left the private sector with only 48 percent of GDP to pay its workers and
investors, so total income tax collections were 22 percent of GDP. Coupled with VAT collections
of 12 percent of GDP, revenues were 6 percent of GDP short of the 40 percent of GDP being
spent. In addition, the accumulated debt of Medland was up to 100 percent of GDP, on which it
had been paying a 4 percent interest rate, just equal to its nominal growth rate. That interest
was being paid to the banks in Kaiserville who owned Medland’s bonds. Recently they got
nervous and demanded a higher interest rate which would put Medland’s debt position in a
clearly unsustainable position and provoke both a sovereign crisis and a banking crisis. The
Prime Ministers of Medland and Kaiserville and the head of the Uberalles Central Bank (UCB)
agreed on a Grand Plan to fix the problem. The Medland VAT would be raised by 10 points to
generate the 6 percent of GDP needed to fix the primary budget deficit. In return the UCB would
buy enough Medland debt to stabilize the Medland interest rate at 4 percent.
The sovereign bond crisis was averted and markets rallied as the banks in Kaiserville would no
longer take losses on their bond holdings and it looked like Medville’s fiscal problems were
solved. But the higher VAT posed a problem. In many countries higher VATs are passed on to
consumers in the form of higher prices. But the UCB favored price stability and there was
sufficient slack in the Medland economy that firms lacked pricing power. Medland companies
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could only respond by cutting costs (in this case wages) from the old rate of 48 to the new rate of
42, which is what they had left after the higher VAT. Income tax collections on private sector
workers immediately dropped from 12 to 10.5, so state revenues declined and the primary deficit
reappeared. With after‐tax wages now down, demand for private sector goods and services
dropped by 7 ½ percent. Layoffs rose. Both VAT and income tax receipts began to drop. Worse
for the long run, Medland’s most productive private sector workers and entrepreneurs began
leaving as their current compensation was now unattractive relative to both the public sector
and to Kaiserville’s private sector and their prospects were bleak.
The banks in Kaiserville quickly sensed something was wrong and began to sell their Medland
bonds to the UCB. Their rationale was simple. If Medland should default or be restructured, the
UCB would not take a haircut. This meant that the more bonds the UCB bought, the greater the
haircut would be on private sector bond holders. The rush for the exit quickly became a
stampede as more banks caught on and sensed that the UCB’s interest rate stabilization policy
was their best chance to head for the exits. The Grand Plan was coming apart and UCB money
creation through the purchase of Medland debt did not solve the problem. Medland’s
fundamental problem was that its unproductive public sector was too large and its tax wedge on
its private sector to onerous. Restructuring a country’s or a company’s finances buys time, but
unless its fundamentals are also restructured, it returns to the same problem.
If we are correct regarding our hypothesis on the outcome of the debt crisis, the world will have its
social fabric ruffled or even torn for a period of time. Be mindful that we are not talking about the end
of the world as we know it; we are simply saying that it will be a different and slightly more difficult
place to live in for those of us in the developed and indebted West. We will all wake up in the days,
weeks, and months afterward and go to work, continue to invest, and live our lives. I am eagerly
awaiting the day to finally arrive when our fiduciary duty compels us to worry less and invest more. It is
our job as a fiduciary to avoid nursing 50%+ losses because we failed to believe that a cluster of
sovereign defaults was even possible (let alone probable). We urge you to consider the ramifications of
our thesis being correct, preparing yourself for the worst while hoping for the best. As one of my closest
friends advises me; "Trade as you like, divest accordingly."
Sincerely,
J. Kyle Bass
Managing Partner
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The information set forth herein is being furnished on a confidential basis to the recipient and does not constitute an
offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment
advisory services. Such an offer may only be made to eligible investors by means of delivery of a confidential
private placement memorandum or other similar materials that contain a description of material terms relating to
such investment. The information and opinions expressed herein are provided for informational purposes only. An
investment in the Hayman Funds is speculative due to a variety of risks and considerations as detailed in the
confidential private placement memorandum of the particular fund and this summary is qualified in its entirety by
the more complete information contained therein and in the related subscription materials. This may not be
reproduced, distributed or used for any other purpose. Reproduction and distribution of this summary may
constitute a violation of federal or state securities laws.
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OECD says Japan risks rise in long‐term rates
Nov 28 (Reuters) ‐ Japan is at risk of a rise in long‐term interest rates due to growing government debt, which
could damage the economic outlook and rule out additional stimulus spending if growth falters, the OECD said on
Monday.
Japan should respond to a spike in yields by improving on its plan to achieve a primary budget surplus by the end
of the decade and should rely on the sales tax for additional revenue, the Organisation for Economic Cooperation
and Development said in its twice‐yearly Economic Outlook report.
A sharp deterioration in the global economy would also harm Japan's prospects, and the Bank of Japan would have
to expand asset purchases and fund‐supply operations to bolster the economy, the OECD said.
"If such downside risks materialised, the OECD has identified ... key macroeconomic policies, as well as structural
reforms which, while desirable in any case, would become essential to raise growth," the Paris‐based organisation
said.
Japan's long‐term rates have remained low for some time as domestic investors hold almost all outstanding debt,
but a sudden rise in borrowing costs could squeeze already weak public finances.
Japan's economy will contract 0.3 percent this year after the March 11 earthquake and tsunami, which triggered a
radiation crisis at the Fukushima Daiichi nuclear power plant northeast of Tokyo, the OECD said.
This is a much smaller contraction than the 0.9 percent decline the OECD forecast in May.
Japan's economy will likely grow 2.0 percent next year, versus a previous forecast of 2.2 percent growth, as the
government plans to spend around 19 trillion yen ($244.6 billion) rebuilding areas devastated by the March
disaster, the OECD said.
Growth will then slow to 1.6 percent in 2013 as reconstruction spending peters out, but domestic capital spending
and a pickup in global demand will support Japan's export‐focused economy, the report said.
Reconstruction spending is worsening Japan's public finances in the short term, and the ratio of debt to gross
domestic product will rise to almost 230 percent in 2013, pushing public finances further into "uncharted
territory", the OECD said.
Japan's public finances, already the worst among developed economies, would deteriorate even if the government
met its target of halving the primary budget deficit by fiscal 2015/16, the OECD said. A primary budget balance
excludes debt servicing costs and income from bond sales.
The government also hopes to achieve a primary budget surplus in fiscal 2020/21 but needs to come up with a
plan detailed enough to reassure investors on edge due to Europe's sovereign debt crisis.
Japan should improve its existing plan by creating an objective body to evaluate fiscal policy, the OECD said.
Japan will raise income and corporate taxes to pay for reconstruction and separately plans to raise the sales tax to
cover rising welfare spending. It would be better to lower corporate taxes and raise the sales tax to increase
revenue, as that would be less harmful to the economy, the OECD said.
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BOJ Shirakawa warns Japan outlook severe
Nov 28 (Reuters) ‐ Bank of Japan Governor Masaaki Shirakawa said Europe must make its own efforts to contain
its sovereign debt crisis but using funds from the IMF and from outside the region could be an option.
He also said Japan's economy will eventually resume a recovery but will remain in a severe state for the time being
due to the pain from recent yen rises and slowing global growth.
Below are his key quotes from a meeting with business leaders in Nagoya, central Japan, and a news conference
that followed:
EUROPE DEBT WOES
(From news conference)
"European countries need to implement measures they agreed on at the European Union and euro zone summit.
Boosting the region's financial resources was one of the steps agreed at the summit.
"What's most important is for Europe to make its own efforts to fix the problem. Alongside that, making use of
funds from the IMF and from outside the region could be an option. Various steps have already been examined, as
the G20 communique shows.
"I must also stress that supplying funds alone isn't enough. Countries that accept funds need to pursue economic
and fiscal structural reforms ... This problem won't be solved just by supplying funds."
"A delay in Europe's policy response would have a huge impact on the global economy. We must prevent this at all
costs. Europe needs to act swiftly and decisively on what it agreed upon."
(From meeting with business leaders)
"In Europe, government bond yields for countries whose fiscal conditions have become subject to concern have
been rising significantly. Rates have started to rise even in Italy, the third‐largest economy in the euro area.
"As a result, European financial institutions with large holdings of government bonds in question have faced
difficulties raising funds from the market, forcing them to curb lending.
"In Europe, shrinking market confidence in its fiscal state is heightening concern about the stability of the region's
financial system, which in turn is affecting the economy. An adverse feedback loop is beginning to operate with
respect to the fiscal situation, the financial system, and economic activity."
JAPAN ECONOMY, YEN
"The BOJ's baseline scenario is that from a slightly long‐term perspective, Japan's economy will eventually return
to a sustainable growth path with price stability. But we recognise that this outlook is subject to various
uncertainties.
"The most significant risk is the sovereign debt problem in Europe, or in the words of European authorities in
official documents, 'the sovereign debt crisis' ...
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"When uncertainty over the overseas economic outlook is high, as is the case now, rises in the yen may hurt
Japan's economy by reducing exports and corporate profits as well as by worsening business sentiment. We need
to be mindful of this.
"The government decides when to intervene and the BOJ acts as its agent. The G7 and G20 share the view that
excessive volatility and disorderly currency moves are undesirable. Based on this understanding, Japan conducted
intervention and this had a certain effect ... I hope to continue efforts to gain understanding (of Japan's stance on
currencies).
"Currency moves have a big effect on the outlook for Japan's economy and prices. The BOJ does not ease policy in
response to each and every currency move. We ease policy when the currency moves affect the outlook for the
economy."
JAPAN LONG‐TERM INTEREST RATES
"Global market tension is high due to Europe's sovereign debt problem ... Japan's fiscal situation is very severe. It's
important for Japan to work steadily toward improving its fiscal balance."
DEFLATION
"To believe that deflation could be solved by printing money alone would be to take a too simplistic view of the
problem. When interest rates are high we can cut rates, but that's not possible with rates now effectively at zero.
"In this situation there is virtually no cost for holding on to cash. When financial uncertainty is high, as in Europe
now, financial institutions tend to hoard cash. That means even if central banks supply huge amounts of liquidity,
private financial institutions will just keep on hoarding cash ...
"The BOJ will strive to ease aggressively, both in terms of interest rates and the amount of liquidity. On the other
hand, (government and corporate) efforts to make use of this easy monetary environment are also needed. Only
when the two come together can Japan escape deflation."
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© Hayman Capital Management, L.P. 2011
Yields Rise at Fastest Pace of ‘11 Before Auctions: Japan Credit
By Monami Yui
Nov. 28 (Bloomberg) ‐‐ Investors are driving up Japan’s government bond yields at the fastest pace in almost 11
months, and the move may continue before two auctions this week amid concern the nation may face a credit‐
ratings downgrade.
The yield on the benchmark 10‐year security touched 1.065 percent today, the highest since Sept. 2. The rate
added 8.5 basis points last week, the biggest five‐day gain since the week ended Jan. 7, according to Japan Bond
Trading Co., the nation’s largest interdealer debt broker. Ten‐year U.S. yields declined
4.7 basis points last week to 1.96 percent.
Twenty‐year bonds fell the most since May on Nov. 25, the day after Standard & Poor’s said it may be closer to
lowering Japan’s grade as Prime Minister Yoshihiko Noda’s administration isn’t improving the nation’s finances.
The International Monetary Fund said there’s a risk a “sudden spike” in yields may make the country’s borrowings
unsustainable. Japan is planning two‐ and 10‐year note auctions this week.
“Given how the sentiment quickly deteriorated over the past couple of days, the government bond market is
likely to be unstable unless it gets results at the 10‐year sale,” Shinji Nomura, chief debt strategist in Tokyo at
SMBC Nikko Securities Inc., one of the 25 primary dealers obliged to bid at government‐debt sales, said Nov. 25.
“Shorter‐term bonds will be bought instead as a refuge, steepening the yield curve.”
The government plans to sell 2.7 trillion yen ($34.8
billion) of securities maturing December 2013 at auction tomorrow and offer 2.2 trillion yen of December 2021
notes on Dec. 1.
Investors bid for 4.07 times the two‐year notes at the last sale on Oct. 26, the highest bid‐to‐cover ratio for such
debt since July. The Nov. 1 sale of 10‐year, 1 percent bonds drew the strongest demand since April as the bid‐to‐
cover reached 3.26.
Yields Jump
Twenty‐year yields rose 2.5 basis points to 1.815 percent today after gaining six basis points on Nov. 25. A basis
point is 0.01 percentage point.
Ten‐year yields climbed in 20 of 24 developed markets tracked by Bloomberg over the past week.
Japan’s finances are “getting worse and worse,” Takahira Ogawa, Singapore‐based director of sovereign ratings
at S&P, said in an interview on Nov. 24. S&P rates Japan at AA‐ and has had a “negative” outlook on the rating
since April.
Downgrade Closer
Ogawa said that it “may be right in saying that we’re closer to a downgrade. But the deterioration has been
gradual so far, and it’s not like we’re going to move today.”
Japanese Chief Cabinet Secretary Osamu Fujimura said the S&P comments didn’t reflect an official conclusion by
the ratings company. He told reporters in Tokyo on Nov. 25 that the government intends to explain its plan on
debt management.
Concern that Japan’s debt burden will worsen have hurt most debt maturing in 10 years or longer. The yield
spread between
two‐ and 10‐year bonds expanded to 92 basis points, the widest level since July on a closing basis.
The IMF said in a report on Nov. 23 that concerns about Japan’s fiscal sustainability may result in a “sudden
spike”
in bond yields. Japan’s outstanding debt increased 1.1 percent to 954.4 trillion yen in the three months ended
Sept. 30, almost double Japan’s 2010 gross domestic product of 479.2 trillion yen, government figures show.
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© Hayman Capital Management, L.P. 2011
Borrowing Increasing
The nation’s public borrowing will exceed 1 quadrillion yen in the year through March as the nation pays for
reconstruction from a record earthquake. U.S. obligations were 94.4 percent of gross domestic product and
Germany’s were 84 percent, IMF data from a September report show.
The European Commission forecast this month that Greece’s debt would rise to 162.8 percent of its economy
this year and
198.3 percent next year.
Moody’s Investors Service cut Japan’s debt rating by one step to Aa3 on Aug. 24. S&P lowered its rating to AA‐
in January. Fitch Ratings also has Japan at AA‐ with a negative outlook.
Japan’s bonds have returned 0.3 percent, including reinvested interest, since Sept. 30, the 10th‐best
performance among 26 markets worldwide tracked by Bloomberg/EFFAS indexes.
U.K. debt advanced 4.3 percent to have the best returns.
The climb in the 10‐year yield to above 1 percent may encourage investors to buy Japan’s securities at auctions
this week, according to Tomohiko Katsu, deputy general manager of the capital markets division at Shinsei Bank
Ltd. in Tokyo. The rate, which touched a one‐year low of 0.94 percent on Nov. 17, is still the lowest among
developed nations after Switzerland’s.
Demand Ahead
Japan’s 10‐year yield will advance to 1.15 percent by the end of March, according to the weighted average of
analyst forecasts compiled by Bloomberg.
“There will be demand at two‐ and 10‐year auctions as further decline in yields had been expected,” Katsu said
in a telephone interview on Nov. 25. There is a chance the government will set coupon at 1.1 percent for 10‐year
bonds, he said. That would be the highest since the September sale, according to Bloomberg data.
Elsewhere in Japan’s credit markets, Mitsubishi Gas Chemical Co. sold 15 billion yen of 0.67 percent five‐year
bonds last week, while Daido Steel Co. issued 10 billion yen of 0.68 percent five‐year notes.
Kintetsu Corp. plans to sell 20 billion yen of four‐year bonds that will be marketed mainly to individual investors,
according to a filing with Japan’s finance ministry. The terms of the bond sale will be set on Dec. 9, the document
showed.
Japan Bonds
Sanyo Electric Railway Co. registered to sell as much as 6 billion yen of bonds, while Sumitomo Rubber
Industries Ltd.
registered to issue as much as 50 billion yen of bonds, according to separate filings with the ministry last week. A
shelf registration allows for bond sales without obligating the company or country to borrow.
On Nov. 25, Shimizu Corp. offered for sale 10 billion yen of five‐year, 0.71 percent bonds, according to a
statement from Nomura Securities Co. The same day, Konica Minolta Holdings Inc.
offered 20 billion yen of five‐year, 0.61 percent bonds, according to a statement from SMBC Nikko Securities Inc.
The extra yield investors demand to hold Japanese corporate debt instead of government bonds widened to 48
basis points on Nov. 25 from 44 on Oct. 31, while the spread on global company debt increased 40 basis points to
270 in the same period, according to indexes compiled by Merrill Lynch.
Five‐year credit‐default swaps on Japanese government bonds rose 19 basis points last week to 135 basis
points, the largest increase since the five days ended Sept. 23. CMA prices in New York show. CMA is owned by
CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
Yen Gains
The yen has strengthened against all of its 16 major peers this year as the spread of Europe’s sovereign‐debt
crisis to larger economies spurred demand for haven assets. The currency declined 1.1 percent last week and was
at 77.63 as of 11:20 a.m.
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© Hayman Capital Management, L.P. 2011
in Tokyo.
France risks losing its top credit rating in the event of further economic shocks, Fitch Ratings said on Nov. 23.
The same day, Germany’s 10‐year debt slumped the most since 1990 after the nation failed to get bids for 35
percent of the securities that it offered for sale.
German 10‐year bund yields advanced 30 basis points last week to 2.26 percent, posting the sharpest such
increase since January 2009.
“There has been a flight to quality into Treasuries, gilts, JGBs and bunds before, and now one of them is
collapsing, leading to anxiety in the market,” SMBC Nikko’s Nomura said.
“We had a bad auction on German bonds and a report on a possible downgrade by S&P at a time when Japan’s
fiscal risk is coming under the spotlight.”
For Related News and Information:
Bonds for sale: PREL
Bond yield forecasts: BYFC
Top bond market stories: TOP BON
International yield curves: NIYC
Most read Japanese bond stories: MNI JPB Stories on analyst recommendation: NI ANABON
‐‐With assistance by Jonathan Annells in Tokyo and Masaki Kondo in Singapore. Editors: Pavel Alpeyev, Garfield
Reynolds.
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© Hayman Capital Management, L.P. 2011
Swaption Surge Signals Euro Contagion in Yen Debt: Japan Credit
By Masaki Kondo and Hiroko Komiya
Nov. 29 (Bloomberg) ‐‐ Options traders are the most bearish on Japanese bonds in seven months, signaling
concern that Europe’s debt crisis may spread to a market that’s been insulated by currency gains and a trade
surplus.
So‐called swaptions linked to Japan’s debt have soared to
54 basis points, the highest since April 25 on a closing basis.
The risk‐reversal rate for one‐month options on the dollar versus the yen advanced above zero for the first time in
seven years, as more traders wanted the right to buy the greenback if it starts to rise. Japan’s 10‐year note has
fallen for five‐ straight days, sending the yield to a 12‐week high of 1.065 percent that’s still the second‐lowest rate
in the world.
Japan’s borrowing costs are less than half the level of Germany’s even though Standard & Poor’s rates the Asian
nation three levels lower than Europe’s biggest economy. Germany failed to get bids for 35 percent of the 10‐year
debt it sold on Nov.
23, as concern mounted that the sovereign‐debt crisis that started in Greece is spreading to larger economies.
“There’s speculation that a bad gain in bond yields and yen weakness will happen simultaneously,” said
Yunosuke Ikeda, head of Japan foreign‐exchange research at Nomura Securities Co., the nation’s biggest
brokerage. “Overseas investors may be thinking a bond slump should spread to Japan especially after it occurred in
Germany.”
The yield on Japan’s benchmark 10‐year security rose 8.5 basis points last week, the most since the week ended
Jan. 7 and touched 1.065 percent yesterday, the highest since Sept. 2. That compares with 2.26 percent in
Germany and 2 percent in the U.S.
Tandem Climb
The climb in the fixed, 10‐year rate used in yen swaptions, which grant the right to enter into agreements to
exchange the rate for the London interbank offered rate for yen loans in a year’s time, shows traders want to lock
in deals now before borrowing costs climb, according to Toru Suehiro, a market analyst in Tokyo at Mizuho
Securities Co.
“Because swap rates move in tandem with government‐bond yields, this trend indicates that some investors
expect both rates to rise,” said Suehiro, whose company is one of the 25 primary dealers obliged to bid at
government debt sales.
The risk‐reversal rate for one‐month options on the dollar versus the yen reached 0.115 percent on Nov. 25, the
highest since March 2004 and indicating increasing demand for calls that give traders the right to buy the dollar.
‘Sudden Spike’
Takahira Ogawa, Singapore‐based director of sovereign ratings at S&P, said on Nov. 24 that Japan’s finances are
“getting worse and worse.” S&P rates Japan at AA‐ with a negative outlook, compared with Germany’s AAA grade.
It “may be right in saying that we’re closer to a downgrade,” he said in an interview. “But the deterioration has
been gradual so far.”
The International Monetary Fund said in a report on Nov. 23 that concerns about Japan’s fiscal sustainability
may result in a “sudden spike” in bond yields.
Prime Minister Yoshihiko Noda has backed a proposal by his predecessor Naoto Kan to raise the 5 percent
consumption tax by the end of the decade. He will ask the government and ruling Democratic Party of Japan to
compile by year‐end a detailed timetable to raise the consumption tax, the Asahi newspaper reported yesterday.
Noda said in a speech last month that the crisis in Europe isn’t a “fire on the other side of the river.” Japan has a
public debt burden that’s twice as big as its annual economic output, the biggest ratio in the world.
Libor Advance
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© Hayman Capital Management, L.P. 2011
The gain in swaptions also stems from an increase in the yen Libor, Mizuho’s Suehiro said yesterday. Three‐
month yen Libor advanced to 0.198 percent on Nov. 18, the highest since April, amid concern losses on European
debt will impair the fiscal health of banks acting as counterparts in the interbank market.
Twelve of the 16 banks that contribute to the rate’s fixing are non‐Japanese companies, with WestLB AG in
Germany offering the highest rate of 0.25 percent, followed by Societe Generale SA’s 0.23 percent, according to
data compiled by the British Bankers’ Association.
Italy’s 10‐year bond yields this month reached the 7 percent threshold that prompted Greece, Ireland and
Portugal to seek European Union bailouts.
Elsewhere in Japan’s credit markets, Bank of Fukuoka and Nishi‐Nippon City Bank Ltd. are planning to sell bonds.
Bank of Fukuoka, a unit of Fukuoka Financial Group Inc., hired Nomura Holdings Inc., SMBC Nikko Securities Inc.
and Daiwa Securities Group Inc. for a 10 billion‐yen ($129 million) sale of 15‐year subordinated bonds, Nomura
said in a statement yesterday.
Nishi‐Nippon will sell the same amount of 10‐year subordinated bonds that will be marketed mainly to
individual investors, according to a filing with the Ministry of Finance.
Narrowing Surplus
The extra yield investors demand to hold Japanese corporate debt instead of government bonds was 48 basis
points on Nov. 25, compared with 270 basis points for global companies, according to indexes compiled by Merrill
Lynch.
The yen has outperformed all of its 16 major counterparts this year. The currency tends to strengthen during
periods of financial stress because Japan’s export‐reliant economy doesn’t need foreign capital to balance its
current account.
The nation, which had the world’s second‐largest current‐ account surplus last year after China, will see a 28
percent decrease its surplus through 2016, according to estimates from the IMF.
The government plans to sell 2.7 trillion yen of securities maturing December 2013 at an auction today and will
offer 2.2 trillion yen of December 2021 notes on Dec. 1.
Japan’s surpluses and the dominance of domestic investors in its bond market will prevent the country’s debt
from any sell‐off for the time being, said Shinji Hiramatsu, senior investment manager at Sompo Japan Nipponkoa
Asset Management Co.
“There’s a possibility that bond yields will surge because of the worsening of Japan’s finances,” Hiramatsu,
whose Tokyo‐ based company manages about $58 billion, said yesterday. “That day is coming closer, but not this
year or next year.”
For Related News and Information:
Bonds for sale: PREL
Bond yield forecasts: BYFC
Top bond market stories: TOP BON
International yield curves: NIYC
Most read Japanese bond stories: MNI JPB Stories on analyst recommendation: NI ANABON
‐‐With assistance from Monami Yui and Yumi Ikeda in Tokyo.
Editors: Rocky Swift, Brian Fowler
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© Hayman Capital Management, L.P. 2011