Very Important News Today?

The big four accounting firms – Deloitte, Ernst & Young, KPMG and PwC – are the ones reported as working on this mandate. Commentary: I commented on the appointment of auditors, the timing of their reporting, and the problems they were likely to encounter when Spain’s bank audits were announced in mid-May, suggesting then that readers consider that:

• it is likely beyond highly doubtful that if the two auditing firms are just now beginning an audit of property values underlying the bank’s property loan portfolios, they will be able to reach meaningful property valuation conclusions within two weeks – simply because of the time-frame involved, and the likely complexity of their task;
• now valuation undertakings have been announced, it may be that any interested ‘new equity investors’ may wait until the completion of those valuations to make ‘equity injection’ decisions;
• property (or business) values are subjective enough, and difficult enough, to determine in normal markets. They become ever more difficult to determine and subjective the more uncertain and volatile are the markets for said properties; and,
• where property values must be determined in poor markets, the valuation concept of ‘blockage’ has to be considered. That is, it is one thing to put one property on a market where ‘normal market conditions’ prevail. It is quite another thing to opine on the value of 500 or 5,000 (or more) properties where an abnormal market prevails, and where one has to take into account what would happen if all those properties were introduced to that abnormal market at the same time – with unusual downward pressure on price.

The last point is something that not all persons opining on property or business value necessarily focus on or input into their value conclusions. This last point is also something that may have influenced the decisions made in Europe and America in 2008 – 2009 when mark-to-market accounting rules where changed. Consider carefully that changes in reporting do not impact market reality at a point in time.

The two audit firms that have been appointed to opine on the Spanish bank property values have a very difficult job. Potential arm’s length lenders or equity investors likewise will have very difficult decisions to make.

(see: Spain and Spanish Bank Dilemma, May 14, 2012) In the best of economic times:

• rendering audit and audit-type opinions is fraught with subjective decisions;
• add property and business valuation issues to the mix, both of which encompass significant ‘guesswork’ in those same ‘best of times’; and,
• the end reporting decisions become ever more subjective and take ever more time to complete.

In uncertain and volatile economic times:

• subjectivity is (significantly) exacerbated;
• the work of ‘opinion givers’ is made much more difficult;
• reporting delays are common; and,
• importantly, the best-intentioned opinions become less reliable.

It can be argued that the Spanish banking problems today represent an even greater risk to the Eurozone and its continuity than does Greece. That said:

• any delay is a bad delay; and,
• preliminary reporting may prove to be a bad idea, as greater uncertainty with respect to final reported information makes ‘interim reporting’ more tenuous and more dangerous.

On the balance of probabilities, this reported delay in auditor reporting tips the Spanish teeter-totter in the direction of ‘not auguring well’. Spain May Delay Bank Audit Deadline Source: Fox Business, from Dow Jones Newswires, June 19, 2012 Reading time: 1 minute Germany – Between a Rock and Hard Place Why Read: In order to better understand Germany’s Eurozone dependencies, and why Germany is between ‘a rock and a hard place’ as it makes decisions that likely will:

• result in the continuation or demise of the Eurozone as it currently is structured; and,
• impact all developed and developing non-Eurozone countries to a larger or smaller degree.

Featured Article: An article yesterday sets out in quite clear terms a number of current ‘facts and circumstances’ that are relevant to what a Euro rescue may have to mean to German taxpayers, and what a Euro break-up would mean to Germany. By way of background, the following table sets out population, 2011 GDP and Outstanding Debt:GDP Eurozone country data (source: Wikipedia).

Ranking by 2011 GDP	Population (millions)	2011 GDP (U.S.$ billions)	Debt:GDP Ratio
Germany	81.9	3,577	82.0
France	65.4	2,776	86.5
Italy	60.9	2,199	120.9
Spain	46.2	1,494	69.3
Netherlands	16.7	840	65.9
Belgium	10.9	513	98.7
Austria	8.5	419	72.9
Greece	10.8	303	144
Finland	5.4	267	49.3
Portugal	10.6	239	108.5
Ireland	4.6	218	108.4
Slovakia	5.4	96	43.5
Luxembourg	0.5	58	18.6
Slovenia	2.1	50	48.5
Cyprus	0.8	25	72.4
Estonia	1.3	22	6.1
Malta	0.4	9	73.0
Total	332.4	13,105

In summary, the article suggests that proposals made to date within the Eurozone create concerns that German taxpayers will in the end be asked to pay for the financial problems of other Eurozone countries. That said, reasons suggested as to the consequences to Germany of a Euro break-up include:

• high costs estimated to amount to about 1.5 trillion euros, with the greatest share of that risk accruing to the Bundesbank;
• what are said to be ‘disastrous consequences’ for German banks, including large euro values in bond holdings of other Euro countries, and loans to banks and companies in those countries;
• significant euro exposures of German insurance companies and other businesses;
• an exchange rate escalation of new German currency estimated to possibly be 30% in the first year if the euro is abandoned – which would have an estimated 12% decline in German exports and a 7% drop in German economic output; and,
• significant post-euro increases in German sovereign debt.

Commentary: Assuming the foregoing ‘consequences’ to Germany are realistically stated, and they sound ‘directionally right’, Germany has to be caught between a ‘Rock and a Hard Place’. My comments:

• I had the opportunity to travel through East Germany within months of the Berlin Wall falling, and met in what was by then the former East Berlin with the German Government agency responsible for finding ‘homes’ for the over 11,000 former East German businesses that operated in East Germany prior to the Wall falling. I was told that books and records for a good number of the smaller of those companies were difficult to sort out, and that most of those businesses had inefficient multiple-management levels. Moreover, it seemed to me that within months of the Wall coming down that the majority (if not all) of the best of the East German businesses had been spoken for. The task facing the people I met with was formidable;
• in the ensuing +20 years Germany has not only restructured the former East Germany economy, but Germany overall has flourished – in part due to the formation of the Eurozone; and,
• the question now has to be: on balance, will Germany work with the other Eurozone countries and support them out of Germany’s own self-interest, or will it ‘take its losses’ and move on? The likely answer has to lie in:
• a final quantification, estimation, and guessing by Germany of losses it will suffer if it supports Eurozone continuity versus those same losses Germany will suffer if it effectively abandons the Eurozone; and,
• whether an ‘in-between’ position can be found where only some of the current 17 countries leave the Eurozone, where the resultant ‘Eurozone’ will be reasonably certain to function in a manner favourable to Germany.

This is a hugely important matter whose economic implications extend well beyond the Eurozone. It is also a highly complex matter that seems to become more complicated ‘by the week’. In a second article, Bill Gross ( who heads Pacific Investment Management Company, LLC, the world’s largest bond fund) is reported as saying on Bloomberg television that German bonds are no longer attractive given:

• the potential economic issues that will befall Germany should Greece exit the Eurozone; and,
• Germany’s potential requirement to support Spain and other Eurozone countries.