Now, I wish that I could present PDFs of both reports here (i.e. the VP and Iberian Equity report), but I can't due to the fact that such reports are usually behind the firewall. However, this first note by FT's Alphaville on the VP report and the second note, just published, on the challenge by Iberian Equities are enough to get a sense of the argument.

I have seen VP's rebuttal and I still square with their side of the fence. Especially, Iberia Equities make the following point in their report;

"Variant claims Spanish banks are not marking their loan books to market. Non-performing loans in Spain (4.6% of the system’s loans by the end of Jun’09) are marked-down according to different provisioning calendars set by the Central Bank. For non-mortgage loans, NPLs are provisioned at the end of year 2. The majority of mortgage loans (40% of loans or two thirds of mortgage loans) have been – until the BoS made changed the interpretation of the rule - also 100% provisioned by year 2. Only a small fraction of
low –risk mortgages (20% of loans) are provisioned according to a long calendar (100% provision by year 6). By international standards, Spain’s provisioning calendars are quite strict especially considering >60% of loans have a mortgage collateral".

To which VP replies;

"Non-performing loans are being passed off as current, vacuumed up and rolled ito cedulas to deposit at the ECB's repo window.  (Incidentally, that is the only way many Spanish banks are finding any semblance of liquidity right now.  Without the ECB, some Spanish banks would have the same liquidity problems that subprime mortgage originators had.  The ECB is a mega warehouse, effectively, for the Spanish banking system.  This is intimately tied in to the question of funding excess consumption in Spain, which we discussed.)"

In my opinion and apart from the glaring neglect, in the Iberian Equity report, on the macroeconomics of the situation this is the most important omission. This is to say, that had it not been possible (which it still is) for Spanish banks to park many of their assets at the ECB as collateral for funding, they would have effectively needed to mark to a non-existing market (i.e. write off the whole thing in one swoop in which case it would have been bye bye Sandy). I mean, this was what happended with Bear Stearns and Lehmann and then only afterwards did the Fed (and the "appointed" buyers) wade in to scoop up these assets which are now sitting and waiting for better times (presumably, I mean, I don't know how quick they are ground down to reflect market fundamentals).

So, as you can see, I am still with VP here but not everyone may agree in which case it is naturally something which should be debated with facts and reason.

Surely, the pressure has only piled on since I last wrote about this only a few days ago (see links above). The Financial Times' blog Alphaville in this case personified by Izabella Kaminska has steadily been supplying us with the latest on the unravelling in Latvia. A particularly good piece hammers down the point that it is not only freelance bloggers such as yours truly who are questioning the Baltic (Latvian) currency peg but also, now, most professional analysts close to the situation. This is a called a market discourse and although the commitment to maintain status quo may be there one cannot make the waters go back.

However and to be fair to all parties it does seem as if the Latvian authorities got the best of the discourse this week if, that is, being the last one to shout constitutes an upper hand in this case. Consequently, both the central bank and the premier minister Valdis Dombrovkis issued strong statements to suggest that the peg will hold simply because Latvia is committed to seeing this correction through.

Latvian Prime Minister Valdis Dombrovkis pledged to push through budget cuts and ensure the inflow of international loan payments as speculation grows the Baltic state may devalue, threatening the economy of Sweden. “These rumors and speculations should finally be stopped” about the devaluation of the lats, Dombrovskis, 37, said in an interview with Latvian Independent Television today. The currency will not be devalued, he said, and the country will pass budget cuts needed to get the next tranche of money.

This is of course all well and good, but one has the distinct feeling that all this merely constitutes the inevitable last launches before the opponent finally lands the kidney blow to send you crushing into the canvas.

In terms of a more thorough look at the Latvian situation which goes beyond the immediate plethora of market jitter you could do a lot worse than visit Edward's latest post on this issue. As he sets out pointing towards, overnight interbank rates rose to a record of 20% this week and it suggest more than anything the stress being levied on the system.

Another particular issue Edward deals with is the risk of contagion and essentially fallout from a devaluation in Latvia. Certainly, this is an important question in itself but I also agree with Edward [1] in the sense that the immediate plunge in other CEE currencies not to mention the Swedish Krona following a Latvian devaluation is not really the main issue here.

For the record, I see no decoupling and a Latvian devaluation would clearly force others to do the same, most notably I would think Lithuania and Estonia. As for the ripple effects towards the entire CEE edifice, they are likely to be substantial although not necessarily catastrophic. The real issue we need to understand I think is that that IMF program has problems and that this will become clearer and clearer as we move forward. Edward points to one very important data point in the form of a real effective exchange rate where numbers have just been published in 2008 format.

This gives a very clear image of the amount of down scaling the Baltics, and indeed many of the Eastern European Economies, need. It is important to understand that there is a level effect and relative effect here in the sense that one thing is to correct relative to one's own past level, and quite another to correct relative to others. Consequently, this is a chronic problem all across Eastern Europe and thus everybody has to correct. In this sense, the IMF are submitting those with pegged exchange rates to a dose of "medicine" which is simply too strong and which the domestic "system" cannot muster.

So, my feeling is that all this goes beyond whatever effect currency speculation would have in the wake of a Latvian devaluation/default. There are clear signs that the "exit strategy" from this crisis is not working and it is next to scandalous that the IMF/EU do not realize that while these countries certainly need a strong dose of "stick" to get themselves on the right track we need to ensure that they are not obliterated over the course of the next year. I mean, this talk about Euro adoption in 2012 is just so silly and counterproductive since who the heck knows where we are in 2012. Who knows, for example, where the Eurozone itself is in 2012. Really, I cannot stress enough how these road maps of convergence need to be rethought since there has been a structural break. We need a new plan and one which factors in the change in environment.

Moreover, I think we have established by now that the Eurozone is no magic potion and in fact faces a series of very severe tests on Spain, Italy not to mention the mental crush it will be when Germany does not recover because I can tell you; in terms of domestic demand she won't.  Basically as I see it, the option has always been to "let the CEE in", but that would also take a much stronger coordination on the fiscal side and essentially joint European financing through Euro bonds. At the moment, this is far to big a step for the gents in Frankfurt and Brussels to consider.

So, no decoupling in an immediate devaluation context, but more importantly, I tend to look at this more structurally than a simple question of how much the e.g. Forint and Leu will fall in the context of a Latvian devaluation.

At the end of day, this is a question of swallowing those camels and accepting the idea that the current solution being applied is out of touch with reality. Essentially, I don't think the parties involved quite understand the structural damage many of the CEE, and Latvia in particular, have suffered. As per usual I am implicitly referring to the importance of factoring in demographics but then again; it is absolutely amazing that none of the presumed experts here have not added this variable to the equation yet. As Edward says towards the end in his entry ...

That is, the simple fact of the matter is that there is no exit strategy. The programme simply doesn't work. It is "over determined", since whichever way you look at it, there is always one more problem than there is solution. Gentlemen. I think its time to give up. Honourably, but to give up. Come on out of the bunker, white flags and hands in the air will not be called for. There's a world out here waiting for you, it's on your side, and there will be a tomorrow.

I couldn't have put it much better myself, I really couldn't.

---

[1] - There is a surprise :)

The list is long and varied, and ebbs and flows over time. But here are some of the sources (public, private and otherwise) that I turn to in my day-to-day reading. I'm sure I'm leaving out quite a few sites, but this at least is a partial list.

NATIONAL PUBLICATIONS

IndexUniverse.com and IndexUniverse.eu: It goes without saying that IndexUniverse.com and IndexUniverse.eu are the best sites on the Web for information about ETFs and how they are used in portfolios.

IndexUniverse.com

IndexUniverse.eu

Slate/The Big Money: Those two Web sites aside, I start my day at Slate.com, and its sister finance site The Big Money. I find the daily news summary (and weekly magazine summaries) the best meta-journalism on the Web. They offer quick, succinct and erudite summaries of the major national, international and business news of the day. Five minutes and I'm up to speed.

Today's Papers

Today's Business Press

Weekly Magazines

Wall Street Journal: After Slate, I usually turn to WSJ.com. Rupert Murdoch or no, the Wall Street Journal is still the organ of the finance industry, and has some great reporters. I read much of the paper, but make sure never to miss columns or articles by Jason Zweig, Shefali Anand, Eleanor Laise, John Spence or Ian Salisbury, among others.

For what it's worth, I stopped getting the paper version of the WSJ last year, after subscribing for nearly a decade. I miss it, but it seemed like a waste of trees.

http://www.wsj.com/

Financial Times: As good as the WSJ is, the FT is smarter about the markets, and I read it on a daily basis as well. I scan for ETF stories and read the commodity section in full; I also monitor the Lex columns. I don't follow their Alphaville section much, but I'm always impressed when I do get there.

http://www.ft.com/

MarketWatch: John Spence, as mentioned above, is one of the best ETF reporters out there (and an IndexUniverse.com alum). I keep an eye on his columns at MarketWatch, and also read Chuck Jaffe regularly.

http://www.marketwatch.com/

Barron's: I wish I read Barron's more than I do, but I check in periodically. When I do, I find that I like Tom Sullivan's column quite a bit. I've also started to regularly read Mike Santoli, who is smart, funny and to the point.

http://www.barrons.com/

OTHER SOURCES

Yahoo Finance: Yahoo Finance Is the go-to site for news aggregation and (most importantly) total-return data on ETFs and indexes. I love the charting features, and the fact that you can download historical total returns for any stock, index or ETF is simply invaluable.

Finance.yahoo.com

Pimco: If you're not visiting Pimco's Web site once a month, you're doing yourself a disservice. Bill Gross and Paul McCulley's commentaries are invaluable, and often fun to read. I read Mohamed El-Erian's commentary too, but less religiously.

http://www.pimco.com/

SEC.Gov: One of the least user-friendly Web sites in the world, but once you've cracked the code of the SEC search engine, you can find filings for any ETF that exists or is in registration. I'm on there five times a week reviewing prospectuses.

http://www.sec.gov/

Cumber.com: I keep pace with the commentary of the Cumberland Advisors crew, including David Kotok and Bob Eisenbeis. They're both smart and frank about how they're approaching the market, and use ETFs exclusively for the equity side of their business.

http://www.cumber.com/

Random Roger: Ditto Roger Nusbaum, who takes a nice real-world view of the markets, with just the right touch of detached irony.

randomroger.blogspot.com

Ed Yardeni: As a member of the press, I get Ed Yardeni's summary reports, which are extraordinarily useful. If you're not a member of the press, it costs big $$$.

http://www.yardeni.com/

Barclays Capital Research: Ditto the research reports from Barclays Capital. I read their weekly reports regularly, and devour their annual Equity Gilt study from cover to cover. Whenever I get my hands on one, I feel like I have received the blueprint to how the universe really works.

http://www.barcap.com/Client+offering/Research/Global+Asset+Allocation/Equity+Gilt+Study

Provider Web sites: Provider Web sites are often the best source of information on ETFs. iShares is probably the best, but nearly all of the providers do a good job and offer a lot of information.

ETF News Aggregators: To gather some of the other stories that I would otherwise miss, I subscribe to a host of ETF news aggregators, including the LinkedIn ETF Group and ETF Express.