November30,2011 Menpreferafalsepromisetoaflatrefusal.

QuintusCicero ImminentDefaults
Wewritetoyoutodaytoprovideourthoughtsonthemostlikelypathofglobaldebtandthepotential consequencesofaclusterofsovereigndefaults.Weseeaninterestingrelationshipbetweenthedual aspects of the situation the quantitative and the qualitative. First, the quantitative data sets are simplefacts whichareeasilyanalyzable.Second,andmuch moreopentodebate,arethequalitative thoughtsandreactionsofmarketparticipantstothatdata. Oftenwhenthereisalargeandrapidchangeinamarketdynamictoanewparadigmthereisachorus of analysts proclaiming that nothing has changed, yet undeniably the market indicates it has. We believethatinmanycasesthequantitativedataleadsthequalitativechangeinopiniontosuchadegree thatitmaylooklikenothinghaschangedinthedatatodrivethechangeinopinion.Inmostcasesthisis merelythemarketcatchingupwiththefundamentals. Oncethequantitativedatapointsgetasbadastheyaretodayinmanynations,thequalitativebeliefs andactionsoftheparticipantscanrapidlychangeasituationfrombenignorstabletofullcrisis(think Italy).Itisthebeliefsoftheparticipantsthataremostimportantintimesliketoday.Thedatasetsare 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 qualitativebeliefsarehardtoshake.OneoftheaxiomsthatwehavebeendevelopingatHaymanisa more precise definition of debt sustainability. Debt sustainability is often defined as the ability of a countrytomeetandserviceitsdebtobligationswithoutrequiringdebtrelieforaccumulatingarrears. The nonlinearity 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 nations debts become many multiples of centralgovernmentrevenues,anonlinearrelationshipdevelopsthatbecomesinsurmountablebecause expensesgrowfasterthanrevenuesevenininflationaryorgrowthenvironments.Webelievethedebts 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 mentionedJapan?TheUnitedStatesisquicklyapproachingthezoneofinsolvencybutcanavoiditwith

massive spending cuts and severe reductions in entitlements into the future (but don't hold your breath). Whiletherearemanyinputsthatarefunctionallyrelevant,welookforacoupleofwarningsigns.We move a nation out of the risk free category as soon as they spend more than 10% of their central governmentrevenuesoninterestalone.Wealsoworryaboutdebtloadsthatrepresentmorethan5x therevenueoftheresponsiblegovernment.Whentheseandothercharacteristicsaremetorexceeded, itcanquicklymovethecountryintocheckmate.

GlobalDebtSaturation
Since2002,totalglobalcreditmarketdebthasgrownatmorethanan11%compoundannualgrowth rate(CAGR)from$80trilliontoapproximately$200trillion.Overthesametime,globalrealGDPhas onlygrownatapproximatelya4%CAGR. TotalGlobalDebt(LeftAxis)andGlobalDebt/GDP(RightAxis) ($inTrillions)
$220 $200
TotalGlobal Debt(Trillions ofDollars)

350% 340% 330% 320%

GlobalDebt/GDP

$180 $160 $140 $120 $100 $80 $60 $40 $20 $ 2002 2003 2004 2005 2006 2007 2008 2009 2010 PublicDebtSecurities PrivateDebtSecurities BankAssets

310% 300% 290% 280% 270% 260% 250% 240% Debt/GDP(RightAxis)

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 fueledbyborrowingasnationspreparedforandthenfoughtwars.Tothevictorwentthespoils(and 2
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debtpaydowns)andtotheloserwentdefeatanddefault.Giventheenormityofthedebtburdensof thePIIIGSBF(Portugal,Italy,Ireland,Iceland,Greece,Spain,BelgiumandFrance)coupledwiththoseof Japan (and at some point the US), lending schemes designed to lend more into an intractable debt problemaredestinedtofailmiserably.Thereisnosaviorlargeenoughwithamagicalpoolofcapitalto stave off this unfortunate conclusion to the global debt super cycle. We think hard defaults are imminent. For those of you that arent following European rates closely, please see the charts below. After reviewingthehistoryofratesinEMUmembercountries,onekeytakeawayisthatthemarketshavetold participantsthattheEMUhasALREADYBROKENUP. Greek2YearGovernmentBondYield

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Portuguese2YearGovernmentBondYield

ItalyGermany10YearGovernmentBondSpread

4
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ManyabsolutelevelsaswellasspreadlevelsarehigherandwiderthanpreMaastrichtextremes.This indicatessomethingthatthepoliticians,bankers,andregulatorsdontwanttoacknowledge:Theyhave alreadylostcontrol,andtheywillnotbeabletoputthisgeniebackintothebottle.Itisalreadyoverfor theEMU,theyjustdonotwanttoadmitit.BelowwecompareMoodysofficialsovereignratingstothe implied default ratings derived from market trading levels of sovereign debts the marketplace ratings.
Country Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Malta Netherlands Portugal Slovakia Slovenia Spain Moody'sRating Aaa/Stable Aa1/RvwDng Baa3/RvwDng A1/Stable Aaa/Stable Aaa/Stable Aaa/Stable Ca/Developing Ba1/Negative A2/Negative A2/Negative Aaa/Stable Ba2/Negative A1/Stable Aa3/RvwDng A1/Negative CDSImpliedRating Baa3 Ba2 B3 Baa2 Aa3 Baa3 A2 C B2 Ba2 Ba1 A3 B3 Ba1 Ba2 Ba2 NotchDifference Nine Ten Six Four Three Nine Five One Four Seven Five Six Four Six Eight Seven

Needlesstosay,asevennotchdifferentialpromptedathreenotchdowngradeforItaly.Whenthereis a 10notch differential (Belgium) or even a 9notch differential (France), expect a multinotch downgradeintheverynearfuture.

TheMirageoftheIMFandEFSF(andwhateverthenextvehicleiscalled)
Recently,rumorscirculatedinthepressofaEUR600billionloan($794billion)beingreadiedbytheIMF forItaly,whichwould(theoretically)providethecountrywithanother1218monthsofrunwaytosort outitsintractabledebtproblems.Isupposeitwasonlyamatteroftimeanotherbazookawithan eyepopping headline number put forth to calm the market participants. It is unconscionable that 5
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anyone thinks that lending more into this debt problem solves anything, but in the true spirit of KeynesandWhite,LagardeandDraghiareattemptingtoplacatethemarketwithoptics.Theproblemis thattheopticshavenowbrokendown. The optics of an EFSF levered CDO idea are collapsing as one of the largest guarantors of early EFSF bondsItalyisnowlookingtobearecipientofaid.Recently,theEFSFhadtopurchaseitsownbonds astherewerenotakersfor20%ofaEUR3billionissue.Imaginehowtheywilldowhentheyattemptto issueEUR200billionmore(answer:poorly,ifithappensatall).Oneotherpointtoponderisthefact thatsovereignbondmanagerstakecareerriskbysimplyowningthesetoxicsecurities(thereforethey wontdoit).Again,thereisaneedtofullycomprehendtheenormityofthecircularreferenceinvolved withtheIMFandEFSFschemesbeingcontemplated.TheEFSFisacombinationofahandfulofdebtor nationsthatareoutofmoney.Themechanismisonlyasstrongasitsweakestlink,andthelinksare crumbling.HowwillEFSFbondstradeinthemarketplacewhen,inthefirstissue,thereareagroupof 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 mechanismisdeadonarrival.ItisamazingtousthatthisideacontinuestobepursuedbytheEurocrats intheir17themergencysummitonDecember9th. Now, let's discuss the IMF. Perhaps this would be a workable temporary mirage in the nearterm assumingtheIMFhadthefundsatitsdisposaltomakesuchapromise.Asitturnsout,thatassumption iswayoffthemark.Currently,IMFresourcesfallsignificantlyshortoftherumoredItalianloanamount, and further increases to IMF funds exacerbate the circularreference problem of heavily indebted nations providing money that they do not have to bail each other out. Even former IMF chief economistsagreethat theIMFwasneverdesignedtomakeevenamediumsizedloan.TheIMFwas designed to assist small thirdworld countries with balanceofpayments problems. The IMF was not designedtoactasalenderoflastresortforprofligatedebtornationsinEuropeorJapan.Itmayseem bizarre given some suggested IMF action, but the socialization of global losses run up by profligate developednationscannotbefoundintheIMFmissionstatement. According to data provided on the IMFs official website, there is only approximately $385 billion of remainingfirepowercurrentlyavailabletoprovideaidtomembernations(referredtobytheIMFasits 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 IMFs New Arrangements to Borrow (NAB) (assuming activation could be expeditiouslyapprovedandfunded),totalforwardcommitmentcapacitywouldincreaseby$153billion, 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 leaveaholeof$256billion. Wearereachingthepointatwhichtheamountoffundsrequiredtocontinuedelayingtheinevitableis simplybecomingtoolarge.Asmorecountriesrequireaidandthusareunabletoprovideaid,theburden
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 IMFasmeasuredbybothitsquotaanditslendingcommitmentsunderNAB,istoobigtosave,whatis tobecomeofFrance(fourthintermsofquotaandfifthintermsofNABcommitment)?Orworseyet, Japan(secondintermsofbothquotaandNABcommitment)? Imagineateamofmountainclimbersallstrappedtogetherforsafetyastheyascendatreacherouspeak. Whiletheyareallholdingontothemountainthereisnoadditionalstrainplacedoneachother.Now consider what happens if one climber, lets call him Stavros, slips and loses his grip. He places added strainontheremainingclimbers.Oneclimbermightnotmakeadifference,butasSeamus,Pabloand Jose each lose their grip they not only add extra total dead weight to the team but also increase the amounteachotherclimberhastocarry,untilfinallyFrancois,LuigiandTakehiroletgoandpoorJurgen, andUncleSamarelefttryingtokeepthewholeteamonthemountain. TheIMFhasalreadymadeamockeryofitsownpoliciesbymakingacommitmenttoGreecethatwas 3,200%oftheGreek'sSDRquota.2WiththeTroikaowning40%ofGreeksovereigndebt,a100%write down (complete loss) of the remaining public sector debts will not bring Greece into "debt sustainability".ItappearstousthattheIMFandtheECBmighthavetotakealossontheirGreekdebt as well. Just think, the ECB has been purchasing Greek bonds in the open market since May 2010. Greek10yrrateswereaslowas6.34%whiletheECBwasinitiallypurchasingbonds.TheECBandIMF nowown40%oftheoutstandingdebtofGreeceandGreek10yrratesarenowatALLTIMEHIGHSof 31.98%.IftheECBcan't holdback Greekrates,whatmakesanyonebelievethey candoanythingfor Italianrates(whereItaly'sdebtsare$3trillionwhileGreecewasapaltry$500billion)? Thebillisdueandpaymenttimeisnow.Theworldsitswithnearly$200trillionoftotalcreditmarket debt(onbalancesheetexcludingcontingentliabilitiesarisingfromsocialwelfareprogramsandthelike). One more dollar worth of global credit market debt produces almost no additional utility via GDP growth. BelowwepresentthelargestcontributorstoboththeIMFNewArrangementstoBorrowandtheEFSF inorderoftotalcommitments,largesttosmallest.

IMFNewArrangementstoBorrow UnitedStates Japan China Germany France UnitedKingdom Italy

Howdotheopticsoftheseschemeslooktoyou?
2

EFSF Germany France Italy Spain Netherlands Belgium Greece

Thecommitmentasapercentageofthequotafellto2,400%thisyearafterIMFraiseditsquotaforGreece.

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IMFFacilitiesCommittedandOutstandingas%ofCountriesQuotas
3000% TotalCommitted TotalOutstanding 2500%

TotalOutstandingandCommittedCreditLinesas%of AggregateIMFFundingCapacity
TotalCredit Outstanding 7% TotalUndrawn Commitments 22%
Arrangements toBorrow from Members, $573,494

2000%

Member Currencies, $414,900

1500%

1000%

Draft Contributionto Eurozone 35%

IMFFundingSources($inmillions)
500%

0%
Seychelles Armenia Georgia Kenya Macedonia Moldova Ghana GuineaBissau Grenada Burundi Djibouti Angola Malawi Nicaragua Kosovo Yemen Mauritania Zambia Iceland BurkinaFaso Coted'Ivoire SierraLeone Congo,Rep. Afghanistan Portugal Greece Poland SolomonIs. Ukraine Bosnia Dom.Rep. ElSalvador Congo,DR Mexico Antigua Liberia Maldives Colombia Comoros Pakistan Romania Ireland Togo Honduras SriLanka Jamaica Latvia Benin Tajikistan Mali Iraq Haiti SaoTome St.Kitts

500%

PreorPost?
Afterperusingaboutasmanyopinionsonthecurrentdebtcrisisasishumanlypossible,itbecomesclear thattheconsensussolutioninvolvestheideathattheECBtakestheglovesoffandfreelyprintseurosto solvethedebtproblemsofEurope.Theconsensusarguesthatwhenthepainbecomesmostacute andunbearable(i.e.threatensthebreakupoftheEMU),theECBwilljumpinandprintmoneyuntilall problems go away. The qualitative inputs here have become predictable as we have all been programmedtothinkthatwewillalwaysbesavedfromdefaultinapostLehmanworld.TheEurocrats know fullwell that they dont have any spare capital to recapitalize their entire banking system in a postdefaultworld,nortoadequatelyrecapitalizethempredefault.Instead,EUmembernationsknow thattheywillberequiredtoprintmoneyinordertorecapitalizetheirsystems.The$18trilliondollar3 questionfortheEMUperipheryis:Shouldthey(NationalCentralBanksortheECB)printbeforeorafter a default? We think they print postdefault as they come to the realization that printing predefault withoutaddressingthetoxicdebtproblemwouldrewindtheclocksbacktothedaysofVonHavenstein andthenyouknowwho.

ThetotalcreditmarketintheEuropeanperipheryis$18trillion(source:IMF).

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TheImportanceofPsychologySelfDeception
WhetheritisKahnemansavailabilityheuristic(whereinparticipantsassestheprobabilityofanevent based on whether relevant examples are cognitively available), the Pavlovian procyclicality of thought,ortheextraordinarydelusionsofgroupthink,investorsintodayssovereigndebtmarketscan'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 haventcontemplatedharddefaults(untilmostrecently)becausetheyhavebeenconditionedtobelieve theycannotoccurbecauseitisagainsttheinterestsoftoomanypowerfulparties.Theybelievethat thereisnoupsidetothinkingthisscenarioallthewaydownthroughthelogicalstepsduetothefactthe last few steps are so painful for everyone (both financial and nonfinancial). Developed Western sovereigns haven't defaulted since WWII and current generations have not experienced a cluster of defaultsoranydevelopeddefaultintheirlifetime.Howeverfinancialhistoryhasshownrepeatedlythat wavesofdefaultarecommonplaceacrossalongertimehorizon.Aseventstranspire,investorswillbe forcedtoacceptdevelopeddefaultswithenormouslossseverities.Theriskfreeratewon'tberiskfree anylonger.Theveryfoundationofthecollectivefinancialeducationwillbeproventobeflawed.The ValueatRisk (VAR) models that Wall Street continues to use today will blow apart once again. The modelsthatcurrentlyprovideuswithsomeofthemostmispricedanomaliesinthehistoryoffinance because of their reliance on historical implied volatility as substitute for true risk will be rendered useless.Itisanalogoustodrivingaracecarusingtherearviewmirrors.

JapanWillSoonBeontheFrontPage
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 populationpeakedwithinthelastfewyearsat127.9millionandhassincelostalmost3million.Japan has one of the most homogeneous and some might even call it xenophobic societies of any developednationintheworld.ItisnosecretthatthereisnolovelostbetweentheJapaneseandtheir neighbors, and therefore, immigration is an unlikely answer to a dwindling populace. Even if immigrationwasencouraged,suchaninfluxwoulddepresscarefullybalancedwagesandwouldfurther disruptthethreejewelsofJapanesecorporateculture(senioritybasedwages,employmentforlife,and company unionism). It is indisputable that Japan has the worst on balance sheet debt burden in the world(roughly229%ofGDP).Japanhastheworstdebtdynamic(totaldebtoutstandingasamultipleof centralgovernmentrevenues)ofanycountryintheworld(atastaggering20X).Theynowhavemore people leaving the workforce than entering. Soon they will have more people dissaving than saving. Without rehashing our entire thesis here, the funding mechanism (including Japan's current account surplus)isdwindlingandinfact,weforecastthetradecomponentofthecurrentaccounttobenegative forFY2011.PersonalsavingsoftheJapanesepopulationisforecasttobebelowzerobythemiddleof 2012.Theirabilitytofundthemselvesinternallyiscomingtoanend.WebelievethatJapanwouldhave a bond crisis of its own within the next two years without the current European debt crisis. The 9
HaymanCapitalManagement,L.P.2011

European debt crisis will simply act as an accelerant to the Japanese situation as it will most likely changethequalitativethoughtsofJGBinvestors.Webelievethatthissequenceofeventsissettobegin inthenextfewmonths(beginningwithdefaultsinEurope).Attached,pleasefindseveralrecentarticles showingtheinitialstressesbeginningtoshowintheJGBandswapsmarketplace.

TheProblemsBetweenKaiservilleandMedland
Recently,LarryLindsey,formerDirectoroftheUSNationalEconomicCouncilattheWhiteHouseanda trustedfriend,pennedasatiricalpiecethatwarrantsinclusionintothisletter.WithLarry'spermission, wearepleasedtoshareitwithyou. KaiserontheHill TheEuropeanFinanceMinistersmeetinghardlyqualifiedasKingoftheHill,maybeEarlofthe Hill,andhaditnotbeenfortheactionsoftheworldscentralbanks,equity marketswouldbe headedsouthtoday.Thecentralbankactioncertainlyqualifiesasdoingtheurgent.Oddswere weweredaysfromamajorEuropeanbankcollapseandheadingthatoffwasbothurgentand important.Buttheunderlyingsovereigndebtcrisisremains.Hopesnowfocusonadealinwhich centralizedfiscalcontrolisaquidproquoforincreasedECBpurchasesofperipheraldebt.We consider the underlying dynamics of this by examining what happened in Medland and Kaiserville,whowerelockedinacurrencyunionknownastheUberalles. Medlands 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 privatesector.TheVATlefttheprivatesectorwithonly48percentofGDPtopayitsworkersand investors,sototalincometaxcollectionswere22percentofGDP.CoupledwithVATcollections of 12 percent of GDP, revenues were 6 percent of GDP short of the 40 percent of GDP being spent.Inaddition,theaccumulateddebtofMedlandwasupto100percentofGDP,onwhichit hadbeenpayinga4percentinterestrate,justequaltoitsnominalgrowthrate.Thatinterest was being paid to the banks in Kaiserville who owned Medlands bonds. Recently they got nervous and demanded a higher interest rate which would put Medlands 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) agreedonaGrandPlantofixtheproblem.TheMedlandVATwouldberaisedby10pointsto generatethe6percentofGDPneededtofixtheprimarybudgetdeficit.InreturntheUCBwould buyenoughMedlanddebttostabilizetheMedlandinterestrateat4percent. ThesovereignbondcrisiswasavertedandmarketsralliedasthebanksinKaiservillewouldno longer take losses on their bond holdings and it looked like Medvilles fiscal problems were solved.ButthehigherVATposedaproblem.InmanycountrieshigherVATsarepassedonto 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 10
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couldonlyrespondbycuttingcosts(inthiscasewages)fromtheoldrateof48tothenewrateof 42, which is what they had left after the higher VAT. Income tax collections on private sector workersimmediatelydroppedfrom12to10.5,sostaterevenuesdeclinedandtheprimarydeficit reappeared. With aftertax wages now down, demand for private sector goods and services droppedby7percent.Layoffsrose.BothVATandincometaxreceiptsbegantodrop.Worse for the long run, Medlands most productive private sector workers and entrepreneurs began leaving as their current compensation was now unattractive relative to both the public sector andtoKaiservillesprivatesectorandtheirprospectswerebleak. The banks in Kaiserville quickly sensed something was wrong and began to sell their Medland bondstotheUCB.Theirrationalewassimple.IfMedlandshoulddefaultorberestructured,the UCBwouldnottakeahaircut.ThismeantthatthemorebondstheUCBbought,thegreaterthe haircut would be on private sector bond holders. The rush for the exit quickly became a stampedeasmorebankscaughtonandsensedthattheUCBsinterestratestabilizationpolicy wastheirbestchancetoheadfortheexits.TheGrandPlanwascomingapartandUCBmoney creation through the purchase of Medland debt did not solve the problem. Medlands fundamentalproblemwasthatitsunproductivepublicsectorwastoolargeanditstaxwedgeon itsprivatesectortoonerous.Restructuringacountrysoracompanysfinancesbuystime,but unlessitsfundamentalsarealsorestructured,itreturnstothesameproblem. If we are correct regarding our hypothesis on the outcome of the debt crisis, the world will have its socialfabricruffledoreventornforaperiodoftime.Bemindfulthatwearenottalkingabouttheend of the world as we know it; we are simply saying that it will be a different and slightly more difficult placetolive inforthoseofusinthe developedandindebted West.Wewillallwakeupinthedays, weeks, and months afterward and go to work, continue to invest, and live our lives. I am eagerly awaitingthedaytofinallyarrivewhenourfiduciarydutycompelsustoworrylessandinvestmore.Itis our job as a fiduciary to avoid nursing 50%+ losses because we failed to believe that a cluster of sovereigndefaultswasevenpossible(letaloneprobable).Weurgeyoutoconsidertheramificationsof ourthesisbeingcorrect,preparingyourselffortheworstwhilehopingforthebest.Asoneofmyclosest friendsadvisesme;"Tradeasyoulike,divestaccordingly."

Sincerely,

J.KyleBass ManagingPartner
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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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OECDsaysJapanrisksriseinlongtermrates Nov28(Reuters)Japanisatriskofariseinlongterminterestratesduetogrowinggovernmentdebt,which coulddamagetheeconomicoutlookandruleoutadditionalstimulusspendingifgrowthfalters,theOECDsaidon Monday. Japanshouldrespondtoaspikeinyieldsbyimprovingonitsplantoachieveaprimarybudgetsurplusbytheend ofthedecadeandshouldrelyonthesalestaxforadditionalrevenue,theOrganisationforEconomicCooperation andDevelopmentsaidinitstwiceyearlyEconomicOutlookreport. AsharpdeteriorationintheglobaleconomywouldalsoharmJapan'sprospects,andtheBankofJapanwouldhave toexpandassetpurchasesandfundsupplyoperationstobolstertheeconomy,theOECDsaid. "Ifsuchdownsiderisksmaterialised,theOECDhasidentified...keymacroeconomicpolicies,aswellasstructural reformswhich,whiledesirableinanycase,wouldbecomeessentialtoraisegrowth,"theParisbasedorganisation said. Japan'slongtermrateshaveremainedlowforsometimeasdomesticinvestorsholdalmostalloutstandingdebt, butasuddenriseinborrowingcostscouldsqueezealreadyweakpublicfinances. Japan'seconomywillcontract0.3percentthisyearaftertheMarch11earthquakeandtsunami,whichtriggereda radiationcrisisattheFukushimaDaiichinuclearpowerplantnortheastofTokyo,theOECDsaid. Thisisamuchsmallercontractionthanthe0.9percentdeclinetheOECDforecastinMay. Japan'seconomywilllikelygrow2.0percentnextyear,versusapreviousforecastof2.2percentgrowth,asthe governmentplanstospendaround19trillionyen($244.6billion)rebuildingareasdevastatedbytheMarch disaster,theOECDsaid. Growthwillthenslowto1.6percentin2013asreconstructionspendingpetersout,butdomesticcapitalspending andapickupinglobaldemandwillsupportJapan'sexportfocusedeconomy,thereportsaid. ReconstructionspendingisworseningJapan'spublicfinancesintheshortterm,andtheratioofdebttogross domesticproductwillrisetoalmost230percentin2013,pushingpublicfinancesfurtherinto"uncharted territory",theOECDsaid. Japan'spublicfinances,alreadytheworstamongdevelopedeconomies,woulddeteriorateevenifthegovernment metitstargetofhalvingtheprimarybudgetdeficitbyfiscal2015/16,theOECDsaid.Aprimarybudgetbalance excludesdebtservicingcostsandincomefrombondsales. Thegovernmentalsohopestoachieveaprimarybudgetsurplusinfiscal2020/21butneedstocomeupwitha plandetailedenoughtoreassureinvestorsonedgeduetoEurope'ssovereigndebtcrisis. Japanshouldimproveitsexistingplanbycreatinganobjectivebodytoevaluatefiscalpolicy,theOECDsaid. Japanwillraiseincomeandcorporatetaxestopayforreconstructionandseparatelyplanstoraisethesalestaxto coverrisingwelfarespending.Itwouldbebettertolowercorporatetaxesandraisethesalestaxtoincrease revenue,asthatwouldbelessharmfultotheeconomy,theOECDsaid.

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BOJShirakawawarnsJapanoutlooksevere Nov28(Reuters)BankofJapanGovernorMasaakiShirakawasaidEuropemustmakeitsowneffortstocontain itssovereigndebtcrisisbutusingfundsfromtheIMFandfromoutsidetheregioncouldbeanoption. HealsosaidJapan'seconomywilleventuallyresumearecoverybutwillremaininaseverestateforthetimebeing duetothepainfromrecentyenrisesandslowingglobalgrowth. BelowarehiskeyquotesfromameetingwithbusinessleadersinNagoya,centralJapan,andanewsconference thatfollowed: EUROPEDEBTWOES (Fromnewsconference) "EuropeancountriesneedtoimplementmeasurestheyagreedonattheEuropeanUnionandeurozonesummit. Boostingtheregion'sfinancialresourceswasoneofthestepsagreedatthesummit. "What'smostimportantisforEuropetomakeitsowneffortstofixtheproblem.Alongsidethat,makinguseof fundsfromtheIMFandfromoutsidetheregioncouldbeanoption.Variousstepshavealreadybeenexamined,as theG20communiqueshows. "Imustalsostressthatsupplyingfundsaloneisn'tenough.Countriesthatacceptfundsneedtopursueeconomic andfiscalstructuralreforms...Thisproblemwon'tbesolvedjustbysupplyingfunds." "AdelayinEurope'spolicyresponsewouldhaveahugeimpactontheglobaleconomy.Wemustpreventthisatall costs.Europeneedstoactswiftlyanddecisivelyonwhatitagreedupon." (Frommeetingwithbusinessleaders) "InEurope,governmentbondyieldsforcountrieswhosefiscalconditionshavebecomesubjecttoconcernhave beenrisingsignificantly.RateshavestartedtoriseeveninItaly,thethirdlargesteconomyintheeuroarea. "Asaresult,Europeanfinancialinstitutionswithlargeholdingsofgovernmentbondsinquestionhavefaced difficultiesraisingfundsfromthemarket,forcingthemtocurblending. "InEurope,shrinkingmarketconfidenceinitsfiscalstateisheighteningconcernaboutthestabilityoftheregion's financialsystem,whichinturnisaffectingtheeconomy.Anadversefeedbackloopisbeginningtooperatewith respecttothefiscalsituation,thefinancialsystem,andeconomicactivity." JAPANECONOMY,YEN "TheBOJ'sbaselinescenarioisthatfromaslightlylongtermperspective,Japan'seconomywilleventuallyreturn toasustainablegrowthpathwithpricestability.Butwerecognisethatthisoutlookissubjecttovarious uncertainties. "ThemostsignificantriskisthesovereigndebtprobleminEurope,orinthewordsofEuropeanauthoritiesin officialdocuments,'thesovereigndebtcrisis'...

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"Whenuncertaintyovertheoverseaseconomicoutlookishigh,asisthecasenow,risesintheyenmayhurt Japan'seconomybyreducingexportsandcorporateprofitsaswellasbyworseningbusinesssentiment.Weneed tobemindfulofthis. "ThegovernmentdecideswhentointerveneandtheBOJactsasitsagent.TheG7andG20sharetheviewthat excessivevolatilityanddisorderlycurrencymovesareundesirable.Basedonthisunderstanding,Japanconducted interventionandthishadacertaineffect...Ihopetocontinueeffortstogainunderstanding(ofJapan'sstanceon currencies). "CurrencymoveshaveabigeffectontheoutlookforJapan'seconomyandprices.TheBOJdoesnoteasepolicyin responsetoeachandeverycurrencymove.Weeasepolicywhenthecurrencymovesaffecttheoutlookforthe economy." JAPANLONGTERMINTERESTRATES "GlobalmarkettensionishighduetoEurope'ssovereigndebtproblem...Japan'sfiscalsituationisverysevere.It's importantforJapantoworksteadilytowardimprovingitsfiscalbalance." DEFLATION "Tobelievethatdeflationcouldbesolvedbyprintingmoneyalonewouldbetotakeatoosimplisticviewofthe problem.Wheninterestratesarehighwecancutrates,butthat'snotpossiblewithratesnoweffectivelyatzero. "Inthissituationthereisvirtuallynocostforholdingontocash.Whenfinancialuncertaintyishigh,asinEurope now,financialinstitutionstendtohoardcash.Thatmeansevenifcentralbankssupplyhugeamountsofliquidity, privatefinancialinstitutionswilljustkeeponhoardingcash... "TheBOJwillstrivetoeaseaggressively,bothintermsofinterestratesandtheamountofliquidity.Ontheother hand,(governmentandcorporate)effortstomakeuseofthiseasymonetaryenvironmentarealsoneeded.Only whenthetwocometogethercanJapanescapedeflation."

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YieldsRiseatFastestPaceof11BeforeAuctions:JapanCredit ByMonamiYui Nov.28(Bloomberg)InvestorsaredrivingupJapansgovernmentbondyieldsatthefastestpaceinalmost11 months,andthemovemaycontinuebeforetwoauctionsthisweekamidconcernthenationmayfaceacredit ratingsdowngrade. Theyieldonthebenchmark10yearsecuritytouched1.065percenttoday,thehighestsinceSept.2.Therate added8.5basispointslastweek,thebiggestfivedaygainsincetheweekendedJan.7,accordingtoJapanBond TradingCo.,thenationslargestinterdealerdebtbroker.TenyearU.S.yieldsdeclined 4.7basispointslastweekto1.96percent. TwentyyearbondsfellthemostsinceMayonNov.25,thedayafterStandard&Poorssaiditmaybecloserto loweringJapansgradeasPrimeMinisterYoshihikoNodasadministrationisntimprovingthenationsfinances. TheInternationalMonetaryFundsaidtheresariskasuddenspikeinyieldsmaymakethecountrysborrowings unsustainable.Japanisplanningtwoand10yearnoteauctionsthisweek. Givenhowthesentimentquicklydeterioratedoverthepastcoupleofdays,thegovernmentbondmarketis likelytobeunstableunlessitgetsresultsatthe10yearsale,ShinjiNomura,chiefdebtstrategistinTokyoat SMBCNikkoSecuritiesInc.,oneofthe25primarydealersobligedtobidatgovernmentdebtsales,saidNov.25. Shortertermbondswillbeboughtinsteadasarefuge,steepeningtheyieldcurve. Thegovernmentplanstosell2.7trillionyen($34.8 billion)ofsecuritiesmaturingDecember2013atauctiontomorrowandoffer2.2trillionyenofDecember2021 notesonDec.1. Investorsbidfor4.07timesthetwoyearnotesatthelastsaleonOct.26,thehighestbidtocoverratioforsuch debtsinceJuly.TheNov.1saleof10year,1percentbondsdrewthestrongestdemandsinceAprilasthebidto coverreached3.26. YieldsJump Twentyyearyieldsrose2.5basispointsto1.815percenttodayaftergainingsixbasispointsonNov.25.Abasis pointis0.01percentagepoint. Tenyearyieldsclimbedin20of24developedmarketstrackedbyBloombergoverthepastweek. Japansfinancesaregettingworseandworse,TakahiraOgawa,Singaporebaseddirectorofsovereignratings atS&P,saidinaninterviewonNov.24.S&PratesJapanatAAandhashadanegativeoutlookontherating sinceApril. DowngradeCloser Ogawasaidthatitmayberightinsayingthatwereclosertoadowngrade.Butthedeteriorationhasbeen gradualsofar,anditsnotlikeweregoingtomovetoday. JapaneseChiefCabinetSecretaryOsamuFujimurasaidtheS&Pcommentsdidntreflectanofficialconclusionby theratingscompany.HetoldreportersinTokyoonNov.25thatthegovernmentintendstoexplainitsplanon debtmanagement. ConcernthatJapansdebtburdenwillworsenhavehurtmostdebtmaturingin10yearsorlonger.Theyield spreadbetween twoand10yearbondsexpandedto92basispoints,thewidestlevelsinceJulyonaclosingbasis. TheIMFsaidinareportonNov.23thatconcernsaboutJapansfiscalsustainabilitymayresultinasudden spike inbondyields.Japansoutstandingdebtincreased1.1percentto954.4trillionyeninthethreemonthsended Sept.30,almostdoubleJapans2010grossdomesticproductof479.2trillionyen,governmentfiguresshow.

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BorrowingIncreasing Thenationspublicborrowingwillexceed1quadrillionyenintheyearthroughMarchasthenationpaysfor reconstructionfromarecordearthquake.U.S.obligationswere94.4percentofgrossdomesticproductand Germanyswere84percent,IMFdatafromaSeptemberreportshow. TheEuropeanCommissionforecastthismonththatGreecesdebtwouldriseto162.8percentofitseconomy thisyearand 198.3percentnextyear. MoodysInvestorsServicecutJapansdebtratingbyonesteptoAa3onAug.24.S&PlowereditsratingtoAA inJanuary.FitchRatingsalsohasJapanatAAwithanegativeoutlook. Japansbondshavereturned0.3percent,includingreinvestedinterest,sinceSept.30,the10thbest performanceamong26marketsworldwidetrackedbyBloomberg/EFFASindexes. U.K.debtadvanced4.3percenttohavethebestreturns. Theclimbinthe10yearyieldtoabove1percentmayencourageinvestorstobuyJapanssecuritiesatauctions thisweek,accordingtoTomohikoKatsu,deputygeneralmanagerofthecapitalmarketsdivisionatShinseiBank Ltd.inTokyo.Therate,whichtouchedaoneyearlowof0.94percentonNov.17,isstillthelowestamong developednationsafterSwitzerlands. DemandAhead Japans10yearyieldwilladvanceto1.15percentbytheendofMarch,accordingtotheweightedaverageof analystforecastscompiledbyBloomberg. Therewillbedemandattwoand10yearauctionsasfurtherdeclineinyieldshadbeenexpected,Katsusaid inatelephoneinterviewonNov.25.Thereisachancethegovernmentwillsetcouponat1.1percentfor10year bonds,hesaid.ThatwouldbethehighestsincetheSeptembersale,accordingtoBloombergdata. ElsewhereinJapanscreditmarkets,MitsubishiGasChemicalCo.sold15billionyenof0.67percentfiveyear bondslastweek,whileDaidoSteelCo.issued10billionyenof0.68percentfiveyearnotes. KintetsuCorp.planstosell20billionyenoffouryearbondsthatwillbemarketedmainlytoindividualinvestors, accordingtoafilingwithJapansfinanceministry.ThetermsofthebondsalewillbesetonDec.9,thedocument showed. JapanBonds SanyoElectricRailwayCo.registeredtosellasmuchas6billionyenofbonds,whileSumitomoRubber IndustriesLtd. registeredtoissueasmuchas50billionyenofbonds,accordingtoseparatefilingswiththeministrylastweek.A shelfregistrationallowsforbondsaleswithoutobligatingthecompanyorcountrytoborrow. OnNov.25,ShimizuCorp.offeredforsale10billionyenoffiveyear,0.71percentbonds,accordingtoa statementfromNomuraSecuritiesCo.Thesameday,KonicaMinoltaHoldingsInc. offered20billionyenoffiveyear,0.61percentbonds,accordingtoastatementfromSMBCNikkoSecuritiesInc. TheextrayieldinvestorsdemandtoholdJapanesecorporatedebtinsteadofgovernmentbondswidenedto48 basispointsonNov.25from44onOct.31,whilethespreadonglobalcompanydebtincreased40basispointsto 270inthesameperiod,accordingtoindexescompiledbyMerrillLynch. FiveyearcreditdefaultswapsonJapanesegovernmentbondsrose19basispointslastweekto135basis points,thelargestincreasesincethefivedaysendedSept.23.CMApricesinNewYorkshow.CMAisownedby CMEGroupInc.andcompilespricesquotedbydealersintheprivatelynegotiatedmarket. YenGains Theyenhasstrengthenedagainstallofits16majorpeersthisyearasthespreadofEuropessovereigndebt crisistolargereconomiesspurreddemandforhavenassets.Thecurrencydeclined1.1percentlastweekandwas at77.63asof11:20a.m.

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inTokyo. Franceriskslosingitstopcreditratingintheeventoffurthereconomicshocks,FitchRatingssaidonNov.23. Thesameday,Germanys10yeardebtslumpedthemostsince1990afterthenationfailedtogetbidsfor35 percentofthesecuritiesthatitofferedforsale. German10yearbundyieldsadvanced30basispointslastweekto2.26percent,postingthesharpestsuch increasesinceJanuary2009. TherehasbeenaflighttoqualityintoTreasuries,gilts,JGBsandbundsbefore,andnowoneofthemis collapsing,leadingtoanxietyinthemarket,SMBCNikkosNomurasaid. WehadabadauctiononGermanbondsandareportonapossibledowngradebyS&PatatimewhenJapans fiscalriskiscomingunderthespotlight. ForRelatedNewsandInformation: Bondsforsale:PREL<GO> Bondyieldforecasts:BYFC<GO> Topbondmarketstories:TOPBON<GO> Internationalyieldcurves:NIYC<GO> MostreadJapanesebondstories:MNIJPB<GO>Storiesonanalystrecommendation:NIANABON<GO> WithassistancebyJonathanAnnellsinTokyoandMasakiKondoinSingapore.Editors:PavelAlpeyev,Garfield Reynolds.

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SwaptionSurgeSignalsEuroContagioninYenDebt:JapanCredit ByMasakiKondoandHirokoKomiya Nov.29(Bloomberg)OptionstradersarethemostbearishonJapanesebondsinsevenmonths,signaling concernthatEuropesdebtcrisismayspreadtoamarketthatsbeeninsulatedbycurrencygainsandatrade surplus. SocalledswaptionslinkedtoJapansdebthavesoaredto 54basispoints,thehighestsinceApril25onaclosingbasis. Theriskreversalrateforonemonthoptionsonthedollarversustheyenadvancedabovezeroforthefirsttimein sevenyears,asmoretraderswantedtherighttobuythegreenbackifitstartstorise.Japans10yearnotehas fallenforfivestraightdays,sendingtheyieldtoa12weekhighof1.065percentthatsstillthesecondlowestrate intheworld. JapansborrowingcostsarelessthanhalfthelevelofGermanyseventhoughStandard&PoorsratestheAsian nationthreelevelslowerthanEuropesbiggesteconomy.Germanyfailedtogetbidsfor35percentofthe10year debtitsoldonNov. 23,asconcernmountedthatthesovereigndebtcrisisthatstartedinGreeceisspreadingtolargereconomies. Theresspeculationthatabadgaininbondyieldsandyenweaknesswillhappensimultaneously,said YunosukeIkeda,headofJapanforeignexchangeresearchatNomuraSecuritiesCo.,thenationsbiggest brokerage.OverseasinvestorsmaybethinkingabondslumpshouldspreadtoJapanespeciallyafteritoccurredin Germany. TheyieldonJapansbenchmark10yearsecurityrose8.5basispointslastweek,themostsincetheweekended Jan.7andtouched1.065percentyesterday,thehighestsinceSept.2.Thatcompareswith2.26percentin Germanyand2percentintheU.S. TandemClimb Theclimbinthefixed,10yearrateusedinyenswaptions,whichgranttherighttoenterintoagreementsto exchangetheratefortheLondoninterbankofferedrateforyenloansinayearstime,showstraderswanttolock indealsnowbeforeborrowingcostsclimb,accordingtoToruSuehiro,amarketanalystinTokyoatMizuho SecuritiesCo. Becauseswapratesmoveintandemwithgovernmentbondyields,thistrendindicatesthatsomeinvestors expectbothratestorise,saidSuehiro,whosecompanyisoneofthe25primarydealersobligedtobidat governmentdebtsales. Theriskreversalrateforonemonthoptionsonthedollarversustheyenreached0.115percentonNov.25,the highestsinceMarch2004andindicatingincreasingdemandforcallsthatgivetraderstherighttobuythedollar. SuddenSpike TakahiraOgawa,SingaporebaseddirectorofsovereignratingsatS&P,saidonNov.24thatJapansfinancesare gettingworseandworse.S&PratesJapanatAAwithanegativeoutlook,comparedwithGermanysAAAgrade. Itmayberightinsayingthatwereclosertoadowngrade,hesaidinaninterview.Butthedeteriorationhas beengradualsofar. TheInternationalMonetaryFundsaidinareportonNov.23thatconcernsaboutJapansfiscalsustainability mayresultinasuddenspikeinbondyields. PrimeMinisterYoshihikoNodahasbackedaproposalbyhispredecessorNaotoKantoraisethe5percent consumptiontaxbytheendofthedecade.HewillaskthegovernmentandrulingDemocraticPartyofJapanto compilebyyearendadetailedtimetabletoraisetheconsumptiontax,theAsahinewspaperreportedyesterday. NodasaidinaspeechlastmonththatthecrisisinEuropeisntafireontheothersideoftheriver.Japanhasa publicdebtburdenthatstwiceasbigasitsannualeconomicoutput,thebiggestratiointheworld. LiborAdvance

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 ThegaininswaptionsalsostemsfromanincreaseintheyenLibor,MizuhosSuehirosaidyesterday.Three monthyenLiboradvancedto0.198percentonNov.18,thehighestsinceApril,amidconcernlossesonEuropean debtwillimpairthefiscalhealthofbanksactingascounterpartsintheinterbankmarket. Twelveofthe16banksthatcontributetotheratesfixingarenonJapanesecompanies,withWestLBAGin Germanyofferingthehighestrateof0.25percent,followedbySocieteGeneraleSAs0.23percent,accordingto datacompiledbytheBritishBankersAssociation. Italys10yearbondyieldsthismonthreachedthe7percentthresholdthatpromptedGreece,Irelandand PortugaltoseekEuropeanUnionbailouts. ElsewhereinJapanscreditmarkets,BankofFukuokaandNishiNipponCityBankLtd.areplanningtosellbonds. BankofFukuoka,aunitofFukuokaFinancialGroupInc.,hiredNomuraHoldingsInc.,SMBCNikkoSecuritiesInc. andDaiwaSecuritiesGroupInc.fora10billionyen($129million)saleof15yearsubordinatedbonds,Nomura saidinastatementyesterday. NishiNipponwillsellthesameamountof10yearsubordinatedbondsthatwillbemarketedmainlyto individualinvestors,accordingtoafilingwiththeMinistryofFinance. NarrowingSurplus TheextrayieldinvestorsdemandtoholdJapanesecorporatedebtinsteadofgovernmentbondswas48basis pointsonNov.25,comparedwith270basispointsforglobalcompanies,accordingtoindexescompiledbyMerrill Lynch. Theyenhasoutperformedallofits16majorcounterpartsthisyear.Thecurrencytendstostrengthenduring periodsoffinancialstressbecauseJapansexportrelianteconomydoesntneedforeigncapitaltobalanceits currentaccount. Thenation,whichhadtheworldssecondlargestcurrentaccountsurpluslastyearafterChina,willseea28 percentdecreaseitssurplusthrough2016,accordingtoestimatesfromtheIMF. Thegovernmentplanstosell2.7trillionyenofsecuritiesmaturingDecember2013atanauctiontodayandwill offer2.2trillionyenofDecember2021notesonDec.1. Japanssurplusesandthedominanceofdomesticinvestorsinitsbondmarketwillpreventthecountrysdebt fromanyselloffforthetimebeing,saidShinjiHiramatsu,seniorinvestmentmanageratSompoJapanNipponkoa AssetManagementCo. TheresapossibilitythatbondyieldswillsurgebecauseoftheworseningofJapansfinances,Hiramatsu, whoseTokyobasedcompanymanagesabout$58billion,saidyesterday.Thatdayiscomingcloser,butnotthis yearornextyear. ForRelatedNewsandInformation: Bondsforsale:PREL<GO> Bondyieldforecasts:BYFC<GO> Topbondmarketstories:TOPBON<GO> Internationalyieldcurves:NIYC<GO> MostreadJapanesebondstories:MNIJPB<GO>Storiesonanalystrecommendation:NIANABON<GO> WithassistancefromMonamiYuiandYumiIkedainTokyo. Editors:RockySwift,BrianFowler

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