Interest Rate Spread Widens as Greece Heads Toward Default

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Global interest rates continue to diverge, with rates rising in the troubled eurozone countries and falling to new lows in Germany and the United States.  The same sort of divergence took place during the 2008 Credit Crisis with yields on safe-haven governments falling markedly, while yields on low-grade corporates soared.

Nowhere in the world is the current interest-rate spread more extreme than in the Eurozone (the epicenter of the current credit crisis). Greece is leading the pack with ever-rising yields on its government paper, while German rates keep falling. In Tuesday morning trade, two-year Greek government yields reached a high of 74.88% and ten-year yields a high of 25.01%. Yields on German 10-year bunds were moving in the opposite direction falling as low as 1.679%, even lower than Monday's record-low rate of 1.877% on 10-year U.S. treasuries.

Italy had an auction of 5-year bonds this morning and had to pay a 5.6% yield to get them out the door
compared to 4.9% in July.  Interest rates on the Italian 10-year were at 5.75%. They were over 6% before the ECB started buying Irish, Portuguese, Spanish and Italian bonds on August 8th to force down surging rates as contagion from Greece spread to other parts of the Eurozone. Before that, yields in Ireland had reached approximately 14%, they were over 13% in Portugal, and in Spain they were at similar levels to Italy. Intervention can only maintain below free market rates for so long however. Eventually, the ECB will run out of funds.

The trajectory of Greece's decline toward insolvency is instructive for the future of Ireland, Portugal, Spain and Italy in the near future and for other highly indebted countries such as Japan, the United States and the UK later in the decade. In early 2010, Greek 10-year rates spiked above 12%, but were then driven below 8% with the first bailout. Greece had a debt to GDP ratio around 120%. Severe budget cutting was implemented to hold the debt down. This caused the economy to contract sharply, which lowered tax revenues. Despite the first and now a second bailout a self-feeding spiral of ever-increasing interest rates began. Higher interest rates and a weakened economy have caused the debt to GDP ratio to reach the 140% level (according to official numbers, estimates are as high as 160%). Rates on credit default swaps now indicate a 98% chance of default.

What the immediate effects of a Greek default will be remain to be seen. There will certainly be damage to the Eurozone banking system, which is still in a weakened state from bad loans accumulated before the 2008 Credit Crisis. At some point, the euro will have to be restructured or
it will be weakened considerably. Economic damage will not be limited to Europe, but will affect other regions of the globe just as was the case in 2008.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Risks of Market Contagion from a Greek Default

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While U.S. markets closed slightly up on Monday September 12th, panic reigned in Europe. The risks of a hard default by Greece reached 98% according to one model. Interest rates in Greece were spiraling out of control (the two-year government yield hit almost 70%) and credit default swaps on European sovereign and bank debt reached record levels again.

While Greece is a small economy and there are only two major countries --- France and Germany -- that hold substantial amounts of Greek government and corporate debt, this is only the very tip of the financial iceberg that threatens a titanic like sinking of world markets similar to what occurred during the 2008 Credit Crisis when Lehman Brothers collapsed. Problems in Greece are shared by two other small national economies, Ireland and Portugal, and by two much large economies, Spain and Italy. The Italian economy is roughly the size of the UK economy. It is too big to bail out. Can you imagine the UK defaulting and there being enough money available for an international rescue? If not, don't assume that problems with Italy can be fixed either. Spain is also too large to rescue.

Country defaults have implications well beyond their borders because large international banks have exposure to loans in them. In the global financial system, all large international banks are interconnected. Big banks such as Deutsche Bank, Société Générale, and Bank Paribas have substantial relationships with U.S. banks. The large banks are still in a weakened state from the 2008 crisis. This is showing up in British banks, which like the U.S. banks have limited exposure to Greek debt, and in Bank of America. Credit default swaps have reached record levels for some British banks and Bank of America's stock price keeps dropping.

The Greek default, and this will happen one way or the other at this point, will be similar to the demise of Lehman  in 2008. Contagion spread throughout the world financial system. In the U.S. the close to trillion dollar TARP program had to be instituted to hold up the banking system. In total, as much as $11 trillion in programs (the Federal Reserve alone had half a dozen major ones) had to be implemented to patch things up. The will for such an effort no longer exists, which will mute whatever response the authorities come up with will be delayed and muted. After Greece, something will have to be done with Ireland, Portugal, Spain and Italy. Those who think that the U.S. markets will be isolated from these events are at best engaging in wishful thinking and at worst are purposely misinforming the public.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Why a Greek Default is Imminent

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

It may only be weeks, if not days, before Greece defaults on its debts. Interest rates and credit default swaps (bond insurance) have hit record levels and are still climbing. Stocks are getting slammed throughout the word, especially EU bank stocks. The Germans appear ready to abandon further attempts at bailing out the debt-ridden country. 

Yields on two-year notes in Greece were above 60% Monday morning -- the highest ever. The yield on the 10-year governments was over 20%. Both rates continue to climb making it more and more difficult for Greece to pay down its enormous pile of debt and requiring larger and larger bailout packages if Greece is to avoid bankruptcy. The market is becoming increasingly skeptical that Greece will survive financially however. The five-year credit default swaps on its government debt were at records highs last Friday and their cost keeps rising as well.

Markets presaged this week's trouble last Friday, with the Dow Industrials down 304 points. Juergen Stark announced he was resigning the ECB's executive board because of its program of buying bonds of the financially troubled EU members. Markets got slammed in Europe and in North America. The damage continued in Asia Sunday night with Hong Kong's Hang Seng down 836 points (4.2%) and the Japanese Nikkei down 202 points (2.3%).  Germany and France were down almost at mini-crash levels (a 5% drop in one day) after their Monday opening, but recovered somewhat by the end of the morning. As of last Friday, the German DAX had fallen approximately one-third (33%) from its highs earlier in 2011.

Bank stocks are bearing the brunt of the selloff in EU markets.  Major banks such as Deutsche Bank, BNP Paribas and Société Générale were down in the 10% range. Outside of Greece, German and French banks are the most exposed to Greek debt. German banks have more exposure to Greek government debt (the debt that wouldn't be paid off in the event of a default), while French banks have more exposure to commercial loans to Greek businesses. Reports indicate that BNP Paribas, Société Générale and Credit Agricole may have their credit ratings lowered by Moody's this week. Credit default swaps on some major European banks are also rising to record high levels.

The Germans appear ready to throw in the towel on the second Greek rescue package. Officials have increasingly been making statements that indicate that Greece must meet its targets for deficit reduction if further bailout payments are to be made. It is highly unlikely this will happen. Nevertheless, the Greek Finance Minister stated over the weekend that Greece was committed to the "full implementation" of the terms of the second bailout. He dismissed rumors of a possible default. Of course, so did the CEOs of Enron and Bear Stearns days before their companies imploded.

Disclosure:  None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing
meetup http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.