EU Deal With Greece Falling Apart

 

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.

The market lost its rose colored glasses today with Greece announcing a political referendum early in 2012 on the recent EU bailout deal. This could lead to the deal falling apart sooner rather than later.  Stocks sold off on the news in Europe and the U.S. while interest rates rose in Greece and other troubled EU countries.

The deal that the EU put together last week to handle its debt ridden members and to help prop up its banks was essentially smoke and mirrors surrounding a house of cards. It had no chance to work in the long run and the best it could accomplish was to buy more time before the inevitable day of reckoning. The 50% haircut on Greek debt, plus $130 billion euros did provide Greece with enough funds to keep going. It did not stabilize the situation enough however to ensure another debt crisis didn't occur within the next few years. Nor was there any reason to believe that Italy, Spain, Portugal and Ireland wouldn't need a similar bailout in the future. The plans for recapitalizing EU banks were likely to create a credit crunch and send the EU into a deep recession before further steps were taken. The centerpiece of all the bailout operations — the EFSF (European Financial Stability Facility) — was based on essentially printed money that was going to be leveraged. This was how the problem of too much debt was going to be solved.

While stock markets worldwide had huge rallies based on the "good" news that came out of the EU last week (traders like hearing about governments printing more money), they were giving back those gains on Tuesday. Both the German DAX and French CAC-40 were down over 4% in late day trading. The euro, which has held up remarkably well during the entire crisis was down over 1%. Big EU banks were getting slammed hard. France's Société Générale (FR:GLE) was down  almost 17%, Credit Agricole (FR:ACA) fell almost 13% and BNP Paribas (FR:BNP) dropped almost 12% .  Deutsche Bank (DB) was down over 6% and Commerzbank (DE:CBK) down over 10%. The U.S. S&P 500 was lower by a comparatively mild 2% in early going.

Bonds reacted more strongly. The yield on the safe haven 10-year U.S. treasury fell over 6% and the yield was barely above 2% in the morning in New York. Yields on trouble country debt in the EU were moving in the opposite direction. Italian 10-year governments traded over 6.25% (above 6% is considered a critical point of potential breakdown). Only buying from the ECB, which also included Spanish government debt, kept yields from soaring much higher. Yields in Greece were even more telling of the market's true opinion of the EU debt deal and its aftermath. Before the deal, yields on one-year Greek governments reached 193%. They had only fallen to 154% (no solvent country pays anywhere close to this amount) before the announcement of the Greek referendum. This yield peaked at 200% today (November 1st).

Panic was caused by the proposed referendum in Greece because polls show that the terms reached with the EU and IMF are highly unpopular with the Greek people. Even though they have gotten an incredibly good deal, the average Greek is focused on the additionaly years of austerity that would be required on Greece's part.  Apparently, neither the Greeks, nor the markets like hearing that there is no free lunch.

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.

60% Cut for Greek Bondholders on the Table

 

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.
Bloomberg reported overnight that Greek bondholders were preparing to lose 60% on their investments. This is much bigger than the constructive default of 21% proposed with the second bailout in July. A big cut in the value of Greek bonds will cause major problems for German and French banks — and the ECB itself.

Rumors have been floating around the markets for days about a managed default of Greek debt at around the 50%, or greater, level and an occasional brief or cryptic comment has been made publically by EU officials. While this news was reported by the Helicopter Economics Investing Guide blog days ago, it is only just now filtering into the mainstream news services even though a large cut on Greek debt is an arithmetic inevitability. The only alternative would be a second bailout package several times larger than the proposed 109 billion euros (say 500 billion euros or more). Considering that populations of the EU countries are hostile to spending even the 109 billion euros, additional bailout funding is highly unlikely.

Bloomberg quoted a number of well-placed financial executives, including the CEO of Deutsche Bank, in its report indicating a general consensus was building that Greek bondholders would accept a deep reduction in their holdings. There ECB (European Central Bank) seems to be a major exception however. The ECB had amassed a considerable holding of Greek debt earlier on in an attempt to hold down interest rates there. Interest rates have since gone as high as 141% on Greek one-year governments. The ECB subsequently bought up debt from Portugal, Ireland, Spain and Italy to hold interest rates down in those countries. Investors should expect that ultimately these efforts will prove just as successful as they have in Greece.

Recapitalization (a euphemism for "bailout") will be necessary for EU banks if they have to take major losses on their Greek loans. Dexia, the largest bank in Belgium, folded almost overnight recently and its exposure to Greek debt was only a little over 1% of its loan portfolio — and this was before talk of a 60% haircut for Greek bonds. Imagine what would happen to banks with larger exposures? EU banks also hold substantial amounts of loans to Ireland, Italy, Portugal and Spain. The largest holders of Greek debt by far are of course Greek banks themselves. Proton Bank recently closed there, but officials made it clear that it was because of alleged criminal activity and not because of the debt crisis.

Sovereign credit and bank downgrades throughout the EU are becoming increasingly common.  S&P downgraded Spain's long-term credit rating from AA to AA- with a negative outlook (meaning more cuts are likely) today. The agency predicted Spain would miss its deficit cutting targets for 2011 and 2012. S&P downgraded the credit ratings of a number of Spanish banks three days ago including Santander (STD). Credit Suisse analysts just declared the Royal Bank of Scotland (RBS) to be the "most vulnerable" bank in Europe. RBS is 87% owned by the UK government. Credit rating agency Fitch threatened across the board downgrades of the banks yesterday. This potential downgrade would impact Barclays (BCS), BNP Paribas (FR: BNP), Credit Suisse (CS), Deutsche Bank (DB), Goldman Sachs (GS), Morgan Stanley (MS), and Société Générale (FR:GLE) among others.

Perhaps in the next few weeks there will be some temporary resolution to the Greek debt crisis. Unless the cut that bondholders are forced to take is big enough, it won't last however. Whatever happens with Greece won't solve the problems in Ireland, Italy, Portugal, Spain, and possibly in Belgium. To be effective, the recapitalization (bailouts) of EU banks will have to be substantial. This will by necessity involve using money printing to resolve a debt crisis.  That's actually already been done since 2008 and look at what great shape the global financial system is in now. 

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.