It's a 50% Default for Greece

 

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.

EU leaders have agreed to seek a 50% reduction in Greek debt from bondholders. This supersedes the 21% reduction decided on in July that was supposed to resolve Greece's financial problems. Apparently $30 billion will be given to the banks as an inducement for them going along with the plan. The EU and IMF will also give Greece an additional 100 billion euros in bailout aid.

While the announcement was delivered with a sense of finality, the first bailout of Greece in May 2010 was supposed to solve Greece's debt problems and so was the second bailout this July. It has only taken three months since the  "everything is really fixed now" July announcement before a much bigger bailout and debt writedown proved to be needed. Until fairly recently, EU officials have constantly denied that this would be necessary or that Greece would default. Not paying 50% of your bond debt is not only a default, but it's a major default.

EU officials still seemed mathematically confused about the situation in Greece. EU President Van Rompuy claimed that the current deal will reduce Greece's debt to GDP ratio to 120% by 2020. If so, Greece is still likely headed for more trouble. Since it is estimated that Greece's debt to GDP ratio is around 160%, it should fall to 80% if all bondholders took a 50% hit. Perhaps all bondholders will not be taking a reduction after all. Both the IMF and ECB hold large amounts of Greek government debt and have in the past been reluctant to accept any writedown of their investments.

The pre-dawn news for the EFSF (European Financial Stability Fund), which is supposed to receive 440 billion euros, is that it will be leveraged up to a trillion euros. The U.S. has been pressing for two trillion. This money can be spent to bail out all the EU banks hurt by the Greek default, but only if they can't raise additional capital in the open markets. So the debt problem will be solved by incurring additional debt and borrowing against it. If this isn't a financial system ticking time bomb, nothing is.

The unanswered question is what is going with happen to Portugal (the next most likely crisis), Ireland, Spain and Italy. EU officials tried to minimize the situation by saying Greece is a special case. It would have been more accurate to say that its problems were more extreme and urgent. They are not unique.  The other countries are already somewhere on the path to insolvency and this will have to be dealt with in the future. The only question is how soon that future will arrive. 

 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.

Is Dexia Bank the Bear Stearns of the Current Credit Crisis?

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.

Over the weekend French President Sarkozy and German Chancellor Merkel said they had come to an agreement on recapitalizing EU banks. No details of their mystery plan were released. Plenty of details were forthcoming however on how Dexia bank was going to be bailed out and they indicate that it's time for EU leaders to stop talking and to start acting. 

Before its recent failure, Dexia bank was described as one of the strongest banks in Europe. It had no trouble passing the recent EU stress tests for banks (so much for the accuracy of those tests, which I have maintained for some time are nothing but a meaningless public relations gambit). Its Greek debt exposure was cited by the mainstream media as a primary reason for Dexia's demise. Dexia though had only 5.4 billion euros of Greek debt on its books out of an asset base of 518 billion euros according to Bloomberg. So, Greek debt was a little over 1% of Dexia's loans. Apparently this was enough for wholesale funding for the bank to dry up. Like most banks, consumer deposits were not enough to maintain Dexia's operations, it needed to continually borrow in the interbank market.

Dexia was a Franco-Belgium bank created 15 years ago by a merger of banks from the two countries. It also operates in Luxembourg and owns a 75% stake in Denzibank AS in Turkey, which it purchased in 2006. The Belgium government agreed to buy Dexia for 4 billion euros.  The French and Luxembourg units will be sold. Together, the three European governments will guarantee 90 billion euros of interbank and bond funding for 10 years. Belgium's share will be about 15% of its GDP. Guaranteeing bank debt has its risks and this is why Ireland required an EU bailout. Could Belgium be next?

If Dexia can fail, what EU bank is safe?  Moreover, the failure happened without a default by Greece, so it is clear many more bank failures are possible regardless of the outcome of the Greek debt crisis.
It can also be assumed that default will make the situation much worse. There are reports from German news agency DPA that Eurozone finance ministers are working on a plan involving a 60% reduction in Greek debt (previous reports indicated a 50% reduction).

The recent Dexia failure just like Bear Stearns failure in March 2008 happened because confidence from lenders in the interbank market disappeared. This can happen overnight. The monetary authorities patched things together temporarily after Bear Stearns demise, but the overall situation continued to deteriorate until Lehman Brothers failed six months later. A Greek default is likely to be the Lehman moment for the current credit crisis and Dexia's sudden collapse is similar to Bear Stearns. More bank failures in the EU will be a warning that the current crisis is escalating out of control.

Disclosure: None
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.
 

Gold and Silver Recover After Big Drop in Asia

 

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 Americans slept, gold and silver prices plummeted in Asia. The low took place in Hong Kong  at approximately 3AM New York time when spot gold flirted with the $1540 level and silver was around $26. A strong rally then took place after the London market opened half an hour later.

By the time Monday New York trading began at 8AM, spot gold was selling for $1626 and spot silver at $28.50 an ounce. So the average American investor wasn't able to buy into the carnage. The low prices set in Asia will almost certainly be tested in the future however and there is a good chance that  will take place during U.S. trading hours. As of now though, the $30 support level for silver is history.

In the last three days, gold has experienced it biggest drop since the 2008 Credit Crisis. Silver has had it largest decline on record. There is significant technical damage, especially for silver. On the 24-hour charts, silver has decisively broken its 325-day/65-week simple moving average -- a key line in the sand separating bullish and bearish trading behavior. This level is in the low 1400s for gold. Silver's behavior is telegraphing that gold will almost certainly hit that level. If silver can't hold the 26 level in the future, the next stop for it will be in the 21/22 range.

What is causing the big drop in precious metals? Well, both silver and gold were extremely overbought at their highs. When this happens, a lot of traders were buying heavily on margin. This creates a situation where many of them will be forced to sell at the same time if any bad news takes place. Once the selling starts, the market cascades downward. We are seeing that with gold and silver right now. Such behavior is common in any strong rally and does not by itself indicate a bubble (that would require at least a 500% to 1000% yearly price rise for the precious metals).

While a rising U.S. dollar during September and new margin requirements from the CME last Friday have led to precious metals selling, the big problem is in Europe. The Greek debt and EU bank crisis is causing a liquidity crunch for the big trading houses and they are selling whatever they can to raise cash.  The inadvertent result is that investors are being given the opportunity to pick up precious metals at bargain prices. A little patience might be advisable before hitting the buy button however.


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.

Stocks Weaken With the Economy

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.


U.S. stocks are in sell off mode this morning with all major indices trading below their 200-day moving averages. If current trends continue, the Dow and S&P 500 will give a bear market trading signal next week.

Problems in Europe continue to be a drag on the markets. The prices of Greek debt credit default swaps (CDSs), a type of bond insurance, are rising rapidly again. Experts say they are now indicating a 57% chance of default. Meanwhile, strikes are planned throughout France because the government is trying to raise the retirement age to 62. Investors should assume that EU attempts to reduce the socialist gravy train will be fought tooth and nail by the populace everywhere on the continent. Good news came out of Australia however. Prime minister Kevin Rudd was forced out because of his unpopular 40% super-tax on the mining industry (a key part of the Australian economy).  Australia doesn't have the debt problems that exist in the U.S. and Europe.

In the U.S., the economic numbers continue to be less than impressive. After the disastrous New Homes Sales report yesterday indicated a 33% drop in sales in just one month, the Durable Goods report showed a 1.1% decline in May. Weekly claims fell to 457,000, still well within recession levels, and this got some positive commentary from the cheerleading section of the press. The stock market didn't seem impressed however. While weekly claims have been much better this year than the depression levels they were at early in 2009, they have yet to indicate that the U.S. has recovered from the recession that began in December 2007.

The technical picture for stocks turned south again this Wednesday with the Dow and S&P 500 falling and closing below their 200-day moving averages. The tech heavy Nasdaq dropped below its 200-day yesterday, but managed to close just above it. It looks like it will close below it today. The small cap Russell 2000 is trading below its 200-day today for the first time since earlier this month. The 50-day moving averages for all the indices are still above their respective 200-days in a typical bull market pattern. The 50-days are all falling however and in the case of the Dow and S&P 500, it looks they will be crossing below their 200-days next week. This is a classic bear market signal.  Investors should be watching this carefully.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.