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.

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.

Euro Banks Up on Stress Test Farce

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.


Euro banks rallied nicely on Monday after results of the EU's stress test indicated there are essentially no problems in the European banking system. The stress tests have been heavily criticized as a whitewash and a cynical PR maneuver however. Nevertheless, rallies in bank stocks are continuing today on earnings reports from UBS, Deutsche Bank, Societe Generale and Credit Agricole.

Of the 91 EU banks analyzed for the stress tests, only 7 failed - five in Spain, one in Germany and only one in Greece. No bank in Portugal, Ireland or Italy failed the test and was deemed to be in need of raising more capital. The 7 banks that did fail were supposedly only short $4.5 billion. An alternative result produced by an analyst at JP Morgan indicated at least 54 banks should have failed the stress tests and at least $100 billion in new capital needed to be raised. Even that view may be optimistic.

Although considering the great earnings out today for UBS (UBS), Deutche Bank (DB), Societe Generale and Credit Agircole perhaps enough money is being poured into the euro banks from the ECB that it is irrelevant what condition they are in. After all, another bailout is potentially always around the corner. The UBS earnings were the most telling in this regard. One reason stated for UBS doing so well was that "withdrawals in the private banking arm have continued to slow". Yes, losing business at a slower rate is certainly bullish. The stock was up 7% on the news.

In a separate report released today, lending to non-financial companies was down 1.9% year over year in the EU. So euro bank earnings are rising even though less lending is taking place to businesses. Interesting, to say the least. Mortgage lending in the EU is going up at a 3.4% annual rate however. So maybe some minor reinflation of the real estate bubble is taking place in Europe while the economy slows down. That certainly bodes well for the future.

The stress tests show once again that any number, no matter how outrageously manipulated or false, will be accepted by the market as gospel.  We saw this last week with the UK second quarter GDP figures. The construction spending number was up by an amount indicating a major building boom was taking place even though there is no other evidence of a big pick up in construction. The fact that the reported numbers didn't match up with reality apparently didn't disturb anyone. You would think it would have since the current EU financial crisis that necessitated the stress tests was cause by Greece lying about its fiscal state. Greece's numbers were off by more than 400%, but no one in EU headquarters noticed any problem with them.

When economic or business numbers are fantasies, but are accepted anyway, a major crisis will invariably follow. Before the Greek debt crisis, there was a the subprime crisis in the U.S. Bundles of subprime loans - loans from borrowers who had no job, no assets, and no history of paying their bills - were believed to be triple A credits because some authority said they were. This allowed common sense to be thrown out the window and complete absurdity to be regarded as wisdom. This type of behavior though isn't as bad right now as it was during the subprime era - it's actually much worse.

Disclosure: No positions.

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.