Greek Deal is Another "Fiscal Solvency in Our Time"

 

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.

Once again Greece has avoided a messy default and once again its creditors have had to take a greater loss on their loans and once again standards had to be abandoned to make the deal go through. And once again, we're not done yet.

Realistically, Greece is actually undergoing a messy default; it's just doing it in slow motion. When creditors are not fully paid, there is a default. The original default terms for creditors last summer were for a 21% loss for private bondholders (read banks). This percent has been raised more than once and with the latest round of negotiations, it will be above 70% according to Jean Lemierre, who co-headed the talks for the IIF (Institute of International Finance). The ECB and national central banks in the eurozone have agreed to "forgo profits on their holdings" (presumably this means the interest payments on Greek government bonds -- something which also indicates default).The eurozone countries will reduce the interest on Greece's first package of bailout loans to 1.5% over market rates from the previous 2% to 3%. This is the first time the ECB and other eurozone central banks have agreed to take a hit on their own holdings.

What prompted the further concessions to Greece was an attempt to get its 2020 projected debt to GDP ratio down to 120%. Without them, the ratio would have been 129% even under the bailout troika's (EU, ECB and IMF) most optimistic scenario (for the non-political reader, this means the complete fantasy scenario). Projections during the first bailout deal proved too good to be true and it should be presumed that these are as well.

There are still a lot of approvals needed to ensure that the current deal goes forward. If it does, every Greek man , woman and child will have received the equivalent of $29,000 from bailout payments. Greece holds elections in April and support for the anti-bailout parties is increasing. Whether or not it will be enough to derail the bailout deal remains to be seen.

Greek one-year government bond yields reached a high of 682% today according to Bloomberg.  To say that the market is not giving the bailout deal a vote of confidence would be an understatement. Last summer, they were around 40% and have been rising continually since then. While euro-politicians are once again claiming the problem is solved, the market indicates that Greece is imploding.

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.

The Outlook for U.S. Treasuries

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.


Treasuries rallied the last week of February, which should be expected in a strong dollar environment. The rally in the U.S. dollar that started in early December (around the time that news of the problems in Greece began to surface) is ongoing and this will continue to be bullish for U.S. government bond prices and bearish for interest rates while it lasts. Inflation expectations cause the opposite outcome however. These two competing forces help explain why longer dated treasury interest rates have been trading in a bullish pattern since May 2009, but after a brief initial burst upward have traded sideways since that time. Current conditions indicate that a breakout rally to higher rates will probably have to wait a while longer.

In the intermediate and long-term, there are a number of significant risks to U.S. treasuries as well as most other government's bonds for that matter. Direct default is now on the table for smaller economies like Greece. Indirect default through inflation and currency devaluation is the risk for the major economies, such as the U.S., UK, and Japan. Some top mainstream economists, such as Nobel Prize winner Joseph Stiglitz and chief economics commentator for the Financial Times Martin Wolf, have recently made the case that the U.S. can't default on its debt because it owns a printing press. While this is technically true, it doesn't mean the paying back a bond investment with money that is worth much less than it was at the time when it was lent isn't a type of default. Why would anyone want to buy a government's bonds under such circumstances? Bill Gross, managing director at the world's largest bond fund PIMCO, refers to this type of default as stealth-default.  Gross has made the case that the risk of either type of default of government debt will cause government debt and corporate debt to have similar interest rates in the future. This would cause interest rates on government bonds to rise relative to corporates in the next few years.

In the short-term though bad economic news along with the strong dollar should keep U.S. treasury interest rates from rising. There have been a host of negative economic reports in the last couple of weeks on the banking sector, consumers, housing, and durable goods. The ISM Manufacturing Index released on March 1st was a disappointment and its component parts provide an excellent representation of the current push-me pull-you factors on U.S. interest rates. While manufacturing is still in an expansionary mode, new orders and production (indications of future activity) declined sharply and this is a bearish for interest rates. However, the prices paid component, which represents inflation, was the highest number in the February report as it was in the January report. This is bullish for interest rates.  

While the Federal Reserve has frequently announced that U.S. economy is in recovery, it has always followed this up with a statement about how it is going to keep interest rates low for a prolonged period of time. This would not be necessary in an economy that was actually recovering. When the Fed is talking out of both sides of its mouth, investors should pay attention to what it is doing and ignore what it is saying. A prolonged period of low interest rates is inflationary and this means long-term treasury rates will be going up. The only question is when.

Disclosure: None

NEXT: A Snapshot of the Energy Markets

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.