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.

Credit Crisis Déjà Vu

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.

In September 2008, the markets were in sharp decline because of a bank-centered financial crisis. The authorities took action with bailouts and by buying bonds to prop up the market. Short selling of financial stocks was banned in order to stabilize the markets. Things are certainly different in 2011.  It's not that all of these events aren't happening again, they certainly are. This big difference is that now they are happening in August instead of September.

The geographic epicenter of the crisis has shifted as well. Europe is now dragging down the global financial system, whereas it was the United States that was doing the heavy lifting in 2008. Yet stocks have been down by similar amounts in continental Europe and in the U.S. this month. Whereas the U.S. was dealing with the failure of Lehman Brothers in September 2008, the EU is dealing with a selective default of Greek debt and trying to prevent new crises from arising in Spain and Italy (problems in Ireland and Portugal are on the back burner for now). Greece received its first bailout in May 2010 and then another bailout this July. The original terms of the new bailout require bondholders to take a 21% loss on their holdings. If the bondholders were just in Greece, this would not have major implications. However, French and German banks were major lenders to Greece. The Greek bailout is really a bailout for them.

Rumors have been rife that a number of French banks are in trouble and that S&P was going to downgrade them and France's AAA credit rating. Rumors also dogged Bear Stearns before its failure in March 2008. The company vehemently denied them, especially in the week before it collapsed. The SEC threatened to investigate and find the culprits spreading false rumors about Bear Stearns being in trouble. The SEC's case fell apart though after the company closed its doors. 

Any company, especially any bank, in trouble is going to publically deny it. So French banks denying that they are financially troubled, which they have done, is in and of itself meaningless. In this case, more credence can be given to S&P's statements on the matter. S&P denies it is about to downgrade the credit ratings for France or of the French banks rumored to be in trouble. It would look pretty foolish if it turned around and lowered them in the near future. S&P of course is still smarting from the reaction from its downgrade of U.S. debt from AAA to AA+. Even though the U.S. can't pay its everyday bills without borrowing money and this is as good a definition of insolvency as any, there was incredible outrage that S&P lowered its credit rating. After all, they had given the top rating to securitized mortgage bonds containing subprime loans and some of those borrowers had no income, no assets and no prospect for paying off their debts.

Another government reaction that took place in 2008 that is repeating itself in 2011 is a short selling ban. France, Spain, Italy and Belgium have just banned short selling of select financial stocks. On September 19, 2008, the U.S. banned short-selling on 799 financial stocks. Britain banned short selling on similar stocks the day before. Did it work back then?  No, it didn't. A large number of banks failed and many that didn't remained functioning only because of massive bailouts or because they were nationalized. 

Direct government takeovers were more common in the UK than the U.S. in 2008 and 2009, but just as the land of the free banned short selling, the supposedly capitalistic U.S. took over Fannie Mae, Freddie Mac and eventually GM (it had been lumped in with financial stocks as part of the short selling ban). It's not clear that the bailouts have yet to end either. In August 2011, Fannie Mae paid $500 million to buy servicing rights for 400,000 of Bank of America's worst-performing loans, loans with an unpaid balance of $73 billion. or these instead of Bank of America. Who exactly benefitted from this arrangement? Fannie Mae and Freddie Mac back $5 trillion in loans and many of them are not likely to be paid off. This debt is not counted as part of the $14 trillion plus U.S. national debt, but at least some of it should be.   

In 2011, the ECB (European Central Bank) has established a Securities Market Program to buy government bonds of its troubled members in order to keep interest rates lower than the free market rate. Its first buys were Spanish and Italian bonds on August 8th. The U.S. Fed was a heavy buyer of bonds in September 2008, although it didn't announce its first quantitative easing program until late November of that year. It also denied at the time that it was engaging in quantitative easing. Most of QE 1 had already taken place by the time the Fed announced it. This highly relevant fact remained unmentioned.

So here we are in 2011 and we find events are very similar to what was taking place in 2008. Some of the players are different, the locations are different and the order things are happening may be a little different. But all in all, it looks like the more things change; the more they remain the same.  

Disclosure: None

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


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