June 26, 2011

Greece and the Eurozone Russian Roulette

A key week is starting tomorrow for Greece and regardless of the decisions that will take place in Athens the situation in the Eurozone is deteriorating by the day.
The reality is that Greece should have defaulted in May 2010 and avoid an austerity torture that is destroying the country and dragging the Euro to hell.

Had the May 2010 deal provided for debt writedown, the Greek crisis would be over by now. The crises in Ireland and Portugal would probably have happened anyway but would have been easier to handle and the European sovereign debt market would surely be less fragile.
Greece, Ireland and Portugal are small countries and a major disaster can be averted if the debt meltdown can be confined to these three. But if Spain goes under, threatening next-in-line Italy, the world financial crisis will enter a new and potentially disastrous phase.
There is a dangerous divide in the Eurozone which has been getting bigger in the last years and is widening up rapidly. While Ireland has some hope to get out of this mess thanks to its offshore companies' production provided will be able to disentangle itself from the burden of the irish banking system; the situation is appalling in Spain, Greece and Italy.



On Friday, the yield on Irish 10-year bonds reached 12 per cent, the highest level yet seen, with Portugal not far behind. But more ominously, yields on Spanish 10-year bonds have been creeping up and reached 5.7 per cent on Friday.
Ten-year yields for Italy, Europe's largest bond market, have shot back up towards five per cent, close to the danger zone, and one of the ratings agencies (Moody's) has threatened a downgrade.
There is a high risk of accident in the Spanish or Italian bond markets, or of an unexpected bank failure or a government collapsing somewhere. On Friday, Bank of England governor Mervyn King put it: "Providing liquidity can only be used to buy time."
As for the ECB we are not sure if they are trying to save the situation or complicate it.
Last week's Irish edition of The Sunday Times, quoted an unnamed ECB official saying: "In the meantime, we may have to come to the conclusion that it doesn't really make sense for the ECB to keep putting €100bn into Irish banks. What we are doing is actually illegal, but we have being doing it because we want to help Ireland. Maybe we might come to the conclusion that we should stop."

Der Spiegel pointed out correctly:


If the rest of Europe abandons Greece, the crisis could spin out of control, spreading from one weak euro-zone country to the next. Investors would have no guarantees that Europe would not withdraw its support from Portugal or Ireland, if push came to shove, and they would sell their government bonds. The prices of these bonds would fall and risk premiums would go up. Then these countries would only be able to drum up fresh capital by paying high interest rates, which would only augment their existing budget problems. It's possible that they would no longer be able to raise any money at all, in which case they would become insolvent.



And the cash is running out fast, disturbing news last week on the liquidity of European banks is that the number of banks tendering for ECB liquidity surged to 353: higher by 118 from the week earlier as the liquidity contagion spreads, the highest since September 2008, when 371 banks were rushing to suckle at the ECB's teat.

In the meanwhile Labour Unions in Greece decided to cut another 0.15% from Greek GDP by doing absolutely nothing. As a result, as Athens News reports, "according to the General Confederation of Workers of Greece (GSEE) and the civil servants' umbrella federation Adedy, the 48-hour strike is an escalation of their recent industrial action comprising 24-hour nationwide strikes in protest of the medium-term programme. A main demonstration will be held on Tuesday, June 28, at the Pedion tou Areos park in central Athens at 11am, while on Wednesday another demonstration will be held in downtown Klafthmonos Square."
As a reminder June 28, is the far more critical Greece austerity vote, which unlike the vote of confidence already has several PASOK members saying they will vote against it. 


This could explain why Le Figaro reports today that a working group of French banks led by BNP Paribas has proposed, and been agreed to by the French Treasury, that maturing debt would be rolled over into a a 30 year maturity piece, accounting for 50% of the total existing debt, and another 20% would go into a "zero coupon" fund focused on high quality stocks. Also according to Le Figaro, borrowings under the proposed scheme would pay an interest equivalent to what Greek "public" interest is plus a variable interest rate "likely to be linked to an economic Greek indicator such as GDP" (which being negative for years to come will likely means lower interest than prevailing).
The implied haircut for the Greek Treasury would be between 30% and 50%.
At least 30% of the rolling over debt would not come back to the issuing authority.
This funding avenue closure would commence the waterfall that triggers the liquidity cascade that culminate with every single European money market fund breaking the buck.
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