Tuesday, December 8, 2009

Greek Fiscal Situation Continues Slow Boil

We continue to see interesting developments involving Greece; which at this point the markets have sniffed at in "see no evil, hear no evil" attitude.  As with all things in markets, it will only matter.... when it matters.  [Nov 27, 2009: UK Telegraph - Greece Tests the Limits of Sovereign Debt as it Grinds Toward Slump]  If things play out to fruition, the end game will be the same one Ben Bernanke faced in the US - will the European Union bail out "too big to fail" Greece?  Since the largest economic member of the European Union is Germany I found an interesting article a bit lower in this piece from Der Spiegel, so we can see how they view this slow boil.

  • Greece may have its credit rating cut for the second time this year by Standard & Poor’s as the government of Prime Minister George Papandreou struggles to shore up its finances.  The country’s A- long-term sovereign rating was placed on “creditwatch with negative implications,” the company said in a statement from London today, signaling the classification may be lowered within two months.
  • The decision reflects “our view that the fiscal consolidation plans outlined by the new government are unlikely to secure a sustained reduction in fiscal deficits and the public debt burden,” a team of S&P analysts led by London-based Marko Mrsnik said in the statement. Without further measures, debt will reach 125 percent of gross domestic product next year, the highest among the 16 countries using the euro, S&P said.
  • Credit-default swaps on Greece’s debt rose 6 basis points to 189, according to CMA DataVision prices. That means it costs $189,000 a year to protect $10 million of the country’s debt from default for five years.
For those unfamiliar with CDS, this is how John Paulson made the "trade of the century" - buying credit default swaps against US mortgages.  Now we are talking CDS for countries... not nonsense mortgages.
  • Greece’s government, elected in October, plans to cut the budget deficit to 9.1 percent of GDP next year from 12.7 percent this year. The plans, including one-off measures and a partial freeze on public-sector pay, “are unlikely by themselves to alter Greece’s medium-term fiscal dynamics,” given the prospects of high deficits, debt and sluggish economic growth, S&P said.
  • European Union officials are increasing pressure on the Greek government to take lasting measures to reduce the deficit, which stands as the highest this year in the 27-nation European Union.
  • They must show the EU and investors “ they are serious about reducing the deficit. I don’t think they can spend their way out of the budget deficit, that’s not how it works. The deficit is too big.”  (that last sentence is ironic, considering this is the current US plan.... "spend your way to prosperity")
  • The difference, or spread, between the yield on Greek 10-year government bonds and German equivalents widened to 192 basis points today, up from 108 basis points in August. That compares with 163 basis points for the debt of Ireland, which the EU predicts will have the bloc’s second-biggest deficit this year at 12.5 percent of GDP.
Now it seems Greece is banking on "hope" rather than strict cost measures as in Ireland
  • About 75 percent of the deficit reduction plan comes from raising revenue rather than cutting spending, (i.e. the wing and a prayer option) Deutsche Bank AG economists Mark Wall and Thomas Mayer estimate. Much of that will come from a crackdown on tax evasion, a chronic problem in Greece that a series of governments have pledged to combat.
  • “Its banking on the hope that everything will turn your way,” said Elwin de Groot, an economist at Rabobank Groep in Utrecht, the Netherlands. “There are no strong measures like we are seeing in Ireland.”  The Irish government will announce on Dec. 9 it’s cutting spending by 4 billion euros, or 10 percent of GDP even after public-sector pay cuts triggered the biggest strike in 30 years.
Oh those public sector workers - even as the country is on the brink of disaster they are striking for their just rewards.  Circle that thought for USA 2019 :)

And the stock market is reacting in kind as Fitch jumps ahead of S&P in downgrading the country. 
  • The benchmark Athens Stock Exchange General Index dropped as much as 6.1 percent, its biggest intraday decline since Nov. 26.  Fitch Ratings cut Greece one step to BBB+ today, the third-lowest investment grade.  The decline in the ASE General Index brought its slump since Oct. 14 to 25 percent.
  • It’s a long-term sustainability problem. Now the government has to tell the Greek public that something needs to be fixed.”

Years of placing head under the sand in ostrich like posture apparently are coming to an end. The question is when... and what happens next?


For that, we turn to Der Spiegel: Timebomb for the Euro - Greek Debt Poses a Danger to Common Currency
  • As economic indicators have improved, concern about the financial crisis has abated. But the next big problem could be approaching. Greece's public deficit is skyrocketing and the country may become insolvent. The effect on Europe's common currency could be dire.
  • Practically unnoticed by the public, an issue has returned to the forefront in recent weeks -- one that was a cause for great concern at the height of the financial crisis but then, as optimism about the economy began to grow, was eventually forgotten: the fear of a national bankruptcy in the euro zone. And the question as to whether such a bankruptcy, should it come about, could destroy the common European currency. (that would seem doubtful since the countries in question are smaller members... if we were talking France or Germany - that's another situation)
  • Greece was always at the very top of the list of countries at risk. But now the danger appears to be more acute than ever.  Today, when the code "Greece CDS 10Yr" appears on Bloomberg terminals, a curve at the bottom of the screen points sharply upward. It reflects the price that banks are now charging to insure 10-year Greek government bonds against default.
  • The finance ministers and central bankers of the euro-zone member states are as alarmed as they are helpless. "The Greek problem," says a senior administration official in Berlin, "will be an acid test for the currency union." 
  • Greece has already accumulated a mountain of debt that will be difficult if not impossible to pay off. The government has borrowed more than 110 percent of the country's economic output over the years, and if investors lose confidence in the bonds, a meltdown could happen as early as next yearThat's when the government borrowers in Athens will be required to refinance €25 billion worth of debt -- that is, repay what they owe using funds borrowed from the financial markets. But if no buyers can be found for its securities, Greece will have no choice but to declare insolvency -- just as Mexico, Ecuador, Russia and Argentina have done in past decades.
So if you are American you have been brainwashed by now on how this gets resolved.  Have the central bank print money and throw it in every direction - problem solved!  Well, it is not quite so easy.
  • (in 4 years) ... by then the government deficit will have reached about €400 billion, or about 150 percent of GDP. Servicing that amount of debt, even at current interest rates of about 5 percent, will make up at least one third of government spending.
  • This puts Brussels in a predicament. European Union rules preclude the 27-member bloc from lending money to member states to plug holes in their budgets or bridge deficits.
  • And even if there were a way to circumvent this prohibition, the consequences could be disastrous. The lack of concern over budget discipline in countries like Spain, Italy and Ireland would spread like wildfire across the entire continent. The message would be clear: Why save, if others will eventually foot the bill?  (which is the same question, "prudent" people in America must ask themselves each morning as they wake up... why save when all I am doing is subsidizing the reckless neighbors and my financial oligarchy)

So to bail out or not to bail out?  That is the question (unless you are Ben Bernanke, at which point it is only a rhetorical concern)
  • On the other hand, if Brussels left the Greeks to their own devices, the consequences would also be dire. Confidence in the euro would be shattered, and the union would face a crucial test. What good is a common currency, many would ask, if some of the member states pay their debts while others do not?
  • Furthermore, there is a threat of a domino effect. (contagion) If one euro member falls, speculators will test the stability of other potential bankruptcy candidates. This could destroy the currency union. Because of this systemic risk, say the economists at the Swiss bank UBS, "we believe that if a country is facing a problem with debt repayment or issuance, it will be supported.
  • A default of a euro-group country doesn't worry the monetary policy hawks at the Bundesbank, Germany's central bank. "So what if Greece stops paying its debts?" one of the executive board members asked at a recent banquet in Frankfurt. "The euro is strong enough to take it." The real threat, he says, is if Brussels comes to the Greeks' aid. "Then the currency union will turn into an inflation union."
  • But it remains to be seen whether politicians can maintain such an unbending approach. The prices for Greek government bonds plunged once in the past, until then German Finance Minister Peer Steinbr├╝ck, to the horror of the Bundesbank, publicly pledged to help the Greeks if necessary. There is much to be said for the government taking exactly the same position today.  (my belief is "no way", the central bankers will print, print, print, and surely American treasure will be passed through the back channels to make sure Greek public workers can retire early and have 6 weeks of vacation.  We're a very generous people us Yanks.)
  • Central bankers in the euro zone are already speculating, behind closed doors, what would happen if the Greeks started printing euros without ECB approval. There is no answer to the question, and that makes central bankers from Lisbon to Dublin even more nervous than they are already.
Of course moral hazard is firmly in place... as this investment banker clearly showcases:
  • A London investment banker is betting on the continued decline of prices for Greek bonds in the short term, while simultaneously waiting for the right time to start buying the securities again. He jokes: "If someone has €1,000 in debt, he has a problem. If someone has €10 million in debt, his bank has a problem. And the bank, in this case, is Europe." 

Why do you care about this story?  Because the "solutions" of the past 2 years in Western economies has been to move the debts from the private sector to the much larger balance sheet of the taxpayer.  Many of these balance sheets were already in trouble, and on long term paths of insolvency.  The crisis has simply moved up the doomsday points.  At some point when investors lose confidence than a country can service that debt - which has now skyrocketed in certain nations - you get Greece.  Or Argentina 2001.  Or... well history is full of them.  The difference in the future is the names of the countries we shall see in this situation in the next 2 decades will be your brand names.

But until then it will be fun to watch the Romans (not literally) party as the city burns slowly around them.

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