It’s been a while since we last visited Bizarro world, but boy, it’s starting to feel like we never left.
First, Merkel and Sarkozy over the weekend promise to present a plan that they unabashedly declare will “resolve” the entire eurocrisis. Only, they won’t let us know what’s in it until the end of the month. Which can only possibly mean that they don’t know either.
The announcement on Sunday used quite peculiar language, if you ask me. They said something along the lines of the plan being “sustainable and comprehensive”, the sort of terms mostly used by politicians exclusively to make things look much better than they really are. They could have just said that they are working on a plan to make things better. Instead, they claimed they have the power to resolve the entire crisis, and sustainably too, whatever that means in this context.
They have no such power, and if they don’t know that, they should be removed from what power they do have. Alternatively, both should be held accountable by their voters on November 1, when it will be crystal clear that the crisis has not been resolved. I must admit, I still can’t fully fathom why they made that claim when there didn’t seem to be any reason to.
Second, a committee representing the ECB/EU/IMF troika on Tuesday said that as far as they’re concerned, Greece can get its next tranche of aid, some €8 billion. That too has some bizarro aspects to it. The aid is provided under a deal that was updated in July when the second Greek bailout was negotiated. That deal also included a provision that stipulated that private investors would take a 21% haircut on their Greek debt, provided some 90% would agree to participate (a condition to prevent a hard default).
Now, while the troika team was evaluating Greek compliance with other parts of the deal, such as budget cuts and austerity measures, they were at all times acutely aware that there were and are discussions ongoing about a much bigger haircut for investors, as in more like 60%. And that will make the July deal invalid. Which puts the approved €8 billion tranche in a somewhat strange light. To put it mildly.
Moreover, it is already obvious that Greece will not be able to meet its deficit targets, something that also risks invalidating the deal. The same is true for Spain, by the way, but that’s another story for another day. That is, if the troika team finds time to fly to Madrid anytime soon.
Those Europeans whose money is used in this segment of the Greek bailout might want to ask their politicians for an explanation: why should we pay up when the conditions that were put on paying only 3 months ago are missed out on by a mile and a half? That could be a fun discussion. And if you ask questions in a sufficiently persistent manner, you may notice that they have no clue what they’re doing, and they’re very near the end of their very wits.
If I were a betting man, I’d put my money on the option that what is going on here are the preparations for dropping Greece. The idea being that if you kick out Athens, you can spend lots of money on ringfencing the banks in the remainder of the Eurozone. Such, undoubtedly, are at least some of the calculations.
Sarkozy sees both his banks AND his sovereign credit rating under immense pressure. If he can convince Merkel to use EFSF funds to catch the -Greek- fall of Société Générale and BNP, and he can simultaneously convince Moody’s that this means France lets Europe (co-) pay for catching that fall, so France can retain its AAA rating, he will have no qualms about pushing the Acropolis into the ocean.
It is, however, nowhere near that simple and easy. And Sarkozy knows it. But he seems increasingly willing to make the bet, to close his eyes and jump into the unknown, simply because the known looks ever more likely to catch up with him and his presidency. Seen from that perspective, maybe his claim that the crisis will be resolved by the end of the month isn’t so peculiar anymore. It’s then purely an act of desperation.
To begin with, a Greek hard default would trigger a credit event. That means credit default swaps on Greece will have to be “made whole”. And there’s no one party in the world that has a 20/20 360 overview of the total CDS out there. Wholesale chaos could ensue.
Then, banks with large Greek sovereign, let alone CDS, exposure, would face downgrades of their credit ratings, and trouble in lending markets, both interbank and bonds. Just in the past few days, we’ve seen Belgium nationalize Dexia, Greece nationalize its Proton bank, and Denmark (not even a Eurozone member) nationalize Max Bank. It looks like they are just the vanguard; there could be a whole lot of banks being either saved, or not: both options are expensive.
I’m not the first one to call this a Pandora’s box, and I won’t be the last. But I did say quite a while back that I thought Europe’s leaders were losing control. And today that is more tangible than ever in the past 3 years.
There is nobody, and that includes Sarkozy and Merkel and their ilk, who can predict what happens if Greece defaults. And as if that’s not enough of a headache for them, there isn’t anyone who can predict what happens if Greece doesn NOT default, either. Therein lie the crux and the conundrum. It’s a guessing game and a virtually blind gamble all the way forward from here.
If Athens is allowed to continue to fester on the European body politic, contagion is the key. The rot will spread to the rest of the periphery, and from there to the core. Very much like a disease will do. The (bond) markets are predatory. They will pick the weakest bits off one by one. If Greece, however, is cut off, those same markets are free to go after any and all of the other contestants for most feeble euro member.
Greece is not the problem, it’s just the first sign that there is a much wider and deeper problem. Which inexorably leads to the conclusion that the Eurozone of 17 members will not exist much longer. And getting rid of Greece will not make it much more stable. There’s still be Portugal, Ireland, Italy and Spain for the predators to go after. And somewhere during that process France will lose its AAA rating. Also somewhere during that same process US banks will need additional bailouts.
We’re just getting started in round two of the great unwind. Europe’s last hurrah is but the kick-off. And when I say Europe’s last hurrah, I mean Europe as it is organised today. Europe will still be here tomorrow. But it will not look the same. Nor will it have the same leaders.
Ambrose Evans-Pritchard has some nice details for the Telegraph:
Germany is pushing behind the scenes for a “hard” default in Greece with losses of up to 60% for banks and pension funds [..]
Officials in Berlin told The Telegraph it is “more likely than not” that investors will suffer fresh losses on holdings of Greek debt, beyond the 21% haircut agreed in July. The exact level will depend on findings by the EU-IMF “Troika” in Athens. “A lot has happened since July. Greece has fallen back on its commitments, so we have to assume that the 21% cut is no longer enough,” said one source.
Ilargi: “Greece has fallen back on its commitments”. In other words: all previous deals are off. And who feels like renegotiating a new one when a 60% haircut is just the beginning?
Finance minister Wolfgang Schäuble told the Frankfurter Allgemeine that the original haircuts were “probably” too low, saying banks must have “sufficient capital” to cover greater losses if need be. Estimates near 60% have been circulating in Berlin. [..]
“This could set off a snowball effect,” said Andrew Roberts, credit chief at RBS. “The markets will instantly switch attention to Portugal, where two-year yields are already 17%”.
Ilargi: The real problem becomes what anyone should wish to buy Greek debt for. The ECB or EFSF can’t buy it at 100 cents on the dollar when it trades in the market for 40 cents, or 20 cents. But if it doesn’t, that sets off another course of events. Damned if you do, doomed if you don’t.
Although Greece’s 10-year bonds are trading at a 60% discount on the open market, European banks do not have to write down losses so long as there is no formal default and the debt is held in their long-term loan book. [..]
Ilargi: And that means those banks are loaded with unrecognised losses. Ugly.
Marchel Alexandrovich from Jefferies Fixed Income said Germany risks opening a “Pandora’s Box” by unpicking the Greek deal. “It would be a complete disaster, a signal that sovereign debt is not safe. Investors would pull their deposits out of Portugal, Ireland, Spain and Italy and set off bank runs across Europe,” he said. [..]
Ilargi: There’s no saying what exactly would happen, but it would certainly be chaotic. The EU periphery would crumble. But then, that will happen no matter what.
“No details of the plans were released, presumably because they haven’t actually got any yet. That in itself is astonishing,” said Gary Jenkins from Evolution Securities. “Nothing has really changed and we still expect that the most likely outcome will be a comprehensive package – that circles the wagons around the sovereigns and the banks – that will only be agreed at one minute to midnight when the alternative is that the market is about to implode on the Monday morning.” [..]
Ilargi: A “comprehensive package”, you said? There is no package comprehensive enough. Forget it.
France wants banks to be able to tap the EU bail-out fund (EFSF) directly if they cannot raise enough capital on the open market. This would avoid any further strain on the French state, already at risk of losing its AAA rating.[..]
Yield spreads between German Bunds and 10-year EFSF debt have widened from 66 to 112 basis points since early July. If yields creep much higher, the fund itself may become a problem.[..]
Portugal is as vulnerable as Greece, with higher levels of combined private and public debt and an equally large trade deficit. Spain is still in the early phase of its housing bust. Italy has lost 40% in unit labour competitiveness against Germany since 1995.
Ilargi: There’s Portugal, Ireland, Spain and Italy, with Belgium hot on their heels. All of them lethally vulnerable. And the leadership all over about to wake up and give up. Maybe not Europe’s last hurrah, but inevitably the end of the Eurozone. As we know it.
Merkel and Sarkozy will come with a -heavily contested- plan in late October that’s going to be very costly (think trillions of largely carefully hidden euros), and after an initial market rise, prove to be wholly inadequate. And then the fun can start.
In the end, the question remains one and the same: where do broke economies get the money to lend to other broke economies? In that regard, nothing has changed since Clarke and Dawe asked exactly that question in the summer of 2010. And there’s still no answer: