Jeff Harding

Greece, The Eurozone, Uncertainty = Nervous Markets

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Europe’s financial system is, in a word, a mess. They have been scrambling to backstop bankrupt countries and the banks which have lent to them and who may themselves be bankrupt if this debt were marked to market.

The market is betting that Greece will default – soon. The cost of insuring Greek bonds has shot skyward:

Greek two-year note yields added as much as 203 basis points to 57.08 percent, a euro-era record. Credit-default swaps insuring Greek sovereign bonds jumped 475 basis points to a record 3,500, according to CMA. One-year Greek note yields jumped 325 basis points to a record 97.96 percent. Spanish and Italian 10-year yields increased 14 and 13 points respectively.

The cost of insuring sovereign debt climbed, with the Markit iTraxx SovX Western Europe Index of credit swaps on 15 governments up 17 basis points at 340. The Markit iTraxx Financial Index of swaps on 25 banks and insurers rose 26 basis points to 290 at 4:30 p.m. in London, according to JPMorgan Chase & Co.

Losses to Greece’s lenders could be from 50% to 75%, depending on who you believe.

There have been rumors going around all Friday to the effect that Greece may default this weekend. In fact, the noise was so great (check out Zero Hedge) that Greece’s finance minister came out and formally denied the rumor. DoctoRx and I were discussing these events this morning and we believe the louder the denials the more likely the fact denied could occur.

The series of events leading to the market’s concern started when Jürgen Stark, ECB’s chief economist and a German, abruptly resigned from the ECB in protest over the central bank’s purchase (monetization) of Spanish and Italian sovereign bonds. That prompted a quick G7 meeting and Tim Geithner flew over to urge the Europeans to be responsible, swallow the bailout cost, and stand firm against short-term political interests. Also the ECB announced it was backing off on proposed penalties for banks who kept borrowing from the central bank to cover their liquidity requirements (similar to the Fed’s discount window). Then came the word that Germany was preparing a “Plan B” in the event Greece defaulted:

Reflecting mounting concern Greece may default, German Chancellor Angela Merkel’s government is preparing plans to shore up its nation’s financial sector. The measures involve aiding lenders and insurers that face a possible 50 percent loss on their Greek bonds if the next tranche of Greece’s bailout is withheld, said three coalition officials, who spoke on condition of anonymity because the deliberations are private.

The existence of a “Plan B” comes as German lawmakers intensify their criticism of Greece, threatening to withhold aid unless it meets the terms of its austerity package, after an international mission to Athens suspended its report on the country’s progress.

This is something to worry about. Remember that markets abhor uncertainty and run from chaos.

It comes down, in my opinion, to when Greece is going to default. Greece has to stick to its austerity program as a condition of the new bailout package from the ECB, the IMF, and members of the eurozone (the so-called, European Financial Stability Facility, or EFSF). I for one don’t think they can do it.

This weekend massive union and student protests are planned in Thessaloniki. Part of the austerity program is to dismiss 120,000 public sector workers. These protests are the tip of the iceberg:

Reacting to the plan, tax-office employees and customs officials are also scheduled to strike on Monday and Tuesday over cuts to benefits, while teachers have called a walkout for Sept. 22.

Separate protests are also planned next week by Athens garbage collectors, while doctors have already staged one 48-hour strike over health-care reforms. Taxi owners are planning a second 24-hour strike Saturday over moves to liberalize the sector.

Many of those groups will also be taking part in the protests in Thessaloniki, which will include demonstrations by Greece’s two major umbrella unions—private-sector GSEE and its public-sector counterpart ADEDY—and the communist-backed labor union PAME.

Students, angered over education reforms, are also expected to take to the streets, and will be joined by other left-wing groups, as well as Greece’s new grass-roots movement of self-styled “indignant” citizens.

The new EFSF bailout requires the approval of the legislatures of each member of the eurozone and the banks who must take a huge haircut by exchanging their Greek bonds for new 30-year Greek bonds which are in turn secured by the EFSF. The Greeks say 70% of the banks have agreed to the exchange, but I don’t believe them:

Late last month, Greece’s government sent a letter to Greek banks setting a Sept. 9 [today!] deadline for them to detail their participation in the bond-swap program. But according to two Greek government officials, the September 9 deadline doesn’t represent a final date for the deal—as was widely understood in the markets—and no statement is expected to be issued Friday.

“The swap program is not over on Friday,” said a second Greek government official. “There are still information sessions scheduled for the coming weeks in Asia and the Americas.”

Despite more than a month of talks with lenders on the deal, so far, participation rates have been less-than-hoped for. According to a third Greek government official, financial institutions holding about 75% of Greek government bonds have declared their participation—less than the 90% target set out by the government.

Personally I don’t think they will default this weekend, but … What I can assure you of is uncertainty and that leads to nervous markets.

Copyright © 2011 · The Daily Capitalist

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Published by kind permission of Jeff Harding.
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