Saturday, October 29, 2011
"The financial crisis in Europe is just getting started. 2012 looks like it is going to be an extremely painful year."
Once the euphoria of the initial announcement faded and as people have begun to closely examine the details of the European debt deal, they have started to realize that this "debt deal" is really just a "managed" Greek debt default. Let's be honest - this deal is not going to solve anything. All it does is buy Greece a few months. Meanwhile, it is going to make the financial collapse of other nations in Europe even more likely. Anyone that believes that the financial situation in Europe is better now than it was last week simply does not understand what is going on. Bond yields are going to go through the roof and investors are going to start to panic. The European Central Bank is going to have an extremely difficult time trying to keep a lid on this thing. Instead of being a solution, the European debt deal has brought us several steps closer to a complete financial meltdown in Europe.
The big message that Europe is sending to investors is that when individual nations get into debt trouble they will be allowed to default and investors will be forced to take huge haircuts.
As this reality starts to dawn on investors, they are going to start demanding much higher returns on European bonds.
In fact, we are already starting to see this happen.
The yield on two year Spanish bonds increased by more than 6 percent today.
The yield on two year Italian bonds increased by more than 7 percent today.
So what are nations such as Italy, Spain, Portugal and Ireland going to do when it costs them much more to borrow money?
The finances of those nations could go from bad to worse very, very quickly.
When that happens, who will be the next to come asking for a haircut?
After all, if Greece was able to get a 50% haircut out of private investors, then why shouldn't Italy or Spain or Portugal ask for one as well?
According to Reuters, German Chancellor Angela Merkel is already trying to warn other members of the EU not to ask for a haircut....
Chancellor Angela Merkel said on Friday it was important to prevent others from seeking debt reductions after European Union leaders struck a deal with private banks to accept a nominal 50 percent cut on their Greek government debt holdings.
"In Europe it must be prevented that others come seeking a haircut," she said.
But investors are not stupid. Greece was allowed to default. If Italy or Spain or Portugal gets into serious trouble it is likely that they will be allowed to default too.
Investors like to feel safe. They want to feel as though their investments are secure. This Greek debt deal is a huge red flag which signals to global financial markets that there is no longer safety in European bonds.
So what is coming next?
Hold on to your seatbelts, because things are about to get interesting.
Around the globe, a lot of analysts are realizing that this European debt deal was not good news at all. The following is a sampling of comments from prominent voices in the financial community....
*Economist Sony Kapoor: "The fact that a deal has been agreed, any deal, impresses people. Until they start de-constructing it and parts start unravelling."
*Economist Ken Rogoff: "It feels at its root to me like more of the same, where they’ve figured how to buy a couple of months"
*Neil MacKinnon of VTB Capital: "The best we can say is that the EU have engineered a temporary reprieve"
*Graham Summers of Phoenix Capital Research:
First off, let’s call this for what it is: a default on the part of Greece. Moreover it’s a default that isn’t big enough as a 50% haircut on private debt holders only lowers Greece’s total debt level by 22% or so.
Secondly, even after the haircut, Greece still has Debt to GDP levels north of 130%. And it’s expected to bring these levels to 120% by 2020.
And the IMF is giving Greece another $137 billion in loans.
So… Greece defaults… but gets $137 billion in new money (roughly what the default will wipe out) and is expected to still be insolvent in 2020.
*Max Keiser: "There will be another bailout required within six months - I guarantee it."
The people that are really getting messed over by this deal are the private investors in Greek debt. Not only are they being forced to take a brutal 50% haircut, they are also being told that their credit default swaps are not going to pay out since this is a "voluntary" haircut.
This is completely and totally ridiculous as an article posted on Finance Addict pointed out...
We now know that private holders of Greek bonds will be “invited” (seriously–this was the word used in the EU summit statement) to take a write-down of 50%–halving the face value of the estimated $224 billion in bonds that they hold. This will help bring the Greek debt-to-GDP ratio down from 186% in 2013 to 120% by 2020. The big question–apart from how many investors they will get to go along with this, given that they couldn’t reach their target of 90% investor participation when the write-down was only going to be 21%–is whether this will trigger a CDS pay-out.
That this is even up for discussion is mind-boggling. These credit default swaps are meant to be an insurance policy in case Greece doesn’t pay the agreed upon interest and return the full principal within the agreed timeframe. If they don’t pay out when bondholders are taking a 50% hit then what’s the point?
European politicians may believe that they have "solved" something, but the truth is that what they have really done is they have pulled the rug out from under the European financial system.
Faith in European debt is going to rapidly disappear and the euro is likely to fall like a rock in the months ahead.
The financial crisis in Europe is just getting started. 2012 looks like it is going to be an extremely painful year.
Let us hope for the best, but let us also prepare for the worst.