How long before financial markets ask, So who’s going to pay that $1 trillion?
The European Union’s $1 trillion rescue plan will reassure financial markets for a while.
But at some point the bond markets are going to ask “So how are they going to pay for this?”
In the coming days you’re going to hear lots of comparisons between this $1 trillion plan and the $700 billion rescue package that the U.S. government put together to stabilizer the U.S. financial system after Lehman Brothers collapsed and American International Group threatened to head down the same path.
But there is one critical difference. The U.S. bailout transferred risk from the balance sheets of private companies to the balance sheet of such public entities as the Federal Reserve and the U.S. Treasury. The ultimate backstop, of course, was the U.S. taxpayer.
The European Union rescue transfers risk from public balance sheets at fiscally challenged periphery countries such as Greece, Portugal, and Spain to public balance sheets for the European Union as a whole.
In some ways this reminds me of the financial engineering Wall Street practiced during the subprime mortgage boom.
Greek crisis postponed, it’s time for the Spanish crisis to move front and center
Assuming that the $146 billion bailout of Greece goes ahead as planned, investors can forget about a Greek crisis for about three years.
And start to focus on Spain. The debt problem there looks like it’s developing along exactly the same path as the Greek debt crisis. I’d call the current stage denial of the size of the problem: On Friday Spanish finance minister Elena Salgado announced a new austerity plan that would save $21 million a year by cutting 32 senior jobs in government and eliminating 29 public agencies. Not exactly impressive for a government facing a $140 billion annual deficit. (Spain’s economy is about one-tenth the size of the U.S. economy so that deficit is equal to about $1 trillion in U.S. terms.)
It’s by no means certain that the bailout plan agreed to by European Union leaders over the weekend will go through. The biggest source of uncertainty, as it has been through the crisis, is Germany. It looks like Angela Merkel’s government has the votes to get the plan through the German parliament but the measure faces a constitutional challenge in the country’s supreme court, and there is a possibility, albeit small, that the court could stay Germany’s contribution to the bailout, until it rules on the issue. It’s doubtful that the court would decide to throw the European Union into crisis—the Supreme Court follows the election results, as Finley Peter Dunne’s Mr. Dooley commented about the U.S. court more than a century ago, so let’s assume the deal goes through.
Go figure: Markets rally on news that Euro leaders will have a plan to bailout Greece “soon”
Sure glad that’s over.
Suddenly Monday’s downgrade by Standard & Poor’s of Greece’s sovereign debt to junk doesn’t matter anymore.
European stock markets have hauled out the rally monkey today on news that—well, on news that discussions on an aid package for Greece will conclude in the next few days. Details on the package will be available “soon,” European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters today.
Speculators (since there aren’t any investors playing this trade) looking for a quick profit as the schizophrenic market swung back to hope from despair bid up Greece’s benchmark ASE Index 7.1% today. Shares of National Bank of Greece, the country’s biggest lender, rose 18%.
Greece faces a May 19 deadline to refinance $11.3 billion in government debt. To meet that deadline, bankers say, a deal must be in place by May 6.
Frankly, it’s inconceivable to me that Greece and the European Union will miss that target. The amount of money that it will take to avert this immediate crisis is relatively small.
But solving the immediate crisis leaves the big problem still on the table.
Greek bonds get junk rating from S&P
You know that your country is in trouble when investors want 15% to buy your bonds.
If you still needed confirmation of the depth of the Greek debt crisis, today Standard & Poor’s lowered its long- and short-term rating on Greek government debt to BB+ and B, respectively. BBB- is Standard & Poor’s lowest investment grade rating. BB+ is its top “speculative” rating.
In other words Greek government bonds are now junk bonds.
Before this downgrade Standard and Poor’s had rated the country’s bonds BBB+ and A-2 for the long-term and in the short-term.
“Medium-term financing risks related to the government’s high debt burden are growing, despite the government’s already sizable fiscal consolidation plans,” S&P said today. “Our updated assumptions about Greece’s economic and fiscal prospects lead us to conclude that the sovereign’s creditworthiness is no longer compatible with an investment-grade rating.”
And worse is yet to come, according to S&P, which said that the outlook for Greek debt is negative.
How bad is the Greek crisis? 14% bad
The yield on 10-year Greek government bonds briefly hit 14% yesterday, April 26, before finishing at just 13.52%. That was an increase of 3.4 percentage points on the day. (Just for reference the total yield on 10-year U.S. Treasuries is 3.75%.)
So much for the European Union/IMF (International Monetary Fund) rescue plan. Investors see squabbling politicians and doubt that the plan will save Greece from default. (For more on how the European Union has let politics defer a solution see my post http://jubakpicks.com/2010/04/26/politicians-in-germany-do-their-best-to-make-the-greek-crisis-worse-and-it-looks-like-theyre-succeeding/ )
The rout in Greek bonds has spilled over into the market for the sovereign debt of other deficit-heavy countries. The yield on the 10-year Portuguese government bond rose above 5% yesterday, for example.
The best guide to how the market is setting the odds of the crisis expanding to other members of the European Union is the credit default swap market.
