Yet again, I have an unfinished post, and again it is due to events that I have changed direction. The Greek crisis has now entered a new phase, with the bailout from the IMF and EU finally enacted:
Greece bowed to market pressure yesterday and formally requested a bailout from the European Union and the International Monetary Fund.
It is the first time a eurozone member has asked for a financial rescue and it is likely to test European political cohesion as well as the stability of the euro itself.
Greece asked for the €45 billion package after being downgraded by the Moody’s credit rating agency on Thursday.
The first problem is that it is just not going to be enough. The problem of the scale of Greek debt is worse than was feared:
Greece's deficit for last year is worse than the cash-strapped country originally reported and could still be revised higher, the European Union said Thursday, news that weighed on the common currency. A sharp upward revision to the 2009 figure, which sent Greek bonds into a tailspin, was surprising because Greek officials just two weeks ago denied reports of a big spike.
And the bailout will only take Greece so far.....
However, there are concerns that despite the unprecedented scale of the loan, it will not be sufficient to do little more than buy the country time, allowing it to finance its state only for another few months. The full details of the loan will not be laid out in the next few weeks, as IMF and euro area officials hammer out an economic plan for the country, which is likely to involve further severe cuts in public spending.
Then there is the problem of the potential challenge in Germany as to whether the Greek bailout is unconstitutional:
The German constitutional lawyer seeking to derail Berlin's contribution to a Greek rescue plan said he likes his chance better this time than in 1998, when he tried unsuccessfully to block Germany's adoption of the euro.
Karl Albrecht Schachtschneider, a retired University of Nuremberg law professor and expert on the constitutional court, said he believes that the Greek aid package is in clear violation of European treaties and the German constitution and sees a chance of convincing the court this time.
What may seem a contrarian quest has attracted attention in financial markets, where investors fret over any sign that Germany would withhold or even delay providing its share to the EUR30 billion rescue plan if Greece requests it.
Schachtschneider is drafting the legal complaint with three other established euro skeptics, all of whom are into retirement age.
Working with him are economics professors Wilhelm Hankel, Wilhelm Noelling and Joachim Starbatty. Noelling is a one-time governor of the Bundesbank, Germany's central bank. The same foursome were behind the ill-fated legal challenge 12 years ago.
I would like to give some perspective on whether the challenge might be realistic, but must confess that I have no particular insight on the issue. Some time ago, when first reading about this (sorry, no references) I did see some fairly persuasive cases for the challenge, but still remain on the fence with regards to whether the challenge might gain traction.
As I have posted before, the real issue of interest is the wider consequences of the Greek crisis. When first starting my blog, I contemplated the possibility that the Euro might not survive the crisis, and others are now seriously contemplating this possibility. This is Edmund Conway of the Telegraph writing from the G20:
Though they don’t admit it, they also privately suspect that this crisis will be the biggest challenge yet for the euro project. And for many it is no longer anathema to suggest that the euro may not survive this crisis – at least not in its current form.
I would agree that, at the very least, that there will be strong pressure to reform the structure, with Germany leading the way. Of course, the only kind of reform that might work is closer regulation of Euro-wide fiscal policy, which implies a significant loss of sovereignty of Euro member countries. Somehow, I suspect that, even for those who support the European project, this might just be too much.
Then there are the next contenders for debt crisis. Spain and Portugal are looking increasingly vulnerable:
Iberian stocks fell sharply Thursday amid concern the escalating Greek debt crisis could spread to other southern European countries with troubled finances.
Madrid's IBEX-35 index ended 2.19% lower at 10,821.9 points, while Portugal's PSI-20 index closed 2.57% down at 7,751.95 points.
"There's confusion and a great insecurity in the market," said Karsten Sommer, a trader at BCP in Lisbon, adding that rising government sovereign yields are bad news for stocks.
As Moody's Investor Service Inc. downgraded Greek sovereign debt, the cost of taking out insurance of Greek government bonds through credit default swaps surged about 10% to 620 basis points earlier Thursday. Spanish CDS spreads were also pushed higher to 171.5 basis points from 158.5 earlier in the day, while Portuguese CDS spreads moved to 260 basis points from 232.
Banking stocks were hit hard, with Banco Santander SA (STD) down 3.1% to EUR9.91, and Banco Bilbao Vizcaya Argentaria SA (BBVA) plunging 3.1% to EUR10.55. Portugal's Banco Espirito Santo SA (BES.LB) shed 4.1% to EUR3.569 after a Nomura downgrade.
....then there are the banks that hold Greek bonds, with the largest holders in France and Germany. A Greek default will put new stresses on an already stressed banking system. Unlike commercial loans going sour, it will be hard for the banks suffering such losses to have the news buried or obscured:
Private investors are already seeking ways to decrease their exposure to Greek debt although European banks appear to own some 58% of Greece’s 270 bln euro debt. Greece’s indebtedness to European banks appears to have been one of the key facts that convinced Brussels to take the lead and seek a mainly European solution.
It is worth reminding readers that the Basel rules gave OECD debt a zero risk rating in the calculation of capital adequacy ratios. These are the same regulators who will now, apparently, be able to foresee future risk and prevent it. The new regulation will, of course, learn the lessons of the past, implement a new and more secure structure, and so forth. Just as they do after each crisis and problem.....and remember, this is not new obscure financial instruments, this is sovereign debt. This has been around for centuries.
With regards to the next phase of the crisis, it is tempting to use emotive expressions such as 'now that the markets have tasted blood...' and all of the cliches that we see in so many articles. However, it is not a question of 'tasting blood', but rather the facing up to the reality of the terrible fiscal position of so many 'rich world' nations. The markets, the holders of 'safe' sovereign debt, are just waking up to the fact that it is not, after all, safe.
The big questions, aside from the crisis in Greece is who is next, and where the bailout money might come from? Will the EU also be prepared to bailout the next country in line, or the next....? How about the IMF? Can it fund a series of EU country bailouts? As has been discussed in the case of Greece, this bailout is likely to just be the first tranche, Greece will need further finance later. Then there will be the steep fall in Greek GDP as the austerity bites, and the picture will be one of a GDP to debt ratio moving in the wrong direction, it will not be pretty. This will cause even more alarm, as the markets see what happens to an economy that is mired in debt and where GDP has been sustained/obscured with debt.
And then...if the crisis gathers pace, will the markets start to look at economies such as the US, the UK and Japan. For example, Japan has now had a rating downgrade:
Fitch Ratings said Thursday that Japan's credit ratings face downward pressure in the medium term due to the ballooning debt, increasing the urgency that the government come up with a plan to get it public finances under control.
"In the absence of sustained economic recovery and fiscal consolidation, government debt will continue to rise, placing downward pressure on sovereign credit and ratings over the medium term," the credit-rating agency said in a report.
"The Japanese government is one of the most indebted in the world," Fitch said in the report titled, "Just How Indebted Is The Japanese Government?"
Fitch estimates Japan's headline gross government debt reached 201% of gross domestic product at the end of the last year, the highest ratio of any country the agency rates.
Any downgrade would elevate market concerns about Japan's creditworthiness and could prompt investors to unload their government bond holdings.
"It's important to show that the government is managing fiscal policy in an appropriate manner," Cabinet Office Senior Vice Minister Motohisa Furukawa said at a press conference following the release of the report.
Just for the sake of interest, I undertook a Google new search for 'sovereign debt' and found an article that is illustrative of the growing concerns in the media:
So here’s a brief look at some aspects of the UK’s debt vulnerability compared with that of France, using a useful table in an IMF report issued this week. (The link is below).
It shows the rating agencies agree with the continental finger-pointers. France’s top triple-A rating is stable; while the UK’s has a negative outlook. That’s even though the UK’s deficit at the end of this year will be below France’s, at 78% of GDP compared with 84%.
By some measures, France is more vulnerable. Foreigners tend to be more skittish than domestic bond holders and foreigners hold only 22% of British debt, compared with 58% of France’s. On top of that, a fifth of France’s debt is maturing in the next year, compared with 8.4% of UK government debt.
The article is not of particular interest of itself, but for the way that it is framed. The article is about relative vulnerability. The framing of the article speaks volumes.
The IMF now sees sovereign debt crisis as a real possibility, and they are a long way from the (sometimes) radical musings of a blogger - they are the embodiment of the mainstream:
Greece's upheaval could mark the starting point of a "new phase" in the global crisis if countries don't get their fiscal houses in order, despite the low risk of contagion, the International Monetary Fund said Tuesday.
While the IMF slashed its projections for bank losses from the crisis to an amount deemed manageable, the rapid buildup of sovereign debt among advanced countries to levels not seen since the end of World War II has emerged as the biggest threat to global financial stability.
"In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured," said Jose Vinals, director of the IMF's monetary and capital markets department, at a press conference to discuss the semi-annual Global Financial Stability Report.
"If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the real risk of undermining the recovery and extending the financial crisis to a new phase," he said.
All of this leads to a question. When, and under what circumstances are the policymakers, the politicians and economists cheerleading for fiscal profligacy going to wake up to what is taking place. When I first started writing my blog, the situation was different. Reality was obscured, theory was not being tested in the real world, and there was some kind of excuse (albeit a poor excuse) for the lunatic policy that was being enacted. As we now see the consequences, there is simply no excuse for the continuation of the madness, but still it continues.
Notes:
The UK election has taken some unusual twists and turns of late, with the Liberal Democrats making a big splash. However, I am not convinced that they, any more than the Conservatives or Labour, are serious about the dire fiscal crisis. Interestingly, some commentators and analysts seem to think a hung parliament is not a problem. I am agnostic on this, as it is always possible that the right leader, and the right coalition might work, but do recognise that this represents big uncertainty. What will finally matter is not who does it, but what they do.
Yet again, some very interesting comments on the last post, and it good to see some further challenges to Lord Keynes. Interestingly, his view of economics is now starting to face the real test. I would like him to be right, as I do not want what is coming, but alas I think this unlikely.
My original post was on housing / real estate, and I will try to finish in the week.
