The Second Annual Greece Bailout: Rolling the Snowball

Includes: EU, FXE, IXG, VGK
by: Cliff Wachtel

Here’s our take on preliminary news from the EU summit on the second annual Greek bailout.

Short version: they’ve done a decent job – of insuring we get a third annual default threat somewhere.

They’ve gone from kicking the can down the road to rolling a larger snowball of potential trouble that just keeps getting larger the farther away it rolls.

We see 3 key problems:

1. Private sector “involvement,” aka losses, are still very much on the menu: However, these very significant, ahem, “details” have yet to be worked out. As ECB head Trichet and others have warned, once the precedent is set that the EU will no longer fully guarantee member bonds, yields on all GIIPS sovereign bonds will rise beyond what these nations may be able to pay. Why would anyone buy these bonds without a yield high enough to compensate for the likely “burden sharing” losses of unknown degree awaiting at some point later?

2. The EU has now upped the bill for saving the other GIIPS, whose leaders will not be able to face their voters, who will be expecting equal concessions. Why not? Portugal, Ireland, and especially Spain can flash the blade of default and contagion threat under the EU’s nose.

3. Moral hazard plus lack of unified budgeting controls, in addition to the above two problems with the latest Second Annual Greek Bailout means we’ve no reason to believe we won’t be facing a third annual default threat next year

EU leaders must know this too, so again, it appears they’ve opted for yet another Band-aid solution though a bigger one that might hold longer. We’re not so sure it will, for the same reason as ECB Head Trichet and others believe, because of problem 1 – why would anyone buy GIIPS bonds unless at extremely high yield to compensate for likely ‘burden sharing’ losses of unknown magnitude in the future? Higher GIIPS borrowing costs mean they all move closer to default and towards igniting another Lehman style contagion of greater magnitude.

Add problems 2 and 3, and it seems clear the EU is still essentially just kicking the can down the road. Only now the can has become a snowball of overspending and debt that keeps getting larger the farther down the road it rolls.

How To Profit

We’re still in the crisis stage in which markets gyrate on the latest hope or fear. Thursday was a hope day that fed a risk asset rally. How long before markets wake up to the above problems and relapse?

Thus the EU situation alone is enough to keep out downside safe haven asset bias. Toss on the ongoing US debt ceiling mess, and that compounds the situation. Even if a deal is reached, as we suspect it will be, failure to take decisive action in a timely manner has undermined US credibility, as it did with the EU last year.

We refrain from new longs in risk assets, and look to establish new shorts in risk assets and longs in gold, as more money will be printed on both sides of the Atlantic.

Disclosure/Disclaimer: The above is for informational purposes only, responsibility for all trading decisions lies solely with the reader. If we really knew what would happen, we wouldn't be telling you for free, now would we?