The market lost its rose colored glasses today with Greece announcing a political referendum early in 2012 on the recent EU bailout deal. This could lead to the deal falling apart sooner rather than later. Stocks sold off on the news in Europe and the U.S. while interest rates rose in Greece and other troubled EU countries.
The deal that the EU put together last week to handle its debt ridden members and to help prop up its banks was essentially smoke and mirrors surrounding a house of cards. It had no chance to work in the long run and the best it could accomplish was to buy more time before the inevitable day of reckoning. The 50% haircut on Greek debt plus $130 billion euros did provide Greece with enough funds to keep going. It did not stabilize the situation enough however to ensure another debt crisis doesn't occur within the next few years. Nor was there any reason to believe that Italy, Spain, Portugal and Ireland wouldn't need a similar bailout in the future. The plans for recapitalizing EU banks were likely to create a credit crunch and send the EU into a deep recession before further steps were taken. The centerpiece of all the bailout operations - the EFSF (European Financial Stability Facility) - was based on essentially printed money that was going to be leveraged. This was how the problem of too much debt was going to be solved.
While stock markets worldwide had huge rallies based on the "good" news that came out of the EU last week (traders like hearing about governments printing more money), they were giving back those gains on Tuesday. Both the German DAX and French CAC-40 were down over 4% in late day trading. The euro, which has held up remarkably well during the entire crisis, was down over 1%. Big EU banks were getting slammed hard. France's Societe Generale (OTCPK:SCGLY) was down almost 17%, Credit Agricole (OTCPK:CRARY) fell almost 13% and BNP Paribas (OTCQX:BNPQY) dropped almost 12% . Deutsche Bank (NYSE:DB) was down over 6% and Commerzbank (OTCPK:CRZBY) down over 10%. The U.S. S&P 500 was lower by a comparatively mild 2% in early going.
Bonds reacted more strongly. The yield on the safe haven 10-year U.S. treasury fell over 6% and the yield was barely above 2% in the morning in New York. Yields on trouble country debt in the EU were moving in the opposite direction. Italian 10-year governments traded over 6.25% (above 6% is considered a critical point of potential breakdown). Only buying from the ECB, which also included Spanish government debt, kept yields from soaring much higher. Yields in Greece were even more telling of the market's true opinion of the EU debt deal and its aftermath. Before the deal, yields on one-year Greek governments reached 193%. They had only fallen to 154% (no solvent country pays anywhere close to this amount) before the announcement of the Greek referendum. This yield peaked at 200% today (November 1st).
Panic was caused by the proposed referendum in Greece because polls show that the terms reached with the EU and IMF are highly unpopular with the Greek people. Even though they have gotten an incredibly good deal, the average Greek is focused on the additional years of austerity that would be required on Greece's part. Apparently, neither the Greeks nor the markets like hearing that there is no free lunch.