Wow, why own any asset class other than the 10 year treasury. While the S&P 500 and its tracking exchange traded fund, SPY, has rallied nearly 20% from the market lows of last summer, and stocks such as Apple (AAPL) are up nearly 30% in the last year, the recent sell-off has been brutal.
Still, while the economic data continues to deteriorate, European and Chinese equities are trading at one year lows, the U.S. economy continues to expand at 2-2.5%, and the recent Spanish bailout suggests European policy makers are beginning to take more aggressive actions.
This why I thought it was particularly interesting to see the recent story that there have been significant outflows from Greek Banks. Recent reports are of between $500-800 million in outflows from Greece's major banks, and millions of dollar in outflows from smaller banks as well. The rationale for these recent withdrawals; fear that the Greek government may switch back from the Euro to the Drachma.
To me this event is ridiculous, and shows that fear levels over the European debt crisis are likely peaking.
First, it is well-known that the IMF owns a significant portion of Greek debt, so if Greece were to switch currencies the country would obviously need to consult the IMF prior to taking such an action if the country wanted to continue to receive emergency bailouts. The head of the IMF, Christine Lagarde, is French, and she has repeatedly talked about the need to consolidate Europe over the last several months. Also, it is well-known that French and other foreign banks hold around 70% Greek debt, with Germany estimated to have about 10% of its exposure to European debt in Greek debt, and France having about 20% of its exposure to European debt in Greek debt. Obviously, if Greece changed from the Euro to the Drachma, these countries would be paid back in devalued currency that would have only speculative value longer-term.
In March, the IMF approved an additional $28 billion euro additional for Greece as part of the continued disbursement of a $114 billion euro bailout package that is designed to finance Greece through 2014. The IMF is funding around 10% of these funds, reportedly since the Euro-Zone is already financing most of the Greek bailouts. The European Financial Stability Fund is funding a significant portion of the Greek aid package, and the EFSF recently approved an emergency disbursement of $5.2 billion just a month ago ahead of the country's schedule bond payments. The EFSF two biggest contributors are France and Germany, contributing 20% and 27% of the fund.
The IMF and the EU, through funds such as the EFSF, are only disbursing the bailout package in quarterly and emergency payouts, and the IMF has also recently suspended part of the bailout package because of concerns the Greece government is not making progress towards the fiscal goals outlined in the aid package. In addition to make sure the Greek government is making progress towards the fiscal goals set out when the IMF bailout package was originally approved, the decision to payout funds to Greek leaders on a quarterly basis gives the monetary institution leverage over the leaders of this highly indeted nation.
So, essentially, the IMF and EU are funding the Greek government, but on a quarterly basis, and EU and IMF leaders will likely wait until the new greek government is elected to approve additional financing, in order to ensure continued progress towards the fiscal goals outlined in the original aid package. Obviously, the IMF and EU will likely want to have leverage to negotiate with new Greek government before they disburse new bailout funds to the country's leaders.
Greece was only allowed to join the Euro-Zone when the country misrepresented its financial numbers in the first place, representing the country's budget deficit to be around 1%, since the EU had rules imposing penalties for country's with deficits over 3%. Two years after joining the EU, Greece's government had to revise its deficit from around 1% to nearly 4%, and it has since been revealed that Greece hired a part of Goldman Sachs's investment banking division to use credit swaps at fictional exchange rates to refinance the country's debt at lower rates.
With the IMF holding a significant portion of Greek debt, IMF leaders representing countries with significant exposure to Greece's bonds, and the IMF funding Greece's bonds, it is unlikely a new government will change the country's economic policies or official currency. Greece obviously also saw membership in the EU as important to continuing to be able to finance the country's debt at appealing rates, and it is unclear how, if at all, the Greece government would finance itself without further IMF and EU assistance.
To conclude, while the deteriorating economic data and fears over the European debt crisis have caused the market to sell-off hard over the last several months, the U.S. economy continues to grow at 2-2.5%, company's such as GE and Citigroup (C) have recently reported strong year-over-year earnings growth, and Europe is taking much more aggressive actions today to backstop the PIIGS debt. While the upcoming Greek elections are creating uncertainty in equity markets, Greece would not likely will receive additional necessary funding from the IMF and EU if the country were take such steps, and the IMF and EU are likely waiting until the election to approve the next quarterly disbursement.