Gratification Delayed – EU Keeping Up the Pressure?

The notion that the EU was 'keeping up pressure on Athens' was the judgment of the media when it turned out yesterday that the euro-group would delay disbursement of the next loan tranche to Greece 'until the Greek government has voted on implementing new austerity measures'.

The German news magazine Der Spiegel put it this way:


“Observers had been expecting that the ministers would at least approve the next tranche of aid, worth €12 billion ($17 billion), from the current €110 billion package that was agreed on by the EU and International Monetary Fund in May 2010. Greece needs the money by mid-July at the latest to avoid a national default.

But the euro-zone partners want to wait until the last minute before giving the green light. In a statement, the euro group said that the Greek parliament would first have to approve the latest round of austerity measures and a €50 billion privatization program before the next tranche was disbursed.

The motive behind the finance ministers' tactic is obvious: They want to keep up the pressure on the Greek government – not to mention the recalcitrant opposition. On Tuesday, Prime Minister George Papandreou will face a confidence vote in parliament, which will also vote on the austerity package next week. The euro-zone ministers explicitly appealed to all political parties in Athens to support the austerity measures. "Given the length, magnitude and nature of required reforms in Greece, national unity is a prerequisite for success," the statement read.”


(our emphasis)

This not only keeps up the pressure on Greek politicians as it were – it also keeps up pressure on the financial markets. However, as we have noted before, when stock markets are as oversold as they are at present and bearish sentiment has become extremely thick, the high probability expectation is normally that the markets will seize on even the tiniest scrap of good news as an excuse to bounce.

However, playing these bounces is dangerous: the euro-group has maneuvered itself into a corner now. What happens if the Papandreou government falls tonight? If the disbursement of the next loan tranche indeed hinges on approval of the new austerity measures by Greece's parliament, then a fall of the government would surely pave the way for a default.

There are also signs that short term bounces in 'risk assets' are leading to a much too fast unwinding of bearish sentiment – people are evidently eager to 'catch the low'. To wit, see yesterday's large one day decline of the CBOE equity put-call ratio from its recent high.



The CBOE equity put-call ratio plunges from a recent fear spike as the market manages a small bounce – click for higher resolution.



Nevertheless, it must be noted that the bearishness recently exhibited by the smallest option traders (10 contracts or less per trade) argues that the market could be ripe for a bigger bounce.



The ROBO options data, via This suggests that there is a fair amount of fear now among the smallest option traders – click for higher resolution.



We want to reiterate though that the current 'oversold' conditions can in rare instances resolve into an outright panic. This would very likely happen if Greece ends up defaulting.

We would also argue that the delay in disbursing the next loan tranche to Greece is not only about 'keeping up the pressure' on Greek politicians. There is also the still simmering issue of how to get private sector creditors to chip in without a default being declared by the credit rating agencies. As we have been saying for some time now, this amounts to an attempt to square the circle. The rating agencies have once again confirmed this view yesterday. Both Fitch and S&P yesterday reiterated their stance on this issue.

According to Reuters:


Standard & Poor's reaffirmed a voluntary debt restructuring for Greece as currently foreseen by euro zone governments would likely be deemed a default, its head of European sovereign ratings told a German newspaper.

"Past experiences show that restructuring the debt of a country, whose creditworthiness is rated at CCC like Greece is currently, tend not to be voluntary and investors must sustain losses," Moritz Kraemer told Die Welt in an article due to be published on Tuesday. Euro zone officials have told Reuters a second bailout plan for Greece is expected to fund Athens into late 2014 and feature up to 30 billion euros in aid from a voluntary private sector participation on the basis of the so-called "Vienna Initiative." S&P's Kraemer said whether extending a bond's maturity voluntarily or not is of lesser importance.

"What's decisive is how does it compare to what was promised to creditors when they first invested their money," he said.”


(our emphasis)

Concurrently CTV news reported on the stance espoused by Fitch:


Fitch Ratings warned it would treat a voluntary rollover of Greece’s sovereign bonds in any rescue package as a default and would cut the credit rating, keeping pressure on European policy makers who intend to outline a new plan by mid-July.  Fractious euro zone finance ministers are trying to patch together a second aid package for Greece, with more official loans and, for the first time, a contribution by private investors of Greek government bonds.

“The essence of the problem … is that Greece needs new money,” Andrew Colquhoun, head of Asia-Pacific sovereign ratings with Fitch, said at a conference in Singapore.

Fitch would regard such a debt exchange or voluntary debt rollover as a default event and would lead to the assignment of a default rating to Greece,” he said.


(our emphasis)

It couldn't be any clearer. There is no longer any possibility to avoid a default rating for Greek government debt if private creditors take a haircut or agree to a debt rollover that involves a lengthening of maturities. It doesn't matter whether it is called 'voluntary'.  The circle can not be squared, period.

Alas, this means the ECB has painted itself into a corner as well, since it continues to vehemently insist that once Greek government bonds are rated as being in default, it will no longer accept them as collateral. ECB funding for the Greek banks would then have to end and that would mean instant insolvency for Greece's biggest banks.

We would suggest that the ministers of the euro group were grappling with this problem as well and have thus far failed to resolve it. No wonder – it appears intractable.

In summary: whether Greece defaults or not now hinges on two things:

1.    the Papandreou government must survive the vote of confidence tonight, and

2.    if the euro-group really wishes to kick the can down the road one more time while avoiding an official default of Greece, Germany and others must abandon their plan to involve private creditors in the Greek rescue. The 'no bondholder left behind' farce must in other words continue, or else. 

We would suggest that market participants should keep their celebratory impulses in check for now. If everything 'works out', then there could be a large, playable relief rally. If only one small thing goes wrong, the stock market could very well suffer a waterfall decline.



The Athens General Index resumed its decline yesterday after a one day bounce on Friday – click for higher resolution.



The most recent update on Greece's looming debt rollovers, via Der Spiegel – click for higher resolution.



As he prepares to face the upcoming vote of confidence, prime minister Papandreou received some verbal support yesterday from European Council president Herman van Rompuy. This may well cost him a few votes tonight, on the general principle that nobody likes van Rompuy.


“After meeting with Papandreou, European Council President Herman van Rompuy expressed his "strong support" for the Greek prime minister's economic reforms and said he had underlined the need for further efforts. But Van Rompuy noted that "national consensus" was needed for the package to succeed, "given the length, magnitude and nature of required reforms."


Even if Papandreou's government gets the required majority and survives, the problem of how to deal with the private sector haircut/debt rollover will remain hanging over the proceedings.


Exposure to Greece in Unlikely Places

It is interesting in this context that the latest FOMC policy statement will be released tomorrow – right after the world will be appraised of the Greek government's fate. Ben Bernanke and his minions are on record that they will not engage in 'QE3' for now, as they officially all expect a 'second half recovery' in the US economy  – for reasons that are not quite clear. Perhaps the tooth fairy will descend from fairyland and deliver her blessings. If not, then the US economy looks to be on the verge of sliding into another outright 'official' recession (in the bigger picture, the economic situation remains one of secular contraction anyway).

Paul Krugman now opines that all those not predicting a 'lost decade' for the US economy are  burdened with the 'onus of proof' to show why it shouldn't be so. He curiously neglects to mention how it comes that he can now confidently predict such an economic calamity after the government and the central bank have implemented precisely the policies – namely massive deficit spending and even more massive money printing – that he, Krugman, sotto voce recommended as the only surefire way to avoid precisely the economic malaise he is now forecasting. Could it be that interventionism is failing? If so, why is it failing? Krugman remain so far silent on the subject. However, if we were to guess, he will likely eventually argue that 'they didn't spend and print enough', as hollow as such an argument will sound. After all, this remains the standard  excuse for 'explaining' the failure of Keynesian policy prescriptions.

As it were, the Fed may well find itself faced with yet another run on US money market funds in the not-too-distant future, which makes the timing of the FOMC meeting so piquant. The fate of US money market funds seems intimately intertwined with that of the euro area's biggest banks.



Via Credit Suisse: borrowing by European banks from US money market funds – click for higher resolution.





The share of French banks in US money market fund borrowings – click for higher resolution.



As can be seen from the charts above, US money market funds are the among the largest providers of dollar funding to euro area banks at the moment. Ironically, the biggest borrowers are the French banks – which happen to have the by far biggest exposure to Greek government debt among all European banks. You couldn't make this up.



The widening FRA-OIS swap and the (inverted on this chart)  Euribor basis show that stresses in European interbank funding are increasing – click for higher resolution.



As we have noted previously, there are a great many ways in which the Greek debt crisis can redound on the global financial system. Obviously there is little reason for complacency – US markets will be just as roiled as European ones if push were to come to shove.

Meanwhile, the markets appear to have taken notice of the growing risk to Eastern Europe as well – CDS spreads on the debt various Eastern European countries have lately begun to jump higher as well,  as contagion from Greece is beginning to spread.


The Charts

1.    CDS (prices in basis points, color coded)


5 year CDS spreads on Portugal, Italy, Greece and Spain – at 2341 basis points, Greek CDS have just hit a new high (it now costs $2.341 million annually to insure $10 million of Greek government debt over five years), with Portugal, Spain and Italy  down just a tad from their recent highs – click for higher resolution.



5 year CDS spreads on Ireland, France, Belgium and Japan – all trending higher, but with the exception of France slightly dipping from the most recent high – click for higher resolution.



5 year CDS spreads on the Czech Republic, Hungary, Croatia and Bulgaria. All jumping higher, but with the exception of Croatia still well below their late 2010 highs. Bulgaria is especially exposed to Greece as Greek bank subsidiaries hold some 27.5% of all bank credit claims in the country – click for higher resolution.



5 year CDS spreads on Austria, Estonia, Latvia and Poland. Note that Estonia has currently the euro-area's lowest public debt to GDP ratio at a mere 6%. Nevertheless even CDS on the Baltics have now turned up, while those on Poland seem close to breaking out to new high ground – click for higher resolution.



2.    Other Charts


The Greek two year note yield sits just below a record high – click for higher resolution.



Spain's 10 year yield is so far holding its recent break-out and climbs to 5.588%. This remains quite possibly the most important chart in the world right now. Yesterday Spain's government auctioned € 3 billion in three and six month bills at the 'higher end of the targeted range'. If this breakout is sustained, then the troubles of Greece may soon be relegated to the backburner as far bigger troubles come to the fore – click for higher resolution.



The one year euro basis swap – still tame, but far from a 'normal' level and once again dipping – click for higher resolution.



5 year euro basis swap – click for higher resolution.



The gold-silver ratio – this might rally back to the trendline that was broken on account of silver's scorching rally earlier this year. If so, it would indicate more trouble for 'risk assets' is in store, as the gold-silver ratio is akin to a credit spread – click for higher resolution.



5 year CDS spreads on four Middle Eastern countries – Egypt, Saudi Arabia, Qatar and Bahrain. After a recent correction, they too seem to be trending higher once again. Note that there is still an ongoing war in Libya, and massive civil unrest in Syria and Yemen – click for higher resolution.



The euro has held up quite well vs. the dollar this time around, contrary to what happened during the first iteration of the sovereign debt crisis in 2010. As we have explained yesterday, this has likely to do with the ECB's relatively tight policy aa compared to the Fed's. There was an interesting article in the WSJ yesterday discussing the euro's recent strength – click for higher resolution.



Against the Swiss Franc, the euro hasn't fared so well. CHF has risen by about 35% against the euro since mid 2008 – click for higher resolution.



Exposure to Greek debt by country – as can be seen here, France has the most to lose from a Greek debt default. As mentioned above, French banks are the biggest borrowers from US money market funds, so this could turn 'interesting' on several levels, in the Chinese curse sense – click for higher resolution.



Charts by: Bloomberg,, Der Spiegel, BIS Quarterly Review,, Crédit Suisse



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7 Responses to “Greece Continues to Pose a Major Risk”

  • Floyd, why would any country voluntarily enslave itself to another? These countries are going on the austerity diet. They will no longer be markets for goods and services. Otherwise it would be like buying a drunk another case of scotch. I ventured the same idea, that the short run says that the richer countries step in and bail out the bond holders, because they can’t stand the shock. Blackmailed one more time by some banker politicians. If this is bailed out, it is still a loss and if the blood donor keeps giving blood, he eventually dies himself. It is also still debt, only the debtor has changed.

  • Pater, this may be your most fascinating post yet. I find the fact the big money market funds are piling into financing these banks. Didn’t they learn anything from the last time they had to be bailed out? Doug Noland has written the past few years about the government finance bubble and this breaks it, maybe world wide. Greece, in itself, isn’t that big a deal, but it appears the dominoes are lined up. Being the rating agencies aren’t going to allow a so called voluntary deal, the only logical next step is for the rest of Europe, maybe for a long term annual fee, to buy the debts of Greece and bail out the bond holders. Of course, this weakens the other links in the chain, but it is looking like a damn cheap option right now. It also wouldn’t play politically, but it appears we are looking a game of Russian roulette and high brinkmanship for the European economy and maybe for the world. I wonder at times what it would take to rock China off its perch right now. This might do it. History might not repeat, but it is sure rhyming with the early 1930’s.

    I laughed about the comments coming from Wall Street back in the late 1990’s, when the discussion of Japan came up. This was because I thought this would be the same response from the rest of the developed world economies when faced with the same fate. Sure enough, along comes Bernanke and Krugman and we repeat the same sort of actions, then complain about the lost decade coming. Why the hell would they watch Japan then propose we do the same thing? The only thing different was we bailed the banks out first, only to watch them go out and speculate more. Seems Bernanke must think that what was wrong with Japan was their stock market went down, totally missing the fact that what caused their problem was the inflation on the way up, as it went from what has been the recent bottom to the top faster than it went down. Blow another bubble and have Uncle Sam fuel it. This is like watching a film of a bad accident then going out and trying to avoid it by doing the exact same thing. False religion was taught the world round.

    • With regards to China, I have spent the past two weeks collecting material and my thoughts, as I plan to soon write a post on the situation in China. It poses a very intricate problem froman analytical point of view, due to the government’s power over the economy, especially over the banking system (which is far stronger than the comparative powers exerted by central banks in the West over their banking systems). What prompted my to give China more thought is the recent discovery of all the RTO frauds in the US and Canada. I have a feeling that there is a message there…the fraud may go deeper and be more widespread than is generally thought.

  • Floyd:

    With the benefit of hindsight, reading this article in late 6/22nd, we know that the first step was passed successfully (that is, if one perceives bailouts as a positive thing). Greek gov passed the confidence vote successfully.
    The other steps seem less risky (or more predictable):
    – Greek is yet to pass new austerity measures, sufficient for the political needs of the EU and its members.
    – The EU, ECB and IMF are yet to confirm the next tranche and future bailout proceedings.

    There is yet to occur a watershed events that would override the EU commitment to bond holders. It may come from Germany, but thus far no ruling party acted on this issue (even when promised to, see Ireland).

    • Indeed, the ‘Greek can’ has been kicked down the road again, with Papandreou surviving the confidence vote and the new austerity measures now also highly likely to be passed.However, I suspect that by ‘buying more time’ the same problem is invited as last time around – more time only serves to make the problem even bigger down the road, unless a miracle happens.

  • Floyd:

    The powers prove to be exceedingly committed to transfer the debt from private hands to public balance sheets.
    I wonder how would the world look like given that this trend continues unabated. Think the US, EU, CH, AU. What if all keep socializing losses and avoid loss recognition?

    • If this ‘solution’ is implemented to the fullest extent, then the greatest danger from the point of view of the PTB would be either a sudden loss of confidence in the underlying currency, or a loss of confidence in the so-called ‘core’ economies that are supposed to be the ultimate backstop for all these bailouts. There is also a considerable risk (again, from the point of view of the establishment) that the political constellations in various countries change markedly after the next round of elections and that the next batch of politicians takes a dimmer view of the bailout policy than the current one.

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