Sunday, 28 February 2010

EU solution to Greek debt crisis emerges

Economic & political imperatives are starting to surface in the Greek debt crisis. The Euro is a political project but requires economic underpinning to succeed. Politically Greece cannot be allowed to default on its debts and hence leave the Euro. It would be a mortal blow to the great EU project. It cannot be allowed to happen. Economically the only major source of funds is the Germans. The only problem is how to achieve German refinancing of Greek debt without seeming to drive a coach and horses through the EU growth and stability pact and ECB rules. Greece however is running out of time to refinance its debt before default sets in.

The EU answer according to yesterday's FT is to persuade/coerce the German banks to buy up the next offering of Greek debt by offering these banks via the German, state owned investment bank KfW, a government guarantee. The Greeks have delayed this offering until enough banks are signed up or have their arm twisted to ensure the offering is over subscribed and can be hailed as a great success. KfW was set up just after the war to lend in Germany for infrastructure and industrial projects. The German volk wont like it being used to guarantee dodgy Greek debt. There will be nominal involvement from commercial banks from other EU countries so the rescue can be proclaimed an EU success. But will it work?

Currently Greek bonds have a BBB+ credit rating and are virtually untradeable as no one wants to buy them. When locked in holders instead turned to CDS insurance they drove these up to 400+ basis points. I presume the ECB is still taking Greek bonds as collateral in their repo ops despite their published web site criteria of a minimum required single A credit rating equivalent to a 0.001 probability of default in the next year. I cannot see how the EU can influence the ratings agencies but the ECB can take what it likes in its repo ops. Banks forced to buy these Greek bonds will only be able to use them themselves in ECB refinancing operations and will sell off their stock of non - Greek bonds to a level where they hold enough bond stock for their liquidity needs. This will drive up the yields on non-Greek bonds and I can't see many buyers of other PIIGS bonds. I opine these banks will only be able to sell their best credits, i.e. German and French bonds, but they need those for liquidity trading on the inter-bank repo market. The end result of this EU persuasion may well be less day to day bank liquidity - bad news all round. The law of unintended consequences rules OK?

Add in to this the story that Goldmans helped the Greeks hide their true fiscal position, fiddle the books, on Euro entry and it is easy to see how things may rapidly go pear shaped. All the EU directives and all van Rumpoy's Barrosso men won't put Humpty together again! Especially when Greeks are calling the Germans incompetent Nazis and recalling the German occupation of Greece during the war left 300000 Greeks dead.

Europe is in for what AEP in the DT describes as deflation torture followed by huge civil unrest. The politicos, ie Merkel and Sarkozy, may be forced to invoke Article 219 of the Maastricht Treaty and take matters into their own hands to reduce the Euro FX rate. Banking is too important to be left to Bankers and ego driven economists when seats on the gravy train are at stake for the political class.

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