TDIMG Inside Edition – 9/29/2011: France to get Haircut from Greek Debt

September 29, 2011 9:17 am

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The aftermath of the denial by the EIB was enough to put a crimp in any rally overnight on Tuesday. Asian markets were restless and by the time the European markets opened, there was a cloud hanging overhead. The Financial Times has been a good source of the daily machinations that have been occurring with EuroZone leaders as they try to figure out a fix for the quickly deteriorating financial crisis.

The latest news of more dissent within the region concerning the leveraging of the EFSF and the possibility that the July 21st plan will not be ratified is no laughing matter. Investors are starting to get the feeling that even if there is an immediate agreement for a bailout fund that it may be entirely too late to save Greece anyway. Even with the approval of a severe real estate tax in Greece that would help to plug a hole in their leaky budget, the amount that Greek taxpayers are expected to pay in order to win the approval of the next tranche of funds is extraordinary. The additional tax burden will effectively put the country into a growth depression as it breaks the Greek consumer.

Already there was a negative sentiment surrounding markets after the bearish reversal on Tuesday. Adding to the general lack of buying interest, U.S. durable goods were reported for the month of August. The reports were better than expected, but still show a trend down for manufacturing and the potential for near-term economic contraction.

Most components held steady while the standout was definitely computers. There is a very obvious trend that shows computer orders and sales are dropping steadily.

Since the Bernanke Twist was announced, the U.S. dollar has been in a steady path higher and oil lower. There was a bit of a relief rally for crude on Tuesday when the USD dropped, but that was temporary as the API and DOE reports today showed significant builds across the complex.

DoE Inventory Data release today was neutral to bearish. Dept of Energy reports that:

  • Crude oil inventories had a build of 1.9 mln (consensus is a build of 2.0 mln)
  • Gasoline inventories had a build of 0.8 mln (consensus is a build of 1.0 mln)
  • Distillate inventories had a build of 0.1 mln (consensus is a draw of 250K)

Each day, the the economic team over at Bloomberg Professional Services provides an excellent commentary on the global economic condition. Topics range from an analysis of the recently released reports to in-depth global economic research reports.

Usually these are not re-published, but there was a compelling piece yesterday by Bloomberg Economist, Joseph Brusuelas, that did a wonderful job at piecing together the extent of the problems that are occurring due to the EuroZone debt problems. It also puts a fine touch on why we have been so focused on what happens in France as that appears to be the real powder keg in the mix.

Below is his commentary along with some very provocative charts. This is really something that we all need to pay close attention to.

The impact of a Greek debt default on the U.S. may be substantial. While the U.S. financial industry collectively has much lower direct exposure to Greece than does Europe, the picture changes when indirect exposure is estimated as well. Data released by the Bank of International Settlements on Sept. 19 indicate European banks have total direct and indirect exposure of about $153 billion to a potential Greek default, down 6 percent from December 2010. Total direct and indirect exposure of U.S. banks is $47 billion.

From the angle of direct exposure, U.S. institutions appear relatively secure, with $8.7 billion at risk. This compares to $127.9 billion Europe-wide, and $80.7 billion for financial institutions in Germany and France alone. When indirect exposure — credit default swaps and other speculative positions — is added in, the U.S.’s $47 billion catapults it to second in terms of nations whose financial institutions are most exposed, behind only France, at $68.3 billion.

A base case scenario that involves a 75 percent write-down* on both direct and indirect exposure to Greece suggests potential losses of $115 billion among European banks — $72.9 billion of this in Germany and France. For U.S. banks, the figure is $35.2 billion. On the surface, this seems a manageable amount for U.S. banks. The danger is twofold: first, that a disorderly Greece default causes contagion to spread to other peripheral countries, and second, that exposure to Greece and other troubled countries may be concentrated among just a few institutions.

Unlike their European counterparts, the exposure of individual U.S. institutions to Greece hasn’t been disclosed in any systematic fashion. According to calculations based on SEC filings, the net exposure of the five largest banks operating in the U.S — JPMorgan, Citibank, Bank of America, Goldman Sachs and HSBC — to Greece, Ireland, Italy, Portugal and Spain as a whole is about $52.4 billion.

This level of risk may be dangerous, because the U.S. is less likely to contribute government support to bank bailouts than is Europe. European Union policy-makers are already planning to use a portion of the planned $600 billion European Financial Stability Facility, still awaiting individual government approval, to bail out banks.

The U.S., in contrast, is weary of bailouts, and given recent acrimony over the debt ceiling, there probably isn’t support for more TARP -like programs. One reason for Moody’s recent downgrade of Bank of America’s credit rating was an assumption that public funds to recapitalize the bank in case of financial turmoil would not be forthcoming.

That leaves any U.S. bank that may require more capital reliant on private support. With a lack of clarity about how much of this may be forthcoming, it is no wonder that Treasury Secretary Timothy Geithner has begun to push European policy-makers to reach a definitive resolution to the crisis in Greece.


On to another area. Taking a birds-eye view of the markets, we can see that even with the 3-day rally coming into Wednesday, there is a very clear picture emerging that the flight to safety is still on. Often times when we see the Utilities, Consumer Staples, Health Care and Telecom Services sectors lead, it is a sign that investors are looking for the defensive plays. Below is a chart of the S&P 500 Sectors that illustrates the past 12-weeks and how each of the constituents are trending.

As of the most recent data returns, take a look at how far UP and to the RIGHT the Utility sector is. It looks as though it is launching through the top of the chart. On the other hand, to the BOTTOM LEFT, the Materials, Financials and Energy Sectors are lagging and getting weaker. In today’s parlance this what is known as “risk-off” market conditions.

Along with the defensive posturing, he backdrop of the risk concerning money managers around the world has not changed. In fact, the EuroZone banks are still making very good use of tools that have been set up by the ECB. The chart below is evidence that banks are holding higher than usual excess reserves as they hoard cash and are choosing to deposit it with the ECB because of heightened fears of counterparty risk.

As a quick definition, an FX swap agreement is a contract in which one party borrows one currency from, and simultaneously lends another to, the second party. Each party uses the repayment obligation to its counter-party as collateral and the amount of repayment is fixed at the FX forward rate as of the start of the contract.

When the Euro/USD 3M basis swap starts to move lower, it can be seen as a time when the risk of owning Euros over U.S. Dollars is increasing. Many believe that the -100 level is a key level that should be watched and -150 is a time when a full blown crisis is imminent or occurring. Currently the level rests at -100.7, near the lowest since the time of the U.S. banking crisis.

There are several more risk indicators that have had any relief even after the recent rally in EuroZone equities – even though the premise is that the EFSF will be able to come to the rescue of Greece. Remember, the ratification of the EFSF funding increase needs 17 votes of approval (unanimous) and there are already dissenting voices that are coming to the fore. Whether or not this is political posturing is not known just yet, but the more time that goes by without a resolution, the deeper the problem becomes for the entire global economy.

The “no-confidence” vote by markets on Wednesday has been hear loud and clear.

Latest Episode: (click below for show-notes)
TDI Podcast: Barry Ritholtz on Analyst Bias and a Bear Flag Warning (#231)

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