Home > Uncategorized > 2011/06/30: On the Menu This Week? Looks Like Both French Toast and Greek Toast!

2011/06/30: On the Menu This Week? Looks Like Both French Toast and Greek Toast!

Let’s begin with a blind flash of the obvious: the entire process of further deferral of Greek debt payments is a high form of the classic ‘exercise in futility’. (Except for possibly one somewhat stealthy aspect we will explore below.) There are very few (if any) who believe that Greece can actually work its way out of its Debt Black Hole. While we will explore that further below, the reasons to provide them more liquidity on the path to insolvency may be obscure, but are relevant to the broader European financial community and global economy nonetheless.

Which leaves the only question right now whether we will all be partaking in French Toast or somewhat more problematic Greek Toast this week or sometime soon?

Interesting word ‘toast’. It not only has a nominal meaning, but also other implications which are so very much more diametrically opposed than almost any other term. In addition to the obvious reading of mildly roasted piece of bread, there is the brief, often laudatory expression of congratulations or respect. And based upon the previous contentious nature of the open warfare between the German Finance Ministry and European Central, the French are deserving of toasts on several levels due to their recent efforts to avoid the worst ramifications of the Greek debt crisis; along with one other point that is worth noting. On the other hand, the kudos certainly due the Greek government for toughing it out this week can only be accorded partial congratulations in light of the broader financial and social situation… and likelihood that Greece ends up as the other vernacular connotation of the word ‘toast’: completely burnt, and damaged beyond any reasonable chance of repair.

French President Sarkozy certainly deserves some expression of respect and thanks for whatever it was he told German Chancellor Merkel that convinced her to bring her finance ministry to heel and cooperate with the ECB on the latter’s terms. There is also the credit which must be given to the major French banks for the creative approach they have taken to the technical aspects of defraying the losses on Greek government debt.

While the special-purpose vehicle which they suggest should be used for the most critical portions of problem bonds falls short of the ‘Brady Bond’ model to which many are comparing it, they are still likely an effective near-term solution to what would otherwise be a far more serious problem. Especially as it seems that plan is getting the blessing of the rating agencies insofar as they are inclined to not cite the implementation of it as a default per se. That is also the very reason that a carbon copy of the Brady Bond cannot be used in this case: it did entail the use of defaults and write-downs that would be very damaging in the current European context.

The one other aspect of recent events for which the French should be toasted is the finalization of French Finance Minister Christine Lagarde as the new Director of the International Monetary Fund. While we has been dismissive of a lot of the communication from official circles of late (and will have more for you on that very soon), US Treasury Secretary Timothy Geithner undoubtedly had it right when he referred to her as “exceptionally talented…” Her background made her almost a de rigueur choice under current circumstances.

We say that with due respect for all the other candidates from the developed world and rapidly developing economies. No doubt there were folks from South and Central America, Asia and Eastern Europe with quite a bit of knowledgeability in matters of international finance. Along with that there is something to say for the idea that the top positions of the International Monetary Fund and World Bank should not forever remain the exclusive domain of Europe and America (respectively.) However, in light of the current circumstances in Europe (which will be coming soon to a federal government near you if you are in the USA), it would have been less than productive to appoint anybody with any less experience, relationships and in-depth knowledge that Mme. Lagarde.

That goes beyond her sheer intellectual understanding of matters of finance, and even her extremely extensive background in international finance. There is also the matter of her extensive knowledge of international law as it relates to finance; and no doubt an appreciation of the constitutional and legal context for much of what has already transpired and will continue to evolve across time will be very important. And that does not even begin to acknowledge the usefulness of all the personal relationships she has forged because of her leading roles in both Europe and the United States. Taking all of that in the broadest sense with appreciation for fine line detail, there just was not anybody else who could have stepped into the breach at this extremely critical moment in an equally effective manner.

Regardless of the talents and experience of the other candidates, now is not the time to have someone assume the role of IMF Director who would need to ‘skill up’ on all of the issues she understands so well, and forge relationships with the primary players in each country. That will rightfully need to wait for another time, and the French should be toasted once again for providing us with such a talented and experienced operative.

Then there is the Greek toast. And surely Prime Minister Papandreou and his newly formed cabinet should be lauded for pushing through what are extremely unpopular, very burdensome austerity measures in the face of such massive social rebellion throughout the country. Given the extreme response by some of their countrymen, this was nothing less than an act of bravery; even if some Greeks consider it treasonous treachery.

That said, as noted at the top of this post, in many ways this is an exercise in futility: Greece is ‘toast’, as it has no reasonable process by which it can actually work its way out of its Debt Black Hole. And there are not many extended benefits, other than one key aspect: it saves Greece and the rest of the world from the immediate dire consequences of a Greek government credit default. There are many who will benefit from the avoidance of that circumstance at present, even if it is broadly acknowledged that it may only be buying time. As with all matters of proverbially “kicking the can down the road” there are winners and losers even within a seemingly constructive near-term evolution of events.

The first obvious winner is economic sentiment that is improved on nothing so much as a feeling the global economy has dodged a very toxic Greek bullet. Given the degree to which many portfolio managers either lightened positions or hedged against the potential for a Greek default in other ways, that is undoubtedly the basis for the current end of quarter “relief rally” in equities. Amazing how quickly hiding out can reverse into aggressive window dressing when the psychology shifts from ‘risk-off’ to ‘risk-on’ again. Of course, that perceptual shift is benefiting all of the risk assets once again that were so burdened with worries about Greece and general economic sentiment during most of this month.

And no surprise therefore, the government bond markets are one of the big losers. Having pushed yields down once again to ridiculously low levels during concerns about the weaker economy, they now have to pay the piper with some hefty losses in their par values (reflective of yields heading off once again of course.) However, were not so sure that this is the “Big One” for the govvies: the beginning of the far more major break into a sustained cyclical bear.

There is still more than a passing chance that the equities are in the process of building a broader top with the current September S&P 500 future rally back above the 1,290-88 area. However, especially in light of how well they’ve acted since pushing above there on Tuesday, there is a possibility that will include an extension of current strength to at least the old 1,327-34 area, or possibly even as high as 1,340-50. As such, somewhat extensive further weakness in govvies is to be expected.

And the other good reason for suspecting that the equities may only still be range bound as part of forming a broader top is that there are still further problems which can affect the economic and market psychology once the typically buoyant first part of corporate earnings announcement season is out of the way in a couple of weeks. In large measure that has to do with the still intractable nature of the US fiscal and debt ceiling negotiations. There’s been a lot of ‘happy talk’ about how the parties are coming closer together; but anyone who listened closely to what Mr. Obama had to say yesterday knows that this is pure folderol.

In addition to the market implications of that bit of foolery, the extended indications for what will transpire in Greece are not constructive. We will have more specifics for you from a highly credible source very soon. Suffice for now to say the Greek economic culture is simply not competitive within the Euro-zone. No doubt part of the reason vox populi is so incensed by the selloff of the family jewels (both commercial and historic) to settle such a small portion of the outstanding debt is that it is apparent to even the most casual economic analyst that there will need to be a default at some point. You can call it debt forgiveness, a haircut to lenders, or whatever else you want, but the folks who made such a huge number of ultimately unserviceable loans to the Greek government will need to write down a major portion of those loans at some point.

Of course, at that point the real losers are the governments and banks of those other European countries, and even the European Central Bank that stepped into the breach to try and contain yields when things were so fraught at various points over the past year. And taken as a whole the questionable paper held by the rest of Europe resembles nothing quite so much as one of those truly convoluted Mortgage-Backed Securities which help bring down the likes of Bear Stearns and Lehman Brothers, and almost the entire global financial system with them.

It also explains a lot about why the French banks have been so assiduously designing and ardently promoting ways around a near-term overt Greek default. As a most cursory and simplistic overview, consider the fact that the French hold the highest amount of Greek debt, with the Germans not too far behind. Of course, that is all part of their mutual interest in not having Greece default, lest it trigger a question over which member of Europe’s profligate periphery might be next. Especially so in consideration of the renegotiation attitude of the new regime in Dublin, and the fact that Germany holds a truly massive amount of Irish debt.

Of course, then there is always Spain, which  has its own massive debt that is TBTF: only in this case that doesn’t mean ‘Too Big To Fail’, as it is rather more so ‘Too Big To Finance’. If either Spain or Ireland fall there is no doubt that the contagion will be significant, likely even reaching back to the US and extended stretches of the rest of the global financial structure. Which is what makes l’il old Portugal so important in spite of it similarly marginal place in the global economy. Guess who holds a significant amount of Portuguese government debt? None other than Spain. Again, that’s just the simplistic summary of the web that in its totality is the Euro-zone’s equivalent of MBS: GBS… government-backed security. Or the lack thereof if any portion of it really topples.

So it becomes more obvious that the winners are all of Europe in this seeming exercise in futility. And especially the Germans, who seem to be endlessly whining about how much it costs to keep Greece and the other profligates moving forward. Somehow it has failed to notice that what is is also really doing (at least in part) is buying down the next phase of something that has already benefited them markedly: a much cheaper currency that would’ve otherwise been the case. That, in turn, significantly supports their aggressive mercantilist economic program. While they don’t see it that way, this is just another form of paying the piper for the highly advantaged economic context of a relatively cheap currency.

Allowing that things may improve across time (even if that involves all manner of hostages to fortune), it would seem that the big winners here are the big European banks and their investors. It’s no secret that the only modestly veiled implication of allowing Greece what will hopefully be a couple of years to mend will also allow the major banks some time to bolster their balance sheets under less than crisis conditions. In that regard, it would seem the Greeks are being asked to sell off the family jewels for a song so that the major banks do not have to do so under duress.

There is also one more major loser if the current situation is a finessed in the manner that the powers-that-be would like to see accomplished: all of the folks who bought insurance in the fledgling sovereign credit default swaps (SCDS) market; and the SCDS market itself. If the current effort at a ‘voluntary’ rollover (or adjustment, or read profiling, or whatever else you want to call it) of the Greek government debt doesn’t be proceed without triggering a default designation by the credit rating agencies, then there will be no payout on those SCDS contracts. In effect, the house might’ve been damaged a bit by the falling tree, but the insurance company will be telling the homeowner that it was not sufficient enough to warrant any payment on the insurance policy. Talk about a huge ‘deductable’ prior to the company kicking in due compensation!!

As good as all that may be for the European banks, global financial system at large, equity market psychology and general psychology of risk asset pricing, the sovereign credit default swap market will also be ‘toast’. Who in the world would possibly by an insurance policy that will not pay out in the future even if the damage to the insured asset is obvious? What model or method would one use to price an instrument that would be contingent upon the subjective decision of a rating agency that could be swayed by a significant amount of government legerdemain?

If history has taught us one thing, it is that an instrument that cannot be properly priced is not really a viable economic vehicle. That was the lesson from the (supposedly risk reducing) Mortgage-Backed Securities fiasco, and no doubt all concerned will quickly apply it to the disturbingly uncertain nature of fulfillment for Sovereign Credit Default Swaps. The irony is, of course, that the lack of any credible insurance against such a default will mean that fewer people will be comfortable purchasing government debt, and those who are will demand higher yields to offset the risk of default.


While the equities and other risk assets may benefit for a while, any significant shrinkage or the elimination of the Sovereign Credit Default Swaps market is going to be a burden to government bond markets just as they become more important. And that includes the contingencies that the US government and public will need to be dealing with sooner than not as well. However, that is a more subtle influence that the market will likely discount in the near term.

Market tendencies are likely to follow those noted above for the further improvement of the equities, and weakness in government bonds, into the first part of corporate earnings announcement season over the next couple of weeks. While we did not note it previous, that obviously also includes further pressure on the US dollar that will become more critical into and on any slippage below the US Dollar Index major .7417 November 2009 low. As noted in our other research previous, that works hand in glove with whether the euro could push out more convincingly above its EUR/USD1.4500-1.4600 resistance than on the previous trip earlier this month.

The Gold market is likely to run with the equities for now, and the 1,520-30 range remains a critical resistance, with lower support having held up well on the recent test of 1,490-80. It will also be very interesting to see if that other risk asset and harbinger of economic strength of choice for many analysts, Crude Oil, can push back above its fairly formidable resistance in the 94.50-95.50 range. Even if it does, the potential equities might still be evolving a broader top from which they will ultimately break further than on the selloffs so far this year (i.e. back below the 1,250 area) means the ‘black gold’ likely stalls at no better than the 105.00 area it collapsed back below in early May.

Thanks for your interest.

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  1. September 13, 2013 at 7:11 AM

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