The Bennett Newsletter
It would have been hard for companies like Ngai Tahu to assume there was a risk that they could not access their head office for 1-2 years. They were not to know that an earthquake would lift a parking building and hurl it against the Christchurch’s tallest building. The Grand Chancellor is leaning and will be demolished. Until it is, many nearby buildings are in a no-entry zone. Many businesses which had strengthened their building are caught up in ruinous contagion.
Contagion: UK
The Greek crisis has parallels with the Christchurch CBD red-zone. The present crisis is about solvency, preventing Greece defaulting on its bonds and creating a “euroquake” or Lehman moment. Contagion occurs despite many banks thinking that they are insured. As explained last week using BIS data, the reinsurers for Greek bonds are largely American [NBR 24 June].
I have followed up and find that the Eurozone periphery has indirect exposure, largely though Credit Default Swaps (CDS) of €193bn for the US, €74 bn for the UK and only €35bn for Europe. But many American and British banks have reinsured their reinsurance with hedge funds. I took a long walk cogitating on why the hedge funds would voluntarily get involved. The problem was good for the grey matter, and the explanation is too convoluted and lengthy for the purpose of this column. The important point is the experts like London’s Fathom Institute think the reinsurance may be worthless. [
http://www.guardian.co.uk/business/2011/jun/24/credit-default-swap-insurance-may-be-worthless
] This resonates with the events of 2008, when vast sums of CDS turned up on AIG books, and the world’s biggest insurer went belly-up.
Any thoughts that the UK was safe in its island castle, separate from the Eurozone’s collective problem, have disappeared. The Bank of England and the new Financial policy committee (FPC) believes contagion in Europe is the “most serious and immediate” risk to the UK’s banking system. For example, should the Eurozone “mess’ spread with contagious defaults, UK banks were exposed to French and German banks to the tune of 130% of their core tier-one capital. The FPC is demanding an increase in UK bank capital.
If there is a contagious default, it is clear that the British person-in-the street will be called on to recapitalise British banks. The irony of pensioners enduring a rise in VAT last year to repay debt incurred by bankers (with NZ$20 million bonuses) is rarely commented on in the financial press.
Contagion, Worse
The Greek debt crisis first rattled markets in May 2010. I published a column based on research in several futures markets which pin-pointed a simultaneous crash in equity, forex and bond markets. I satisfied myself that the Greek problem was the cause and not an apparent cause. It hurt the global economy (NBR July 9,2010) until QE2 restored confidence. It is imperative to solve the problem and not kick a can down the road…
Matters have deteriorated. At the peak of the 2010 crisis, the interest rate on the 10-year bonds for Greece, Portugal and Ireland were 12.4%, 6.3% and 5.9% respectively. World markets were in crisis! It almost seemed like the end of days. It was an apocalypse! Could investment continue? Of course it did. And prices which seemed unendurable then seem really quite reasonable now. An apocalypse in 2010 now seems like salad days from a 2011 perspective.
Greek bonds have hit 20%, Portugal 11.4%, and Ireland 11.9% and the CDS have more than doubled.
The situation is worse as Portugal and Ireland have had to ask for terms, and Spain and Italy’s problems have given the market jitters. The contagion risk is higher. Respected observers are warning about “contamination”, and the need for an “exit” mechanism for Euro-members.
Greek position worse
Greece was compliant a year ago as the IMF, European Commission, and ECB laid down a predictable path of austerity in return for help with loans. The paradox of IMF “help” is its conditionality: the conditions always lower GDP, at least in the short-run and this increases the GDP/debt ratio. The loan increases debt to, so Greece owes more than previously and has a smaller economy to generate the essential revenue. The economy shrivelled 4.5% last year and the unemployment rate rocketed to 16%.
The big change this year is solidifying political resistance to austerity and privatisation. There are continual demonstrations and strikes by people who think that the salad days of high living on borrowed money and Olympic glory can be restored by angry shouts of “thief’ and “traitor”.
The drama is set for catastrophe. But the players do not know how the play is destined to end. The Greek politicians will negotiate in good faith but unity is hard when their constituents are expressing deep hatred at the cost of the bailout. They might balk against the inflexible demand for massive privatisation. A socialist government is required to “betray’ its supporters. The cold-hearted rescuers want only to protect bond-holders and to stop the “mess” from spreading.
The price of obtaining more loans is very stiff. Greek politicians are asked to cut 150,000 public sector jobs and raise c NZ$100 billion by selling off the best state assets. Greece will also go into recession as GDP will fall by 4-5%.The economy verges on collapse with no light at the end of the tunnel.
The market obviously thinks default is inevitable. It notes the deterioration of the GDP/debt ratio and re-rates the bonds. It knows Greece is insolvent and sees no political effort to tackle the massive problem of restoring solvency.
A happy end to the play might occur if the IMF and European commission face reality and forgive about half of Greece’s official debt. This would permit an orderly restructuring and might save the currency union. While Greece might respond to generosity, the bond-holders have Shylock’s intransigence. This play will end as tragedy.
|