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Posts Tagged ‘Greece’

Last week I posted an article about the enormous debt problems in Europe and how they went to great lengths to fix those problems (for the time being) with a major bail-out.  The whole idea of the bail-out was two-fold.  First, it was supposed to stop the decline in Europe’s currency, the euro.  Second, it was to re-build confidence.  Thus far, none of that has worked.  Today as I write, the value of the euro is lower than it was before the bail-out occurred.  Plus, there is probably less confidence in this situation getting worked out than before.  Imagine rolling out a huge bail-out that no inspires no confidence at all.  As the value of the euro goes, so does the value of the stock market.

It is the same level of confidence that we have in British Petroleum every time they say the oil leak will be fixed in 7 to 10 days.  I wish that I would have kept track of every time they made that statement. I struck me that what is occurring in the Gulf and what is occurring in Europe are very similar.  If Greece were to default on their debt, it possibly would create all types of unintended consequences throughout all of the financial markets.  The same is true with the oil crisis in the Gulf.  If that oil slick gets picked up by the Gulf Stream, the Gulf problem would potentially be an east coast problem.  That, of course, has unintended consequences as well.

The problem in Europe is just like the problem in the Gulf in that there are no good solutions.  There is one main difference between Europe and the Gulf.  The stock market is paying attention to what is happening in Europe and not to what is happening in the Gulf.  In my opinion, investors should be paying attention to both.  There is no arguing that the crisis in Europe has a bad end game to it.  The possibilities range from Greece defaulting on their debt to the destruction of the euro (many analysts are suggesting that this will happen).  The crisis in the Gulf has a difference type of end game.  The worst case scenario would affect the tourist industry, the seafood industry, wildlife, growth of the economy, gas prices, and the East Coast.  BP seems as if they are trying to solve a problem that they fear is unsolvable. 

Although we are seeing some recovery in the economy and earnings reports have been great, none of that matters if these two problems get out of control.  The risk level continues to accelerate.

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I could write volumes on what happened last week.  I am just going to stick to the most recent news which is the almost 1 trillion dollar bail-out of Greece and everything that ails Europe.  No worries – After last week’s market decline, we wake up to find that the Europe Central Bank is delivering an almost 1 trillion dollar bail-out to solve the problem.  In other words, they are going to fix the debt crisis by issuing more debt.  It gets even better.  The Federal Reserve is also assisting in that bail-out package. 

Taking these enormous steps to save the system just goes to show how close to the brink the euro might have been last week.  Does it solve the problem?  Does the market just go up from here?  

There are several points to consider.

The Europe Central Bank is not the Federal Reserve – The United States can pull something like this off.  It is very suspect that the ECB has the ability to pull the same “solution” or push the problem off into the future without a hitch.  Just like the US, they have no room for mistake and the EU is in an environment where mistakes can easily happen.

The US Government made their big bailout attempts in 2008 first on September 19th and then the TARP on October 3rd.  Following those heroic methods to save the system, over the next 6 months the stock market dropped -40%.  Initially after the bailouts started, we saw the same type of positive stock market action as we are seeing on Monday.  However, it gave way to further large declines.

There are still a lot of European politics to get around.  Politics, the euro, and cultures are vastly different than here in the US.  This solution is not a done deal.  In addition, Greece and some other parts of Europe will still have to deal with the social and civic unrest and backlash. 

If this gets pulled off, we are maxed out as a world economy when it comes to creating more debt to handle current debt problems and pushing current crisis out into the future.  Thus there is no room for any other problems while walking this financial tightrope.  Utilizing the vast majority of the IMF (international monetary fund) to bail-out Europe (of which the US funds 18%) is the last resort.  There are many more countries that could potentially need help.  Further, if this thing doesn’t work (and I believe the odds are that it will not work) look out below.  Debt might end up being Europe’s kryptonite and Superman might not save the day.

Don’t be fooled into believing that the problem in Europe is fixed.  This is an area on the globe that is walking a tightrope.   This is a much bigger problem with many moving parts that connects all of us.

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Please excuse any typos.  My assistant is out today and she normally proofreads my writing. 

There are so many facets of a debt crisis.  Unfortunately, there are many categories of debt that make up a debt crisis.  We have looked at the potential debt crisis in foreign debt.  Next week I am going to write an update on what is happening with mortgage debt.  This week I want to talk about municipalities.  Cities and states appear to be in trouble when it comes to debt. 

Last week, Jamie Dimon of JP Morgan made the statement that California was a worse problem than the country of Greece and is closer to being on the brink.  Of course, the big difference between a debt problem with Greece and a debt problem with California is that we can print money and save California (as if that is a good long-term solution).

Cities and states are feeling the financial squeeze.  The Rockefeller Institute of Government recently confirmed that state revenues fell through the first 3 quarters of 2009, the largest drop in 46 years.  The fourth quarter report showed even deeper declines in tax revenue, extending the decline to 5 straight quarters. 

California faces an estimated 20 billion dollar plus budget deficit.  California represents the 8th largest economy in the world.  By the way, Greece only represents the 34th largest economy in the world.

It is estimated that 43 of the 50 states are in financial trouble right now.  Twenty-one states have already put a number on their 2010 budget shortfall which totals over 60 billion dollars thus far. 

Some of the more noted states that are in trouble:

Budget Shortfalls

New York        $5.5 billion

Florida             $5.1 billion

New Jersey      $2.5 billion

Arizona            $2 billion

Nevada            $1.2 billion

The money has to come from somewhere.  States cannot claim bankruptcy.   As with any type of debt scenario, if the money cannot be paid back, a loss must be created.   Who is going to take that loss?  This is where it might become tricky for municipal bonds.  Bondholders could be at risk.  Through a municipal bond, an investor has essentially become a creditor by lending the city or state money and in return receiving a bond for it.

Would you feel comfortable lending money to a municipality?  By investing in a municipal bond, you are lending money.  With the problems that we are seeing, I don’t know that municipal bonds are such a great bet.

Incidentally, what we are seeing with states and cities is classic deflation.  These budget deficits and debt potentially create enormous losses due to the destruction of debt.  Once again, it is tough to see where inflation is going to come from with all of these debts waiting in the wings.

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The problems overseas aren’t settling with the markets very well and for good reason.  You have the developing problem in Europe with the first of many debt plagued countries on the brink of defaulting on their debt.  Greece is begging for a bail-out.  The EU tells Greece not so fast.  If you want help with your debt in the form of a guarantee by the EU, then some tough choices are going to need to be made.  Greece will actually be forced to cut spending and oh no…make wise financial decisions.  Oh the horror…

The day of the US style easy money bail-outs are over.  Now, bail-outs come with tough terms and conditions.  Shouldn’t it be that way?  Would the US be in a much better place if our creditors would have told us that the US can borrow money as long as changes were made?  The problem is that we are borrowing the majority of our money from ourselves.  So, that would mean we would be forced to actually be wise and make prudent fiscally responsible decisions on our own.  As long as there are politicians in Washington, that will not happen.

John Mauldin points out that there is no good solution for Greece.  The terms and conditions of a bail-out are going to be as tough as the cons of defaulting on debt.  The following is from his latest frontlinethoughts newsletter. This is one of the most excellent resources for investors and is free.  Everyone should be signed up for this newsletter. 

While German Chancellor Merkel has indicated a willingness to help, the German finance minister and other politicians are suggesting German cooperation will either not be forthcoming or only be there at a very high price; and the price is a severe round of “austerity measures,” otherwise known as budget cuts. Greece is being told that it must cut its budget to an 8.7% deficit this year and down to 3% within three years.

Now, here is where it actually gets worse. If Greece bites the bullet and makes the budget cuts, that means that nominal GDP will decline by (at least) 4-5% over the next 3 years. And tax revenues will also decline, even with tax increases, meaning that it will take even further cuts, over and above the ones contemplated to get to that magic 3% fiscal deficit to GDP that is required by the Maastricht Treaty. Anyone care to vote for depression?

And add into the equation that borrowing another E100 billion (at a minimum) over the next few years, while in the midst of that recession, will only add to the already huge debt and interest costs. It all amounts to what my friend Marshall Auerback calls a “national suicide pact.”

The problem is that this is just the problem with Greece.  There are many other countries that are going down the same path.  It is much like the domino problem that we had with the banks and financial institutions in 2008. 

Then there is Dubai.  Dubai created a shock across the markets when it was disclosed in December that they were on the verge of default on their debt.   Well, apparently Dubai has not done anything to solve this problem.  CNBC reported today that “Dubai World will offer creditors either 60 percent repayment over seven years and a government guarantee, or full repayment with a debt for equity swap for property assets of Nakheel and no guarantee.”

Those aren’t good solutions.  The issues that we still deal with in an ongoing financial problem in our own country are seemingly contained in the fact that everyone is getting use to the new normal.  However, the sovereign debt (debt from other countries) crisis is a whole other deal and new dynamic for the markets.  We could be seeing the start of financial crisis round 2.

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