Broken Promises
Research for Online Investors

by John Dalt

10/17/11

The G20 Finance Ministers concluded their meeting in Paris Saturday with promises to make sure European banks had adequate capital and access to funds.  The EFSF now has 440 billion euros in its arsenal to buy dodgy debt and can intervene in markets to buy sovereign debt without the issuing country’s request.

The “plan” by France and Germany to aid Greece, recapitalize banks and reduce concern over other weak eurozone countries was not disclosed. This was saved for the leader’s meetings this next Sunday in Brussels.

Finance Ministers want the International Monetary Fund (IMF) to take a larger role in supporting the eurozone.  The IMF floated a request for larger commitments from its members but was rebuffed by the U.S., Canada and Australia.  U.S. Treasury Secretary Tim Geithner said the IMF has adequate resources.

It seems a given now that investors will have to take a bigger loss on Greek debt than the 21% agreed to in July.  Discussions of 50% and even 60% are now publicly mentioned. Thus, the reason to have to recapitalize eurozone banks.  The banks bought debt as responsibility to their governments, now they have eat the losses.

When the eurozone was created, banks were encouraged to buy sovereign debt from any country that used the euro currency.  They were not required to mark sovereign debt from eurozone countries “to market.”  This encouraged them to lever up; piling sovereign debt on top of sovereign debt.  The Royal Bank of Scotland made the mistake of marking their Greek debt to market and got hammered.

Broken Promises

The market seems to have forgotten the danger that lurks in the eurozone.  CNBC reports that HSBC believes that a worst case scenario could mean the breakup of the eurozone monetary union and a repeat of the Great Depression.

HSBC suggests that if Greece left the euro, the new Drachma would drop in value by 60% and borrowing costs would jump by at least 7%.

If Germany quit the euro, their exchange rate would surge by 40% which would cut exports by at least 20%.  This would stall their economy.  HSBC predicts the U.S. S&P 500 would drop to 750 because corporate earnings would slide as much as 45%.

HSBC assigns a 10% probability to a euro breakup.   That is enough to sober up even the most committed bull.

Quote:
I regard the huge buy-up of bonds of individual states by the ECB as legally and politically questionable. Article 123 of the Treaty on the EU’s workings prohibits the ECB from directly purchasing debt instruments, in order to safeguard the central bank’s independence.--German President Christian Wulff

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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