Credit Watch Redux
Research for Online Investors

by John Dalt

7/18/11

The markets are down this morning on spreading credit concerns from the eurozone and the seemingly stalled negotiations over raising the debt ceiling in the U.S.  Don’t kid yourself; there is a lot of activity going on in the background.  Whether any of it is helpful, we will see.

Eurozone leaders are meeting in an emergency session on Thursday in Brussels.  Meetings are occurring now to pave the way for another bailout of Greece on top of the $154 billion the country received in May of last year.  Bankers are nervous that the contagion is spreading to other country’s sovereign debt.  Interest rates have been moving higher for other endangered eurozone countries.  Italy’s interest rates climbed to a eurozone era high for their 10-year notes on Friday.

Stress tests were released on 90 eurozone banks last Friday.  Eight of them failed.  This was meant to reassure the markets.  Critics pointed out the stress tests did not test the banks for a sovereign credit event.  Ratings agencies are not willing to give a “pass” on the French plan to extend maturities on Greece debt.

Greece needs additional money as they are running a deficit, but they also have bonds that are maturing and need to be paid off.  Greece owes $475 billion dollars with an average maturity of 7.5 years.  This means they have approximately $50 billion dollars worth of bonds maturing every year.

Extending the maturities on existing bonds would mean any new bailout money would only have to cover Greece’s operating deficit, as opposed to paying off existing bondholders.  Ratings agencies have signaled that requiring existing bondholders to buy longer term bonds with the proceeds from maturing securities rather than receiving cash would be declared a ‘default.’

Finance ministers are now working on a tax on eurozone banks.  They believe they can structure the tax to impact the banks that hold Greek debt to raise money that would then be used to help Greece refund their maturing debt.  This sounds like a “looks like a skunk, smells like a skunk, it is a skunk” move to satisfy the Germans.

Angela Merkel, Germany’s Chancellor, has been punished at the polls since the first Greek bailout.  German voters see the bailouts to other eurozone countries as a ‘tax’ on them to support other countries that have better retirement programs and more lucrative social programs than they enjoy.

Germany has pushed for present bondholder’s participation in any new bailout.  It all becomes a matter of semantics.  Germany’s banks are some of the largest holders of Greek debt.  Popular opinion that private bondholders have to take a loss could evaporate if German banks take losses and need government assistance.

Merkel’s government will then be blamed for allowing the banks to become overextended.  This is the tightrope her government, and other eurozone leaders, are trying to walk without falling off.

News surfaced this weekend that the International Monetary Fund (IMF) is putting pressure on eurozone countries to be bolder in their rescue efforts for faltering countries. Former White House Adviser Larry Summers wrote an article that was carried in the Financial Times, How to save the eurozone.

He argues that eurozone bonds should be issued with joint and several liability.  Countries would be allowed to participate and all bonds would be guaranteed by all eurozone countries.  Country’s whose interest rates were higher than the group would not have to contribute funds to help other weaker countries that need economic assistance.  We see from other news resources that the eurozone is considering this kind of move.

We don’t know how credit markets will work this week, but it will be interesting.  Gold is hitting new highs while the dollar is stable to higher.

The mailbag:
I notice that you use democrat (lower case d) and republican (lower case r) when referring to members of the Democrat Party and the Republican Party.  I think that a republican is someone who thinks that a republic is the type of government he prefers/advocates (this is quite different from today's Republicans who are quite interventionist, in clear violation of the Constitution), while a democrat is someone who prefers/advocates a democracy (something abhorred by the founding fathers).—Long-Term subscriber M.T.

John’s reply:  I agree with you on your description of the two parties.  I use lower case in both instances in order not to favor one over the other for the reasons you mention.  Sometimes, I wonder how strongly the republicans believe in a republic; sometimes they seem to be democrats...just a little slower.

Thanks for your emails, it is nice to see someone who is so market savvy. Thanks to you, I have held onto SLV and rolled it out each week.---subscriber L.H.

John’s reply:  Now we just need discipline to sell.  Greed does not pay.

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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