Greeks Bearing Bonds
Research for Online Investors

by John Dalt

5/20/11

Fitch downgraded Greek debt this morning to a B+ rating.  This is four notches below investment grade.  Fitch also placed Greece debt on a negative rating watch.  Ten-year yields on Greek sovereign debt bounced to a record high of 16.59%.  We have written about the eurozone credit problems for 16 months now.  When news gets this old, and shoes keep dropping, it is easy to fall into a comfort zone, thinking “Oh, there they go again, but it doesn’t matter.”

Well it does matter to you.  Here is why.  European Central Bank (ECB) executive board member Jugen Stark said ‘any form of restructuring Greek debt would be a catastrophe for the banking system.’  The New York Times reported that another board member, Lorenzo Bini Smaghi, said that a solution for reducing debt “but not paying for it will not work.”

They are talking about the rumors and ideas that are floated about “reprofiling” Greek debt.  This is a new term for extending the terms.  In other words, a five year bond becomes a seven year bond, and seven year becomes a ten year.  This is being suggested as a back-door way to keep Greece from declaring bankruptcy.

By extending their present loans, they will be isolated from re-entering the market to refinance those loans.  Then all they must do is sell new bonds.  The ECB will backstop Greek bonds by taking them as collateral for loans from eurozone member nation’s banks.  If there is a default or if the issuer changes the terms of the existing bonds, the ECB will no longer accept bonds from the issuing country.  The IMF will issue new bail outs to Greece if they meet their targets to cut the size of their deficit.

Greece is not hitting the target of 7.5% of GDP for their budget deficit this year. This target was agreed to in their bailout last year.  A European Commission reported that Greece’s budget deficit will hit 9.5% of GDP this year. The country’s debt, as a percentage of GDP, is the highest of any country in the eruozone. Greece’s debt may reach 158% of GDP this year.

News this morning that Greek debt was downgraded, that Ireland’s interest rates were spiking again, that the ECB would not accept Greek debt as collateral if any ‘reprofiling’ were done shook currency and credit markets.

The dollar spiked, gold and silver moved higher, and the Euro fell in value. If Greece restructures or ‘reprofiles’ their sovereign debt rather than control spending, it could throw the eurozone banking system into a spiral. Michael Hewson, an analyst at CMC Markets said, "The ECB’s threat to pull funding for Greek banks in the event of any type of restructuring is an indication of the fears the bank has of a contagion effect being set off throughout the European banking system.”

Greek bond restructuring, because they can’t slow government spending, could set off a chain reaction much like the credit crisis of 2008.  Banks would not lend to each other, the LIBOR overnight rate would shoot higher.  Credit would freeze.  Yes, it matters to you.

The US real estate market continues to struggle. Today's chart illustrates the US median price (adjusted for inflation) of a single-family home over the past 41 years. Prior to the financial crisis, the inflation-adjusted median home price rarely declined more than 5% in one year (gray shading). Due to a large number of distressed properties, a high unemployment rate and stagnant wages, the inflation-adjusted median home price has declined 7.9% over the past year -- an annual decline larger than any that occurred during the 35 years prior to the financial crisis.

Chart courtesy of http://www.chartoftheday.com

The mailbox:
I have worked my entire career saving through a 401K due mainly to the employer match.  Now I don't trust politicians any more than you do. But, I was surprised at your comment, "be prepared to close your retirement account within a few days...before Uncle Sugar can take his "fair share." Are you suggesting that I close my IRA or 401K account, pay the tax and put it in a different type of non IRA or 401K account?---Long-Term Portfolio subscriber G.C.

John’s reply:  I struggled with making this comment as I don't want to alarm anyone.  I don't try to tantalize our subscribers with "shocking" headline comments.  But, you need to think about your response to any government actions in advance.  Investing is executing a plan.  Know in advance what you should or will do.  Then it is not a knee jerk reaction to take decisive action.

I cannot tell you whether it is best to close and pay tax to remove your account from government access or not. Considerations such as age would come into this decision. They could tax ANY investment account, no matter if IRA, 401k or a simple trading account. They may also make any 'special' tax retroactive to Jan. 1, which means you cannot escape it anyway. Perhaps one decision would be to withdraw half or close one account if you have multiple accounts. The best course will be different for each of our readers and impacted by the exact legislation. Passage of any such 'special' tax would be difficult, but I trust very few of our elected representatives. How many would you turn your back on in a fox hole?

Consult with your Investment Adviser or CPA for specific advice in your situation.

Keep in mind our presidents, regardless of political party, and our professional diplomatic corps pledge to put America's interests first and foremost. They are traitors if they do not.—subscriber J.R.

John’s reply:  Your point?

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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