Turbulence Ahead
Research for Online Investors

01/23/12

The market is watching Europe…again.  Bondholders made their “last and best” offer to Greece over the weekend to rework their existing debt.  The proposal is off to the eurozone finance ministers for their blessing.  This is like sending a contract to a lawyer.  Does anyone believe they won’t suggest some changes?

Greece is scheduled to receive another tranche of money from the eurozone in March, but the release of those funds is conditional on negotiating a haircut with existing bondholders.  Reuters reports Angela Merkel said there ‘no question of extending Greece a bridging loan if talks with the private sector dragged on further.’

Here is the problem…Greece has $18.7 billion dollars in bonds maturing in March.  If they are not able to negotiate a compact with their lenders, much of the money from other eurozone countries will go to redemptions on existing debt.

The deal taking shape is for bondholders to exchange $206 billion dollars in short term bonds for 30-year bonds with an escalating interest rate that would average about 4% over the life of the bond.  We don’t know the exact particulars, Bloomberg reports the coupon would begin at 3.1% and escalate to 4.75% over the life of the bond.  Rumors place the write-down or “haircut” at 70% in face value, with a companion bond from the EFSF or European Commission underwritten by all euro countries.

Greece’s goal is to reduce their outstanding debt.  Greece’s GDP is under $300 billion dollars and going down.  This is what happens with austerity measures.  The economy contracts when free money from debt is removed.  Greece wants to reduce their long term debt to 120% of GDP in ten years from the projected 160%.  To do that they have to cut their debt substantially now…so they can borrow more money!

The European Commission, IMF and European Central Bank are referred to as the “troika” in the approval process of extending aid to Greece (or other eurozone countries).  They are overseeing and must approve additional funds.  They have approved an additional $170 billion dollars in aid for Greece if the present negotiations are successful and the country stays on target to reduce their deficit.

Bondholders agreed to a 50% haircut last October, but Greece’s economy is continuing to deteriorate.  Business Week reports the negotiations will continue later today between bondholders and the Greek government.

The Federal Reserve meets tomorrow and Wednesday.  We are hearing expectations of QE3 being telegraphed.  I don’t see it, but any expectations just add to the volatility in the markets.

With all the bureaucratic meetings taking place around the world, it is shaping up to be an exciting week.

The European Union banned new contracts to import crude oil from Iran this morning.  The full ban will not take effect until July 1, allowing countries to continue to receive oil already under contract until that time.  Friday, the USS Lincoln joined the USS Stennis and the USS Vinson in the Arabian Sea.  Reuters reports this morning that one of the aircraft carrier groups entered the Persian Gulf accompanied by French and British warships.  The Navy plans on the Stennis leaving the Arabian Sea.

Iran warned the U.S. not to re-enter the gulf three weeks ago.

It could be an interesting week.

Mailbag:
Your article on hypothecation was educational and drew from an awesome body of knowledge about money and banking. It would take me months of research to produce an article with only a semblance of the information contained in the one you produced overnight. Really amazing, exceptional.---subscriber J.R.

John’s reply:  Good to hear from you.  I should have split the article into two parts to explain hypothecation and then how JPM used this financial tool to loot MF Global.  But once it was written I wanted to get it all out quickly.

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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