We Have Seen The Enemy
Research for Online Investors

by John Dalt

3/08/10

We have seen our enemy, he is us!  Greek Prime Minister George Papandreou packed his bags and is traveling the world looking for someone to prop up his country’s creaky financials.

He visited Luxemburg and Berlin on Friday and left empty handed.  French President Nicolas Sarkozy wants to help, but how does one country that needs to cut spending help another that is trying to cut spending?  Greece wants other country’s banks to buy Greek debt to force interest rates lower.  Last week, Greece paid roughly twice what Germany pays on German bunds.

Sarkozy is motivated to help Greece because the lender of last resort for Greece is the International Monetary Fund (IMF).  The IMF is run by a Frenchman, Dominique Strauss-Kahn, Sarkozy’s main political rival.  Sarkozy needs to help Greece to keep Strass-Kahn off the front pages of French Newspapers.

With an apparent lack of understanding of how capital markets work Sarkozy warned “speculators” that France, and other EU countries, would defend Greece with “precise methods….to show that Greece isn’t just supported politically but supported in all aspects of its eventual requests.”  This is not because investors are betting against them, it is because they want a better return to take the risk of buying Greek debt.  What is the default risk?

A small tick up in concern translates into a large tick up in interest rates.  Some of the buyers of Greek debt are EU banks.  They are required to buy only the highest rated bonds.  They cannot buy risky investments with depositors money.  If Moody’s downgrades Greek bonds, they cannot buy them.  They can buy Credit Default Swaps (CDS) against the Greek bonds.  The CDS can be structured to raise the rating on the Greek bond to the level required by regulators.

Doesn’t this sound exactly like what AIG was doing for EU banks with Mortgage Backed Securities (MBS) from the United States?  Who is going to bet their company, selling CDS’s to back sovereign Greek debt?  This will get interesting.

As far as the Greeks are concerned, it is all theatre.  Nine out of ten want government ministers to take a pay cut, and two-thirds want civil servant bonuses slashed.  47% of the public support the austerity plan, but only approve of raising taxes on tobacco, alcohol and other “luxury” items.

Ask people that lived behind the “Iron Curtain”, eventually eating became a luxury.  That is unless you were a government employee.

Do you recognize the U.S. population in this story?  We think government employees are paid too much (they are).  Polls show citizens want all the benefits of large government spending but only want to tax luxury items.  How long will it be before Obama is flying around the world looking for someone to “rescue” the U.S. government…? What will U.S. austerity measures look like?  Will unemployment be limited to two-years? Gasp.   Will the U.S. quit borrowing money from China to give it to other countries as “Foreign Aid”?   Will the Social Security and Medicare eligibility age be indexed to the rising life expectancy under our “terrible private health” delivery system?  Horrors of horrors, would we quit trying to be the world’s policeman, bring our service members home to defend our country and not others?

The biggest change, and most difficult, would be a reversion to Free Markets and personal responsibility.  We can only dream.

The Greek debt problem is not going away; the financing of it may be bandaged over for awhile.  Bond traders will then look for the next most risky bond, and begin avoiding them.  Nobody wants to be left holding the bag!

They won’t have far to look.  Spain has 19% unemployment, the economy contracted 3.6% last year and looks to continue to spiral down this year.  Spain is in the deepest and longest depression in 50 years.

After Spain gets rescued, investors can start avoiding Portugal.  The EU can come to Portugal’s rescue.  Then bond buyers will start avoiding ________ (fill in the blank).  Eventually, bond buyers will get to the U.S., we are on the food chain too.  Just a little farther down the list than the PIIGS.  The U.S. has 10% unemployment, debt greater than GDP, unfunded entitlement mandates.  Who will Obama call?

We have seen the enemy, it is not bond vigilantes, it is us.  There is no free lunch, or free unemployment benefits, or free health care, or free foreign aid, or free retirement benefits.

“Paying taxes is voluntary.”--- Sen. Harry Reid

Hum…

I thought about marking the date in Friday's letter, this weekend marked the one-year anniversary of the S&P low of 666  We have come a long way.  My fear is the next year will be even more exciting.

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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