As news intensifies in Europe, markets are pricing in a likely default by Greece on its debt. The shock waves from counterparty exposure of such an announcement will dictate how far global equity markets will fall and the speed of the decent. On June 12, I re-offered an itemized list of scenarios entitled “Lehman in Drag” that I came across and the trickle effect that may potentially unfold. As disturbing as they may be, what Europe is dealing with is a larger sovereign debt-fueled disease we witnessed in our banking sector in 2008.
1. Every bank in Greece will instantly become insolvent.
2. Greek government will gate all withdrawals (depositors) from its banks.
3. To prevent and manage riots by depositors, a curfew will be implemented. So far as to consider Martial Law.
4. Greek government will redenominate its debt into a new currency and immediately devalue it by 50-70%. By this action it will effectively default on 50-70% of its euro-denominated debt.
5. The Irish will piggyback these actions and within weeks, walk away from their banking debt obligations.
6. Portugal will closely monitor the behavioral chaos occurring in Greece, and then decide whether to default in turn.
7. Numerous French and German banks will be forced to take capital write-downs and go to market to raise fresh capital to meet sufficient requirements.
8. The ECB will become insolvent, due to high exposure levels to Greek government debt, its banking sector, and the Irish banking sector.
9. French and German governments will need to act quickly in order to recapitalize the ECB or allow them to begin printing money to restore solvency. Like the United States Federal Reserve, it can effectively print its way out but will need to reconfigure the founding charter in order to do so.
10. Germany and France will recapitalize all its banks and signal an end to future bailouts.
11. Spanish banking bond yields will skyrocket in anticipation of an ensuing default but will be saved by a series of debt for equity swaps.
12. Attention will then turn to British banks. Then we will see.
Some of these hypotheses are starting to work their way through the system; others are on a worst-case basis. Over the weekend Bloomberg reported: “BNP Paribas, down 52 percent since June 15, Societe Generale down 65 percent and Credit Agricole down 55 percent; France’s largest banks by market value, may have their credit ratings cut by Moody’s as soon as this week because of their Greek holdings.” CDS on the French banks are reaching all-time highs. While on the issuance front, Italy brought nearly $16 Billion worth of debt to market today and paid up due to lack of demand.
U.S. equity markets are being dragged down by Europe, much like our global counterparts were hurt by our credit crisis in 2008. With a lack of a solidified plan of action from this weekend’s G7 meeting, the equity slide will most certainly continue. The continued rhetoric of support out of G7 will not halt the deterioration in market confidence. The ECB needs to act decisively with a cut in interest rates and issuance of euro bonds. Germany and France must then step in as large buyers of these bonds along with injecting capital into their respective banks to shore up tangible common equity levels. The election results that went against Angela Merkel, sent the DAX
spiraling late last week, signifies German citizens do not support propping up Greece and the like. According to Bloomberg, as of June 30, Deutsche Bank
(DB) had $1.5 billion euros of net sovereign risk to Greece. The citizens and Merkel may not have a choice.
The euro looks to be in a long-term downward spiral, having just touched its 61 percent retracement level at 1.36 expect a short-term bounce then a move toward lows.
U.S. equities are also demonstrating similar price action to the euro. A move toward the summer of 2010 lows S&P
1040-1010 seems all but imminent. Twitter: @PeterPrudden
No positions in stocks mentioned.
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