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Posts Tagged ‘European sovereign debt crisis’

Why Portugal May Be the Next Greece

Posted by Admin on May 22, 2012

http://business.time.com/2012/03/27/why-portugal-may-be-the-next-greece/

Why Portugal May Be the Next Greece

The worst is over for the euro zone, the experts say. But Greece isn’t really fixed and Portugal could become a second big problem before year-end

By Michael Sivy | @MFSivy | March 27, 2012

When Greece celebrated its Independence Day on Sunday, there were scattered protests over the harsh austerity program aimed at stabilizing the country’s finances. The government reportedly removed low-hanging fruit from bitter-orange trees along the parade route, so it couldn’t be thrown by protesters. But, basically, the most recent bailout appears to be successful. As a result, worries about the European financial crisis have diminished somewhat. Indeed, European Central Bank president Mario Draghi has said that the worst is over for the euro-currency zone.

Such optimism may be premature, however. Not only does Greece remain a long-term financial concern, but in addition Portugal is on track to become a second big problem.

The dangers Greece still poses are clear. Higher taxes and government-spending cuts may reduce new borrowing, but such austerity policies also undermine a country’s ability to pay the interest on its existing debt. Unless accompanied by progrowth policies, austerity can become the financial equivalent of a medieval doctor trying to cure patients by bleeding them. In addition, the bailout plan for Greece consisted of marking down the value of much of the country’s debt held by banks and other private lenders. That means entities such as the European Central Bank now hold most of Greece’s remaining debt. And so, in the event of a default, important international institutions would suffer the greatest damage.

(MORE: Is Germany’s Euro-Crisis Strategy Actually Working?)

The net result has been to postpone the Greek financial crisis for months or even a couple of years, while raising the stakes if things go wrong. That could be seen as a considerable achievement, if you believe Greece is a unique case and that the problem has been successfully contained. The trouble is that other countries — and especially Portugal — seem to be heading down the same path. Here’s why forecasters are worried:

Portuguese interest rates haven’t come down. Because of the Greek crisis, bond yields rose to dangerous levels in several financially troubled European countries. Then after Greece was bailed out, yields fell in most of them. In Italy, yields on bonds with maturities of around 10 years dropped from more than 7.2% to around 5%; in Spain, from 6.7% to 5.4%; and in Ireland, from 9.7% to 6.9%. The notable exception was Portugal, where bond yields came down a bit but still remain above 12%. Double-digit borrowing costs are impossible for a heavily indebted country to sustain for any significant period of time. Yet Portugal’s bond yields have been above 10% for the past nine months.

Portugal’s total debt is greater than that of Greece. In one way, Greece really is unique — the country’s massive debt is largely the result of borrowing by the government rather than by the private sector (corporations and households). By contrast, Portugal, Spain and Ireland have far more private-sector debt. As a result, while government debt in Portugal is less than that of Greece, relative to GDP, total debt (including private-sector debt) is actually greater.

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The Portuguese economy is shrinking. Portugal’s economy has been weak ever since the financial crisis began in 2008, and the country has actually been in recession for more than a year. Moreover, last month the Portuguese government projected that the country’s economy would contract by 3.3% in 2012. As Portuguese companies struggle to pay off their own massive debt, it’s hard to imagine that they will be able to help pull the country out of recession.

Thanks to a bailout last year, Portugal has enough money to make it into 2013, despite brutally high interest rates and a shrinking economy. But the markets are unlikely to wait that long to go on red alert. In the case of Greece, bond yields topped 13% in April 2011, and by September they were above 20% and heading for 35%. Portuguese yields have been above 11.9% for the past four months and have topped 13% several times. If the country follows the same timeline as Greece, Portugal could suffer a serious financial crisis before the end of the year.

There are a number of reasons such an outcome would be serious, despite the relatively small size of Portugal’s economy. First, the European Union has been operating on the assumption that Greece is a unique case, a poor country suffering from rampant tax fraud and an unusually dysfunctional government bureaucracy. If another euro-zone country experiences similar problems — and they occur partly because of private-sector debt rather than government borrowing — then the flaws in the system start looking more general, and the stability of the entire euro zone is called into question.

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Moreover, much of the borrowing by Portuguese companies has been financed by Spanish banks. That creates the possibility of a domino effect, whereby a financial squeeze in Portugal leads to a crunch in the Spanish banking sector. Moreover, the debt structure in both Spain and Ireland — with large amounts of private-sector borrowing — is similar to that of Portugal. Germany and the Netherlands are already balking at making further loans to Greece. And although Northern European countries could afford to bail out Portugal, their resources are limited. If a second country goes the way of Greece, several more might well follow.

Since Europe’s problems seem to have receded for the moment, U.S. investors are understandably focused on other risks — like conflict with Iran that could sharply push up oil prices, or fights over taxes and the federal budget in the run-up to the elections. But the danger of a European financial crisis has not gone away — and the ultimate costs could run to more than half a trillion dollars.

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Euro Crisis: Why a Greek Exit Could Be Much Worse than Expected

Posted by Admin on May 22, 2012

http://news.yahoo.com/euro-crisis-why-greek-exit-could-much-worse-082511184.html

Euro Crisis: Why a Greek Exit Could Be Much Worse than Expected

By MICHAEL SIVY | Time.com – 4 hrs ago

 At the Camp David G8 meeting last weekend, lip service was paid to keeping Greece in the euro zone. But economists who watch the continuing financial crisis in Europe are increasingly coming to two conclusions: Greece is likely to abandon the common euro currency now used by 17 European countries. And when it does, perhaps within a matter of months, there will be a damaging domino effect throughout much of Europe. Not all domino effects are created equal, however. And there are two possible consequences if Greece leaves the euro zone that few observers seem to have considered.

The scenario everyone recognizes is based on Greece reviving its traditional drachma currency. What this means is that salaries and prices within Greece would be converted from euros to drachmas, and then the drachma currency would be allowed to depreciate to make the Greek economy more competitive. The problem comes with debts that are denominated in euros, especially if the lenders are outside of Greece. These lenders would naturally resist being repaid with less valuable drachmas. However, if Greek borrowers have to repay the loans with euros, the debt would become more expensive for them to pay off after the drachma is devalued.

(PHOTOS: Protests in Athens)

The most likely domino effect, therefore — and the one most widely expected — is that debts to non-Greek creditors are compromised after Greece switches to the drachma. Either there would be lawsuits over which currency to use, or borrowers would default on the loans, or the lenders would be forced to accept reductions in the amount of the loan that has to be repaid, in order to avoid outright defaults. Whichever outcome occurs, the lenders lose money. Just as in the U.S. mortgage-lending crisis, once some banks lose enough money to become troubled, the contamination spreads to other banks, because they all lend to each other.

That’s not a pleasant prospect, but at least it’s fairly clear how to manage it. Greece leaves the euro zone, and its economy suffers for a couple of years but then stabilizes. With Greece gone, the rest of the euro zone could be propped up more easily. Many major banks take big losses on Greek debt. Some fail, some are taken over by stronger banks. Governments have to bail out the biggest losers. And the banking system is made sound again, although at considerable expense to taxpayers in many countries.

(MORE: Why Portugal May Be the Next Greece)

But what if Greece’s exit from the euro zone causes other kinds of domino effects that don’t have obvious precedents? The fallout could be a lot harder to control. As I see it, there are two possible scenarios that aren’t getting the attention they should.

Derivatives could set off a global chain reaction. Most people have heard of the complex, “synthetic” financial securities known as derivatives, which Warren Buffett famously referred to as “financial weapons of mass destruction.” In the case of bonds, these are known as credit derivatives. They include all sorts of loans secured by bonds, as well as incredibly complicated vehicles that amount to insurance policies if the bonds default. No one really knows how much of this stuff is sloshing around the international financial system, but the total value for all types of bonds was estimated at more than $50 trillion in 2008 and has continued to grow rapidly since then. Trouble is, if the bonds underlying these derivatives become questionable, all the derivatives become uncertain, too, even if they add up to far more than the value of the bonds themselves. Moreover, some of the synthetic investments based on Greek bonds could be governed by Greek law, some by British law (if anything originated in London), and some by U.S. law (if Wall Street was involved).

(MORE: Is a Greek Exit from the Euro Inevitable?)

What if one legal system accepts the conversion of euro loans into drachmas and another one doesn’t? Everything could be thrown into the courts for months. Even worse, if synthetic investments secured by Greek bonds become untrustworthy, why would anyone trust similarly complex investments involving Spanish bonds or Italian bonds?

The result of a meltdown in the world of derivative investments could cause far more chaos than simple bond defaults, not least because it would be almost impossible to figure out who owed how much to whom.

Greece recovers quickly and all the other troubled countries want out of the euro zone too. At the opposite end of the spectrum is the possibility that Greece abandons the euro and bounces back surprisingly fast. Paradoxically, that could cause another sort of disaster. Both Argentina and Iceland suffered currency collapses, and after a horrible year or two, both rebounded and were better off than if they had fought to save a failing currency. Analysts point out that both countries were big exporters of grain, meat or fish, and that sales boomed after currencies were devalued. But Greece, in its own way, could profit from a similar recovery — a rebound in tourism. A 30% drop in the exchange rate might make a vacation in Greece the best deal in years.

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So why would that be bad? Think of what it would mean for the other countries in the euro zone. How could the Italian government persuade its people of the need for higher taxes or the Spanish government explain soaring unemployment if Greece were obviously better off outside of the euro zone. Result: The entire European Union might unravel, with financial consequences many times greater than those resulting from Greece alone.

I’m certainly not predicting an extreme, doomsday scenario as the most likely outcome of a Greek exit. But it is important to realize just how unpredictable this situation is. In my own stock portfolio, I eliminated all the banks a long time ago and have largely stuck with financially strong companies that deal in essential goods — such as oil & gas, consumer staples and pharmaceuticals. The euro created a financial entity comparable in scale to the U.S., and if it gets into serious trouble the financial effects could be world-shaking.

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