Eurozone Debt Crisis Recap

Markets Signal Investors Fear a Collapse

September 14th 2011

Debt crisis intensifies,

European leaders scrambled to reassure financial markets over the last week that they were taking more decisive action to deal with the worsening debt crisis, as default threatens Greece again. The Greek economy is in a tailspin, bondholders are in revolt, and voters in Europes creditor countries are increasingly calling on their leaders to cut Athens loose.

Increasing signals that Germany is losing patience with the current process after its executive board member, Jrgen Stark, quit the European Central Bank and its economy minister said an organized bankruptcy of Greece should no longer be a taboo.
The risk of contagion beyond Greece pushed sovereign creditdefault swap prices to record highs across the eurozone. European bank debt risk also rose to the highest ever amid speculation. With the exception of just three days in early 2009, eurozone bank stocks are at their lowest levels in at least seven years.

Merkel Quells Speculation on Greece

Conflicting statements this week by German politicians about Greece have added to markets' fear that Greece will default on its debt and might be forced out of the euro. Tensions between Greece and the team of international inspectors charged with overseeing its fiscal overhauls have also hit investors' confidence that Europe can tame the festering debt crisis in parts of the currency zone. German Chancellor, Angela Merkel, sought on Tuesday to quash talk that cashstrapped Greece might have to declare bankruptcy soon or even leave the euro zone, rebuking her junior coalition partner for fueling market speculation about Greece's fate. She warned that the future of the euro, and with it the future of Europe, was at stake. German official made it clear that the institutional instruments do not exist for an orderly insolvency for Greece as was suggested in an interview by the German economy minister. The chancellor stressed that Germany remains committed to financing Greece through the euro zone's bailout funds until Greece can repair its own finances through austerity measures. Ms. Merkel's comments helped to calm jittery markets on Tuesday, and contributed to a sharp rebound in French banking stocks, which have been hammered recently by fears of a chaotic Greek bankruptcy that could inflict painful losses on banks elsewhere in Europe.

French banks latest casualty of europes debt crisis

French bank shares suffered a fresh sell-off on Monday as concerns about the eurozone sovereign debt crisis intensified despite an attempt by Societe Generale to assuage market concerns by pledging to accelerate asset disposals and cut costs. These banks are the most exposed in the euro zone to Greek borrowers, including businesses as well as the Athens government, and stand to lose heavily from a Greek financial meltdown. Nonetheless, French banks stocks rose strongly on Tuesday following Merkels comments. Shares in Socit Gnrale SA, France's second-largest bank by market value, rose 15%, BNP Paribas SA shares rose 7.2% and Crdit Agricole SA gained 6.7%. Socit Gnrale's reprieve comes after a prolonged selloff since Aug 1, in which its stock sank 46%. Broader eurozone bank shares also suffered early in the week, plunging to depths they only surpassed for three days in early 2009 during the financial crisis. They have now fallen 55% since their peak in February. Moody's Investors Service said on Wednesday that it downgraded the credit ratings of Socit Gnrale and Credit Agricole, marking the latest in a series of blows to French banks that have recently punished European stocks. Moody's cut Socit Gnrales debt and deposit ratings by one notch to Aa3 from Aa2. For Credit Agricole, Moody's cut its long-term debt and deposit ratings by one notch to Aa2 from Aa1.

Time Is Running Out For Greece

Markets are becoming increasingly anxious about the possibility of Athens defaulting. Trouble started again as international leaders demanded further austerity measures due to Greece failing to meet its targets, leading to a 1.7bn funding shortfall. The years budget deficit target was already revised from 7.6% of GDP to 8.1%. The troika refused to pay the latest 8bn EU-IMF aid tranche, if the Greek government does not commit further. On Monday figures showed that for the first eight months of the year, the state budget deficit was 22% wider than a year earlier. The country teeters on the brink of running out of money, as the Greek government stated that it has only enough funds to last until mid-October. Greek bonds were at panic levels, where yields for 10-year bonds rose to 23.6% and two-year bonds over 75%. Both are trading at prices of 40-50 cents in the euro, indicating that investors are fearful of suffering big losses. To calm markets, the Greek finance minister outlined a plan to cover a 2bn shortfall with a special property tax. On Monday, reports suggested that Greeces new measures would be enough to qualify it for its 8bn slice of the first bailout money.

Greece on the brink of default

The amount of aid Athens needs to run its day-to-day operations for the next three years is estimated to be around 172bn. Someone Greek taxpayers, international lenders or private investors will need to come up with enough cash to fill that hole or Greece will go through a potentially disorganized default. Athens has been forced to admit its economy is shrinking even faster than expected. On Sunday, it said GDP would contract 5.3% this year; international lenders had estimated just under 4%. Tax receipts, already thin, will grow thinner. Regardless, when the July deal was struck, officials believed they could fill the 172bn hole from four sources: the remaining cash from Greeces first bail-out; new loans from the second rescue package; the privatization programme; and bond swaps and roll-overs. All four sources now look increasingly at risk. If any falls through, the bail-out must be reconstructed or Greece risks defaulting.

Athens is still relying on its old 110bn bailout from the EU and IMF to finance daily operations. When the deal was struck in July for Greeces second bailout, around 57bn remained from the original bailout to be The most complicated part of the new bailout is a series of disbursed.

debt swaps and rollovers meant to delay Greek bond redemptions for up to new agreed between the parliament Of 50bn privatization plan bailout fund, only EU The Thethe 109bn released years. 12bn tranche wasin the30 in July only after the Greek 34bn is traditional 28bn in austerity to finance Athens narrowly deal struck been a eurozone officials andthegroup and approved has between much hyped Meanwhile, regular of In a Athenslow-interest loans measures. part of aamongst a worsening bail-out. even that the Greece astrouble aslooking to operations. But outlook, has so into to erase leading international banks, government ispublishaaresultthe second economicLenders went runfar would now from impose a two year property tax in order to raise 2bn this anti euro- by of an 54bn assets repayments scheduled year, books unorthodox Finnishademand. The whento be closing detailed list ofin bondand timetable of new they met a 1.7bn budget gap the EU and IMF said must be resolved before centric Finnish parliament agreed to its bonds any of mid-2014 as long as 90%and holders of be part toagree to will the latest 8bn aid now of releasing be sold between tranche. 2015, with 28bn bailouts only if thethree participate in the swap programme. received collateral in be it, Athens says, it governmentnext months July Withoutraised during theloans. years covered by thesalaries and cannot pay return deal. isfor the freshwould follow. pension. It likely default But it looks increasingly unlikely that the target will be reached.the schedule to slipped. None of for called foul, After wants 4bn and senior other countries deals The Already Bankers of spending cuts officials said next year. that EU alsoGreece agreed hasthis, EUand tax rises thelast weekThe and asked resisting, but rate third leading finance ministry isparticipation it theis just quarter are likely 8bn the currentfor a similar in is a This is70-75%. for increased planned for completion deal. condition for release of the tranche. predict Athens will reach 80%. But that been pressure on on new In fact, to be closed the time.bailout. only one sale haswould make it Many completed: of 10% 54bn would be wiped off the books, unlikely all a the stake in Hellenic Telecom to If this tranche was the assumptions of the that the same dance will Deutsche Telekom forhistory suggests July deal. The difference undermining released 390m. be repeated at the next installment date, as Greece is likely to fall short must be made official somewhere, probably more EU and its promises.Greek up from says the government is running out of of A senior The problem is that this years 5bn target IMF be missed but insisted there were hopes of will options. loans. raising close to 4bn.
Source: Financial Times

And the contagion moves to Italy

Troubles increased for Italy after its closely watched auction of government bonds met with tepid demand and the country had to fork out higher yields to lure buyers, on concern that Europes debt crisis will worsen amid Greeces struggle against default. Italy's funding costs have recently surged again and 10-year bonds stabilized above 5%, despite steady buying by the ECB, widely seen as the only major buyer of Italian bonds present. Italy has found itself in the spotlight in recent weeks as its fractious parliament attempts to structure a series of budget cuts, market reform and tax increases. Markets have worried over the Italian governments ability to push though austerity measures. Italy could also see its credit rating trimmed by Moodys Investors Service as the rating firms threemonth review period end on Saturday.

Italy Still A Cause For Concern

The Rome-based Treasury sold 3.9bn, on Tuesday, of a new benchmark five-year bond at an average yield of 5.60%, compared with 4.93% at a previous similar auction on July 14. Demand was 1.28 times the amount on offer, compared with 1.93 times at the previous sale. On Monday, investors charged Italy 4.153% on a one-year bill auction, up from 2.959% a month ago. London-based traders noted that the ECB had bought Italian bonds ahead of the auction and the central bank reportedly also stepped in after the sale. Italian bonds continued to be hammered after the auction, with the spread over 10 year Italian-German yields climbing to 4.03 percentage points. The 10-year Italian bond yield rose 0.19 percentage points to 5.74%, its highest level in a month. The auction came after Mondays news that Italys finance minister held talks with Chinas sovereign-wealth fund and other Chinese officials in a bid to persuade Beijing to buy large amounts of Italian bonds. However, recent reports are suggesting that China is reluctant to buy Italian government bonds.

Italy Still A Cause For Concern

The auction came after Mondays news that Italys finance minister held talks with Chinas sovereign-wealth fund and other Chinese officials in a bid to persuade Beijing to buy large amounts of Italian bonds. A debt of 1900bn, more than Spain, Greece, Ireland and Portugal combined, leaves Italy vulnerable to any advance in yields costs as it refinances maturing debt. While Italy has completed more than 70% of its financing this year, it must still sell more than 60bn of bonds by year-end to cover its budget deficit and redemptions. The case will likely be similar for Spain, which is bracing for a sale of up to 4bn in bonds Thursday. Although Spanish yields are trading below those of Italy across, the results of Italys auctions fuelled concern that the Spanish sale will also prove a hard sell.

European Leaders Face A Fork In The Road

It seems more than not that eurozone leaders will have to come to a decision with regards to the future of the euro. Suggestions for Greece to exit the single currency continue to surface, or a break-up where Germany and other creditworthy economies like the Netherlands set up a new currency. Equity markets have been clobbered this week. Germanys Dax 30 index declined by 27% since the start of July. Italys benchmark index is down by 29%, France by 23%. Such falls have surpassed the US where the S&P 500 has lost 11% over the same period. The potential loss that European banks face on their holding of sovereign debt is on the forefront of markets concerns. Credit default swaps on European banks are above the levels they reached in late 2008. In running from some markets, investors have overwhelmed what they perceived as safe havens. Demand for German Bunds is at its highest, whose 10-year yields fell to a record low of 1.72%

European Leaders Face A Fork In The Road

The eurozone is facing a harder battle in the fight against its debt crisis, as economic growth seems to stall in the face of budget tightening. The eurozone grew by a marginal 0.2% in the second quarter, fueling concerns that the currency area is on the verge of entering a recession. Uncertainty is abundant for European markets. The eurozone is seen as lacking unified political leadership. European leaders seem to consistently fall short on carrying out their promises. Market fears are centered on the inadequacy of the bailout arsenal, the European Financial Stability Facility. Continuing to rely on the ECB to hold the fort with its Securities Markets Programme is unsustainable, especially with the ongoing tension between Germany and the ECB. Moreover, troubled countries do not seem to be fully committed to take control over their financial woes. Berlusconis government continues to flip-flop in pushing through austerity measures. Confidence in European leaders and the ECB seems to be on a declining trend.

Can mutual euro bonds be the magic solution

Calls for a more fundamental step towards a fiscal union have increased. One suggestion was to introduce Eurobonds. Advocates of Eurobonds point out that the public finances of the eurozone, taken as a whole, compare favorably with other big economies such as the US, whose government is currently able to borrow at record low yields. Benchmark 10-year bonds are trading at 1.9% as of late. Thus, the currency area would be able to benefit from low borrowing costs, helped by the liquidity advantage of creating what would become a vast government bond market. Nonetheless, critics argue that creating Eurobonds would weaken budget discipline, reducing the incentive for weaker states to get their finances in order.

Eurozone: Stuck between integration and defragmentation

European leaders will have two choices, either to take a big leap towards a fiscal union, or a break-up of the single currency. Moving towards a fiscal union seems unlikely with Germany and France strongly opposed to such suggestions. The underlying problem remains that the single currency includes different economies that work at different speeds and in different directions. The problem with the idea of countries leaving the euro is that there is no exit mechanism. This complicates the issue of a euro break-up and increases the costs if a member country was to exit the single currency. Economic cost of disintegration of the euro could be immense for Europe and beyond. A departure could lead to devaluation of the seceding countrys currency by as much as much as 60%. Moreover, political costs of breaking up the euro, even in part, are probably to high to quantify in cash terms. This leaves European leaders with its policy of muddling through, as it tries to find common ground. But the problem remains the inability of all members to agree on the next move. Nonetheless, most leaders have continued to promise that they intend to strongly defend the euro.

What to sovereign credit ratings mean

Credit rating agencies have been a large part of the debate in recent months, especially on the heels of S&Ps downgrade of the US sovereign rating. Thus it is interesting to see what is the long-term, foreign currency credit ratings assigned to European sovereign borrowers by the three major ratings agencies. Especially with reports suggesting that Italy might be downgraded by Moodys.

Country Austria Denmark Finland France Germany Luxembourg Netherlands Sweden United Kingdom Belgium Slovenia Spain Italy Slovakia Czech Republic Estonia Malta Cyprus Poland Ireland Bulgaria Lithuania Hungary Portugal Latvia Romania Greece

Moody's Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aa1 Aa2 Aa2 Aa2 A1 A1 A1 A1 A2 A2 Ba1 Baa3 Baa1 Baa3 Ba2 Baa3 Baa3 Ca

Fitch AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA AA+ AAA+ A+ A A+ AABBB+ BBBBBB BBBBBBBBBBB+ CCC

S&P AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA AA A+ A+ A A A AABBB+ BBB BBB BBBBBBBB+ BB+ CCC

Sources: Moody's, Standard & Poor's, Fitch and the WSJ

Disclaimer

The materials of this report may contain inaccuracies and typographical errors. Cairo Amman Bank does not warrant the accuracy or completeness of the materials or the reliability of any advice, opinion, statement or other information displayed or distributed through this report. You acknowledge that any reliance on any such opinion, advice, statement, memorandum, or information shall be at your sole risk. Cairo Amman Bank reserves the right, in its sole discretion, to correct any error or omission in any portion of the report without notice. Cairo Amman Bank may make any other changes to the report, its materials described in the report at any time without notice. The information and opinions contained in this report have been obtained from public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate or complete and are provided "As Is" without any representation or warranty and it should not be relied upon as such. This report does not constitute a prospectus or other offering document or an offer or solicitation to buy any securities or other investment and\or to be relied on for any act whatsoever. Information and opinions contained in the report are published for the assistance of recipients "As Is", but are not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient; they are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. Cairo Amman Bank does not accept any liability whatsoever for any direct, indirect, or consequential loss arising from any use of material contained in this report. All estimates, opinions, analysis and/or any content for whatsoever nature included in this report constitute Cairo Amman Banks sole judgments and opinions without any liability and/or representation as of the date of this report and it should not be relied upon as such. Cairo Amman Bank reserves the right to change any part of this report or this legal Disclaimer at any time without notice. Any changes to this legal Disclaimer shall take effect immediately. Notwithstanding the above, Cairo Amman Bank shall not be obliged to keep this report up to date. The Recipient agree to defend, indemnify and hold harmless Cairo Amman Bank and its subsidiaries & affiliate companies and their respective officers, directors, employees, agents and representatives from any and all claims arising directly or indirectly out of and in connection of the recipient activities conducted in connection with this report.