A specter is haunting Europe: debt default

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machinehead's picture
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A specter is haunting Europe: debt default

After an upside start today, euro stocks turned down. One background factor is rising financial stress in Ireland. This strikes me as a 'sleeper' issue which could become a very prominent concern in coming days:

Nov. 3 (Bloomberg) -- The cost of insuring Irish sovereign debt surged to a record as credit-default swaps on Allied Irish Banks Plc subordinated debt signaled a 63 percent probability of default within five years.

Contracts insuring 10 million euros ($14 million) of Allied Irish’s junior bonds cost about 3.35 million euros upfront and 500,000 euros annually, according to data provider CMA. That’s up from 400,000 euros a year in April. Swaps on the government’s debt jumped 36.5 basis points to 554.5.

Political pressure for bondholders to share the burden of losses is growing. German Finance Minister Wolfgang Schaeuble said today the euro’s stability depends on making investors pay for future debt crises, brushing aside warnings that Europe’s most indebted countries are being hurt by proposals for a permanent-debt crisis mechanism.

“People in the market have a real concern Ireland is going to struggle to fund itself and therefore banks are going to struggle to fund themselves,” saidGary Jenkins, head of credit strategy at Evolution Securities Ltd. in London. “There’s a cause and effect between banks and sovereigns. When you have these problems at a sovereign level, it’s fairly evident that the next rung down where problems lay is with the banks.”

Irish bonds fell, driving the extra yield investors demand to hold the securities instead of German debt to a record for the third day. The Irish-German bond yield spread increased 22 basis points to 505, according to Bloomberg generic data.


Ireland was being cited as a model for the austerity approach adopted by the EC in May, in connection with the Greek crisis. Since then, EC leaders have decided that bank bondholders should share the pain in future crises.

However, the message from deteriorating European debt markets is that bondholders don't think the current crisis is solved yet. Bloomberg reports that 'Allied Irish is selling assets to meet capital targets set by the country’s financial regulator after racking up losses in the collapse of the country’s real estate bubble.'

We can safely assume that Allied Irish is getting ruinously low prices on its asset sales, as is the case in any distress sale. Meanwhile, as the default risk on its debentures spirals skyward, it is effectively cut off from new borrowing to raise capital. The potential for a self-reinforcing downward spiral, not only in Ireland but in other stressed areas of Europe, is rather obvious.

Hang on to your seats; this could be a bumpy ride!

ashvinp's picture
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Re: A specter is haunting Europe: debt default

It's interesting to consider whether this return of focus onto European sovereign debt problems is a function of natural deterioration of sovereign finances, designed financial pressure or both. There is no doubt that the levels of public debt in the Euro periphery are completely unsustainable, and as their economies deflate from natural/planned austerity, their financial situation will grow worse. But we should also note that the countries around the world are trying to manage their debt burdens and decelerating growth rates by devaluing their currencies, and core Eurozone countries can't be happy with the EURUSD pushing 1.4.  These countries can't necessarily print money to devalue, so they must rely on concerns over sovereign debt and the entire Euro breaking apart.

Either way, it's possible that the US and Europe think they can keep playing an eternal game of staggered devaluation, supporting financial markets, exports and consumption all at the same time. It's an extremely dangerous game, like Russian Roulette with 3 bullets chambered, and it would truly be a miracle if they actually pulled it off for more than a year.

agitating prop's picture
agitating prop
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Re: A specter is haunting Europe: debt default
Financial Times:

"Ireland and Spain were on Thursday removed from a list of countries in which Russia’s $130.9bn sovereign wealth funds is permitted to invest, according to the Russian finance ministry’s website. Norway’s $520bn fund said the past few weeks had seen Spanish debt grow significantly less attractive.

“The warnings by sovereign wealth funds creates even more uncertainty in the eurozone,” said Nigel Rendell, senior strategist at RBC Capital Markets. “These funds are big players in the markets and can influence sentiment.”


Irish Independent:

"In a mostly off-the-cuff speech, Taoiseach, John Bruton told the IBEC conference that speculators betting on an Irish default were going to lose money. Ireland remains a rich country, well capable of repaying its debts, he said."


Rich compared to what? The potato famine years?

Taoiseach isn't a typo, I discovered. It's a head of govt.



machinehead's picture
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Re: A specter is haunting Europe: debt default

Nine days in a row -- like a volcano with a rising bulge in its cone, little puffs of smoke rising from the caldera, and daily swarms of mini-quakes rattling the villages below:

Nov. 5 (Bloomberg) -- Ireland led a surge in the cost of insuring sovereign debt to a record as the government struggles to convince investors it can avert a European Union-led bailout.

Credit-default swaps on Ireland rose for a ninth day, soaring 27 basis points to an all-time high of 606, according to data provider CMA. The Markit iTraxx SovX Western Europe Index rose 5 basis points to a record 170.

Austerity measures in Europe’s so-called peripheral countries are failing to reassure investors that fiscal crises are under control. Ireland yesterday accelerated plans to cut its budget to avoid the fate of Greece, which was rescued earlier this year, and Portugal is suffering higher borrowing costs after agreeing the biggest spending cuts since the 1970s.

Peripheral Europe is burning again,” said Sanjay Joshi, who oversees about $500 million as a money manager at London & Capital Group Ltd. “Ireland talking about more austerity cuts, it just makes the whole situation worse, not better.”


I fully agree with the remark by money manager Sanjay Joshi. With Ireland locked into a debt deflation trap, more austerity measures will only shrink its economy faster. Meanwhile, debt continues to increment upward, sending the debt-to-GDP ratio soaring higher until something breaks. Usually this means markets rebel, as they are doing now. 

At 532 basis points over Germany, Irish sovereign bonds are yielding 7.7% -- a crushing rate of interest for an economy that's not growing. Here's why the yield is so high:

(RTTNews) -  The Ireland finance ministry announced on Thursday savings and tax increases of EUR 6 billion or US$8.5 billion in 2011 to reduce its budget deficit from an estimated 32% of GDP this year. The government plans to meet the 3% deficit target by 2014.

The ministry forecasts government debt to peak at 106% of GDP in 2012, then falling to 105% in 2013. The general government deficit is seen at approximately 12%-12.75% of GDP in 2011 if no consolidation measures were implemented. 

Finance minister Brian Lenihan expects the Irish economy to expand mere 0.4% this year and by 1.75% in 2011, following the government spending cuts.


A budget deficit of 32% of GDP -- the horror, the horror! 

What's wrong with the picture painted by the finance minister is that Irish GDP shrank by 1.2% in the second quarter compared to the first -- or an annual rate of about minus 4.7%. Piling on more austerity measures is not going to make GDP grow. On the contrary, it's going to shrink faster.

Ireland is caught in a vise. Like Greece, its only real solution is restructuring the unpayable debt. Until governments and the EC admit the inevitable, all markets can do is sell, sell, sell.

machinehead's picture
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Re: A specter is haunting Europe: debt default

Richard Smith fills in the timeline on the Irish crisis:

Since the Irish budget is fully funded for a few more months (ex any revenue surprises, or God forbid, further bank loan writedowns), they can in principle trundle along like this until their date with destiny in Q2 2011, when they have to raise funds again.

But somehow it’s hard to believe that that is going to be the way things go. We will see if the budget gets thrown out or not; or the government. It will be close, on either count. Either eventuality brings forward the timetable for the Irish crisis proper, but it’s coming, one way or the other.


I would guess that a bad 3Q 2010 GDP report for Ireland causes alarm in December, as debt-to-GDP rages higher.

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