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Generational Dynamics Web Log for 17-Jan-2012
17-Jan-12 World View -- Euro crisis faces major tests this week

Web Log - January, 2012

17-Jan-12 World View -- Euro crisis faces major tests this week

United Nations will train Arab League observers in Syria

This morning's key headlines from GenerationalDynamics.com.

Sarkozy cites 'unprecedented crisis' as EFSF is downgraded
Papademos optimistic as negotiators return to Greece
Portugal's bond prices fall sharply after S&P downgrades
Hungary and EU face major confrontation on Tuesday
United Nations will train Arab League observers in Syria
Iraq criticizes Turkey over remarks about sectarian division

Sarkozy cites 'unprecedented crisis' as EFSF is downgraded

Sarkozy on Monday

Sarkozy on Monday

The consequences of last week's S&P downgrade of France's AAA debt rating are starting to roll out. S&P downgraded Europe's new bailout fund, the European Financial Stability Facility (EFSF) from its previous AAA rating, pointing out that EFSF can't have an AAA rating if one of its major guarantors (the other being Germany) doesn't have an AAA rating. However, France's downgrade is a political blow to France's president Nicolas Sarkozy, just 100 days before presidential elections. Last year, Sarkozy had promised to do everything possible to retain France's "national treasure," its AAA rating. "We are confronted by an unprecedented crisis that forces us to cut spending, lower our deficits but also to find the path to new growth by resolving our competitiveness problems," Sarkozy said. According to an opponent, "It’s not France that has been downgraded, it’s a policy, it’s a strategy, it’s a team, a government, a president." Bloomberg and Expatica France

Papademos optimistic as negotiators return to Greece

Analysts say that Greece has only till the end of this week to finalize the details of the bailout agreement negotiated last year and announced on July 21, if Greece wants to avoid bankruptcy in March. Existing holders of Greek bonds will have to lose 50% or more of their investment, but negotiations collapsed last week over the exact amount of the "haircut." Prime Minister Lucas Papademos expressed the usual bubbly optimism, and said, "We will manage in time to reach an agreement that will be accepted by everyone." A new negotiating meeting is scheduled for Wednesday, and details must be agreed in time for a meeting of EU officials on Friday. According to Moody's, a haircut exceeding 50% will have serious consequences, and could force Greece to leave the euro, and return to the drachma currency. Kathimerini and Reuters

Just for fun, I did a quick computation on how much bondholders will be losing. Suppose you have a $1,000 Greek bond that you expected to redeem in March. As I reported last week, according to the negotiations so far, the 50% haircut plan means that you'll get $150 in cash, plus a $350 bond redeemable in 30 years.

Since the bond can't be redeemed for 30 years, you make a net present value computation, assuming that the market interest rate for the next 30 years will be 6%, and you get a present value of the bond as $350/(1.06^30)=$60. That's the present value of the bond, and the amount you could get if you sell it to someone else right away. So now your $1,000 bond is worth only $150+60=$210.

But actually you get more money than that, because there's also a "coupon payment" that you receive each year - and this is where the disagreement is. The French and the Greeks want to keep it low, at 2% per year. If you apply the annuity formula to that, you get the the present value of ALL your coupon payments is $96, so your $1,000 bond is now worth $150+60+96=$306, for a 69.4% haircut, rounded to 70%.

The investors want at least 4% coupon payments. The present value of those payments is $192, so your bond is now worth $150+60+192=$402, for a 59.8% haircut, or 60%.

So if an agreement is reached between all the parties, then the "haircut" will be a lot more than 50% -- it will be at 60%-70%.

But there are two other alternatives: If Greece simply defaults, then your bonds will be worthless, but some investors, namely hedge funds who have CDS insurance policies, will receive a full payment by collecting on the insurance. So they're going to try to block any agreement.

And the final alternative, the one predicted by the "Kick the Can Theory" that I proposed last year, is that European officials will simply give Greece a new €14.5 bailout loan in March, as they've done before. In that case, they'll have kicked the can down the road once more, but the good news is that you'll be able to redeem your March bond for the full $1,000, with a 0% haircut.

Portugal's bond prices fall sharply after S&P downgrades

Portugal 10-year bonds at 15.667% yield on Monday

Portugal 10-year bonds at 15.667% yield on Monday

While France's bond prices were not affected much by Friday's downgrade of the debt of nine eurozone nations, Portugal's bonds, which were downgraded to "junk" status, were hit very hard on Monday. Many classes of investors permit only investment grade bonds in their portfolios, so the downgrade to junk status meant the forced selloff of a large volume of Portugal's government bonds, pushing prices sharply down and yields (interest rates) up. The yields on 2-year and 5-year government bonds rose to 13.46% and 16.80%, respectively, while the 10-year rose to 15.67%. As the adjoining graph shows, Portugal, which has already been bailed out once, is well on its way to following the same path as Greece, and may require more bailouts soon. Bloomberg

Hungary and EU face major confrontation on Tuesday

The Hungary crisis continues to grow, even though it's eclipsed in the news by the Greece crisis. On Tuesday, Brussels is expected to formally warn Hungarian prime minister Viktor Orban that it will take Hungary to the European Court of Justice unless his government voluntarily changes new laws that critics say undermine the independence of the country’s central bank. Hungary is in desperate need of a €15-20 billion bailout, but the EU and International Monetary Fund have said they won't start talks on the bailout unless the laws are changed. Irish Times

United Nations will train Arab League observers in Syria

After being made fools of by Syria's Bashar al-Assad regime, who continued mutilating and slaughtering people right under their noses, the 150 or so Arab League observers are going to get some help from the United Nations on how to be better observers. The training will done by specialists from the UN High Commissioner for Human Rights, after an Arab League meeting on January 22. Meanwhile, the slaughter and butchery go on every day. Bloomberg

Iraq criticizes Turkey over remarks about sectarian division

Iraq summoned the Turkish ambassador in Baghdad on Monday to complain about statements by Turkish officials, including comments earlier this month by Turkish Prime Minister Tayyip Erdogan, who said a Sunni-Shia conflict in Iraq, if unleashed, could engulf the entire Islamic world. Iraq said the remarks amounted to meddling in its affairs, a sign of increasing tension between the two countries. Iraq under Saddam Hussein was governed by the Sunni minority, but is now governed by the Shia majority, and has close relations with Iran. Fears of renewed sectarian conflict in Iraq have increased since U.S. troops withdrew last month and Maliki's Shi'ite-led government sought the arrest of a Sunni vice president on accusations he ran death squads in the Saddam Hussein days. Turkey, which has a Sunni majority but is officially secular, has attempted to play a moderating role as rivals Shia Iran and Sunni powerhouse Saudi Arabia jockey for influence in the region. Reuters

(Comments: For reader comments, questions and discussion, see the 17-Jan-12 World View -- Euro crisis faces major tests this week thread of the Generational Dynamics forum. Comments may be posted anonymously.) (17-Jan-2012) Permanent Link
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Generational Dynamics Web Log for 17-Jan-2012 17-Jan-12 World View -- Euro crisis faces major tests this week

Sarkozy cites 'unprecedented crisis' as EFSF is downgraded

Papademos optimistic as negotiators return to Greece

Portugal's bond prices fall sharply after S&P downgrades

Hungary and EU face major confrontation on Tuesday

United Nations will train Arab League observers in Syria

Iraq criticizes Turkey over remarks about sectarian division

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Generational Dynamics Web Log for 17-Jan-2012
17-Jan-12 World View -- Euro crisis faces major tests this week