Notes From Underground

As the sun sets on the Greek drama, the most predicted outcome has indeed taken place as the IMF/EU and ECB/EFSF/ESM have come to an agreement about bringing the Greek debt load to a robust level of 124% debt-to-GDP ratio by 2020. There was no way the TROIKA was going to risk the entire EURO project on a mere 44 BILLION EURO payout to the Greek government. The game was played out to the 11th hour–oh those drama queens in Brussels–and although the OFFICIAL SECTOR did not take an official haircut, the core nations of the European financial system do stand to take a bath. IMF Director Lagarde was able to save face as the Greek debt levels will reach the previously promised levels of 120%. Madame Lagarde can now go to the IMF Board and report that all previously agreed to conditions have been ratified by the EU and await the signing of the memorandum of understanding with the Greek leadership. The IMF needed to get Greece out of the way so it can figure out the role it will play in the Spanish bailout and/or Italy.

As part of the final agreement, the ECB will forgo its “profits” on its holdings of Greek bonds with short maturities. This is truly similar to the U.S. FED turning over its interest earnings on its QE purchases to the TREASURY and having the U.S. government putting that on the credit side of the balance sheet. The British have recently played the same game by taking its interest rate gains and putting them back to the Exchequer.S o now it will be on to Spain for the Troika. We will not be able to yada, yada, yada Spain. The EURO tonight rallied above the 130.00 level as the Greek crisis is seen as resolved for the time being. All of the yield curves that we watch have been very tightly range bound so Euro interest rates are not providing any clues to further market direction. The IRISH yield curve has been the biggest mover as the 2/10 widened out to 300 pips as the TWO YEAR NOTE dropped to a respectable 1.37%.

***Last week the market was surprised by a judicial decision from the Federal Court in New York. Judge Thomas Griesa upheld a ruling that the Argentinian Government would have to pay in full the hedge funds that held out against a 2001 forced restructuring before it can pay those who took the restructuring for a far discounted settlement. The Elliott Management Corp. bought steeply discounted Argentine bonds from exhausted creditors and pushed for full payment under the law. The Argentinian bonds didn’t have Collective Action Clauses (CACs) and thus a severe minority bondholder would not have to go along with a super majority. There was a Bloomberg piece last week that highlighted the main points of CACs, which all readers should acquaint themselves. (It was authored by my daughter Alexandra.)

The Argentinian government led by President Cristina Kirchner vowed that it will not pay out the court-demanded satisfaction to the “vulture funds.” This decision by Judge Griesa will be appealed to higher courts. The issue is complicated but in a Financial Times editorial today it was well noted: “Trapping countries in unpayable debt obligations is dangerous. While countries should service their debts in all but exceptional cases, an orderly mechanism for sovereign restructuring is essential for the exceptions. Just as with bankrupt individuals and corporations, value is only destroyed by holding insolvent debtors in never-ending limbo.” If international sovereign borrowers will not operate without a CAC and lenders won’t operate with one, global credit markets can become frozen and the fallout for the European peripheries could be catastrophic. The ability of Greece and others to borrow are dependent on its potential needs for restructuring.

How high will lending rates be forced for those demanding debtor rights? As the FT editorial further states: “If Mr. Griesa’s ruling sets a precedent, a single holdout creditor will be able to exclude a sovereign debtor from international markets indefinitely.” Also, and I think this could be important, international trade could dry up due to a lack of financing. Let’s assume a hypothetical: Argentina owes a hedge fund a billion dollars. The Argentine government contracts to sell a billion dollars worth of wheat and then a court within the jurisdiction of the lenders orders the seizure of the payment for the wheat. Situations like these can play havoc with global trade and harm an already fragile global economy. This is a very serious issue and will be on our radar screen. The impact on global commodity prices could be severe if this court ruling isn’t resolved.

***HOORAY FOR THE BANK OF ENGLAND! The Chancellor of the Exchequer named a new governor for the BOE to replace the retiring Mervyn King (June 30, 2013). The Chancellor chose a non-Brit, Mark Carney, the current Governor of the Bank of Canada. Readers of NOTES know that I hold Governor Carney in very high regard as being a central banker with great vision and respect for the financial markets. Mr. Carney is also the Chairman of the Financial Stability Board to sets  risk policy on a global basis. This was a very strong choice by what has been a very weak British government under Prime Minister David Cameron. The BOE is going to need strong leadership as it seeks to move out of its aggressive QE programs and steer the British economy through a very unstable European economic situation. Picking a foreigner with great credentials and strong international credibility is an act of courage. A tip of the bowler to the guardians of the OLD LADY OF THREAD NEEDLE.

Tags: Argentina, BOE, Christine Lagarde, collective action clauses, ECB, EFSF, ESM, EU, Euro, Greece, IMF, Irish yield curve, Judge Griesa, Mark Carney, Mervyn King, QE, Troika, two-year note

This entry was posted on November 26, 2012 at 9:29 pm and is filed under Argentina, BOE, Greece, IMF. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.