Stocks are soaring today because Greece agreed to another austerity program. However, all this really means is that negotiations can begin for another Greek bailout. The bailout itself is at least 4 weeks away assuming that everyone can agree on everything.
The next steps are:
1) Germany’s parliament must issue a mandate giving Chancellor Angela Merkel the right to negotiate a new bailout deal with Greece.
2) Finland’s, the Netherland’s, Slovania’s, Estonia’s, and Austria’s Parliaments also must agree to let their Finance Ministers negotiate a new deal with Greece.
3) EU Finance Ministers must negotiate a new bailout deal with Greece.
4) Germany’s parliament must sign off on the new deal.
5) Greece must accept the deal.
Anyone who claims a deal is within sight is out of his or her mind. This process will take weeks if not months to complete… assuming it even occurs. Indeed, there are numerous issues any of which could derail the whole process.
The most important development is that both the IMF and the ECB have floated the idea of debt forgiveness. This is the first REAL solution that could reduce Greece’s debt load… but it is completely impractical in that it sets the stage for potential debt forgiveness deals for Spain, Italy and possibly even France down the road.
All of those countries will come knocking asking for help at some point. The fact is that their Debt to GDP levels have soared since the EU nearly collapsed in 2012.
Spain's Debt to GDP has risen from 69% to 98%. Italy's Debt to GDP has risen from 116% to 132%. France’s has risen from 85% to 95%.
This is why German political leaders such as Finance Minister, Wolfgang Schauble, are warming to the idea of a “Grexit”… because as painful as that might be, kicking out a problem country is a more appealing template for future negotiations with problem countries than debt forgiveness.
Remember, the entire Greek debt market is about €345 billion in size. So we’re not talking about a massive amount of collateral… though the turmoil this country has caused in the last three years gives a sense of the importance of the issue.
Spain has over $1.0 trillion in debt outstanding… and Italy has €2.6 trillion. These bonds are backstopping tens of trillions of Euros’ worth of derivatives trades. A haircut or debt forgiveness for them would trigger systemic failure in Europe.
EU banks as a whole are leveraged at 26-to-1. At these leverage levels, even a 4% drop in asset prices wipes out ALL of your capital. And any haircut of Greek, Spanish, Italian and French debt would be a lot more than 4%.
Remember, at the end of the day, it’s all about the big banks’ derivative exposure, NOTHING else. This is what has driven every Central Bank action since 2008. And it’s what will drive Europe’s future negotiations for a 3rd Greek Bailout.
The reality is that the issues that caused 2008 (excessive leverage, toxic derivatives) were not solved. If anything they have worsened. And today, most Central banks are sporting leverage ratios well above those that took Lehman Brothers down.
Another Crisis is coming. And it will feature entire countries going bust, not just a few banks.
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