A Preview Of Monday Morning In Europe

While most will be following what appears to be an almost certain Hollande victory in the French presidential runoff elections tomorrow (InTrade odds around 10%), it is very likely that the Greek election will have a greater acute impact on the political and financial facade of Europe, especially in the short term. As we noted in what we dubbed our first (of many) Greek election previews, the biggest problem facing the new political regime will be its near certain inability to form a coalition government (with just 32.6% of the vote going to PASOK and New Democracy)  that does not undo most of what has been achieved through popular sweat and tears over the past 2 years to assist Europe's bankers in transferring what little Greek wealth remains to fund the insolvent European bank balance sheets. This in turn could begin the latest cascading contagion waterfall, which coupled with an anti-austerity drive emanating from a newly socialist France will threaten to topple Angela Merkel's carefully constructed European hegemony.

As Reuters explains: "If the two parties fail to win a big enough majority to go into a coalition, they will have to woo groups opposed to the bailout, raising fears that Greece will renege on its promises to international lenders and head down a path towards bankruptcy and an exit from the euro, with dire contagion risks for other crisis hit EU states like Spain and Italy. A record 8-10 parties could enter parliament and four small groups are vying to become kingmakers after the poll." And the reason why we believe many more elections are coming is that "New Democracy leader Antonis Samaras is expected to win about 25 percent of the vote but insists he wants to rule alone. Analysts say that if he comes close to the numbers he needs he may be tempted to push for another snap election." And so on, allowing Greece to slowly enter a period of political vacuum. Yet unlike Belgium, it is unlikely that Greece can persist under anarchy, especially with another critical event coming due: a €430 million payment on an international law bond that matures on May 15, and whose owners have held out from the PSI process (remember that? apparently not all has been swept under the rug). In fact we now know that the Norwegian sovereign wealth fund could very well be the entity that will demand payment and when it doesn't get it will promptly proceed to sue Greece.

As a reminder, here is what the Greek political landscape looks like currently (much more here):

As Credit Suisse explained earlier this week, this is the procedure:

The election result will be known late at night on Sunday 6 May. Following that, if no party has the majority of the votes (which is the most likely scenario), the president will ask the leader of the first party in votes to try to form a government (e.g. through a coalition) that enjoys the confidence of the parliament. If this fails or the party withdraws from its right, then the second party is asked to do the same and so on. The process is repeated for the three largest parties and each one has a three-day deadline. If these attempts fail, the president calls the parliamentary leaders of the parties on a last attempt to form a broad coalition government. If that is also unsuccessful an interim government is formed that would lead the country to a new election within a month.

Alas, the bolded section is what we fear will happen again... and again... and again. If that is indeed the case, a downside scenario emerges:

What if Greece does not deliver? We think that there is a clear risk that the IMF simply refuses to make the next payment. In that case it is probable that the EU would follow suit. However, it is unlikely in our view that payments would stop altogether; rather, they might be postponed until Greece fulfills its obligations

And since the biggest losers from the gray swan outcome would be the firm that has expended substantial resources to preserve the European status quo, up to and including allegedly presenting its own alumni Carney and O'Neill to head the Bank of England, below we present how Goldman views the series of events that lead to a less than disastrous outcome. Because if things indeed unravel, the ultimate casualty will be none other than the Euro, the EMU, and from there, a tsunami contagion wave spreading to the US and farther.

The Challenge for The Next Government


From the first week in office, the next government will face significant challenges. First off, a decision will need to be made for the Greek international-law bond maturing on the 15th of May the owners of which have held out from the PSI process. The outstanding notional is not large (about EUR430mn) but the broader implications of a no-payment decision are unknown, while the political backlash from a payment may be large.


Second, by June, budget cuts worth about 11.5bn EUR for the rest of the program period will need to be specified. There is little room left in the budget to promote such an adjustment without affecting public sector wages and pensions.


Third, pressure from international lenders will likely shift on product market reforms going forward. This implies a focus on privatizations, opening up closed professions, reducing barriers to entry for new enterprises, reducing assured profit margins for various sectors etc. Previous governments have been unsuccessful in clashing with organized professional pressure groups and creating a true competitive market for goods and services. Thus the reduction in wages has not been followed by negative trends in market prices as well.


Fourth and final, the recapitalization of the banking system in a format that makes it easy for banks to attract private capital in the future is a key element of the recovery process.


Whether the dispersion of the EUR130bn rescue package continues depends on the new government’s actions, decisions and choices on the issues above. Greece needs the dispersion of funds in order to clear out arrears, avoid cash shortages, and build buffers for additional banking sector recapitalizations in the months to come.


Near Term Election Uncertainty is Probably Overstated


Given the pressing issues at hand for the next government and the downside that lack of policy action could entail, we are inclined to think that the political incentives are aligned towards the formation of some kind of government following the election on Sunday.


As we discussed in our latest note on the subject, despite the low polling rates of the two major parties, PASOK and New Democracy (ND), the electoral law provisions make it likely that they are able to form some type of coalition government on Monday. And even in the extreme event that they don’t, there are other small moderate parties who favor stability and government continuity who could be brought in to form an interim government.


What is more important to focus on is the balance of power within the next governing coalition, the number of seats it commands in the parliament as well as its composition. These factors would determine the room for the next government to be truly functional, its lifespan and its desire to proactively introduce crucial market friendly reforms.


How to Think of The Day After


Without diminishing the probability that an extreme and unexpected outcome occurs, we would focus on what we consider the most likely outcome, as discussed earlier. And based on this, we discuss the criteria to judge the result on Sunday.

  1. Parliamentary majority for the government. A wider parliamentary majority would allow any coalition government to legislate on the difficult issues at hand more freely. It would thus be best for the government to be backed by parties amassing more than 45% of the vote in total (whether this is just PASOK and ND or whether it also includes a third party).
  2. Parliament composition. A smaller presence of radical parties at the extremes of the spectrum and potential parliamentary representation by the two small liberal parties (called Democratic Alliance and “Action” respectively) would likely help improve the intra-parliamentary debate and provide checks and balances of higher quality and applicability for the next government.
  3. Government composition. The parties who will form the next government will need to agree on who becomes prime minister and which individuals staff the key ministries. The more skewed the composition of the government towards one party, the less the likely time horizon that the current government survives.
  4. Mandate. The individuals selected for the key ministries will be a good leading indicator on the success of the government towards meeting its targets. In order to achieve the demanding tasks at hand, it would be best for reform oriented and proactive individuals to take office in key ministries such as the ministry of labor, the ministry of health, the ministry of public transport, the ministry of finance etc

Finally, the biggest wildcard in all of this is Germany's Angela Merkel who stands to suffer a tripple whammy as soon as tomorrow. From Spiegel:

Angela Merkel's position as German chancellor is becoming increasingly contradictory. At the federal level, she reigns unchallenged, while her opponents falter. But at the level of Germany's individual states, her power is crumbling and her center-right Christian Democratic Union (CDU) is bracing itself for further setbacks. At the European level, meanwhile, she has become a figure of hate for many, as her pet project, the fiscal pact, is increasingly called into question.


It seems that the German chancellor is currently inhabiting three different worlds.


But this weekend, those three worlds will converge, as people both in Germany and abroad go to the polls in three key elections which all take place on Sunday. In the northern German state of Schleswig-Holstein, the CDU's current coalition government with the business-friendly Free Democratic Party (FDP) is set to crumble, while in France, Merkel's key euro-zone ally Nicolas Sarkozy has cause to fear for his own hold on power in the second round of the French presidential election. At the same time, Greece threatens to descend into instability following its parliamentary elections. It seems likely that Merkel's worlds will no longer remain so neatly divided after this election "super Sunday." Even the staunchest of supporters sense the chancellor may be facing a turning point.

Oh yes, Germany has elections too:

Supposedly minor elections such as the one in Schleswig-Holstein have suddenly become important. Polls in the state put the CDU and the center-left Social Democratic Party (SPD) neck and neck, while the FDP, Merkel's coalition partner in the national government, will struggle at the state level to clear the 5 percent hurdle required in order to take seats in parliament.


But things could still turn out well here for Merkel. If the CDU comes out ahead and the FDP manages to stay in the state parliament, it won't cause much of a shake-up in Berlin. But if the FDP loses its seats in the state parliament, the chancellor may feel the effects at the federal level. And things will get rough inside the FDP as well. The FDP's lead candidate in Schleswig-Holstein, Wolfgang Kubicki, has a reputation for firing broadsides at the party leadership in Berlin, whose recent haplessness has cost the FDP support across the country. If the state election result is disappointing, Kubicki is likely to make his displeasure felt.


The CDU is also potentially facing a highly symbolic loss. At the moment, the party still heads up the government in one state more than its main rival, the SPD, governing eight federal states to the SPD's seven. But if things go badly in Schleswig-Holstein, then the CDU, which seems to have held this lead more or less forever, will suddenly find itself at a disadvantage.


With one and a half years to go until the country's next national elections -- and just a week until a crunch election in Germany's most populous state, North Rhine-Westphalia -- Merkel's opponents would do their best to exploit the shift in the balance of power, something that the CDU's strategists know all too well.

For now, like most, Merkel is primarily focused on Hollande:

the chancellor's camp is showing a cautious optimism. Merkel's supporters admit that a Socialist victory in France could certainly make things more difficult for them. They also expect that Hollande will remain in feisty campaign mode even beyond this Sunday, since elections to France's National Assembly come just a few weeks later. In private, though, the CDU is hoping Hollande will be forced to adjust to reality quickly. Once he's at the negotiating table and having to make decisions, they say, Hollande will revise his view of the situation. And he'll soon feel the pressure of the markets, they add.

Translated: expect the bond and stock vigilantes to make themselves heard loud and clear in the days and weeks following Hollande's ascendancy in order to put him in his place. After all, as the past two years have proven, no politicians is stronger than the shock and awe of waking up to a trading statement that shows a 20% overnight loss.

Yet while the strength French capital market does likely mean that Hollande has too much to lose by going out on a limb and doing his own thing, it is Greece, where the the myth of wealth through capital markets has been destroyed and no longer matters, that enforcing the behavior of the grand coalition through "capital market controls" will be impossible. As such it is once again the smallest Eurozone economy that will be the biggest wildcard in tomorrow's election day, and likely biggest challenge in the future.

Not even a grand coalition between the center-left Panhellenic Socialist Movement (PASOK) and the conservative New Democracy would really allow Merkel to breathe a sigh of relief. Such an alliance is the most likely outcome, and also, relatively speaking, the most stabile option, given the current situation, but it would bring New Democracy's leader Antonis Samaras to the table in Brussels, possibly even as Greece's prime minister. Although Samaras, during the current election campaign, has pledged his commitment to the austerity measures that Athens agreed upon with the EU in return for financial aid, it worries other EU conservatives that he has taken precisely the opposite position at times in the past.


That erratic behavior poses a danger for Greece and the EU -- and for the German chancellor as well.

For too long have Europe's taxpayers bowed down to greater financial interests, entwined in the mythical welfare state (long since insolvent) symbiosis. It is truly only those who have already lost everything (for now the Greeks but soon many others) that are free to do anything. And that anything will soon mean beginning to take back that what has been legally stolen from them for the past two years. Will the Great European wealth transfer come to a halt tomorrow, and possibly reverse? We will know in less than 24 hours.

Finally, Monday is just the beginning of the May 6 European election juggernaut. Then the real fun begins as the following forward calendar from Deutsche Bank shows.


  • 6 May: Second round of the French presidential elections (see 22 April entry). The results of the 22 April first round suggest  that the Socialist candidate, Francois Hollande, is on course for victory.
  • 6 May: Greek general election. Polls close at 7pm local time, with exit polls released at the same time. Real-time results will start streaming approximately an hour later, and the first reliable country-wide estimate should be available around 10pm local time. If the results are a close call, the final outcome may not be known until the early hours of Monday. The last batch of polls was published on April 20th, ahead of the poll blackout period. These pointed to a picture that has remained remarkably consistent  throughout the last two months: a large number of undecideds (~20%), record-low support for the two traditional governmental parties (New Democracy and PASOK) and rising extremes on both the left and right. The ultimate result is sensitive to how the undecideds vote. Assuming a proportional allocation, New Democracy and PASOK should be able to secure a decent majority. Polls using a more sophisticated allocation technique point to an inability to form a government however. The bottom line is that the result is too close to call.
  • 6 May: German state election in Schleswig- Holstein. On recent opinion polls, the current conservative-liberal coalition will lose its majority despite the fact that the liberals will most likely exceed the 5% threshold to enter parliament again. A CDU/SPD grand coalition is a possible outcome. However, it is open which of the two parties will receive the most votes and subsequently appoint the leader of the grand coalition government.
  • 6 and 7 May: First round of Italian local elections (second round on 20 and 21 May). This will be a first test to see the degree  of electoral support to those parties backing Monti’s government – nine million people are called to the polls (about a fifth of Italy’s total electors). The relative performance of the Northern League and Berlusconi’s PDL could be an interesting insight.  The two parties, which formed the core of the previous government, were unable to prevent and control the sovereign crisis.  Since then the PDL decided to support Monti’s government, contributing to avoid early elections, which would likely have had disastrous consequences for Italy. On the contrary, the Northern League opted to further increase its populist message and  move to the opposition against Monti.
  • 7 May: Germany to debate ESM. Parliamentary public hearing on the ESM Treaty.
  • 8 May: Greece auction. Bills.
  • 8 May: EFSF auction. Bills.
  • 11 May: European Commission to release spring economic forecasts.
  • 11 May: Italy auction. Bills.
  • 13 May: German state election in NRW. The vote in NRW can be seen as an important test of the electorate’s political mood. The polls indicate that the SPD (around 38%) and the Greens (about 12%) may win a stable majority. The CDU has support  levels at about 33% in the polls. NRW’s CDU party leader Norbert Röttgen may well achieve some 35% (roughly in line with national averages) but the Greens clearly have no preference for governing with him. Whether the liberals can clear the 5% hurdle remains to be seen. The election in NRW is the second-last state-level test before the national election in mid-
    September or October of 2013. In January 2013, state elections in Lower Saxony will expose the conservative-liberal camp to new risks (see German political update, Focus Europe, 23 March 2012).
  • 14 May: Spain auction. Bills.
  • 14 May: Italy auction. Bonds.
  • 14-15 May: Eurogroup and ECOFIN finance ministers meetings.
  • 15 May: Greece auction. Bills.
  • 15 May: Flash Estimate EU and euro area GDP. Eurostat to publish preliminary estimates for Q1 2012 GDP.
  • 17 May: Spain auction. Bonds.
  • 22 May: Spain auction. Bills.
  • 25 May: German parliament vote on Eurozone ‘Fiscal Compact’. The Fiscal Compact to strengthen budgetary discipline within the euro area will require a two-thirds majority in both the Bundestag and the Bundesrat, the upper house. Until now, cooperation between the coalition parties and the opposition has been smooth, underlining the pro-Europe sentiment. The SPD and the Greens are insisting on taxation of the financial sector and a growth package in return for their support. The latter fits into the broader debate on a European level, including modification of structural funds or even new financing  instruments such as project bonds. However, we do not feel this will pose a risk to the Fiscal Compact being approved as the opposition has no interest in sending such a signal to the EU. Most probably the compact’s approval will be linked to i) deciding on a growth pact by the end of the year and ii) agreeing on a roadmap for introducing additional taxation on the financial sector, or at least give the go-ahead for national solutions (see article on German politics in Focus Europe on 23 March).
  • 28 May: Italy auction. Bonds.
  • 29 May: Italy auction. Bills.
  • 31 May: Irish referendum on Euro zone ‘Fiscal Compact’. A recent opinion poll put the support for the Fiscal Compact at 47% (down 2pp), the No vote at 35% (up 2pp) and 19% Don’t Know. This equates to a 58%:42% Yes:No ratio when the undecided votes are excluded. The concern is the still high level of undecided voters. Although Ireland is making good progress through its EU-IMF adjustment programme — the sixth review was recently passed successfully — a ‘No’ to the referendum could compromise Ireland’s access to ESM funding should a second loan programme be required. Although a second referendum is a theoretical possibility (Ireland has a history of rejecting EU referenda before accepting), taking away the safety net could be a significant blow to Irish bonds.


  • 6 June: ECB Governing Council meeting, followed by interest rate announcement and news conference.
  • 6 June: Portugal auction. Bills.
  • 7 June: Spain auction. Bonds.
  • 10 June: French legislative election (first round). Elections to entirely renew the deputies in the National Assembly (lower house of parliament). A risk is that the socialist party alone fails to secure an absolute majority and has to depend on the support of the radical left, which could push to try to transform what we hold for pure campaign rhetoric in actual legislation. However, it would be wrong to simply replicate Melanchon’s score in the first round of the presidential election into the number of deputies the radical left would secure, as the “personal factor” was important in Melanchon’s strong performance and as the “two  rounds” majority system of the parliamentary election should favour the socialists.
  • 12 June: Greece auction. Bills.
  • 13 June: Italy auction. Bills.
  • 14 June: Italy auction. Bonds
  • 17 June: French legislative election (second round) See 10 June entry
  • Mid-June: European Commission proposals on failed banks. The EC is due to present proposals for a bank crisis resolution scheme, potentially including plans for creditor writedowns, before the G20 leaders’ summit on 18-19 June. The proposals  being worked on have been reported not to directly involve the euro zone’s EFSF and ESM funds.
  • 18-19 June: G20 Leaders Summit, in Los Cabos, Mexico. Gathering of the leaders of the world’s twenty biggest economies. European Commission’s plan to resolve failed European banks among the issued to be discussed (see the entry above).
  • 19 June: Spain auction. Bills.
  • 19 June: Greece auction. Bills.
  • 21 June: Spain auction. Bonds.
  • 21-22 June: Eurogroup and ECOFIN finance ministers meetings.
  • 26 June: Spain auction. Bills.
  • 26 June: Italy auction. Bonds
  • 27 June: Italy auction. Bills.
  • 28 June: Italy auction. Bonds.
  • 28-29 June: European Council meeting. This is the meeting of the EU heads of state and government.