Wednesday, April 28, 2010

>Weakness Begets Weakness: from Banks to Sovereigns to Banks

The Greek debt situation has been an interesting case study for students of the sovereign bond
markets. If there’s a lesson to be learned from Greece’s experience thus far it’s that sovereign bailouts are far more complicated than bank bailouts. They require more sophisticated negotiations and proposals and involve an extra layer of diplomacy that makes them especially difficult to accomplish. As we write this, the European Union has recently announced new lending terms to support the Greek government, with great efforts made to assure the markets that these new terms do not constitute a ‘bailout’. The problem with the Greek situation is that an actual bailout would involve an almost impossible coordination among all the major powers within the EU. It would require the unanimous pre-approval of all the EU heads of state. It would involve the European Commission, the European Central Bank and the International Monetary Fund (IMF) all visiting Greece to perform financial assessments.1 And finally, it would involve at least seven EU countries affirming support through parliamentary votes - all of this before a single euro is spent. A true bailout involves an almost impossible number of hurdles that essentially guarantee nothing will happen until all other avenues of rescue are exhausted. However, judging by the recent increase in yields on 10-year Greek bonds, Greece may soon need more than a loan package proposal to solve its fiscal problems.

One aspect of the Greek situation that has been obscured by all the recent political wrangling is the crisis’ impact on the Greek banks. Although the banks were supposed to be rock solid after all the government-injected capital they received (not to mention zero-percent interest rates and generous lending terms from the European Central Bank), data shows that Greek bank deposits have fallen 8.4 billion euros, or 3.6 percent, in two months since December 2009.2 With no restraints on capital flows within the European Union, Greek savers are free to transfer their assets elsewhere. Given that bank deposit guarantees in Greece are the responsibility of the national government rather than the European Central Bank, we suspect Greek citizens are pulling money out of their banks because they question their government’s ability to honour its domestic deposit guarantees. We envision Greek depositors asking themselves how a government that can’t raise enough money to stay solvent can then turn around and guarantee their bank deposits? It’s a fair question to ask.

To read the full report: WEAKNESS BEGETS