The primary indicator used by Jim Caron in his daily letter to assuage client fears about contagion, 3 month Libor, has taken a step for the worse. As Market News reports: “Dollar and euro 3-month LIBOR both rose Tuesday, with the dollar rate at its highest since July 6 last year and the euro rate at its highest since Dec 29 2009. The euro overnight LIBOR rate rose 32.13 basis points, due to the end of the European Central Bank maintenance period, while the 3-month LIBOR rate was up 0.19 points.” Adding to increasing short term funding concerns was the fact that going forward the ECB will take a 5% haircut on all Greek bonds posted as collateral with the ECB. As this amount has surged recently, Greece will be now forced to post yet more bonds just to cover the spread. Luckily, Greece is allowed to post any collateral at all, as the once-prudent ECB now allows for any worthless collateral to be pledged for cash on its balance sheet. Very much like our own Fed. Lastly, yesterday’s Greek downgrade by Moody’s drew harsh criticism by Europe. As Reuters reports: “Moody’s decision came at quite an astonishing and unfortunate moment” according to Olli Rehn, who added “the downgrade had not taken into account latest developments in Greece.” On the other hand, seeing how much credibility (none) the Greek government has, after having been caught lying about its deficit for years, is this really a surprise?
There’s been a lot of talk recently about Hungary following in Greece’s footsteps and potentially defaulting on its debt. Bulgaria and Romania are two other weak economies in Eastern Europe, and the chart below shows bank exposure by country to Bulgaria, Romania, Hungary and Greece (source):
It’s interesting to note the exposure that Greece has to Bulgaria and Romania. Romanian and Bulgarian debt comprise more than 25% of the foreign debt that Greek banks hold. Austria also has a high concentration of risk in these four countries, at 29% of total foreign claims outstanding. When investors talk about contagion, what they are really referring to is positive feedback loops. We can see from the chart above how trouble at one country can quickly develop into a concern for other countries. The situation in Greece could make it difficult for Bulgaria and Romania to roll over their debt, an event which would in itself reduce the value of Greece’s assets, creating further difficulty for Bulgaria and Romania.
There were fears that Britain could follow Greece into a financial crisis after a global finance chief warned of economic “contagion” spreading across Europe.
The head of the International Monetary Fund urged politicians to finalise a bail-out for the debt-laden Mediterranean country, saying that every day lost in resolving the problems risked spreading the impact “far away”.
Dominique Strauss-Kahn’s comments came amid more evidence of Europe’s mounting fiscal problems after Spain’s debt was downgraded – a move recently applied to its under-pressure neighbour Portugal as well as Greece.
On Wednesday, shadow chancellor George Osborne raised the spectre of the crisis affecting the public finances of the UK, which faces dealing with its own £163 billion mountain of public borrowing. Read more…
The fiscal emergency in Greece and the turbulence in debt markets are threatening to overshadow this week’s EU summit on business competitiveness. The problem poses a leadership test for Herman Van Rompuy, the EU’s first permanent president, who called the meeting. Greece’s debt crisis, and the risk of eurozone contagion, are not on the summit’s official agenda, but leaders fear the impact on financial markets if the summit does not address the worst crisis to strike European monetary union since its launch in 1999.
