Is Greece, Bear Stearns Part II

Back in January I wrote a note regarding the possibility that the Greek debt problem and the subsequent market reaction was eerily reminiscent of the Bear Stearns crash.  The market knew there were underlying macro issues plaguing Bear, but not many were certain of how widespread those issues were throughout the Wall Street banks.  As well, many risk managers, if they were even aware of what their traders were holding, did not account for the possibility of losses exceeding a certain threshold.  It turned out that Bear Stearns was just the tip of the iceberg, they were just the first in a long line of banks and investment firms to be thrown off the train.  At the end of the day, the structural issues surrounding mortgage backed securities would prove to be poison throughout the financial world, reaching far and wide.

Greece has been bailed out by the IMF and Eurozone, but the actual amount of help they are receiving is far greater than what was first expected.  Similar to the Bear Stearns mess, the Greeks have complained recently that their situation was being made more difficult by CDS traders seeking to profit from their misfortune, causing the situation to deteriorate further.  Frankly, anytime you hear a company complain about traders selling your stock or shorting your debt, you can bet that the CEO is lying out of his $%&, or worse, and typical of the financial crisis, truthfully didn’t understand the issues his company faced.

Fast forward to today, when Spanish politicians and central bankers are denying that they need any help dealing with their debt.  Some believe that Spain may need upwards of 200 billion Euros of help.  We are also beginning to see others throughout the Eurozone come out and bemoan the fact that CDS spreads have widened, and some mad that so many hedge funds are short the Euro.  This all sounds very familiar doesn’t it.

After speaking to many people over the past few months regarding the sovereign debt issues in Europe, it seems to me that the issue is more wide spread than just Greece.  I won’t write a whole thesis here, but the general idea is that many Eurozone countries do not have the ability to grow their way out of the global recession.  Socialist policies in many countries are choking their economies to death, and extricating themselves from these policies is going to be near impossible.  Given that the unemployment rate of 18-27 year olds in Spain is upwards of 20%, major social unrest could take place if the government cuts back on social safety nets.

It seems that many are underestimating the pervasive nature of this problem.  I don’t believe the market is pricing the risk of defaults on sovereign debt accurately, just as they failed to price the risk of default on MBS defaults accurately.  Yes, the default of the underlying assets meant losses for holders of the paper, that was bad, but what brought down many financial institutions were the side bets on those assets where the risk was mispriced.  We all assume that someone will come in to bail out these countries as Greece is being now, but who will ante up?  Will the ECB print money to fund bailouts throughout the Eurozone similar to what the United States government did?  If that’s the case, and their plan is to debase the Euro, then I don’t see any reason to cover that short.  That’s the best case scenario.

The worst case is that there isn’t enough money to bail everyone out, that we do see some sovereign debt defaults, which by the way, does happen, we didn’t always live in a world where everyone gets bailed out of their messes.  I’m not educated enough on the issue to know how much bad debt is out there, but I know this, when politicians begin to vehemently and in a very loud way, deny that their countries are in any sort of trouble fiscally, it’s time to be very suspect of the situation.

I’m not sure how this plays out in terms of inter market price movements.  It’s obvious that the European equity markets are not liking what’s going on.  I talked yesterday about the Spanish ETF $EWP being ripe to be shorted yesterday.  It’s now down 7+% this afternoon.  I should have taken my own advice, but I was busy making sure that my exposure to the long side of the US equity markets was minimized and my risk across the board was taken down.  It seems to me that there is much more downside there.

I’m going to do some digging on who has the most exposure to European sovereign debt, what banks would be the hardest hit.

I’m not saying the Eurozone is set to collapse, what I’m saying is that I believe the term contagion doesn’t make any sense, it’s not about the problem spreading, it’s about figuring out whether the problem persists already throughout the greater Eurozone and has not been accounted for by those who would wish to ignore or hide it.  At this point, I believe it’s prudent to assume the worst.

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