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from MacroScope:

Can Greek public opinion be turned?

So we’ve got the fresh Greek elections we expected and markets, despite the inevitability that we would get here, have reacted with some alarm. European stocks have shed  around 1 percent, and the harbour of German Bunds is pushing their futures price up in early trade. The Greeks will try to form a caretaker government today to see them through to elections expected on June 17.

The key question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position (no to bailout, yes to the euro) and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that. SYRIZA remains ahead in the polls. To be able to pull it off, PASOK and New Democracy will need some help from Europe. There have already been hints from Brussels that if a pro-bailout government is formed, Athens could be given some leeway on its debt-cutting terms. But equally other voices are saying there is no more room for manoeuvre.

France's Francois Hollande used his presidential debut to frame help for Greece within his push for a European growth strategy last night, saying he hoped that could also foster a return to prosperity there. He and Germany's Angela Merkel are due in the United States for a G8 summit at the end of the week where doubtless they will come under heavy pressure to make sure Greece doesn’t bomb out of the euro zone or, if it does, that the effect is contained. Easier said than done. Given a Greek euro exit would probably require rapid concerted reaction from the EU, IMF (to shore up Spain?) and the world’s big central banks (remember the global monetary policy response after the collapse of Lehmans?), planning for that could well be bubbling below the surface at the G8.

IMF chief Christine Lagarde said last night that it was important to be technically prepared for the possibility of Greece leaving the euro zone while Finland’s prime minister said Greek euro exit would not cause the financial mayhem seen in 2008.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies, most of it by the ECB, which could need recapitalizing after that sort of hit, something that would fall back on euro zone governments. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad is more or less palatable than taking a big loss on their Greek debt holdings.

On the growth strategy, there are hints that Spain will get more time to hit its 3 percent of GDP budget target, so why not something similar for Greece? PASOK leader Venizelos, the man who negotiated the bailout and who was humiliated in the election 10 days ago, has pressed for three years rather than two to make the cuts required by Greece’s programme. If he got stronger signals from euro zone partners that something like that could happen – and persuaded the electorate that this is the only way to avoid euro exit  -- it’s possible that he and New Democracy leader Samaras could do better second time around. The problem for the markets is that while you can take a reasonable stab at how politicians might act, it’s much harder to read a battered electorate. So they are in for a rocky month.

What is undeniably true is that the piecemeal European growth measures announced so far to revive moribund economies don’t amount to a hill of beans.

from Global Investing:

Emerging bond defaults on the rise, no surprise

As may be expected, the crisis has increased the risk of default by emerging market borrowers. According to estimates by ING Bank's emerging bond guru David Spegel, the default rate on EM bonds is running at over $6 billion in the first four months of 2012, already surpassing the 2011 total of $4.3 billion. He  predicts another $1.3 billion of emerging defaults to come this year.

Spegel expects the default rate for speculative grade emerging corporates to rise to 3.25 percent by September, up from 3 percent at present.  That doesn't look too bad, given defaults ran at 13 percent after the 2008 crisis and hit a record of over 30 percent in the 2001-2003 period. But ING data shows some $120 billion worth of corporate bonds trading at "distressed" or "stressed" levels, i.e. at spreads upwards of 700 basis points. The longer such wide spreads persist, the higher the probability of default. A worst case scenario  would see a 12.9 percent default rate by end-2012, Spegel says.

Many companies are having trouble rolling over maturing bonds (selling debt to pay off existing creditors). One reason might be the explosion in bond issuance this year. Data from Bank of America/Merrill Lynch shows bond sales by emerging borrowers, sovereign and corporate, totalled 14 billion in the first three months of the year, a quarter more than the same 2011 period.  Clearly everyone is rushing to raise cash before U.S. Treasury yields rise further. (see what we wrote on this a few months ago)

Now look at ING's figures on syndicated bank lending. Syndicated loans are a key funding source for EM borrowers but they have dropped 51 percent in the first three months of 2012 from the previous quarter to $105 billion. Coinciding with the surge in bond issuance and European banks' problems, this suggests many former bank borrowers have turned to bond markets intead.

What about potential loan defaults?  ING estimates $178 billion in syndicated loan repayments remain for 2012 and it is unclear how much of this will spill into bond market issuance. EM debt demand so far has been buoyant,  with EPFR data showing inflows of almost $18 billion year-to-date to EM bond funds. Even lower-rated EM companies and countries have easily raised cash. But Spegel warns:

While the abilityof EM borrowers to find alternative sources of funding is positive, the rotation of borrowing from banks to bonds could potentially have negative implications for bond markets if the improving demand dynamics suddenly change direction in face of increasing supply.

 

from Global Investing:

A Hungarian default?

More on Hungary. It's not hard to find a Hungary bear but few are more bearish than William Jackson at Capital Economics.

Jackson argues in a note today that Hungary will ultimately opt to default on its  debt mountain as it has effectively exhausted all other mechanisms. Its economy has little prospect of  strong growth and most of its debt is in foreign currencies so cannot be inflated away. Austerity is the other way out but Hungary's population has been reeling from spending cuts since 2007, he says, and is unlikely to put up with more.

How did other highly indebted countries cope? (lets leave out Greece for now). Jackson takes the example of  Indonesia and Thailand. Both countries opted for strict austerity after the 1997 Asian crisis and resolved the debt problem by running large current account surpluses. This worked because the Asian crisis was followed by a period of buoyant world growth, allowing these countries to boost exports. But Hungary's key export markets are in the euro zone and are unlikely to recover anytime soon.

The other example  is Argentina.  It too recovered strongly from its 2001 crisis but its way out was default.  Capital Economics writes:

There are arguments for why, in Hungary’s case, default might appear to be an attractive option. The economy runs both a current account surplus and a primary surplus (i.e. government spending is lower than receipts before interest payments are taken into account). This means that if the Hungarian government were to default and were to be barred from borrowing from abroad, it would still not be forced into drastic fiscal austerity or a painful current account adjustment via reduced domestic demand.

Moreover, the note says:

from MacroScope:

CDS and the self-fulfilling default

Wall Street-made financial instruments purportedly created to protect investors against default actually hasten corporate bankruptcies, according to a new study. And it’s not Occupy protesters bashing these credit default swaps (CDS) –  the report comes from none other than the New York Society of Security Analysts. Its findings are as follows:

We present evidence that the probability of credit rating downgrade and the probability of bankruptcy both increase after the inception of CDS trading. […]

Lenders who insure themselves by buying CDS protection help push borrowers into bankruptcy, even though restructuring may be a better choice for the firm from the conventional (without CDS protection) lenders’ perspective.

The problem, say the authors, comes down to a basic conflict of interest – creditors holding the securities suddenly hold an actual stake in the firm’s failure.

CDS could affect bankruptcy risk through two channels associated with the empty creditor problem. The first and direct channel is the effect on the willingness to restructure the debt, whereby creditors (over)insured with CDS break the link between cash flow rights and control rights. Empty creditors are unwilling to restructure the firm even if doing so is efficient for debt value as they can profit significantly from their CDS positions. Several theoretical papers model the empty creditor issue.  […]

The second and indirect channel of the empty creditor mechanism is reduced monitoring by creditors who are insured by CDS, and hence, less concerned about the credit risk of the borrower. Absent monitoring activity by creditors, managers can shift risk from shareholders to creditors, since this improves shareholder value, and thereby increases the probability of bankruptcy.

from MacroScope:

Greek debt – remember the goats

Greece's creditors have essentially let it off the hook by overwhelmingly agreeing to take a 74 percent loss.  So what better time to  remember  one of the first times Athens got in trouble with paying its debts.

In 490 BC, the bucolic plains before the town of Marathon were the site of a bloodbath. Invading Persians  lost a key battle against Greeks, who were led by the great Athenian warrior Kallimachos, aka Callimachus.

The trouble is, Kallimachos shares some of the difficulty with numbers that  modern Greek leaders appear to have.  Before launching himself upon the  Persians,  he  pledged to sacrifice a young goat to the Gods for every enemy that was killed.

His troops slaughtered some 6,400 invaders. Unfortunately the Athenians didn't have that many young goats. So they had to spread the repayment and legend has it that it took them a century to honour the pledge.

Apparently, Zeus and the other Gods had not heard of the Institute of International Finance and were unwilling to take a 74 percent cut in goats.

from MacroScope:

Vultures swoop on Argentina

Holdouts against a settlement of Argentina’s defaulted debt are opening a new front in their campaign for a juicy payout more than a decade after the biggest sovereign default on record.

Lobbyists for some of the investors who hold about $6 billion in Argentine debt are in London to persuade Britain to follow the lead of the United States, which last September decided to vote against new Inter American Development Bank and World Bank loans for Buenos Aires.

Washington believes Argentina, a member of the Group of 20, is not meeting its international obligations on a number of fronts. Apart from the dispute with private bond holders, Argentina has yet to agree with the Paris Club of official creditors on a rescheduling of about $9 billion of debt. It has refused to let the International Monetary Fund conduct a routine health check of the economy. And it has failed to comply with the judgments of a World Bank arbitration panel.

In short, Argentina is not playing by the rules of the international game, says Rob Shapiro, a former U.S. under secretary of commerce, who is now co-chair of the Argentina Task Force America.

According to its website,  the group’s aim is to “vigorously pursue” a “just and fair” reconciliation of the Argentine government’s default in December 2001 on some $95 billion of debt.

Its members and supporters include the delightfully named Montana Women Involved in Farm Economics (WIFE). Another is New York hedge fund Elliott Associates, which has bought distressed debt issued by a number of developing countries and sued them for repayment.

In 2000 Peru paid Elliott $56 million to settle a four-year fight after the hedge fund refused to accept the restructuring terms on offer.

from Global Investing:

Beneath the Greek bailout hopes…

Who's tired of the "Markets up on Greece, markets down on Greece" headlines of the past few weeks? (I am.)

Today it's an up day, with world stocks hitting a six-month peak on hopes that Greece will secure a second bailout package next week (finally, really).

But beneath the optimism lies a dire Greek economic and fiscal situation.

The Greek economy slumped 7 percent in the last quarter of 2011, with the rate of contraction since Q4 2008 reaching a whopping 16 percent in cumulative, real GDP terms.

Weak growth is hampering efforts to consolidate the fiscal position. Goldman Sachs, in fact, expects the deep recession has fully offset budget consolidation efforts. Analysts at the bank write:

"The fiscal adjustment, which started off with an impressive deficit reduction of more than 5% of GDP in 2010 stalled in 2011... despite a significant fiscal effort.

They add:

from Global Investing:

What to do with Belize’s superbond

This year's renewed euphoria over emerging markets has bypassed some places. One such corner is Belize, a country sandwiched between Mexico and Guatemala, which many fear is gearing up for a debt default. There is a chance this will happen as early as next week

Belize is a small country with just 330,000 people but back in 2007,  it issued a $550 million bond on international markets. Known locally as a superbond for its large size (relative to the country's economy), the issue earned Belize a spot on JP Morgan's EMBI Global index of emerging market bonds.

As this index is used by 80 percent of fund managers who invest in emerging debt, many of them will have allocated some cash to hold the Belize bond  in their portfolios. These folk will be waiting anxiously to see if Belize pays a $23 million coupon due on Feb. 20.

Never very liquid, the bond has taken a sharp lurch downwards since Feb.7 when Prime Minister Dean Barrow said in a pre-election speech that he would seek "instructions" from the electorate to "do something about the bond".  That unsurprisingly triggered panic selling and the bond now trades around 40 cents on the dollar, down some 20 cents since the start of February. The yield has risen sharply to 23 percent from 16 percent and and the Belize spread over U.S. Treasuries -- the premium that investors demand to hold the bond -- has blown out to almost 2000 basis points, higher than any other country in the EMBI Global index. That's a rise of 400 bps since the day of Barrow's speech.

Exotix, a frontier market-focused brokerage says:

What happens next? We think the government will pay the forthcoming 20 February coupon but clearly there is a risk that it won't. But even if it does, that does not remove the uncertainty now hanging over the bond... The government has the money and it might be counterproductive politically to default just before a general election. However we do acknowledge that the bond's domestic unpopularity and the low price make non-payment an easier option.

Regionally, there are some parallels with Ecuador which in 2008 defaulted on debt the government said had been contracted unlawfully by a previous administration. Investors pointed out at the time that Ecuador's president Rafael Correa had the cash to pay but did not want to. If Belize misses the Monday coupon, it will not be for want of cash -- the central bank  has $240 million in its coffers.

from Global Investing:

Euro periphery: Lehman-type shock still on cards

The passing of Greek austerity measures is fuelling a rally in peripheral debt today with Italian, Spanish and Portuguese yields falling across the curve.

However, one should not forget that peripheral economies are still under considerable risk of becoming the next Greece -- rising debt and weak economic growth pushing the country to seek a bailout -- as a result of tighter financial conditions.

Take this warning from JP Morgan:

Financial conditions have deteriorated far more in peripheral Europe than in the core. The drag from this on peripheral GDP is akin to that seen following the Lehman crisis.

JP Morgan uses analysis based on quantifying the impact of financial market developments and monetary policy actions on economic activity. The main variables the analysis uses is: the three-month LIBOR rate, the yield on investment grade corporate bonds, the spread of high yield corporates over that of high grade, real equity returns, the change in the real exchange rate and bank lending standards for businesses as reported in loan officer surveys.

According to JP Morgan's calculations, the 838 basis-point rise in the peripheral HY spreads implies a drag of -2.2 percent of GDP relative to what it would otherwise have been, had the HY spread unchanged.

from Global Investing:

Greece’s interest burden, post-PSI, will remain huge

It seems Greece has finally reached a deal on austerity measures needed for a bailout. But what about PSI?

(ECB President Mario Draghi just said he heard it was close to a deal. It's been close for a few weeks though...)

JP Morgan says Greek PSI is hardly going to change the heavy interest burden on the country and the issue of default will inevitably come up.

First of all, Greece's interest payments are huge.

Greece paid 15.5 bln euros in net interest payments in 2011, 17% of total general revenues. This is the highest among all OECD countries and more than 3 times the OECD average of 5%. It is also more than double the 8% average for other peripheral countries in the euro zone.

The U.S. bank estimates the Greek PSI is going to capture 205bln euros of private bond holders (and perhaps a further 55bln euros if the ECB participated).

Of this 260 bln euros, around 85 bln or a third are held domestically, by Greek social security funds, domestic banks to be largely nationalised post PSI, and the Greek central bank.