Monday the S&P 500 made a new 52-week high. On Tuesday hell broke lose after S&P downgraded Greece by 3 steps to junk (from BBB+ to BB+) with negative outlook. Expected recovery in case of default: 30-50%. Greek government bonds (10yr yield 10.5% this morning, 2yr above 18%) would no longer be eligable as collateral at ECB once the other two ratings agencies follow. Greek banks will have to take the collateral back – which they can’t. Greek government would have to bail out the Greek banking sector – which it can’t. Game over.
Portugal also downgraded (A- from A+, negative outlook). Spain (AA from AA-, negative outlook) going down the same path. Contagion works also eastwards; Hungarian Forint under pressure. May be it wasn’t such a good idea to get Swiss Franc denominated mortgages (60% of Hungarians).
Rumors the IMF rescue package being boosted to EUR 100-120bn (vs 35bn) over 3 years. Joseph Stiglitz (2001 Nobel prize) is consulting the Greek government – and this is his chance to get back at Larry Summers (who had him fired from the World Bank in 2000) and the IMF (of which Stiglitz is highly critical).
Merkel wants to drag this out until after the elections in NRW, Germany’s most populous state. Dominique Strauss-Kahn would like to contain the amount of money the IMF has to throw at Greece – at least until he gets a shot as a candidate for French presidency in two years. The Greek must surely be tired of all those fake bail-outs (without as little as a single cent of help being sent so far).
More debt will not heal the problem (too much debt, high unit labor costs). If you can’t devalue your currency, the only way to get competitive again would be via serious deflation – which would bankrupt many businesses (including banks). Or you restructure your debt (=default). If Greece exited the Euro (temporarily?) and devalued their new currency, existing debt would still be in Euros, hence the debt/GDP ratio deteriorate to a point were a default would be unavoidable.
So if almost all scenarios point to a debt restructuring – why not do it right away before being saddled with even more debt and making the problem worse (see Argentina)? Who knows, may be Stiglitz will recommend to the Greek government to do just this, and send the IMF home.
Ironically, a Greek default and/or exit of the Euro zone would actually strengthen the Euro, since otherwise the “strong” Euro members would have to incur more debt to finance the “week” countries. But for European equities (especially exposed German, French and Swiss banks) there might be tough times ahead.