Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Sunday, 13 May 2012

Greece, Spain and the week that was

Looks like I chose a very eventful week to be on vacation. It was great to soak up the sun and history in Granada without cellphone and internet coverage. Since I had strict instructions to not engage in financial disaster tourism, I could only admire the beautifully constructed apartments in Malaga from a distance.

On getting back the only news which surprised was JP Morgan’s $2bn hole. Looks like Ms. Drew didn’t detect what the (fool)hardy boys were up to.

In Europe, things are rocketing towards their inevitable conclusion. Greek election results weren’t that surprising and neither is Spain’s continued delusion.

On Greece there are only two alternatives, either radically reduce demand for austerity and pump more money or prepare for exit. The first is unpalatable and unacceptable to the northern creditors. It also suffers from moral hazard. Any loosening on Greece will ensure that other peripheral countries ease off reforms too. Vested interests will oppose and block most structural reforms even as investors flock to the mirage of a “growth” pact. The rescue of Bear Stearns only emboldened people to buy Lehman senior debt. And it made Lehman management think that the plug wouldn’t be pulled on them.

Therefore the second seems more likely and indeed talk is veering in that direction. This is going to be a guaranteed 100% disaster. And it will make Lehman’s demise a study of excellence in public policy execution. The first problem is that official creditors will take a bath on the €145bn lent so far in addition to the contingent liabilities through the Eurosystem. The second problem is that the market will then start the hunt for the next victim (Portugal). There isn’t going to be just one member exiting. The third problem is that international support for more IMF loans to Europe will change from hesitant to nonexistent. It will make the practice of attempting to impress gullible carry traders by mentioning large numbers a historical curiosity.

Meanwhile in Spain, Bankia, supposedly the super senior tranche of 7 Cajas, was found not to be as highly rated as was thought earlier. Even then, Spain is still unable to grasp the extent of the problems which lie ahead. Not having learnt anything from Ireland it is set to go down with its banks. The €30bn to be set aside is laughable given the €1trn exposure of Spanish banks to real estate and construction.

Let’s see what tomorrow brings.

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