Stock markets took a bit of a knock yesterday.
A few things were unnerving investors. In the US, consumer borrowing fell by $11.5bn. If consumers aren’t borrowing, they aren’t spending. And while that might be a good thing in the longer run, markets don’t think that far ahead.
And of course, after such a strong run, people are looking for excuses to take profits. Stocks in the US are more overbought than at any time since the market bottomed out last March. Or at least, that’s what ‘Bespoke Investment Group’ tells Bloomberg. So they could be due another dip.
But this is all a side show to the main event. What everyone’s really worrying about is Greece…
Greece’s emergency funding hasn’t really bought them time
Investors have got the jitters about Greece. And things aren’t getting any better. Bond markets are now charging the Greek government more than four percentage points extra over and above Germany, to borrow money over ten years.
That’s the biggest gap (or ‘spread’, to give it the technical name) between the two since Greece joined the euro. This morning investors were demanding a 7.26% yield for a ten-year Greek bond, compared to 3.1% for a German bund. Just to put that into perspective, the average gap over the past ten years was just 0.34 percentage points (or 34 ‘basis points’ as you might see it dubbed elsewhere).
The Greeks might have thought they’d bought themselves some time with the vague promise of some sort of emergency funding from Europe and the International Monetary Fund. But clearly not.
“Our central view is that market confidence in Greece is likely to stay so low that the government will eventually be forced to turn to the IMF-EU backstop facility,” Harvinder Sian at Royal Bank of Scotland told the FT the other day.
“The current price action in the markets makes it all the more likely that Greece will be unable to access the markets over the next several weeks, therefore bringing the crisis and EMU policy evolution to a new level.”
The trouble is, markets just aren’t convinced that Greece will be able to sort out its own debt problems without some assistance. And so they’ll likely keep pushing the situation until Greece’s reluctant backers are forced to come up with the goods. The bond market is basically shouting, “Show me the money!”
Greece is bust
Of course, arguably this was all predictable. Greece is bust. It’s not just the markets that have no faith in the country. Its own savers are bailing out of domestic banks in their droves. In the first two months of the year, reports the FT, Greek savers have pulled €10bn of deposits out of the country’s financial system. That represents nearly 5% of total deposits.
This reflects “anxiety among wealthy Greeks about keeping assets here given the increasing uncertainty,” one private banker told the paper. “We expect the funds to return swiftly once the crisis is resolved.”
But that might take a while. These sorts of things feed on themselves. With all that money withdrawn, the banks have now had to ask the Greek government for more help. A €28bn bank support scheme was launched in 2008 by the previous administration. Now the banks have asked for the rest of it, around €14bn or so.
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Meanwhile, the higher the interest rates on Greek debt go, the harder it becomes to roll over its existing debts as they fall due. Greece needs to raise just under €12bn by the end of May to roll over existing debts. If they have to do it at the current rates, then they’ll be spending more money on interest payments.
The International Monetary Fund is in Greece for “discussions with Greek officials”, says the BBC. The team is there ostensibly to “give advice on improving the management of the government’s finances.” But it looks increasingly likely that they might need to discuss a bail-out package too.
Why markets should be worried about Greece
But does the Greek news matter? As Aline van Duyn points out in the Financial Times this morning, it hasn’t had a knock-on effect to Spanish and Portuguese bond yields. Why is that good news? Because it suggests that fears of ‘contagion’ – other European countries catching Greece’s dodgy debt disease – are low.
Effectively, markets are saying that if Greece goes bust, it’s a shame for Greece, but it’s nothing to worry about on a wider scale.
That’s all very soothing. Of course, markets thought exactly the same about US sub-prime home loans. The two Bear Stearns hedge funds that acted as canaries in the coal mine blew up in mid-2007. Stock markets didn’t top out until much later.
And as Michael Hudson, professor of economics at the University of Missouri, points out in the FT this morning, Greece isn’t the only problem. There’s all the dodgy debt sitting in Eastern European economies to worry about too. “Greece is just the first in a series of European debt bombs about to go off.” Property-related debts “in the post-communist countries and Iceland are more explosive.”
These debts are mainly denominated in euros, and are owed mainly to foreign banks. And that’s where you have the problem. “Bankers in Sweden and Austria, Germany and Britain are about to discover that extending credit to nations that cannot (or will not) pay may be their problem, not that of their debtors.”
Hudson’s argument essentially boils down to this – given the choice, governments in these countries will choose to stiff foreign creditors, rather than make decisions that are unpopular with the local populace. If they do that, then “many euro-based banks” could see their capital wiped out. “But these banks are foreigners after all – and… foreign banks do not vote.”
There’s only so much IMF money to go around. And once Greece cuts a deal, investors will realise that it’s only a matter of time before creditors start to feel some serious pain. We suspect the ‘ouzo’ crisis won’t be any more easily contained than subprime was.
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