We all know the story of US subprime by now.
Lord knows it’s been trotted out enough. Bundles of home loans, dodgy borrowers, dodgy lenders, cunning investment bankers, amoral ratings agencies – it was a sorry tale of greed, stupidity, and smoke and mirrors.
But it all boils down to this. Investors thought they were buying one thing (an AAA-rated security), when in fact they were buying quite another (a bundle of debts that could never be repaid in a million years).
It wasn’t until they finally realised what they’d done, that all hell broke loose.
Why am I telling you this today? Because the exact same thing is happening in Europe right now…
Why Greece is Europe’s US subprime crisis
In yesterday’s FT, Wolfgang Munchau described Greece as “Europe’s equivalent of the US subprime crisis.” It’s an excellent analogy.
• Greece won’t be the only European country to blow up
• The euro could still have much further to fall
One of the key factors in the US subprime crisis was the behaviour of the credit ratings agencies. They rubber-stamped subprime securities with the AAA badge. That gave investors all the excuse they needed to take leave of their senses and pile into toxic debt as though they were lending to the US government itself.
In the eurozone, the single currency played the role of the ratings agencies. As soon as a country joined the euro, it became Germany. It didn’t matter how dodgy its credit history was. It didn’t matter that its economy and culture were entirely different to Germany’s. It didn’t matter that Germany didn’t explicitly back the country’s debt. The euro rubber stamp meant that investors were happy to lend to Greece and Portugal and Ireland at only the slimmest of margins above what they’d charge Germany.
Trouble is, now they’re finally realising that what they were buying was nothing like German debt at all. Suddenly the fragile cover of the eurozone has been blown. Arguably, the penny finally dropped on Thursday, when Eurostat, the European statistics agency, said it had revised Greece’s deficit for 2009 up to 13.6%, and it could go higher. Reports Aline van Duyn in the FT this morning: “Bond traders are already calling it ‘Black Thursday’… any trust that was left was shattered.”
Bond yields spiked. So Greece called on Europe and the International Monetary Fund for the €45bn they’d been promised. But here’s the problem. The EU/IMF can’t just click its fingers and dish this money out.
Remember all the drama over the US bail-out package when Hank Paulson was trying to raise $700bn to rescue AIG and by extension, the US investment banking sector? They had to stuff the bill full of bribes for special interests (such as a tax break for a factory making toy arrows in some back-of-beyond US state) before it was passed.
That was for a single country. Now imagine trying to get that bail-out package past 16 of them. They don’t all need to give parliamentary approval. But Germany does. And as far as a good chunk of the German population is concerned, Greece can go hang.
With a regional election coming up on 9 May, Angela Merkel needs to talk tough to please her own voters. At the same time, she’s reassuring Greece that it can have the money, as long as it agrees a package of tougher spending cuts with the IMF.
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The markets don’t seem content to wait. As Alan Beattie puts it in the FT, “the house is burning down and the eurozone is sitting around debating the constitutionality of calling the fire brigade or filling a bucket of water.”
Greece’s two-year borrowing costs are now higher than those of Venezuela or Argentina. In fact, they’re the highest of any sovereign in the world. That’s right. Hugo Chavez, a man who’d appropriate your assets in the name of international socialism as soon as look at you, can borrow at lower rates than those demanded of a developed-world, democratic eurozone country.
“Indeed, to all intents and purposes, the market for Greek government bonds stopped working last Thursday. It has become almost impossible to trade, with volumes very low.” Remind you of anything? That’s right – “the breakdown in trading for asset-backed securities” that happened during the subprime crisis.
Investors have realised there’s only one Germany in the eurozone
It’s easy to blame Germany. But this isn’t just about the immediate bail-out money. It’s also about whether Greece can come up with a decent plan for improving its finances in the long run. Unfortunately, as Wolfgang Munchau said in the FT yesterday, “what I have heard so far from Greek economists is deeply discouraging.”
And now that investors have realised that there’s only one Germany in the eurozone, and it might not be willing to bail out the rest, they’re not just worried about Greece. They’re fretting about Portugal, and Ireland, and Spain.
Portugal’s ten-year yield ‘spread’ (the gap between what it has to pay and what Germany has to pay) has hit a fresh euro lifetime record. Spain and Ireland’s borrowing costs also rose.
The danger here is that Greece probably isn’t Lehman Brothers. Greece isn’t even Bear Stearns. Greece is Northern Rock. It’s simply the first domino to topple, and not even an especially important one. Right now I can’t see where the cavalry comes from for Greece. And more importantly, even if it does arrive, the cavalry can’t save everyone in the eurozone.
What this means for investors
What’s the knock-on impact of all this for investors? I think it’s safe to say that you can keep shorting the euro in the medium term – it will of course see short-term rebounds as hope rises then falls, but it’s hard to be optimistic on it for the foreseeable future. As we noted yesterday, spread betting is the easiest way to play currencies – you can find a provider at our comparison site here.
A Greek default could also be bad news for the banking sector throughout Europe. We can’t be sure where all the exposure lies. But any rapid spread of concerns over sovereign debt in the eurozone region could well drive up the cost of borrowing in general.
Meanwhile, British politicians should take a good look at Greece. If markets start getting jumpy about the dominoes toppling, then Britain isn’t in the most secure position. We’ll be looking at the potential impact of a hung parliament on the UK economy in the next issue of MoneyWeek magazine, out on Friday (if you’re not already a subscriber, subscribe to MoneyWeek magazine).
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