Default Threat Rises

Well it’s all happening very fast now. But let’s pause for a moment to reconsider what may have happened last week with Wall Street’s “trading glitch.” Is it possible that traders saw the cops beating protestors in the Streets and surmised this: No matter what deal European leaders come up with to bailout Greece, that deal isn’t going to fly on the streets of Athens. The Greek people will not feel obligated to keep the promises made by their politicians to the IMF. Greece is going to default on its debt.

If Greece goes then a lot of interesting things start to happen. But that is not the “narrative” being put out by the mainstream today. The official line today is that the $500 billion loan and lending package agreed to by European government is enough to roll over Greek debt, avoid a crisis, defend the euro, and put an end to the widening credit default swaps in the derivatives market.

The trouble for Europe is that Greek debt is the tip of the spear. The Greek’s must roll over $15.8 billion in debt this year and $31.3 billion next year. As Bill shows below, it’s hard to imagine Greece devoting a larger share of tax income to debt service while the economy shrinks. It won’t be politically tolerable.

But what about the $251 billion in Italian sovereign debt that matures this year? And the $76.5 billion Spanish debt? And the $17.9 billion in Portuguese debt? The €500 billion aid package is not enough to disguise the fact that Europe’s debts are larger than the Europe can repay without resorting to debt default or the alternative: massive money printing.

The bond market has figured this out. In Europe and North America, the cost of buying insurance against a bond default in corporate and sovereign debt. According to Bloomberg, “The Markit iTraxx Europe Index, linked to the bonds of 125 companies, soared 45 basis points to 133 basis points as of May 7, according to Markit Group Ltd. The Markit CDX North America Investment Grade Index, tied to 125 companies in the U.S. and Canada, jumped 26.6 basis points to 118.7.”

But did the action in the CDS market migrate to Australia? Well, according to Bloomberg this morning, the news of the big deal in Europe took some starch out of the widening CDS spreads here in Australia. “The cost of protecting Australian corporate bonds from non-payment fell the most in more than nine months, according to traders of credit-default swaps. The Markit iTraxx Australia index fell 15 basis points to 114.5 basis points as of 8:19 a.m. in Sydney, the biggest drop since July 21, according to prices from Nomura Holdings Inc. and CMA DataVision in New York.”

That would suggest some major easing of the tensions in credit markets. But we’d take that with a major grain of salt. One quotation and one chart from the weekend tell Australian investors nearly everything thing they need to know about the effect a European sovereign debt meltdown would have on Aussie stocks and financial institutions.

The quotations come from Eric Johnston at the Age. On Saturday he reported that, “Banks face a surge in wholesale financing costs as fears of contagion spread through global credit markets, with still-fresh memories of the funding squeeze during the global financial crisis not far behind. Some of the nation’s major banks were yesterday believed to be looking at measures to top up holdings of liquid assets as concerns about risk increased on European credit markets. While Australian and Canadian banks continue to have ready access to credit markets, longer-term debt was becoming harder to obtain, bank treasury sources said.”

Once again the link between solvency and liquidity rears its ugly head. Europe’s troubles migrate to Australian balance sheets. And you can see the final proof of the pudding in the chart below from CMA Market data. It shows that when anxiety peaked last Friday night, it was Aussie banks that showed the largest credit deterioration in terms of the increase on their CDS. In other words, the cost of insuring yourself against default in the bonds of these Aussie firms went way up late last week.

Aussie Banks Showing Largest Credit Deterioration

That doesn’t mean any of these firms are going to default. But it does mean bond market investors realise that a global capital crisis that begins in Europe has a massive affect on Australian banks. The effect is not so much on Aussie loan losses of European assets, although there is some exposure there. The effect is a liquidity crisis which forces banks to raise cash by selling assets.

The assumption domestically is that the banks won’t have any trouble finding money to borrow abroad. But it might be a lot more expensive. And that might lead to higher bank interest rates here and less borrowing. Oh and by the way, the CDS rates for the miners were up too, last week, thanks to RuddTax and concerns about a China slow down.

There’s a lot more to say. But we’re off to work on the May issue of Australian Wealth Gameplan. In the meantime, if you’re wondering what the end result of all the machinations in Europe are, it’s probably more money printing, which explains gold’s recent move. And because the biggest debt problem of all is in America, you can expect more of this too.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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13 Comments on "Default Threat Rises"

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If I were still living in the U.K, I would be refusing to pay my tax demands. Why? Because arguably the state is bankrupt, and as such I would claim to be required to be placed on their debtors list during a windup action. I would then demand to negotiate on a per creditor penny in the pound basis. Anything else would be to be throwing my money at a system that cannot pay its way, that is now supporting other countries that cannot pay their way, and generally allowing banks to suck the marrow out of my future tax… Read more »

My arithmetic fails me, surely that must be 20,000 dollars per citizen.
Irrespective of whether they have a job (due to age) or not.

This is looking all too familiar, doesn’t it? I Fail to see how printing more euros is going to” defend the Euro currency”. Now we have two big elephants in the room (one from Europe and the other from the US). Both are called Debt that someone has to pay off. Then we have the Big Panda in the room, which is the looming Real Estate Crash in China. And nobody wants to to look any of them in the eye while our officials do a great impression of officer barbrady in South Park – Nothing to see here people,… Read more »


Don’t forget the 3 monkeys in Australia right now (hear no evil, see no evil, speak no evil), the evil being the real estate monster that is festering in the corner.

Our crash will be upon us soon, that scares me more than what is happening in Greece but something tells me they will all converge to a centre point of pain?!

madjack, they aren’t printing euros, they are printing usd’s. $500bn of them in US fed swap balance sheet expansion (that which they promised to shrink) plus IMF funds. fundamental to understanding this pantomine they call economics is the usd hegemon which by its uncapped leverage and now expeditionary bite into continental europe owns all asset market valuations. Debt rules! So we have USD leveraged sovereign made money pulling against USD leveraged bankster made CDS. Get the common factor? But remember Goldman doesn’t lose (1st quarter 2010 and not one day of trading loss) and we have USD leveraged CDS bets… Read more »

Steve’s quote of the day

“Steve has a horrible gut feeling that Uncle Swanny is going to distort the property market once again in tonights proceedings”

Biker Pete

“… hear no evil, see no evil, speak no evil, the evil being the real estate monster that is festering in the corner*… ”

I resemble that remark!

* But you’ll all be pleased to learn that the festering, occasioned by the matadors’ swords, has healed. My second has bustled me out of the corner and I’m back in the ring… :)


Your ring has a corner, BP?

Biker Pete

Why yes, but it’s Steven who has the horribubble gut feeling.
Clear the decks… .

What’s that metronome I hear, Perhaps the end is drawing near You never hear the shot that takes you down Now your dreams a memory, and seems More true from far away Just like smoke that fades and makes no sound Out of time, So say goodbye What is yours, now it’s mine And I dream broken dreams, I make them come true I make them come true I make them for you Bad dreams come true, I make them for you Bad dreams come true, I make them for you Bad dreams come true, I make them for you… Read more »
Biker Pete
When I woke I woke in the breathless black Of the box. I heard: the earth Was opening over me. Clods Fluttered back To the shovel. The Dear box, with me the dear Departed, gently rose. The lid flew up and I Stood, feeling: Three bullets travel Out of my chest Into the rifles of soldiers, who Marched off, gasping Out of the air a song With calm firm steps Backwards Film Put in Backwards Gunter Kunert, 1965 Translated from German Berlin Afternoon In summer under a cloudy sky in summer with a mild rain falling in summer in the… Read more »

This one doing the rounds at the moment. I like it when these things are updated and Australianised :)

“Over five thousand years ago, Moses said to the children of Israel ”
pick up your shovel, mount your asses and camels, and I will lead you
to the promised land”.

40 years ago, Whitlam said, ” Lay down your shovels, sit on
your asses, and light up a camel, this is the promised land”.

Now Krudd has stolen your shovel, taxed your asses, raised the price
of camels and mortgaged the promised land!”


And Swanny will mount your ass, tax your Camels, and promise relief on your mortgage…

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