The Global Radar Screen – 7/15/11

Posted July 15, 2011 by CLeahey

[private][private]Overview—Politics Trumps Common Sense

The soverign debt situations in both the Eurozone and the US are getting worse (Chart 1 shows the increase in market volatility recently). In the Eurozone, policymakers are still working on how to pay for the second Greek bailout, which may cost as much as €115B. The biggest sticking point is the degree of private sector participation. While everyone knows that the banks will eventually have to suffer a large haircut (of at least 30%?), many policymakers, including the ECB, are afraid that taking a haircut now or even voluntarily rolling over the Greek debt might trigger a Lehman moment. The solvency problem of the peripheral nations, which should been handled at the beginning by EU and IMF with debt restructuring and economic reforms, has been turned into a liquidity problem, handled mainly by the ECB. As a result, the can keeps getting kicked down the road, with a restructuring unlikely until year-end at the earliest. The only place where the politics are even worse is in the U.S. The uniquely American debt ceiling was designed to be a legislative vehicle for the opposition party to embarrass the ruling party. It was not designed to cause financial chaos and a possible double dip. Unfortunately positions are hardening on both sides of the negotiating table. While we think that a breach will be avoided, the chance of a worse case scenario is not zero. However, the Treasury can always extend the August 2 doomsday deadline by pulling their own Goldfinger operation and drawing down $750B in liquid assets, including, gold ($400B), oil ($70B), MBS ($140B), and TARP ($140B). They could even selectively pay bills to insure that bondholders are first in line. But that option is really, really messy, implying a jump in fiscal drag of an astronomical 10% which would almost guarantee a recession if it lasted more than a few weeks.
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