euro zone update- markets yet to discount the discounts

The issues I’ve been discussing over the last year or two while now crystallizing, remain highly problematic.

The idea of Greek default transformed from being a Greek punishment to a gift, with the pending question: ‘If Greece doesn’t have to pay, why do I?’- threatening a far more disruptive outcome that is yet to be fully discounted.

That is, should Greek bonds be formally discounted, the consequences of merely the political discussion of that question will be all it takes to trigger a financial crisis rivaling anything yet seen.

And note, also as previously discussed, that there has yet to be an actual Greek default, and that all Greek bonds have continued to mature at par, as there has yet to be an acceptable alternative.

So what are the alternatives?

1. Continue to fund Greece with terms and conditions.
2. Don’t fund Greece which forces:
  a. Greece is forced to limit spending to actual tax revenues
  b. Greece moves back to the drachma

And what are the ‘terms and conditions’?

Austerity is always the lead demand, which slows both the Greek economy and to some extent the euro zone in general.

Additional demands currently include discounting Greek bonds to bring down their debt to GDP ratio to ‘sustainable’ levels. However, after 8 months of negotiations, this has proven highly problematic, probably for reasons yet to be fully disclosed. And, as just discussed, there may be a growing awareness that discounting opens Pandora’s box with the politically attractive question ‘if Greece doesn’t have to pay, why do we?’

So what actually happens?

My best guess, and not with a lot of conviction, is that nothing is concluded before the coming maturity dates, and the ECB winds up writing the check to support short term Greek funding to buy more time for more inconclusive discussion. So, again as previously discussed, seems like this is the solution- death by 1,000 cuts and reluctant ECB bond buying when push comes to shove to keep it all going.

And, currently, the catastrophic risk I’d highly recommend immediately hedging is the risk that Greek bonds are formally discounted, rapidly followed by a global discussion of ‘so why should we have to pay?’ Possible immediate consequences of that discussion include a sharp spike in gold, silver, and other commodities in a flight from currency, falling equity and debt valuations, a banking crisis, and a tightening of ‘financial conditions’ in general from portfolio shifting, even as it’s fundamentally highly deflationary. And while it probably won’t last all that long, it will be long enough to seriously shake things up.

Bernanke: No Plans to Add New Stimulus Measures Now

More evidence of the suspected understanding with China- they resumed buying US Tsy secs in return for no more QE:

The U.S. economy “has been doing worse than expected” and Beijing needs to “seriously assess” possible risks to its vast holdings of American debt, said Yu Bin, an economist in the Cabinet’s Development Research Center.

Yu expressed concern about a possible third round of Fed purchases of government bonds, known as “quantitative easing” or QE. He said that might hurt China by depressing the value of the dollar and driving up prices of commodities needed by its industries.

Bernanke: No Plans to Add New Stimulus Measures Now

July 14 (Reuters) — Federal Reserve Chairman Ben Bernanke backed away slightly from promising a third round of stimulus measures, telling a Senate panel Thursday that the central bank “is not prepared at this point to take further action.

The comments during his second day of congressional testimony sent the US dollar higher and caused stock to pare their gains.

On Wednesday, Bernanke suggested to a House panel that the Fed was ready to take further steps to boost the flagging US economy. That sent stocks soaring and pushed the dollar lower.

But on Thursday, Bernanke seemed to back away a bit from that plan.

“The situation is more complex,” he told the Senate Banking Committee. “Inflation is higher…We are uncertain about the near-term developments in the economy. We would live to see if the economy does pick up. We are not prepared at this point to take further action.”

He also said a third round of stimulus may not be that effective.

Bernanke also repeated his warning that a U.S. debt default would be devastating for the U.S. and the global economy.

Re: NYtimes.com: Mortgage Re- Defaults Rising, No Sign of Slowing


[Skip to the end]

>   
>   On Mon, Dec 22, 2008 at 12:29 PM, Bill wrote:
>   
>   The dominant reason loan modifications fail IMMEDIATELY is
>   because the borrower’s financial condition is far worse than
>   your records indicate. The most likely reason that’s true is
>   that your loan officers instructed the borrower to lie on the
>   original loan application so that the loan would be approved
>   and the loan officer would get a bigger bonus. The next most
>   common explanation is that the borrower lied on his own
>   initiative.
>   
>   Best, Bill
>   

Agreed, the primary reason for the losses is the lenders were defrauded, often by their own employees.

My proposal was for the government to let homes go into foreclosure and then buy them from the lenders at the lower of appraisal or the mortgage balance, and then rent them at fair market rents to the previous owner, with a right of first refusal on a sale which would happen a year or more in the future.

Yes, it’s an admin nightmare, but far less so than the other proposals and programs I’ve seen, and avoids issues with existing mortgage holders.

It ‘keeps people in their homes’ while at the same time provides for an orderly recycling of the homes.

But it’s never going to happen.

Also, delinquencies on the existing subprime loans seems to have leveled off for a couple of months at just under 20%, last I checked.

Warren

Mortgage re-defaults rising with no sign of slowing

WASHINGTON (Reuters) – The rate of home mortgage borrowers defaulting after their loans are modified is rising and shows no signs of leveling off, U.S. banking regulators said on Monday.

The data showed that after six months, nearly 37 percent of mortgage loans modified in the first quarter were 60 or more days delinquent. After three months, 19 percent were 60 or more days delinquent or in the process of foreclosure.

“One very troubling point is that, whether measured using 30-day or 60-day delinquencies, re-default rates increased each month and showed no signs of leveling off after six months or even eight months,” John Dugan, head of the Office of theComptroller of the Currency, said in a statement.

The number of delinquencies rose across all loan categories, although subprime loans had the highest default rates. At the same time, nine out of 10 mortgages remain current, the joint report by OCC and the Office of Thrift Supervision said.

Some U.S. lawmakers and the head of the Federal Deposit Insurance Corp have called for a more aggressive effort by lenders to modify mortgage terms to help keep people in their homes.

The data, some of which was released in preliminary form earlier this month, were based on information collected from some of the biggest U.S. institutions, such as Bank of America, Citibank and JPMorgan Chase.


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