I’m going to give you a little bit of advice for future reference. When you’re leading a country that’s on the verge of default, and the people that hold your debt decide that you only have to pay back half of it, while also providing you more financial backing, you DO NOT throw a towel in the air and call for a referendum to the austerity measures tied to the financial aid. I’m sorry, usually I’m all about the individual, and about decisions being made in a democratic way. But when it comes to a decision like this, you DO NOT throw the decision to the masses. For one, I hate to generalize, but a solid share of the Greek population does not have a full understanding of what will happen if the country defaults. So if you were asked a question on whether or not you like the idea of harsh austerity measures being imposed on your country, where thousands of jobs would be cut, along with massive cuts in spending, higher taxes, and a higher retirement age… chances are… you’re going to say: ‘No, as a matter of fact, I don’t care for that idea at all.’ But guess what, that little picture pales in comparison to what will happen if these austerity measures are rejected; which would then throw off the 50% debt haircuts and further financial aid. I would bet my hand that Greece would then pull out, or rather be ejected, from the Eurozone due to a default on it’s sovereign debt. Greece would then have literally hours to print millions upon millions of Drachmas, and this is where the hole starts to get a lot deeper. Once people see their bank accounts turn from Euros to Drachmas, you will most likely have a bank run as people panic, thinking that their savings have turned worthless. Oh, and then all of the personal debt, such as mortgages, car loans, school loans, business loans, etc, that are serviced by the Euro, will be a lot harder to pay back under the Drachma. I could go on and on, but you’re talking a major economic and political mess here. And all due to a Prime Minister who thought it would be a good idea to have this decision laid in the hands of the masses.

Oh, and by the way, this little idea of a referendum has already lead to bond yields skyrocketing for most euro nations, which will further exacerbate the situation.

You know, at first, before the haircut deal, I would have looked at this situation a whole lot differently, and nor would I have been so surprised. But what flabbergasts me, is the fact that he called for this referendum AFTER Greece received 50% haircuts on it’s debt, and more lines of financial support from the European Financial Stability Facility and the Troicha. I mean, that was as good as Greece could hope for, and certainly not the aid package you want to throw in the wind.

As I’ve been in the midst of writing this article, two things have just come to my attention. This changes quite a bit. First, the guy I’ve been criticizing above has just agreed to step down so that a National Unity Government can be created (one that will secure international financial aid, and by doing so, steer clear of economic collapse). So that’s good news! Hopefully this can hold off the bad news… Germany is now calling for a referendum. Whether or not they’ll get one has yet to be seen, but if they do, don’t expect the decision to be friendly to market sentiment. Most Germans are completely against the bailout packages and debt deals that are being devised right now, and if they get their vote, I guarantee you it will not be favorable for Greece (a large majority of Germans believe that Greece can’t be saved, and should therefor be kicked out of the Euro). Let’s hope this new National Unity Government can behave, do what it needs to do, and appease the Eurozone so Germany doesn’t have to have it’s own referendum. But you know what I’ve learned since I’ve covered this crisis, more than any other? Get ready for another surprise. In the past 18 months, all you’ve heard is ‘Markets in turmoil over Greece!’ and ‘Markets jumping on relief of Greece concerns!’. I mean come on, when is this thing going to be figured out?!

Take a deep breath… and try not to freak out as if we’ve dodged an apocalyptic meteor blast. Although the EU has made some solid strides towards defeating this problem, the problem still very much remains. As a matter of fact, this major haircut on Greece’s debt could be the building block to an even greater problem threatening the Eurozone: keeping all of the other countries at bay as they try to receive haircuts of their own. Remember the problem back in the 2008 crisis; the too big to fail problem? Well, we’re no longer talking banks here. We’re talking countries. As Portugal, Ireland, Spain, and Italy all continue to suffer economic deterioration; questions will arise as to why Greece, the blackest of the sheep, was forgiven, and they were not. Talk about a whole new storm of animosity building up among Euro members…

So let’s get into the meat and potatoes of this ‘deal’. The reason why I like it is due to the fact that we really saw Europe come together. Angela Merkel has pretty much committed political suicide in order to save the Eurozone (for now), and I give her a thumbs up for that. Although, remember what I always say. In times like these, there is never a perfect solution, and this deal comes with a host of major problems (probably more than it actually solves).

First of all, there’s a good chance this haircut might not go through. I have now learned that in order for the Credit Default Swaps on Greece to be activated, the banks must be ‘forced’ to give the haircut to Greece’s debt. So now they’ve been ‘invited’ to do it. Now here’s where the problem comes in with the banks and the CDS contracts. Many of the banks that own Greek debt have CDS contracts on the Greek debt they own. What this implies… is very interesting, and it also makes me very skeptical of this deal. Since most of these banks, that have been invited to ‘forgive Greece’s debt’ already own CDS contracts on that debt, they get paid the full amount if Greece defaults either way. So if I was a ruthless banker, like most are, I would tell the Eurozone to go kick sand after the little invitation to forgive Greece’s debt. What should anger bankers even more, is the fact that Europe is inviting them to forgive Greek debt, while the European Central Bank will not (the Greek debt that the ECB holds will not receive a haircut). Now doesn’t that sound crazy? It most certainly is. The only reason why banks should consider this is, because if they don’t, Europe could explode. So while I hope the banks do agree to this, I still can’t help but pick out how absolutely absurd the deal is.

So if it’s all of a sudden determined that the 50% haircut on Greece’s debt is a ‘credit-event’, the markets will roil. The value of these CDS contracts are most certainly worth more than the actual debt that would be forgiven under the 50% haircut (which should actually be called an axe chop). So if there is a credit event, then you’ll have a lot of banks and corporations who will be forced to pay up a great deal of money to the other organizations that decided to insure Greek debt. Nobody knows exactly how many CDS contracts are out there (well maybe someone does, but I don’t) so this activation of CDS’s could really wreak havoc.

In regards to the rest of the deal, Europe has agreed to recapitalize banks and to expand, or rather leverage, the European Financial Stability Facility to approximately one trillion euros. Let’s spend a moment to talk about that little word ‘leverage’. It’s the word that brought down the U.S economy, along with dozens of others, in 2008. It’s what wreaks the most havoc in any financial crisis, any credit crisis, and usually any economic crisis. You see… if people ONLY played with the money they physically had, risk could be managed so much easier. But you know how we humans work, don’t you? What we have is never enough, and we simply love to create things out of thin air. That’s what leverage is.

‘Hey buddy! I have ten bucks, but I can’t do much with ten bucks, so can you turn this ten bucks into a hundred bucks?’

‘Why I would be simply delighted!’ Replies the banker. 

God I’m turning into a cynic these days, please forgive me. Anyways, this is how the Eurozone plans on expanding the European Financial Stability Facility, through leverage. Meaning, the money isn’t actually there, but they’re saying it is. In addition to this problem, a lot of the ESFS would be focused on insuring Italian/Spanish bonds. By doing this, Europe is hoping that they can attract the BRICs to get back into the game and start buying Euro bonds. If the BRICs do get into the game, which mainly falls on China to lead the charge, then I’ll be a heck of a lot more optimistic. Although, if China decides not too, I would not expect any of the other BRICs to come in.

What adds to my pessimism to the above situation, is what happened yesterday in Italy’s bond auction. Italy tried to sell off eight billion euros worth of short-term bonds, and to the surprise of the markets, they could only do it at a 6% yield. Jeeze Louise!  That’s an expensive yield (the highest Italy has seen since it entered the Eurozone). And by the way, a yield simply means the interest rate that Italy has to pay to the people who purchase it’s debt. What’s scary about the fact that they had to sell it off at a 6% yield, is it shows that investors are still very wearisome of Italy’s debt, and it’s ability to pay off that debt. Everyone figured that after the big deal that took place on Wed/Thurs, outside investors would pick up Italian bonds at a low yield which would be great for Italy (cheap loans). I guess not.

In conclusion, I still think the bulls have the most momentum. In the trading section, I’ll soon talk about why a psychology degree is probably more apt for trading in the markets than a financial degree. Fundamentally, I would suggest investors to short the markets. But there are things that come into play, that will press the bulls charge further (that really shouldn’t come into play). We’re going into what should be called the summer season for stocks, even though it’s really winter. This alone is a major push for the bulls (it’s like putting them closer to home territory). On top of that, between U.S economic data revealing that 3rd quarter GDP rose by 2.5% and the European debt deal, along with pretty solid corporate earnings, I think the bulls have further to push. Although, the situation in 3-5 months is very uncertain.

I’m off to do some yoga now…

This is an extremely interesting case in the world of economics right now, and also a very troubling case as well. Greece is on the verge of an inevitable default on its debt. The question is, how will the default play out? There are a few different scenarios that could play out, which I’ll go over quickly.

Selective Default: This is the most optimistic scenario we can ask for right now. A selective default would result in debtors rolling over a portion of Greece’s debt, meaning they would take a loss on some of the money Greece owes them. Greece owes a lot of various banks and government’s money, but the key part of a selective default is the fact that it’s controlled and it’s expected, unlike the fall of Lehman Brothers. It’s tough to say what might happen if Greece is to go through a selective default, but chances are, all of Greece’s debt will not be rolled over. It will be restructured, allowing Greece to make the payments later on in the future. One of the very interesting things about a selective default is the fact that it doesn’t activate Credit Default Swaps (CDSs). Right now, there are billions upon billions of dollars of CDSs, a type of insurance contract where one party pays a premium to another party in return for insurance coverage on a certain entity; in this case that certain entity being Greek bonds. If the CDS contracts on Greek bonds were activated, this would cause a lot more volatility in the markets due to investors and corporations trying to scramble to come up with the money to meet the insurance contract.

This is exactly what happened with AIG in 2008. Joe Cassano, head of AIG’s Financial Products division in London took on trillions of dollars of CDS contracts, meaning he agreed to insure certain entities in return for a premium. When most of those entities (Sub-Prime Mortgage Bonds) started collapsing in value, AIG-FP didn’t have the cash flow to meet the insurance contracts that they made. Luckily the U.S. government was there to guarantee the contracts would be paid, or else we’d be in a whole new situation right now. So as you can see, the idea of CDS contracts on Greece activating is a scary thought, which makes the Selective Default scenario one of the better outcomes available to Greece right now.

Orderly Default: The difference between a selective default and an orderly default is the fact that an orderly default is an actual default. Greece will default on its debt payments, but the default will be an orderly and controlled process where creditors and investors can prepare for it. This is a tough scenario to talk about, because there hasn’t really ever been an ‘orderly default’. Most defaults are anything but ordinary. Although, while this type of default scenario may be controlled and orderly, it will certainly cause upheaval in the markets, and it will also activate CDS contracts, which have to be in the value of hundreds of billions, if not trillions, by now. In summary, we do not want to see this happen.

Dis-Orderly Default: The difference between an orderly default and a dis-orderly default is pretty self-explanatory: its dis-orderly and it’s not controlled. This is the scariest possible scenario for Greece and the world markets in general, and this would most certainly cause a Lehman type market reaction. A dis-orderly default would be a catalyst that would immediately cause panic in global markets; spurring instant market collapses in the weakest European economies such as Italy, Portugal, and Spain. This would inevitably spread to the more stable economies such as Germany, France, and the U.K, which would then continue to spread outside of the Eurozone to the U.S. and Asia.