Haircuts Will Be a Long-Term Problem for the EU

by Jason Jenkins

Haircuts Will Be a Long-Term Problem for the EU

by Jason Jenkins, Investment U Research

Tuesday, October 11, 2011

As we are all aware, Greece is the focal point of a European Union sovereign debt crisis, which has engulfed Ireland and Portugal, with Italy and Spain coming to join the party - this doesn't even mention the European banking problem it's caused and the rippling effect on U.S. markets.

Eurozone authorities agreed on a 21-percent voluntary write-down for Greece's bondholders in late July. A second aid program was authorized for the country and changes to the EU's bailout mechanism.

This 21-percent "haircut" on Greek debt through a bond swap deal would see that banks give the Greek government a longer payback period.

In order to receive its latest bailout installment, the country had to implement more austerity measures so that they wouldn't run out of money later this month. Many called for banks to have the ability to exchange Greek bonds for notes issued by the Eurozone safety mechanism (EFSF) to guarantee the stability of the restructuring process.

Many Are Calling for a 50-Percent Haircut

However, these provisions weren't sufficient, and this might have been known from the beginning. A panel of economic authorities wrote in the Financial Times Deutschland that the only way to save Athens was to have creditors renounce around 50 percent of the nominal value of their Greek bonds. They believed this was the only feasible way to bring Greek debt down to a sustainable level through its own efforts.

Now we know European Union countries need to improve - and in some instances create - cooperation between themselves and come up with ways to break this circular dynamic of bank and debt crisis.

This will be the only way to lead to competitiveness and stimulate growth. Both will be needed as all the recently reported numbers state they're headed to recession. But if the 50-percent haircut is implemented, and there may be no way to avoid this, it opens up a Pandora's box.

If Greece Can Do It, Why Can't I?

A 50-percent haircut for Greece will be a game-changing precedent. If I'm another troubled EU economy like Ireland, Portugal, Spain, or Italy, I'm going to fight tooth and nail for the same prescription. And why wouldn't they? Here's a listing of the five aforementioned troubled countries and half of their debt burden:

  1. Italy - 2.22 trillion euros
  2. Spain - 2.17 trillion euros
  3. Greece - 532.9 billion euros
  4. Portugal - 497.8 billion euros
  5. Ireland - 115 billion euros

The problem is that the EFSF only has 440 billion euros in its chest. At least they could help Ireland. The rest of the world sees this issue clearly - except for the whole of the EU. This is the reason Treasury Secretary Geithner pleaded with Eurozone authorities to leverage the EFSF.

The only credible options take on a Shakespearian flavor, "To fail or not to fail." If they carry on with the status quo, expect hard times in Europe with a lot of global market volatility.

It's strange, but it seems that EU authorities are content with the way things are and send out releases just get us off their backs.

Keep looking for a strong dollar and short the euro.

Good investing,

Jason Jenkins

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