Well we thought we had a deal

Last Thursday there appeared to be a breakthrough deal to recapitalize banks, manage Greek sovereign debt and insure against future defaults.  Actually was starting to prepare a blog entry on it last night.  Good thing I waited.  Today the Greek PM George Papandreou announces that there will be a public referendum on the deal.  Given the public resentment that Greeks (see this WSJ article from Saturday on how tough things already are in the private sector) have about bankers and politicians in other EU countries dictating their living standards, the analyses I have seen so far suggest one of two outcomes: (1) Papandreou made a rash emotional decision without consulting anyone and his government will fall in the next 48 hours or (2) Papendreou never intended to live by any agreement and is using the referendum to hold onto power. 

Dilemma for the average Greek thinking about how to vote in the referendum (if it ever takes place): the deal offered last week called for a 50% markdown of sovereign debt in return for continued borrowing from foreign parties -- how does that compare for an Argentine style 100% markdown that would then cut Greece off from foreign sources of capital?  Lack of access to foreign capital would mean that the Greeks would have to balance their budget deficit cold turkey OR print lots of the new currency and run the risk of hyperinflation. 

Happy days are here again?

Well maybe we should not put the champagne on ice quite yet, but there were two very good bits of news today.  One day after being unable to agree to meet for a pre-summit summit, the European Union has come up with a plan to (hopefully) deal with the sovereign debt crisis.   Greek bond holders are going to take a 50% hit, European banks will need to raise new capital, and there is now a bigger fund to try to stop the Greek crisis from spreading to other countries.  We will need at least 48 hours to digest all of the details of this deal, but at least they came up with something. 

The other good bit of news is the third quarter GDP report which showed a decent 2.5 percent growth rate.  Given all of the fears of a double dip recession, this is about the best we could hope for.  Consumer spending and business investment both picked up. 

The stock market celebrated with a 3 percent increase.  Let's hope it sticks

Want a deal on a Greek bond?

The consensus in the economics and finance community is that Greece will at some point have to default on some of its bonds, the only questions being when and how much.  Not so fast, says an NYT story earlier this week.  It turns out that hedge funds are buying large amounts of Greek bonds that days ago were trading at 36 cents per euro of face value.  The anticipated bailout deal will lengthen maturities that will be worth almost twice as much.  About 30 percent of the bonds that are involved in the deal were acquired since July 21, presumably by people who were well aware of the riskiness of the investment. 

S&P's track record on sovereign risk

Not pretty, reports WSJ which did some research covering the last 35 years.  If a government is rated single-A or better, the news is good -- none defaulted over this time period.  But the ratings do a poor job discriminating in the B range.  The best example: Brazil and Argentina were both rated double B minus in January 2001.  One year later, Argentina defaulted on its debt whereas Brazil has grown steadily over the last 10 years. 

In practice, the bond market forces default-probable countries to pay an interest rate premium.  So what are the ratings agencies really doing to create value when they assess sovereign risk?