Greece and Bailout-Fund Move Markets in Europe

Equities in Europe finished the quarter decidedly weak with the Euro Stoxx 50 benchmark equity index losing 23.48 percent since June 30. 

Last week, many rumors resulted in volatile trading, as the Stoxx 50 gained 11.7 percent from Monday to Thursday only to finish off Friday down 2.38 percent from the highs the day before, closing at 2,179 points. 

Initially, the market just shrugged off some official announcements out of Greece, which support the theory that Greece will not be able to avoid a default. Inspectors of the European Central Bank (ECB), the EuroGroup of European Union (EU) finance ministers and the International Monetary Fund (IMF) were in Greece last week to verify the progress being made by the Greek government. 

They met with difficulties, however, as employees of eight ministries staged sit-ins to block the investigation, Greek newspaper Kathimerini reports. Some of those blockades were still continuing at the time of writing. 

This action by government officials comes together with the refusal of the finance minister Evangelos Venizelos to publish much awaited data of how much current debt was definitively tendered by the private sector to be swapped into bonds with longer maturity. Under the agreement made on July 21 with the above three institutions, private sector bondholders were supposed to swap at least 70 percent of their holdings of current Greek government debt into holdings with longer maturities. This measure would alleviate the debt burden in the near-term by stretching out repayment by as much as 20 years. Making the minimum of 70 percent is a critical component for the second bailout package to work as intended. 

The reluctance to publish any official data might have something to do with the rumors that Greece is underwater with meeting many of the requirements set out under the second bailout agreement. Citing officials, the Financial Times (FT) reports that the estimated sum needed for Greece over the next three years will not be 109 billion euros (US$146 billion), but 172 billion euros (US$231 billion).

This dire situation has not escaped global policymakers. "Something must happen. Greece is a few days [from bankruptcy]," says an unnamed official according to Valor Economic, a Brazilian online portal. Sounding an even more cautionary note, Ottmar Issing, the former chief economist of the ECB told the Stern magazine, "Greece will find it ‘impossible’ to get back on its feet even after the country implements austerity measures, and it is inevitable that Greece will have to leave the euro-zone.” 

Beliefs in a successful bailout of Greece gained traction, however, as the German Parliament ratified the increase of the European Financial Stability Fund (EFSF) last Thursday. The vote passed with 523 votes for and 85 against and will see the capacity of the EFSF increased to 780 billion euros ($1,049 billion). Its volume is now big enough to support countries like Greece, Portugal, and Ireland, but would likely be too small for countries like Spain or Italy in the eventuality that they lose access to capital markets. A spokesman of the German department of the treasury also made it clear that there were not going to be any further increases. 

While this vote was critical, it was also widely expected. Many traders suspect that the market gains this week are based on rumors that the EFSF would be increased even further by using leverage, according to a plan that the U.S. Secretary of the Treasury Tim Geither first introduced while visiting Europe two weeks ago. 

CNBC first came out with the rumor last Monday that the EFSF was to work together with the European Investment Bank (EIB), a bank owned by the member countries of the EU, to use up to nine times leverage on the original EFSF volume to guarantee practically all the eurozone’s debt safe for the strongest creditors France and Germany. 

The backing of these two countries would help bonds issued by the EFSF to be AAA rated, giving it the highest investment rating. The market rallied on the news and ignored words of caution from the EIB, which released an official statement saying: “The EIB has not been approached and has no plans to be involved in this. The EIB will continue to focus on its mission, which is financing viable investment projects.”

When asked to comment on plans to increase the size of the EFSF, S&P rating agency also cautioned that a move to lever up the EFSF would "potentially trigger credit rating downgrades in the region.” David Beers, who leads the S&P’s sovereign rating group, warned that even countries like France and Germany could face "potential credit implications in different ways." German Finance Minister Wolfgang Schaeuble was also quoted by Bloomberg news saying, “Increasing the EFSF would damage some AAA ratings” and “Solidarity has its limits.”

Some market commentators, such as Peter Tchir of TF Market Advisers, believe that the extra element of using leverage through the EIB has just added another layer of complexity to the plan and does not solve the underlying solvency issues of the affected countries. 

He also believes that if Germany and France lose their AAA rating, the whole structure would crumble because its AAA status depends on the AAA rating of the two countries.