Greece confidence vote calms some investors, yet default worries remain

Greek Prime Minister George Papandreou’s government  survived a confidence vote in parliament Wednesday. The AP reports on the impact of that vote:

The Greek government’s victory in a confidence vote helped steady markets on Wednesday before an interest rate decision from the Federal Reserve, though a shock profit warning from Dutch lighting and electronics firm Philips kept sentiment in check.

Following days of feverish trading activity due to concerns about a possible Greek default, investors have been calmed — for now, at least — by the confidence vote early Wednesday in Greek Prime Minister George Papandreou’s government.

Investors will be hoping that paves the way to the passage of another batch of austerity measures in a vote next Tuesday. The Greek Parliament needs to pass the additional €28 billion ($40.2 billion) in budget cuts and new taxes and back a €50 billion privatization program so the country can get its hands on €12 billion of rescue loans by mid-July to stave off a disastrous default.

Greece’s partners in the eurozone and the International Monetary Fund have made the cash contingent on a positive Parliamentary vote on the austerity package.

“Considering Papandreou made it perfectly clear ahead of yesterday’s vote that he would push for new austerity measures in order to qualify for a second bailout package, it would appear that he should have enough support to pass the measures,” said Benjamin Reitzes, an analyst at BMO Capital Markets.

Some of the calm was dented by a warning by Royal Philips Electronics NV that worse-than-expected demand in western Europe hit its second quarter performance.

Elsewhere in Europe, the FTSE 100 index of leading British shares closed down a tad at 5,772.99, while Germany’s DAX fell 0.1 percent to 7,278.19. The CAC-40 in France ended 0.2 percent lower at 3,871.37.

In the U.S., the Dow Jones industrial average was flat at 12,189 while the broader Standard & Poor’s 500 index rose 0.1 percent at 1,297.

The Greek government has barely a week to get new austerity measures passed by parliament to avoid a potential default. The AP reports:

European leaders breathed a sigh of relief but kept up the pressure on Greek Prime Minister George Papandreou, who faces a vote June 28 to push though more spending cuts, tax hikes and asset sales. Still, fearing the financial chaos that any Greek default would ignite, EU leaders promised Papandreou additional funds to help the shrinking Greek economy to get back on its feet.

Greece’s creditors, particularly its partners in the 17-country eurozone, are demanding that Papandreou get parliamentary approval for €28 billion ($40.24 billion) in budget cuts and new taxes and for a €50 billion ($72 billion) sell-off of government assists by the end of June. Only then will they hand over €12 billion ($17 billion) in bailout funds that Greece needs to avoid bankruptcy in mid-July.

A default could drag down Greek and European banks, endanger the finances of other weak eurozone countries such as Portugal, Ireland and Spain, and spark financial uncertainty across world markets.

German Chancellor Angela Merkel warned that a default would have “completely uncontrollable” consequences on the financial markets, but she insisted that private creditors should voluntarily share the pain of a second Greek bailout.

Imposing a “haircut” on Greek debt would endanger banks, other creditors who hold Greek bonds, and institutions that sold insurance policies against a default,Chancellor Merkel said.The AP reports:

Those credit default swaps have a “significantly higher” face value than the debt itself, and the consequences of them being called on can’t be foreseen, she said.

“Nobody around the globe knows exactly who holds those papers and what it means if they come due,” Merkel told a meeting of the German parliament’s European affairs committee. She said it was also unclear “who will have to pay how much and who will need fresh capital in what way.”

The chancellor added that the CDS contracts — derivatives that also played a central role during the financial crisis after the collapse of Lehman Brothers — are currently not regulated, but “must be made transparent” amid efforts to tighten financial regulation.

A full-scale debt restructuring also could prove contagious, leading investors to question the stability of other European nations that otherwise would not need assistance from the EU to meet their financing needs, she said.

The chancellor wants to get private creditors to contribute to the next aid package for Greece on a purely voluntary basis, an initiative for which Merkel doesn’t yet have a majority among the leaders of the 27 EU nations holding a summit in Brussels on Thursday and Friday.

However, Merkel voiced confidence that other EU leaders would follow Germany, France and the Netherlands in supporting the idea.

It remains unclear how much money might be contributed by private creditors, but Merkel insisted it must be “substantial ... and measurable.”

The Washington Post’s editorial board says we shouldn’t celebrate the Greek vote just yet. They write:

Should Americans be celebrating? Certainly it’s no cause for joy that U.S. taxpayer money is on the line, too, in the form of the U.S. share of a three-year, $42 billion IMF package for Greece. Nor has the United States avoided all spillover from Europe’s troubles to date. As the Wall Street Journal has reported, many U.S. municipal bond issuers already face higher interest payments because of concerns about the European bank that guaranteed the bonds and also loaned $6.3 billion to Greece.

In the event of a Greek default, U.S. banks could probably take the hit, since their direct exposure to Greece is small. The problem is that German and French banks that hold tens of billions of dollars worth of Greek (and Irish, Portuguese and Spanish) debt are among the biggest counterparties of American money market mutual funds (MMFs). The MMFs lend the Europeans dollars to conduct global business; the largest 10 U.S. MMFs have combined exposure to European banks of $736 billion, or about half of their assets. So, if those banks face big Greek losses, they might not be able to meet their obligations to the MMFs, which, in turn, might not be able to pay their American customers. Something similar happened during the Lehman Brothers meltdown of 2008; only massive federal intervention prevented a run on the MMFs. Oh, and if a Greek default triggers a flight from the euro to the dollar, U.S. exports would suddenly become much less competitive in world markets.

At this point, markets are betting against disaster, because they assume the leaders of Europe’s solvent countries — Germany, in particular — will ultimately stand behind Greece, its fellow financial basket-cases, Ireland and Portugal, and the continent’s big banks. Repeated bailout-for-austerity deals might not be any kind of permanent solution, but at least they allow Europe’s banks to mend their balance sheets — and shunt risk onto the public sector — until such time as the bailout recipients can either grow on their own again or be allowed to collapse without inflicting huge systemic damage. Also, markets hope that Spain will use the time to restructure without a bailout, because there isn’t enough wealth in all of Europe to rescue that $1.5 trillion economy.

The Obama administration is prodding the Europeans to deal with the Greek problem swiftly, even if it means slapping on yet another band-aid. Yes, that is a recipe for moral hazard — perverse incentives for the Greeks, Ireland and Portugal to hold out for a better deal. Yes, that means risking U.S. money on a temporary fix. What’s really needed is a permanent solution, such as a bond restructuring similar to the Brady Bond deal that ended the Latin debt crisis.

But Europe lacks the political and financial wherewithal to do that now. And in the meantime, the U.S. and global economies are too weak to risk a Lehman-like shock. The sad fact is that the United States has few realistic alternatives: Our economy is enmeshed in European finances and therefore at the mercy of European politics. The United States can cope with that situation, but it’s definitely nothing to celebrate.

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