Nobody knows who will win Sunday’s elections in Greece. We may not know even after the elections if the vote is close. For whatever reasons, the Greek government placed a blackout on official polling on June 2.
The big question is whether the radical left-wing upstarts of Syriza will beat the established center-right New Democracy. A win would give Syriza a bonus of 50 seats, making it by far the biggest party in the 300-seat parliament, though probably without a majority. Syriza has vowed to reject the austerity programs agreed to with Greece’s rescue lenders in the eurozone and with the International Monetary Fund (IMF).
Greece’s eurozone lenders have made it very clear that if the government rolls back the austerity measures, no further bailout loans will be forthcoming. In that case, the Greek government would then literally run out of cash within a couple of months.
And if the government does not have enough money to pay its bills, then the Greek banks – which are among the government’s biggest lenders – would go bust. In that case, the European Central Bank (ECB) would have no choice but to cut off its lending to the Greek banks. In following, the Greek banks would also run out of euros in short order, in effect forcing Greece out of the eurozone.
But Syriza claims that Germany and the ECB are bluffing. Syriza warns the ECB and Germany that if Greece is cut off, it will spark a financial panic that would soon engulf Spain and Italy, posing a dangerous threat to the euro and the region. Yet Germany and other EU members are in effect saying: “Vote Syriza and you are out of the eurozone.”
Again, no one knows what will happen.
Now, let’s turn to Spain. Last weekend, European leaders announced a $125 billion package to recapitalize Spain’s banking system. On Monday morning, financial markets reacted positively, seemingly accepting official assurances that, this time, Europe had finally put a big enough plan in place to handle the financial challenge and had done so in a timely manner.
As the day wore on, however, investors started asking about the details of the bailout, and their enthusiasm quickly waned. By Tuesday, markets had rendered a thoroughly negative verdict, with interest rates on Spain’s 10-year bonds spiking above 6.8%, and Italy’s were surging as well.
What went wrong? The $125 billion bailout, underwritten by Germany and other financially solvent countries, was delivered in the form of a loan for which the Spanish government is ultimately responsible. Markets worry, reasonably, that Madrid is no more capable of paying off this obligation than its existing mountain of debt, especially given the ongoing recession plaguing its economy.
Things might have been different if the money had gone straight into the banks themselves, but Germany vetoed that plan as it looked too much like a direct bailout of another country’s profligate bankers. Markets were also unhappy to learn that the creditors of the bank bailout might outrank all others in the hierarchy of Spanish obligations, which would be another reason for private investors to shun Spanish bonds.
On Wednesday night, Moody’s rating agency downgraded Spain’s sovereign debt three notches, to just one grade above junk, and the yield on its 10-year bond rose above 7% on Thursday to a new euro era record. As this is written, the yield is at 6.9%.
The most interesting thing about the $125 billion bailout for Spain is that it came with none of the usual conditions associated with similar bailout loans to Greece, Ireland or Portugal. No new austerity measures were required. The only condition was an agreement that the money be used to shore up its banks.
You can bet that these other countries, and Italy if it comes to that, will insist on similar terms for their next loans.
Conclusions. As noted above, no one knows what will happen in Greece on Sunday. So many people have asked me what I think will happen, especially if Syriza wins. There’s an old political saying: “Most people will not vote for anarchy.” If I had to guess, I think the New Democracy party stays in power. I don’t think even the Greeks will vote for anarchy. But I could be wrong.
One thing that makes me think this is the behavior of the stock markets the last two days. You would have thought there would be huge selling to get out before the elections in Greece on Sunday. Instead the markets rallied strongly. Why? There have been rampant rumors that the Fed and other central banks around the world will quickly enact new Quantitative Easing if Syriza wins the Greek election.
The FOMC meets on Tuesday and Wednesday next week. If Bernanke does not announce some form of additional stimulation on Wednesday after the meeting, I predict there will be widespread disappointment. If so, this will not be good for the stock markets. We’ll see.
Have a great weekend everyone!