Time for a bail out for Greece?

10th February 2010 by Shaun Richards

This week the economic news is being dominated by the peripheral countries in the Euro zone. Today is the day for the Quarterly Inflation Report from the Bank of England and I will post on it and yesterday’s disappointing trade figures later. However events around the potential sovereign debt crisis in Southern Europe are gathering pace. Yesterday I reported that it looked like a bail out was being considered by the Euro zone and set two main criteria.

1. That action needs to be quick and decisive. A decent plan operated quickly is preferable to a perfect plan that is dithered about.

2. Such talk will improve markets but like the boy who cried wolf it only has a limited lifespan. So politician’s who feel that talk is sufficient (and I am sure there are plenty of them) must be made to realise that talk without action is only a short-term palliative.

Hope has gathered apace overnight.

Market Reaction

If we look at my main measure which is comparing ten-year bond yields with the German bund we saw the following at yesterday’s close.

Greece +3.2%, Ireland +1.60%, Portugal+1.45% and Spain +0.94%

The Greek ten-year government bond yield closed at 6.4% last night. I understand that this morning it briefly dipped below 6% on hope of a bail out. I have worked in such circumstances and prices will be very volatile as any news can make them move in either direction. So yields have dropped substantially in the last 24 hours. In addition equity markets rallied with the Dow Jones Industrial Average rallying 200 points before closing up 150 points.

Bail out plans

As always seemed likely Germany is staring to take a lead (please see my earlier posts, I have a category for the Greek financial crisis). Essentially this is for two reasons. The first is that it is the dominant Euro zone economic power and the second is that Germany’s banks are heavily exposed in Greece. So there is an element of self-interest as well as altruism. I have written about the losses that must have taken place in the Greek government bond market as yields rose. These must have affected German banks. Yet suddenly with yields retreating from 7 to 6% their profit and loss situation will have improved particularly if they had the courage to invest again at 7% yields for Greek government bonds.

In terms of what is being proposed a German government official has stated that the fall in the Euro and the pressure on bond prices had changed the view in Berlin about how to deal with this crisis. He also expressed concerns about contagion and the problem spreading from Greece to other countries. Interestingly Germany seems to be thinking of a “firewall” and problem containment and not helping the Greeks. The German Finance Minister Wolfgang Schäuble will brief lawmakers today on the options for such a firewall and apparently will be considering German and Euro zone help.

However both the UK and Sweden have been privately briefing that any bail out should be under the aegis of the International Monetary Fund (IMF). Both countries have said that the IMF has the technical knowledge. Of course both are also probably frightened of the domestic political response should they get drawn into a bail out. I still feel that the IMF’s resources are likely to be under strain and Europe should take care of its own.

So in truth for all the excitement there is little real detail and still some confusion.

Moral Hazard

I wrote yesterday about the potential moral hazard issue of coming up with rescue plans for Greece just as a general public-sector strike takes place. I feel that timing can be very important and that the strikers might feel that their industrial action is being rewarded. If so this is not good for Greece and her future.

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