Creditors, Not Sovereign Debtors, Are Bailed Out

Up and Down Wall Street
| TUESDAY, MAY 11, 2010
Creditors, Not Sovereign Debtors, Are Bailed Out

By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR(S)
Bonds, bank stocks rally on near-trillion-dollar EU/IMF package, but austerity remains for the public in debtor nations.

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EUROPEAN LEADERS MAY INSIST their €750 billion financial rescue package was aimed at bailing out sovereign debtors, but the evidence shows the main beneficiaries were their creditors.

The beleaguered euro, after soaring to close $1.31 in response to the announcement of the plan, ended Monday in New York at $1.2775, scarcely changed from Friday's close. That's not much to show for the bailout, which was valued at close to $1 trillion at the common currency's session peak.

But for major European banks exposed to weak sovereign debtors of Greece, Portugal, Spain, Italy and Ireland, the scheme was more than worth it. Indeed, as Charles Dumas of Lombard Street Research writes in a research note, the size of the facility may be enough to take "core" European banks out of their "ClubMed" government bonds. And their stocks soared as the European Central Bank began to buy up that trashed paper.

BNP Paribas American Depository Shares (BNPQY) soared 22% on volume of over 1 million shares in New York, 12 times the usual volume in the past three months, while Banco Santander ADS (STD) vaulted 23% on six times recent average volume. Barclays ADS (BCS) added 18% on three times the average turnover. And Deutsche Bank (DB) tacked on a mere 11%, also on three times average volume.

Of course, the European sovereign bonds rallied as well in response to the package. Little wonder, given the size of the total package from the European Union and the International Monetary Fund, plus their newly found assertiveness in dealing with the problem.

"The authorities appear to have stopped dithering and are now doing, offering a package that is about a third of the entire outstanding stock of Italian, Portuguese, Spanish and Greek public debt," according to BCA Research's Daily Insights.

The markets responded in kind, with 10-year Greece government bond yields tumbling nearly 400 basis points, or four full percentage points, 8.75%. The cost to insure Greek debt with credit-default swaps plunged 330 basis points, or 36%, to 586 basis points (or $586,000 annually to insure $10 million for five years), according to CMA Datavision.

The biggest improvement among CDS was Portugal in percentage terms was Portugal, which tightened 170 basis points to 255 basis points, a 40% reduction, following by Banco Santander, by 91 basis points, or 37%, to 157 basis points.

While the plan does dramatically reduce the liquidity risks for sovereign issuers, BCA adds, it "does not solve the longer-term solvency issues facing some euro member countries, or the fact that parts of Europe face an extended period of deflation."

This comes as the euro zone enters its thirteenth year of stagnation, Dumas of Lombard Street Research writes. Germany has grown only 0.5% per annum in the eight years since it exited the last recession. Italy's gross domestic product has contracted over a full business cycle, a first for a major economy, he adds.

Ireland was the "Icarus" of the eurozone, crashing to earth after flying too high. Its GDP is down 13.5% in real terms and 17.5% in nominal terms since it bit the bullet and deflated to remain in the euro. Spain and Italy are uncompetitive because of the euro and its relative labor costs. Even though its relative exchange rate isn't overvalued, Greece's finances "are so out of kilter" that it will have to suffer a "massive recession" without "the salve of devaluation." "ClubMed is going into depression," Dumas flatly declares.

That prospect makes somewhat understandable the strikes and riots in Athens last week, which no doubt helped spur the authorities into action. But the bailout plan does nothing to alter the austerity required to deflate the southern European countries, to make them lean and mean and competitive, without the easy out of devaluation.

And so it seems, once again, it isn't the debtors who are getting bailed out but their creditors -- that is, the bondholders.


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