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Bill Gross just loves to manufacture heavily publicized comments about the U.S. Treasury market every now and again. At first glance, they may even come off as his deeply personal opinions about Treasury bonds and the future of U.S. fiscal and monetary policy. Take more than a glance, though, and it becomes easy to see that men like that, in such lofty positions of financial power, never make any "public statements" very lightly. In fact, they are usually calculated to several decimal places in a room full of financial vultures, political hawks and public relations wizards before they ever see the light of day.
That was the subject of a piece I wrote about two months ago, found here at The Automatic Earth, which argued that Pimco's net short position on Treasuries in its flagship fund was very little more than a magician performing a misleading sleight of hand on stage. It was certainly not an unconditional bet against the U.S. Treasury market, the Fed and the entire debt-dollar system of corollary bonds and derivative instruments, as some had began to claim when the position was made public. It is very well known that Gross has an all-access VIP pass to the Fed's monetary nightclub, but that level of inside connect is exactly why we should be skeptical of his public actions or statements.
[Bill Gross, Master of Monetary Psy-Ops]: "Now, the TRF is net short treasuries and many people are convinced that its short position is, in fact, nothing short of a prediction by Gross that the treasury market will soon collapse. Indeed, he seems to be at least betting that rates will increase significantly in the short-term. Perhaps that is true or perhaps he is making a bad bet, but perhaps we should also be wary of such plainly advertised convictions. After all, the insider "beltway" encompassing Wall Street and Washington has two lanes running in both directions.
...An unexpected end to QE operations will send the dollar soaring, and as mentioned before, all asset markets plunging except for the U.S. treasury market. Bill Gross may have dumped all of his treasury exposure for now, but has any other major financial institution or money manager followed suit? Has the Fed announced any plans to sell its treasury holdings back into the primary or secondary markets?
I suspect that, by that time [when the rush to Treasuries as a "safe haven" really gets underway], there would have been a significant reversal in the treasury holdings of TRF and the superficial justifications for the investment decisions of the omniscient Bill Gross. Perhaps he will continue to have minimal exposure to U.S. treasuries throughout the year, as a partial hedge to his fund's enormous cash holdings, but that certainly should not be taken as an absolute bet against the treasury market."
The record cash holdings were obviously a bet on dollar-based deflationary pressures, and the value of the entire Treasury curve really doesn't have that much distance from the value of the dollar. Indeed, it didn't take very long before Gross made another statement to lay the foundation for justifying such a reversal in his fund's position on Treasuries:
Gross: "Treasury yields are currently yielding substantially less than historical averages when compared with inflation. Perhaps the only justification for a further rally would be weak economic growth or a future recession that substantially lowered inflation and inflationary expectations." [Bill Gross: Only a Recession Will Change Short Bets on Treasuries].
You mean the type of weak economic growth and low inflation evidenced by significantly declining or decelerating home prices, consumer spending, retail sales, consumer/business confidence, manufacturing strength and PPI/CPI levels, Mr. Gross? Well, I know the man doesn't need me to tell him this, but that kind of "justification for a further rally" is quite easy to stumble upon these days, and it turns out we already have. Add in the entirely predictable worsening sovereign debt situation across Europe, and a Treasury rally becomes all but inevitable. Perhaps its time for those short bets to change?
Of course, no self-respecting financial shark would just give up the guaranteed extra value he could gain from buying bonds at even lower prices, so Gross may have to stretch out the role of "bad cop" for a bit longer:
[Bill Gross, Master of Monetary Psy-Ops]: "(Gross is) The bad cop who beats the suspect over the head and tells him he has one last minute to confess before the entire case is blown wide open, followed by the good cop [UST/Fed] who enters the room and promises they will go easy on the suspect and recommend leniency to the judge, as long as he just tells them where all the money is hidden. Once again, it is not about enforcing the law or finding justice, it's only about using deception to drive all of that money out of its hole and into their hands."
Recently, Gross has made another stir about how further QE operations by the Fed may come in the form of "interest rate caps" on 2-3 year Treasury notes. . The comment came over Twitter as a "tweet", so I guess we can be certain that it was strictly intended as his informal and personal opinion about monetary policy. Zero Hedge commented that this tweet was "troubling" because it also seemed to back up what David Rosenberg had predicted earlier, when he wrote that the Fed may engage in "Operation Twist 2". The initial "Operation Twist" occurred in the 1960s when the Fed began buying the long-bond and selling the short-bond to flatten the rate curve. .
This time around, Rosenberg believes that it may only start buying up 10-year Treasury bonds on the open market to clear them at a targeted interest rate, instead of targeting a specific increase on its balance sheet like it did with QE2. Therefore, the amount monetized (and added to the Fed's balance sheet) would ultimately depend on how much supply was being issued by the UST and how much demand existed for that supply from other investors. Rosenberg surmises that the potential upside for the Fed in capping long-term rates would greatly exceed the downside, "since just about everything that has to do with the economy is either directly or indirectly priced off the 10-year part of the curve" (such as variable mortgage rates).
There are a lot of valid points made in Rosenberg's "OT2" analysis, and I would be the first to support the argument that the Fed is focused on maintaining the integrity of the Treasury market above all else (especially the long-end). A re-implementation of OT may very well be in the cards for our future, but, then again, Rosenberg tends to over-emphasize the benefits of strictly "capping rates" relative to additional asset purchase programs and indirect support via selling derivative swap options on bonds, as well as natural "flights to safety". The 10-year must be maintained, but when it's yielding close to 3% on the brink of a risk asset collapse, I'd say it really isn't in too much danger right now. It's also hard not to once again notice the fact that so many people are speculating about QE3 and it's arrival on the monetary scene any day now, in whatever form it may happen to take (i.e. OT long-end, OT short-end, direct QE, etc.).
Perhaps some of the well-connected ones (not ZH or "Rosie)" have more sinister motives, such as creating the expectation of QE to support both risk assets and bonds for the time being, and prepare the justifications of "austerity" measures for the American people when their bell has tolled.
Does it really make sense for the Fed to risk the potential downsides of a balance sheet ex(im)plosion at this stage of the financial crisis, when equity and commodity markets have barely lost any value back from QE2? That question brings us back to Bill Gross, who has also recently stated that the banks do not have excess capital waiting to buy Treasury bonds when QE2 ends, in another example of his righteous and very public indignation with the bond market. Just as a reminder, though, we are talking about THE bond market that has kept Pimco, Gross and El-Erian filthy rich for many years now.
[Bill Gross, Master of Monetary Psy-Ops]: "Besides, did anyone really think that the world's biggest bond fund was about to unconditionally give up on the world's biggest bond market (which just so happens to support every other U.S. bond market, and foreign ones as well)? Personally, I think Bill Gross is going to continue doing what he does best - speaking in half-truths and pretending like he cares about day-to-day developments in the U.S. fiscal situation, while carting his millions in compensation to undisclosed personal bank accounts around the world. That is one financial shark who cannot survive outside of the deep waters, and his next feast of flesh will be no less filling than the last."
Zero Hedge reported on June 12, after conducting a solid analysis of bank reserves data, that almost the entirety of QE2 funds to date (~$600B) have gone to European Banks, and concluded that this revelation provided support for Gross' contention that the funds would not be available for re-investment in Treasury bonds. Here is a simple graph indicating strong evidence of the Fed-European transfer and the relevant quote from the ZH report (emphasis mine):
Tyler Durden: "Recall that Bill Gross has long been asking where the cash to purchase bonds come the end of QE 2 would come from. Well, the punditry, in its parroting groupthink stupidity (validated by precisely zero actual research), immediately set forth the thesis that there is no problem: after all banks would simply reverse the process of reserve expansion and use the $750 billion in Cash that will be accumulated by the end of QE 2 on June 30 to purchase US Treasurys.
The above data destroys this thesis completely: since the bulk of the reserve induced bank cash has long since departed US shores and is now being used to ratably fill European bank balance sheet voids, and since US banks have benefited precisely not at all from any of the reserves generated by QE 2, there is exactly zero dry powder for the US Primary Dealers to purchase Treasuries starting July 1."
From my point of view, that conclusion makes no sense whatsoever, unless we assume that European-owned banks listed as Primary Dealers for the Fed are no longer allowed to show up at Treasury auctions. The Treasury bills and notes purchased with U.S. dollars could essentially perform the same "re-capitalization" function as the cash itself (theoretically, of course). There is really no credible reason to think that at least some of that cash won't find its way back into the Treasury market in the near future. Of course, that train of thought does not sit well with those consistently trumpeting the imminent collapse of the Treasury and USD markets, which happens to be something ZH is quite fond of doing.
Which also may be why it continues to take Bill Gross' tweets at face value, and expects more details of "Operation Twist 2" on the short-end to be revealed quite soon (perhaps when the FOMC minutes of its June 22 meeting are released). . I still suspect that we are not going to hear anything about further monetization in the next few months, at least not from the Fed itself. A few bold statements from Gross and the speculative rumors that naturally accompany such statements should do the trick just fine. Indeed, what better way is there to support a naturally forming Treasury market rally without opening yourself up to the political and/or financial risks of actual monetization?
The latest Treasury International Capital (TIC) report shows that net inflows into Treasuries increased for the month of April, mainly due to foreign government purchases. So when can we expect all of those "private accounts" to get with the program?
"Outside of equities, official accounts, which include foreign central banks, were the biggest buyers in the month with net inflow into Treasuries of $24.4 billion vs a net outflow from private accounts of $1.0 billion.;
A look at Treasury holdings by nations shows a $7.6 billion rise in mainland China, which is also a positive, to $1.15 trillion and a small decline in Japan to $906.9 billion. UK-based accounts, which are the third largest holders of US Treasuries, shows a $7.8 billion increase to $333.0 billion."
Well, with the rapidly progressing financial troubles of Europe and Japan, I suspect it will not be very long from now. In the meantime, as discussed in Bailing Out the Thimble with the Titanic, the Fed can continue to exert some influence over longer-term rates by selling insurance (IR swaps) on Treasury bonds through primary dealer banks, without any explicit monetization or anyone being the wiser (major investors). Eventually, the time will come when some form of QE3 is necessary, but that time will likely be sometime next year after asset prices have come down significantly. As for Gross, well, I still expect that financial shark to be well-positioned for the long-bond rally when it occurs, and in no small part because of his immensely pubic fear-mongering tactics.
Why Your Money-Market Fund Could Be Hit by Greek Default
by John Carney - CNBC.com
Some of the safest, plain-vanilla investment accounts in the U.S. could be challenged if Greece defaults on its sovereign debt. 44% of mutual fund assets in the U.S. are invested in the short-term debt of European banks, according to a report from Fitch.
A separate report from Moody's noted that 55% of those holdings are in the commercial paper of French banks, such as Societe Generale, BNP Paribas and Credit Agricole. French banks are some of biggest creditors to Greece, with over $53 billion in outstanding loans to the Greek government and private sector.
While fund managers have had plenty of warning of the potential of a default in Greece, many would likely still be caught off guard. Many fund managers assume that a bailout will prevent a default by Greece. The bankruptcy of Lehman Brothers similarly caught money-market fund managers off guard, famously causing the Reserve Fund to "break the buck."
The debt of these French banks is still very highly rated and Moody's says the risk of default on the short-term debt is very low. But the high ratings assume that the probability of a default by Greece is very low.
If Greece defaults, it is possible that the market value of the commercial paper of French banks could plummet and the ratings could be downgraded. Money-market funds would likely refuse to fund new issuances of the short term debt, creating a liquidity problem for the French banks. Other European banks would likely face pressure as investors tried to measure their exposure to Greece and those over-exposed to Greece.
One thing that may help money-market funds weather the Greece storm better than the Lehman hurricane is that they now have an implicit US government backing. While no longer directly insured by the FDIC, many believe that in a crisis the government would once again step in to insure the accounts, just as it did in 2008.
Greek debt crisis is Europe's 'Lehman moment'
by Louise Armitstead, and Philip Aldrick - Telegraph
Stock and bond markets lurched on Thursday amid fears that the Greek sovereign debt crisis was about to unleash a "Lehman-like" shock on the global financial system.
Traders feared that the political chaos and riots across Greece would cause a default, which in turn would trigger a tsunami through the financial system – as the collapse of Lehman Brothers did in 2008. Neil Mackinnon, an economist at VTB Capital in London and a former Treasury official, said: "The probability of a eurozone Lehman moment is increasing. The markets have moved from simply pricing in a high probability of a Greek debt default to looking at a scenario of it becoming disorderly and of contagion spreading to other economies like Portugal, like Ireland, and maybe Spain, Italy and Belgium."
London's FTSE 100 closed down 0.76pc at 5698.81, following a 1pc drop on Wednesday. Major exchanges in Germany and France plunged as well. Asian stock markets had already fallen overnight on Wednesday and US markets followed in early trading yesterday. The euro hit an all-time low against the Swiss franc and fell 0.1pc against the dollar to $1.4161. The cost of insuring Greek debt against default also hit a fresh record. Five-year credit default swaps on Greek government debt rose by 124 basis points to 18.5pc. Greek debt is the most expensive in the world to insure, with the next closest being Venezuelan debt.
At the same time, yields on Greek and Portuguese benchmark 10-year debt hit new highs, up 27 basis points to 17.42pc for Greece and 18 points to 10.28pc for Portugal. Two-year Greek debt is paying 27.55pc annual interest as investors expect it to default. Spain was also caught up in the scare, with yields on 10-year debt hitting an 11-year high of 5.7pc.
The European Union's top economic boss raced to stem the rout by claiming that Greece would be given €12bn (£10.5bn) this weekend, whether leaders had reached agreement on debt repayments or not. Olli Rehn, the European Union's economic commissioner, said the international authorities had decided to get around their differences by providing the Greek rescue package in "two stages".
He said he was "confident" European leaders and the International Monetary Fund (IMF) would on Sunday consent to release the fifth tranche of the €110bn bail-out agreed last year. The IMF had said it would not release the funds unless Greece passed tough economic tests. It has also demanded European leaders agree a fresh bail-out of as much as €120bn and settled the treatment of bondholders. Mr Rehn said he hoped the "contents and conditions of a successor programme for Greece and the nature of private sector involvement in this" would be discussed on Sunday and Monday.
European Commission sources confirmed the UK is likely to be sucked into the second bail-out since it is likely the European Financial Stabilisation Mechanism (EFSM) will be tapped. Germany has insisted the EFSM – to which all EU countries contribute – is used to help Greece. It could be tapped for €8bn, which would put the UK's liability at about €1.2bn. Mr Rehn said the two-step strategy would "avoid the debt default scenario" and resolve the "medium term" disagreements. "It has been difficult," he said. "But I strongly believe that with this two-step approach, in agreement with IMF, we can avoid any accident scenario."
Referring to the split between France and Germany over whether to force bondholders to share the costs of bail-outs, Mr Rehn said: "I call on all EU decision-makers to overcome the remaining differences and come to a responsible agreement at this critical juncture." Private-sector creditors appear to be accepting that participation is inevitable. The Institute of International Finance's Market Monitoring Group, a forum of lending executives, said: "To facilitate Greece's adjustment efforts, some form of voluntary participation from the private sector will have to be considered."
Fears about contagion remain acute, with Nout Wellink, a governing council director of the European Central Bank, warning that eurozone members may have to double the size of their European Financial Stability Fund to €1.5 trillion to cover potential risks from Ireland, Portugal and elsewhere. Holger Schmieding, chief economist at Berenberg Bank, said Greece may still default if the disarrayed government rejects the terms of a new bail-out. While a default alone would be manageable, he said, "Europe would likely switch to contagion control to prevent the turmoil from spreading to Spain and Italy".
Europe’s ‘Lehman Moment’ Looms as Greek Debt Unravels Markets: Euro Credit
by Mark Gilbert and Liz Capo McCormick - Bloomberg
The European Union’s failure to contain the Greek debt crisis is sending fresh shockwaves through currencies, money markets, equities and derivatives.
The euro lost more than 2 percent against the dollar in the past two days and the cost of protecting corporate bonds soared to the highest level since January, with credit-default swaps anticipating about a 78 percent chance that Greece won’t pay its debts. Equities declined around the world, while a measure of fear in fixed-income markets jumped the most since November.
Market moves suggest heightened concern that authorities won’t be able to keep Greece’s debt troubles from spreading after Moody’s Investors Service said it may downgrade BNP Paribas SA and two other big French banks because of their investments in the southern European nation. The collapse of Lehman Brothers Holdings Inc. in September 2008 caused credit markets worldwide to freeze as investors fled all but the safest government debt.
"The probability of a eurozone Lehman moment is increasing," said Neil Mackinnon, an economist at VTB Capital in London and a former U.K. Treasury official. "The markets have moved from simply pricing in a high probability of a Greek debt default to looking at a scenario of it becoming disorderly and of contagion spreading to other economies like Portugal, like Ireland, and maybe Spain, Italy and Belgium."
Lehman’s collapse contributed to $2 trillion in writedowns and losses at the world’s biggest financial institutions, data compiled by Bloomberg show, and central banks cut interest rates to record lows as economies slipped into recession.
Markets were roiled yesterday as Greek Prime Minister George Papandreou said he would name a new government and call a vote of confidence in Parliament as he seeks to pressure rebel lawmakers to back an austerity plan that would secure a new bailout. The MSCI World Index fell a further 1.1 percent today, while the Swiss franc rose to a record against the euro.
Papandreou needs to clinch a parliamentary vote on a 78 billion-euro ($110 billion) five-year package of budget cuts and asset sales by July to ensure the country receives a new EU aid package to avoid the euro-area’s first default. "Our duty is to the nation, not to political parties," Papandreou said in comments televised live on state-run NET TV. "I will form a new government and immediately afterwards seek a vote of confidence in Parliament. It is a time for responsibility."
Papandreou’s options narrowed as his bid to garner support from the biggest opposition bloc failed, party allies turned against him and police deployed tear gas to break up anti- government protests in central Athens.
"This is by no means the end of the story, but based on current majority, such a motion should pass," Charles Diebel, head of market strategy at Lloyds Bank Corporate Markets in London, wrote in a note to clients yesterday. "If not, then Armageddon scenarios come into play, which include default and potentially the whole contagion scenario plays out."
Earlier this week, Standard & Poor’s slashed Greece to CCC from B, handing the nation the world’s lowest credit rating and noting it’s "increasingly likely" to face a debt restructuring.
Greece’s unemployment rate jumped to 15.9 percent in the first quarter from 14.2 percent in the last three months of 2010, the Hellenic Statistical Authority in Athens said today. The jobless rate, at a record 16.2 percent in March, has climbed faster than projected under last year’s 110 billion-euro bailout.
The current sticking point is how to engage private investors in the next stage of rescuing Greece. European Central Bank authorities, including President Jean-Claude Trichet, have pushed back against German plans to lengthen the maturity of Greek bonds, leaving open only the option to persuade bondholders to voluntarily reinvest the proceeds of maturing debt into new securities.
"Keeping existing creditors engaged is far from trivial, as it involves a combination of incentives and penalties," Francesco Garzarelli, a strategist at Goldman Sachs International in London, wrote in a report yesterday. "If the transactions are to be completed on a ‘voluntary’ basis in order not to trigger a default event, the ‘hold out’ problem is material" as persuading all lenders to move in lockstep is difficult, he wrote.
Moody’s placed the ratings of BNP Paribas, France’s biggest bank, and local rivals Societe Generale SA and Credit Agricole SA under reviews that will focus on their holdings of Greek public and private debt "and the potential for inconsistency between the impact of a possible Greek default or restructuring and current rating levels," the firm said in a statement.
"This is a ripple effect of the Greek crisis spilling into European banks," said Sarah Hewin, a senior economist at Standard Chartered Bank in London. "Clearly, there would be an impact if there is an escalation" of the situation, she said. German lenders were the biggest foreign owners of Greek government bonds with $22.7 billion in holdings last year, according to data compiled by the Bank for International Settlements in Basel, Switzerland.
French banks, which led the group of Greek creditors with overall claims amounting to $56.7 billion, trailed their German peers on sovereign debt with $15 billion, according to the June report from the BIS. The figure for French banks was inflated by $39.6 billion in lending to companies and households, mainly because of Credit Agricole’s Greek unit, Emporiki Bank SA. German lenders have no major units in the country. At the end of 2010, Greek government bonds held by banks in countries reporting to the BIS totaled $54.2 billion, of which 96 percent was owned by European lenders.
U.S. interest-rate swap spreads, used to gauge investor perceptions of credit risk, widened the most since November after the announcement about banks by Moody’s. The difference between the U.S. two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, widened 5.06 basis points to 25.15 basis points. That was the largest increase since Nov. 30, when the gap widened by 6.5 basis points. The spread is based in part on expectations for the London interbank offered rate, or Libor.
"There is some worry that with what is going on in Greece there will be downgrades and this will cause a problem in funding and result in a rise in Libor," said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG. "Swap spreads are widening as direct result." The yield on two-year Greek notes rose to a record 28.85 percent and 10-year bond rates gained 14 basis points today to 17.86 percent. The cost of protecting Greece against default climbed 74 basis points yesterday to an all-time high of 1,844 basis points in London, prices compiled by CMA show.
The contracts, which typically rise as investor confidence worsens and fall as it improves, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds across the euro region underperformed German debt, Europe’s benchmark government securities. The extra yield, or spread, investors demand to hold Greek 10-year securities instead of similar-maturity bunds climbed today to 1,493 basis points, or 14.93 percentage points, while Irish, Spanish and Italian spreads also widened. The securities of so-called core members of the currency bloc also underperformed relative to German debt, with 10-year yield spreads between Austrian, French, Belgian and Dutch debt over bunds widening. The yield on the German bund dropped 3 basis points to a five-month low of 2.92 percent.
The euro depreciated 0.5 percent today to $1.4109, the weakest in three weeks, while demand for options that protect against a drop in the euro versus the U.S. currency is at the highest level in a year as the EU struggles to contain the sovereign-debt crisis. The premium for euro three-month put options granting the right to sell the currency against the greenback reached 2.54 percentage points yesterday over calls, which allow for purchases. That’s the most since June 2010 on an intraday basis.
In the corporate bond market, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 2.25 basis points to 114, the highest since Jan. 10, according to JPMorgan Chase Co. The gauge has risen from the low this year of 94.3 on April 8. "Nervousness has intensified," said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. "The market is increasingly fretting that the components won’t be in place for a bailout package. You see signs of contagion spreading. Until we see a resolution with the situation in Greece, you’ll see a flight to quality."
Moody's threat to downgrade Italian debt raises eurozone contagion fears
Moody's has threatened to cut Italy's credit ratings on concerns over a possible rise in eurozone interest rates may derail the country's fragile economic recovery, raising more fears of contagion from the Greek debt crisis.
Moody's announcement placing Italy's Aa2 rating on review for downgrade of the next 90 days came after European markets had closed for the weekend. The agency said structural weaknesses such as a rigid labor market posed a challenge to growth.
Italy's potential downgrade highlights the risks facing indebted European countries as they struggle to avoid a Greece-style crisis. Markets are worried that Italy, like Greece, will struggle to make the necessary spending cuts and other fiscal measures needed to cut its debts to affordable levels. "The Moody's news on Italy reinforces the ECB's concern about the prospect of contagion. And contagion should not happen," said Greg Salvaggio, senior vice president at Tempus Consulting in Washington. "As a result, I think there's a going to be a package put together over the weekend, which is going to effectively offer Greece another lifeline."
Moody's analyst Alexander Kockerbeck told Reuters: "Italy has had structural impediments to growth for some time. However, today, these challenges coexist with a scenario of rising interest rates and fragile market sentiment." The European Central Bank held interest rates steady at 1.25pc this month but signaled that it will raise rates in July.
Earlier on Friday, Greek bonds rallied as a tentative agreement by France and Germany on broad steps over how to move forward with a second Greek aid package prompted investors to cash in on recent gains in German. However, analysts and economist expect markets to remain volatile next week.
Greek debt worries spread to Spain
by Miles Johnson and David Oakley - Financial Times
The cost of Spanish borrowing soared to 11-year highs on Thursday as political turmoil in Greece raised fears of contagion in the eurozone debt crisis and sent investors scurrying for safety. Spanish 10-year bond yields, which move inversely to prices, jumped to 5.74 per cent at one point, above the closing high of 5.63 per cent seen in September 2000.
Investors said that the uncertainty surrounding the Greek government and worries over when Athens would get the next instalment of bail-out loans from the International Monetary Fund were weighing on bond markets. Greek two-year bond yields also surged to fresh euro-era highs, while the euro slumped to a three-week low against the dollar. A Spanish government debt auction failed to raise the maximum €3.5bn planned by Madrid, contributing to the surge in benchmark Spanish bond yields.
Spain sold €1.51bn of 15-year debt at a yield of 6.027 per cent, up from the 5.953 per cent premium investors demanded at a similar auction late last year. The so-called bid-to-cover ratio for the 15-year debt auction, a measure of investor demand for the sale, rose slightly to 2.57 times compared with the 2.52 level seen in the December sale. Spain also auctioned €1.33bn of 8-year bonds, raising a total of €2.84bn, below the maximum €3.5bn the government had targeted.
The premium Spain pays over Germany to borrow for 10 years rose to 282 basis points, creeping back towards a record level of just less than 300 bps hit at the end of November last year. Spain’s socialist government has suffered political fallout from its programme of austerity measures to reduce the country’s public sector deficit to 6 per cent this year, with the socialist party last month succumbing to its worst local election defeat in the post-Franco era.
In the latest outbreak of public anger at Spanish austerity measures Catalan politicians were forced to travel into the regions’ parliament by helicopter after a large crowd staged a protest and attempted to block a budget debate on Wednesday. Foreign investors who hold and purchase Spanish government bonds have also become increasingly concerned about the prospect of "hidden debt" concealed within the country’s powerful regional administrations, which can be difficult to fully consolidate into Spain’s overall accounts.
Madrid has called on the regional governments to deliver a deficit of 1.3 per cent of gross domestic product in 2011. But Barclays Capital analysts expect that deficit to be 1.8 per cent and Spain’s total deficit to be 6.5 per cent as a result, higher than the targeted 6 per cent. European equity markets slid further, falling within a few points of their March lows. Banks bore the brunt of the selling again and the pan-European banking sector on the FTSE Eurofirst 300 has now fallen 6.5 per cent in June, compared with the index’s 5.2 per cent drop.
Concerns about the strain on banks of holding eurozone periphery debt were highlighted on Wednesday by Moody’s, which warned it may cut its rating on French banks due to their exposure to Greek sovereign debt. The euro dropped to a three-week low against the dollar and a record trough against the Swiss franc.
Ireland Snubs ECB Effort to Avoid Meltdown With Threat to Bank Bondholders
by Jana Randow and Simon Kennedy - Bloomberg
Ireland opened a new front in the drive to restructure debt on the euro area’s periphery, adding to the European Central Bank’s concerns as it tries to head off another wave of financial turmoil.
Irish Finance Minister Michael Noonan said yesterday that senior bondholders should share in the losses of Anglo Irish Bank Corp. and Irish Nationwide Building Society, reversing a policy of protecting owners of senior securities. The ECB is against imposing losses on investors. President Jean-Claude Trichet said on Feb. 7 that haircuts aren’t part of a plan to reduce Ireland’s debt load.
Ireland’s about-face on bondholder involvement in its banking crisis comes as European lawmakers struggle to settle a dispute over how to avoid a Greek sovereign default. While German Finance Minister Wolfgang Schaeuble said last week that Europe’s biggest economy insists on the participation of the private sector, his French counterpart Christine Lagarde has ruled out any action that constitutes a "credit event," backing the ECB’s view.
"Noonan must be kidding," said Klaus Baader, an economist at Societe Generale in London. "It’s not so much money-saving as a way of Ireland trying to improve its bailout terms, just as the Eurogroup is focused on Greece. Naturally, it means investor stress and increases pressures on bank funding. The ECB won’t take this particularly seriously, but the annoyance factor is extremely high." The Frankfurt-based ECB, which sets monetary policy for the 17 nations sharing the euro, declined to comment.
Greece, Ireland and Portugal have already secured bailout packages worth a combined 273 billion euros ($385 billion) to help them reduce debt levels and budget deficits.
Ireland, which has injected a combined 34.7 billion euros into Anglo Irish and Irish Nationwide over the past two years, is merging both lenders and winding down their assets over a 10- year period. The government had previously said it wouldn’t seek to impose losses on senior bondholders unless the lenders need additional capital. The Irish central bank said last month neither would need a further cash injection. Noonan was referring to Anglo Irish and Irish Nationwide’s senior unguaranteed, unsecured bonds. These total 3.8 billion euros, the central bank said on April 1.
Noonan said in an interview in New York today that he’ll seek to discuss Anglo Irish’s senior debt with the ECB in the autumn. He told Bloomberg Television’s "In Business" with Margaret Brennan that his comments yesterday related to Anglo Irish and Irish Nationwide alone. There is "no question whatsoever of bondholders being touched" at the "pillar banks" Allied Irish Banks Plc and Bank of Ireland Plc, he said. "We’ll pay every last red cent." The government won’t act unilaterally in its aim to share losses with investors, he said.
"The ECB’s position was justified on financial stability concerns for Ireland, as well as on grounds of potential contagion for other European banking systems," said Antonio Garcia Pascual, chief economist for southern Europe at Barclays Capital in London. "Ongoing concerns on financial stability, especially in European periphery financial institutions, could make contagion remain a relevant issue for ECB’s stance on this issue."
The ECB’s dispute with the German government over private- sector involvement in a Greek bailout has helped send the credit default swaps of Ireland, Greece and Portugal to records. While European Union leaders were scheduled to hammer out their differences at a June 23-24 summit, European Economic and Monetary Affairs Commissioner Olli Rehn said today an agreement won’t come until July 11.
Ireland secured a bailout package of 85 billion euros on Nov. 28 after it was locked out of credit markers due to concerns about its ability to cope with its bank debt and budget deficit. The government has failed to negotiate a reduction of the 5.8 percent interest rate on its aid loans because it has resisted pressure to raise its 12.5 percent corporate tax rate.
Greece, which remains shut out of financial markets a year after its initial 110 billion-euro bailout, sent fresh shockwaves through markets yesterday. As violence erupted on streets in Athens, Prime Minister George Papandreou announced he would name a new government and call for a vote of confidence in parliament in an effort to pressure rebel lawmakers into backing an austerity plan that would secure a new bailout and avert a default. The risk that euro-area banks holding Greek government bonds will be saddled with losses has jumped after Standard & Poor’s slapped Greece with the world’s lowest credit rating on June 13.
"Greece could have a contagion effect," ECB Vice President Vitor Constancio said yesterday. "That’s the reason why we are against any sort of default with haircuts and any form of private-sector event that could lead to a credit event or a rating event."
The euro fell to $1.4074 in New York, the weakest level since May 26, before paring its decline. The cost of protecting European corporate bonds soared to the highest level since January and credit default swaps anticipated an 81.5 percent chance that Greece won’t pay its debts. The cost of insuring against default on Irish and Portuguese government debt also surged to records.
"Given the amount of pressure the ECB is under on Greece and its hardening position against any private-sector involvement, I don’t think they’ll be changing their position on Ireland at this stage," said Giada Giani, an economist at Citigroup Inc. in London.
Ignored Greek Default Risk Makes EU Bank Stress Tests 'Irrelevant'
by Gavin Finch, Boris Groendahl and Liam Vaughan - Bloomberg
European Union stress tests on the region’s banks are becoming "irrelevant" because they ignore the possibility of a default by Greece. "Everybody is so concerned about Greece defaulting and the effect that’s going to have on banks, yet that’s not something even being considered as part of the stress tests," said Jane Coffey, head of U.K. equities at Royal London Asset Management, which manages about $51 billion. "Greece defaulting isn’t exactly a black swan event. There’s a very good chance it will happen."
The cost of insuring Greek government debt against the risk of default surged to a record yesterday as concern mounted that policy makers will struggle to stop the crisis. Credit-default swaps indicate an 82 percent chance Greece will fail to meet its commitments within five years, according to CMA prices. The cost of insuring Irish and Portuguese government bonds also hit records this week, driving a gauge of European bank bond risk to the highest level since January.
The European Banking Authority, set up by the European Union last year to oversee the tests, won’t include a Greek default in the scenarios in the second annual assessment of banks’ resilience to economic shocks. European bank stocks have fallen 12 percent since last year’s tests, led by the EBA’s predecessor. Allied Irish Banks Plc, which passed those tests, later required a taxpayer bailout. "The stress tests have lost all credibility and look like a complete waste of time for all involved," said Lex van Dam, a London-based fund manager at Hampstead Capital LLP, which oversees about $500 million. "They are totally irrelevant."
The EBA can’t include a sovereign default in the stress tests because that would lend credence to the possibility of such an event happening and undermine confidence in the region, said Richard Reid, an economist at the London-based International Centre for Financial Regulation. Credit-default swaps on Greece soared 435 basis points to 2,189 yesterday, Ireland rose 37 basis points to 799, and Portugal climbed 21 basis points to 806. The average cost of insuring the debt of 13 of Europe’s biggest banks surged 6 basis points to 163, the highest since Jan. 14.
"Politically it’s very difficult for the EBA to assume a sovereign restructuring," said Richard Barnes, the primary credit analyst for European banks at Standard & Poor’s Ratings Service. "But by requiring the banks to publish their sovereign exposures, investors and other market participants are given the means to adjust the stress-test results however they like."
Officials at the EBA didn’t respond to requests for comment. The London-based regulator has said it has toughened the tests after criticism that last year’s weren’t stringent enough. The disclosure of banks’ bond holdings by country will allow analysts to model their own scenarios. The watchdog will also "check what banks are doing with reference to some sovereign exposures and see whether they’re taking a conservative attitude" when valuing the assets, Enria said in an interview in April.
"We want more certainty on what exposures are, and for a lot of the banks the last disclosure is from the stress tests last year," said Philip Richards, a banking analyst at Societe Generale SA. "Everything that’s going on and might happen in Greece makes the stress test more important and not less."
French Banks Cut
German lenders were the biggest foreign owners of Greek government bonds with $22.7 billion in holdings last year, the Bank for International Settlements said last month. French banks were second with $15 billion. At the end of 2010, Greek bonds held by banks in countries reporting to the BIS totalled $54.2 billion, of which 96 percent was owned by European lenders. BNP Paribas SA, France’s biggest bank, Societe Generale and Credit Agricole SA may have their credit ratings cut because of their investments in Greece, Moody’s Investors Service said this week.
The EBA, led by former Italian banking supervisor Andrea Enria, has been carrying out the tests since April, and may publish the results in July. A date for publication hasn’t been set formally because the EBA has said it must ensure it is satisfied with the quality of submissions from the banks. Ninety-one banks will be expected to maintain a Core Tier 1 capital ratio of at least 5 percent under the stress-test scenarios, the EBA said. That capital measure is stricter than last year’s assessment, which had a pass rate of 6 percent Tier 1 capital, a measure of financial strength that encompasses a broader range of securities.
This year’s exams will test banks’ resilience to a 0.5 percent economic contraction in the euro area, a 15 percent drop in equity markets and a 125 basis point jump in short-term inter-bank financing costs. "The main weakness is that the stress scenario in absolute terms is milder than what we do when we’re doing similar exercises," said Richard Barnes, the primary credit analyst for European banks at Standard & Poor’s Ratings Service.
S&P’s own stress test, published in March, found European banks would need as much as 250 billion euros ($354 billion) in fresh capital if faced with a "sharp" increase in yields and a "severe" economic downturn. In contrast, a survey of 113 investors by Goldman Sachs Group Inc. published last week showed they expect banks to raise 29 billion euros after the tests.
'Taking Them Seriously'
Last year’s tests were criticized for not being tough enough because lenders in the 27-nation region were shown by regulators to need only 3.5 billion euros of additional capital, about a 10th of the lowest analyst estimate. "This feels very similar to last year when the Irish banks passed the stress tests and then duly collapsed," said Bruce Packard, a banks analyst at Seymour Pierce in London. "It is difficult to see who exactly they are for, but I see little evidence that the buy-side is taking them seriously."
What’s going on in Greece now is war – journalist
[On Wednesday], anti-government protests in debt-stricken Greece have turned violent. Demonstrators clashed with police forces after tear gas was used to disperse protesters. People in central Athens are protesting against new austerity measures to aid the economy. They formed a human shield around the Greek parliament to prevent lawmakers from debating the issue Wednesday afternoon. Tens of thousands of protesters started to throw stones and firebombs at the police in response to tear gas. Between 25,000 and 27,000 demonstrators were on the streets of the capital by the middle of the day, police said.
"People in Athens protested very peacefully as they [have done] for more than 70–80 days and what is going now is beyond logic. It is a war with helicopters, with motorbikes, with Molotov [cocktails] and chemical stuff," journalist Stylianos Chrysostomidis, who was at the scene, told RT.
Protesters are not satisfied with the new measures. They say the money is not going into the country’s economy. "Everybody in Greece knows that all the money they take, all these billions they go to derivatives, securities of the banks, and they go to the bonds. They don’t come to the real economy of Greece. All the money we take is in order to pay high interest rates. This is robbery. And the problem for the now is that people know that," Chrysostomidis said.
Economic analyst and international lawyer Nick Skrekas says that Greeks are very disappointed, and many of those who gathered in the streets would like to see new regime in the country.
"They had not been told that the national dept was going up 17 per cent. So other than just the obvious trigger of austerity and a plan to increase taxes, make cuts about 6.5 billion for this year alone and another 22 billion in 2015, plus a fifty billion [euro] privatization program – there is more than enough unhappiness to go around," Skrekas said. "I think there are many that would like to see a completely new political system with fresh faces, and no one is holding to powerful interests inside and outside the country. There are some parallels which can be drawn with the Arab Spring," he added.
Global markets view Greek measures as hollow
by Christopher Spink - International Financing Review/Thomson Reuters
Global markets started to realise comprehensively on Thursday that Greece's debt levels are unsustainable and that adding further loans to them, in the form of international bailouts, will exacerbate rather than ameliorate the situation.
The country's borrowings are expected to rise to 170% of GDP by June 2013 when the original three-year 110bn euros bailout package from the European Union and International Monetary Fund was meant to come to an end. This was designed to be sufficient to cover the country's funding needs over that period.
However, Greece was also expected to return to the market and issue bonds to cover 60bn euros of redemptions during the second half of that period from next January. With some Greek five year bonds now offering a yield to maturity of 27.6%, or more than four times the rate at which the country is borrowing money from its official creditors, it seems highly improbable it will be able to, at anything like a reasonable rate.
To get over this hump the EU and IMF have indicated that they are prepared to stump up a further package, provided this will flesh out further austerity measures by Greece, a more detailed privatisation programme and possible participation by private sector creditors.
However, reaching agreement on the top-up has proved an immense test of diplomacy. The European Central Bank has resisted moves to restructure existing debt, which Germany is almost insisting upon. And the IMF has said unless the EU will guarantee the 60bn euros funds, the 12bn euros tranche of funding from the existing bailout package, due on June 29, will not be paid.
Meanwhile the EU has said it will only put up the extra money required in 2012 and 2013 if the Greek Parliament shows all-party support for the amended austerity package. Prime Minister George Papandreou's party is losing members and his majority looks threatened. This comes amidst a background of civil unrest with the populace fiercely opposed to these harsher terms.
However, even after the EU's economic commissioner Olli Rehn said that he had agreed with the IMF to disburse the next tranche of the original package, thus avoiding the issue of possible default this summer, markets seem unconvinced a more fundamental restructuring can be avoided. CDS on the five-year Greek debt widened by a fifth to 2083bp, as an unplanned default loomed as a real possibility.
If that happened then the ECB, if not the Eurozone, would face an existential crisis. As lender of last resort the ECB would theoretically be bound to prop up Greek banks, whose capital primarily consists of Greek sovereign debt. Greek banks fell on average 4% on Thursday to new euro-era lows even though Credit Suisse, believes a 35% haircut on their sovereign debt holdings is already priced in.
That in turn would require the ECB's equity owners, the major Eurozone economies, to provide more capital to the bank. That is before possible contagion to other Eurozone sovereigns and their banks in vulnerable countries such as Ireland, Portugal and Spain, is even considered.
"I am confident that next Sunday, the Eurogroup will be able to decide on the disbursement of the fifth tranche of loans for Greece in early July. And I trust that we will be able to conclude the pending review in agreement with the IMF," said Rehn. He added that he hoped Eurozone finance ministers would agree final details on the top-up package at a meeting on July 11. Meanwhile on Friday Germany's Chancellor Angela Merkel meets French President Nicolas Sarkozy to discuss a possible compromise.
Interest Rate Swap Spreads Widen Most Since November on European Debt Woes
by Liz Capo McCormick - Bloomberg
U.S. interest-rate swap spreads widened the most since November after Moody’s Investors Service said it may cut the credit ratings of three French banks with investments in Greece.
The difference between the U.S. two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, widened 4.6 basis points to 24.75 basis points. That was the largest increase since Nov. 30 when the spread widened by 6.5 basis points. The spread is based in part on expectations for the London interbank offered rate, or Libor, and used to gauge investor perceptions of credit risk.
BNP Paribas SA, France’s biggest bank, and local rivals Societe Generale SA and Credit Agricole SA may have their credit ratings cut by Moody’s. The rating company placed the three banks’ ratings on reviews that will focus on their holdings of Greek public and private debt "and the potential for inconsistency between the impact of a possible Greek default or restructuring and current rating levels," the ratings company said in a statement today.
"There is some worry that with what is going on in Greece there will be downgrades and this will cause a problem in funding and result in a rise in Libor," said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG. "Swap spreads are widening as direct result of these concerns."
The move by Moody’s reflects Europe’s deepening debt crisis, centered on Greece, where bond yields touched a record for the euro area today. Pressure on European governments to craft a second rescue plan for the country intensified this week after Standard & Poor’s slapped Greece with the world’s lowest credit rating.
A drop in Treasury two-year yields today also helped widen swap spreads. Yields on two-year notes dropped six basis points, or 0.06 percentage point, to 0.38 percent, the biggest since April 15 on an intraday basis. Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.
Hardline IMF forced Germany to guarantee Greek bailout
by Ian Traynor - Guardian
Germany was forced to agree to bail out Greece for the second time in a year under strong pressure from the International Monetary Fund following the resignation last month of its head, Dominique Strauss-Kahn, the Guardian has learned.
Under its acting chief, the American John Lipsky, the IMF has taken a more hardline stance. The fund warned the Germans in recent weeks that it would withhold urgently needed funds and trigger a Greek sovereign default unless Berlin stopped delaying and pledged firmly that it would come to Greece's rescue. Senior officials and diplomats in Brussels confirmed that the IMF threat to pull the plug on its funding, in stark contrast to the more emollient line of Strauss-Kahn, had been defused because of a German climbdown.
As political turmoil continued in Greece on Thursday, with the prime minister, George Papandreou, scrambling to form a fresh government, the stage was being set for a political struggle between Europe's powerbrokers over the fine print of the proposed new €100bn-plus rescue of Greece. Berlin is deeply at odds with France and with the key EU institutions – the European Central Bank (ECB), the European commission, the presidency of the EU, and the head of the eurozone, Jean-Claude Juncker, prime minister of Luxembourg – over the terms of a deal.
While conceding the need for the fresh bailout, Berlin is insisting that the banks and other private creditors holding Greek debt take losses as part of the rescue plan, which is expected to amount to €125bn (£110bn), or about €90bn if the Germans succeed in forcing losses on holders of Greek bonds.
Although international stock markets enjoyed a calmer day on Thursday, Juncker believes that imposing losses on investors could trigger a European version of the Lehman Brothers bank collapse – a so-called "credit event". Juncker said: "It's a really ugly situation. The [German] idea is dangerous. It could provoke the gravest risk, that all three rating agencies declare a credit event and then there are big contagion risks for other countries."
Nout Wellink, a member of the ECB's governing council, warned that the EU bailout fund would have to double to €1.5tn if Greece does fail to pay its debts and spreads financial turmoil to other countries. French president Nicolas Sarkozy goes to Berlin on Friday for a summit with German chancellor Angela Merkel, with the aim of stitching up a compromise.
Under Greece's first €110bn bailout, shared by the EU and the IMF, a fifth tranche of €12bn is to be disbursed next month. Publicly, the IMF had been threatening to withhold its share of the money unless Greece's funding gap for 2012 is closed. But Olli Rehn, the European commissioner for monetary affairs, said on Thursday that the EU and the IMF had agreed to throw Greece the €12bn lifeline by next month to forestall a default.
Privately, sources said that Lipsky challenged the Germans on the fringes of a G8 summit in France almost three weeks ago, and demanded that Berlin guarantee Greece's borrowing requirements and put a figure on the pledge. The IMF ultimatum came a week after Strauss-Kahn, a former French presidential contender, resigned as IMF chief following his New York arrest on charges he denies of attempted rape and sexual assault of a hotel chambermaid.
Berlin blinked, according to participants in the negotiations, and 10 days after the IMF challenge, the Merkel government admitted for the first time that Greece would need a new bailout. But it stoked further controversy by demanding that Greece's private creditors take losses on their loans.
Before a series of crucial EU meetings starting this weekend, Berlin looks increasingly isolated in its demands, spelling trouble for Merkel at home, where the rescue of spendthrift eurozone countries is deeply unpopular. Merkel's junior coalition partner, the liberal Free Democrats, on Thursday reiterated the need for the banks to take some of the pain in the Greek crisis. The rescue scenario is also hostage to developments in Greece, with European leaders anxiously eyeing the political turmoil in Athens and questioning whether Papandreou would be able to deliver on his side of the bargain: savage spending cuts and tax increases aimed at raising €28bn, combined with a €50bn privatisation programme.
"We expect the Greek parliament to endorse the economic reform programme as agreed by the end of June," said Rehn. "We will not let the euro area face any kind of catastrophe." The turmoil sent the euro tumbling to a record low versus the safe-haven Swiss franc, and intensified pressure on the region's other lower-rated states, highlighted by weakening demand at a Spanish bond auction. Senior officials in Brussels worried that time was running out. Papandreou's attempt to form a government, win a vote of confidence and then drive the austerity package through parliament could take longer than scheduled, jeopardising the planning in European capitals.
Greek banks and the leaked options paper
by Peter Spiegel - Financial Times
As expected, Tuesday evening’s meeting of eurozone finance ministers to discuss a new Greek bail-out produced few results, other than an agreement to meet again Sunday evening. That session will be a last-gasp effort to reach a consensus before Monday’s much-anticipated formal ministerial meeting, where officials are hoping a deal can be finalised.
But as we reported in today’s paper, the assembled ministers got a pretty dire picture of what would happen if they decided to proceed with a German-backed plan to get private investors to take part in the bail-out by swapping most existing Greek bonds with new bonds that wouldn’t have to be repaid for seven years.
To give Brussels Blog readers more insight into the thinking of the European Commission, which produced the memo outlining the scenario for eurozone ministers – titled "Options for private-sector involvement in financing a macro-economic adjustment programme for Greece: Note for the Europgroup" – we thought we’d post a few relevant exceprts.
The first excerpt is from a section listing the "advantages/disadvantages" of the German-backed plan. The advantages of the plan have always been obvious: by using an "extensive set of coercive incentives", the programme could guarantee high participation of private bondholders, allowing new bail-out loans from the EU and IMF to be smaller.
The disadvantages are also pretty well known, but in the Commission’s wording, they sound quite alarming. Greece will default; other teetering eurozone counties – presumably Ireland, Portugal and Spain – will see runs on their sovereign bonds; and Greece may not be able to raise money in the financial markets for years to come. (For those uninitiated to the jargon of the bond market, "SD" means "selective default".):The main disadvantage of the operation is that, although it is still a legally-speaking voluntary operation, the degree of coercion required to achieve the high participation rate will certainly result in Greece entering an SD status. This outcome will heighten contagion risk, as investors in government bonds in other Member States will most likely take pre-emptive action to avoid the risk of similarly coercive measures in other Member States. The high degree of coercion inherent in this option would in all likelihood be seen by markets as indicating that a hard debt restructuring in subsequent years has become more likely, thus carrying the risk that Greece would not be able to return to the market at the end of the programme period.
The other issue we highlighted in our story this morning is the previously undisclosed concern about Greece’s banking sector. Because Greek banks hold a significant portion of Greece’s sovereign debt, there would need to be a recapitalisation from EU government loans totalling as much as €20bn. And because Greek bonds would be suddenly rated "default", the European Central Bank would no longer accept them as collateral for bank liquidity, meaning that even before the bail-out began, there may have to be money pumped into the Greek banking system from even more international loans:These [bail-out] amounts exclude the potential need to set aside additional resources to enhance the capital base of the Greek banking system, which could reach €15-€20bn under the conservative assumption that banks are recapitalised to withstand an upfront recognition of current depressed market prices [of Greek bonds]. Finally, additional resources may need to be temporarily deployed if the ECB could not accept SD rated collateral for refinancing operations, in which case a cash reserve buffer may need to be established to enhance the government guarantees during the period when the issuer is rated SD.
One final issue regarding the Greek banks, which we really didn’t touch on in today’s paper, is the issue of an old-fashioned run on the banks. In a separate analysis in the paper labelled "Potential impact of PSI on Greek banks" – PSI stands for private-sector involvement – the Commission notes that there’s already been some panic withdrawals, and warns they could accelerate:A PSI operation would elevate the risk of a deposit run. The banking system has already been contending with elevated deposit outflows, due early in the year to the recession but more recently also reflecting fears about the impact that a disorderly sovereign debt restructuring could have on bank solvency. Moving towards maturity extension would likely lead to some additional deposit outflows, with the risk of a full-blown bank-run.
All in all, not a pretty picture.
Default by Greece 'Almost Certain': Greenspan
by Vivien Lou Chen - Bloomberg
Alan Greenspan, former Federal Reserve chairman, said a default by Greece is "almost certain" and could help drive the U.S. economy into recession. "The problem you have is that it’s extremely unlikely the political system will work" in a way that solves Greece’s crisis, Greenspan, 85, said in an interview today with Charlie Rose in New York. "The chances of Greece not defaulting are very small."
Greek government bonds slumped, pushing the yield on the two-year note above 30 percent for the first time, as Prime Minister George Papandreou’s failure to win support for more austerity fueled speculation the European country will fail to meet its obligations. More than 20,000 people protested in Athens this week against wage reductions and tax increases, with police using tear gas on crowds and strikes paralyzing ports, banks, hospitals and state-run companies.
The chances of Greece defaulting are "so high that you almost have to say there’s no way out," said Greenspan, who ran the central bank from 1987 to 2006. That may leave some U.S. banks "up against the wall."
Greece’s debt crisis has the potential to push the U.S. into another recession, Greenspan said. Without the Greek issue, "the probability is quite low" of a U.S. recession, he said. "There’s no momentum in the system that suggests to me that we are about to go into a double-dip," Greenspan said.
Economic data released today show confidence in the expansion eroding among Americans and businesses, as unemployment remains above 9 percent.
U.S. Debt Limit
The U.S. recovery is being hindered by apprehension among businesses over the long-term outlook, and there’s nothing more for Fed policy makers to do, Greenspan said. U.S. lawmakers are wrangling over spending cuts and budget reforms as they seek an agreement to increase the $14.3 trillion debt limit before Aug. 2, the date on which the Treasury Department said it will have exhausted its borrowing authority. The U.S. debt issue is becoming "horrendously dangerous," said Greenspan, who added he doubts lawmakers have another year or two to solve it.
After leaving the Fed, the former chairman founded the consulting firm Greenspan Associates and became a consultant or adviser to Deutsche Bank AG, Pacific Investment Management Co. and Paulson & Co., a hedge-fund firm that profited from the collapse of the U.S. subprime-mortgage market.
Greenspan, appointed Fed chairman by Republican President Ronald Reagan, was once described as "the greatest central banker who ever lived" by economist Alan Blinder, the central bank’s former vice chairman. He has since been blamed for contributing to the U.S. financial crisis by keeping interest rates low for too long and failing to regulate the mortgage market, according to critics including Allan Meltzer, a professor at Carnegie Mellon University in Pittsburgh, and members of the Financial Crisis Inquiry Commission.
Indirect US Exposure to the Euro Debt Crisis, part 2
by Kash - Street Light
As last week's new BIS data showed, it appears that US banks indirectly have substantial exposure to the peripheral Euro-zone countries that are teetering on the edge of bankruptcy. Exactly what form that exposure takes is a bit uncertain, though it seems likely that much of it is in the form of credit default swaps (CDS) written by the US banks to provide insurance against default to the holders of bonds from Greece, Ireland, and Portugal.
But it's a bit frustrating not to have a clearer understanding of exactly what form this exposure takes. So I've been trying to see if there is any public information that can give us a hint about exactly how the big US banks have incurred such exposure.
Unfortunately, it's very difficult to get any good information about banks' derivatives exposures. The major US banks tend to downplay their exposure to the Euro debt crisis in their SEC filings. For example, in their 2010 10-K filing Bank of America wrote:Certain European countries, including Greece, Ireland, Italy, Portugal and Spain, are currently experiencing varying degrees of financial stress. These countries have had certain credit ratings lowered by ratings services during 2010. Risks from the debt crisis in Europe could result in a disruption of the financial markets which could have a detrimental impact on the global economic recovery and sovereign and non-sovereign debt in these countries. The table below shows our direct sovereign and non-sovereign exposures, excluding consumer credit card exposure, in these countries at December 31, 2010. The total exposure to these countries was $15.8 billion at December 31, 2010 compared to $25.5 billion at December 31, 2009.
In fact, B of A's direct exposure to Greece is listed at only about $500 million. But note that that is their direct exposure. What we learned from the BIS data is that they also have indirect exposures, which probably arise primarily through their credit derivatives purchases and sales.
The following table summarizes all of the useful information I could gather about credit default derivative activities from the 2010 annual SEC filings of the six largest banks in the US. It's not much, and doesn't really answer our original question, so mainly this just confirms what we have no way of knowing which US banks are exposed to the Euro debt crisis or why.
Let me walk you through the figures in this table. The first line shows CDS contracts sold by each bank -- essentially how much insurance against default each bank sold to third parties. Note that some of that insurance was on non-investment grade assets (which would include Greece, of course). That's the second line.
Now, it's often the case that a bank doesn't want to have an open position on that contract -- in other words, it doesn't really want to make the bet that the underlying asset will remain sound. In those cases the banks purchase default insurance themselves on the same asset. The effect is that the bank is then just making money on the spreads and fees, but has nothing to gain or lose based on whether the underlying asset defaults.
If you subtract line 3 from line 1, then you have the net open positions taken by each bank on the credit default insurance it has written. That line is highlighted in the table above, because that tells us how active each bank has been in actually placing bets on default outcomes. No details are provided by the banks about where those exposures are, however, either geographically or by type of underlying asset.
Finally, the last line is also somewhat interesting, because it tells us how much income each bank earned from their trading in CDS as well as their betting (taking open positions) on default events. Obviously, if you do it right you can really make some good money in the CDS market -- over $9 billion in 2010 for B of A. Note that every month that goes by without a Greek default is great for the sellers of default insurance on Greek assets, so it could well be that some of these banks are making a killing right now on the default insurance they've sold.
What can we conclude from this? I can think of a few things.
- Bank of America, Morgan Stanley, and Goldman Sachs are the most aggressive in terms of taking open positions on default outcomes. But we have absolutely no idea how much of those positions (if any) were with peripheral Euro assets. Also, while the last two firms don't break out income attributable to CDS activities (at least not that I could find), B of A made a huge portion of their profits in 2010 from them. (Note that Citi did not indicate how much of the CDS protection that they sold was covered by purchases of CDS insurance, so they may or may not be in that list as well.)
- The aggregate CDS exposures of the big US banks are certainly large enough to be plausibly consistent with the BIS estimate of about $100 bn in indirect exposures to peripheral Europe. If you add up the highlighted numbers (and make a guess at Citi's position), it seems reasonable to guess that the total net open positions on CDS protection sold to third parties by the big US banks is between $1,500 and $2,000billion. Attributing $35 bn of that (about 2%) to Greece, which has certainly had one of the most active markets (proportionally) for CDS contracts over the past year, doesn't seem to be a stretch.
- Banks do not have to provide much detail about the indirect credit exposures that they take on when they sell default insurance through the CDS market. We have incredibly scant information about the positions that US banks take through default insurance, and therefore no idea about how any individual bank will be affected by a Greek default.
- It's hard to find any other potential exposures to Greece, Ireland, and Portugal in the banks' public filings, other than through CDS contracts. Combined with points 2 and 3 above, the process of elimination suggests to me that CDS contracts are indeed likely to be the source of the bulk of US banks' indirect exposures to a Euro-zone default.
Finally, a note about the risk this poses to the US banking system. The big US banks are well-capitalized now, and can fairly easily absorb losses of several billions of dollars in the event of a Greek default. But two serious concerns remain. First, I fear that this may have the potential consequence of exacerbating the flight to safety that will happen in the event of Greece's default; if you have no idea who is really going to be on the hook and ultimately liable for CDS payments, your best strategy may be to trust no one. I don't think that triggering post-traumatic flashbacks of the fall of 2008 is going to do good things to the market or the economy. Second, I wonder if there's a public relations disaster just lying in wait for the big US banks. After all, how will you feel (assuming you don't work on Wall Street) when you read the headline that Big Bank X lost money because it sold billions of dollars of credit default insurance while it was on taxpayer life-support? Rightly or wrongly, I'm guessing that Big Bank X will not be very popular for a while.
Greek crisis threatens European decade of economic implosion
by Mohamed El-Erian - Financial Times
From day one, immense challenges faced the coalition of international institutions that opted for a liquidity approach to address Greece’s debt solvency problems. Now that this coalition is stumbling and bickering publicly, the outlook for Greece has taken a significant turn for the worse. Even as George Papandreou, the Greek prime minister, prepares to reshuffle his cabinet, he must know his nation’s predicament is now extremely hard to reverse.
It is now commonly accepted that Greece’s predicament is due to two inter-related problems: the economy is unable to grow, and the debt burden is enormous. Yet neither has influenced sufficiently the approach that has been adopted by the crisis management coalition, consisting of the Greek government, its European creditors (namely other eurozone governments, the European Commission and the European Central Bank) and the International Monetary Fund.
Instead, the focus has been on dramatic austerity for Greece and massive loans from the official creditors. Not surprisingly, every economic, financial and social indicator for the Greek economy has deteriorated. This has happened both in absolutes term and, more alarmingly, relative to the coalition’s already grim expectations. Such failure naturally encourages a blame game, and sadly that is exactly what is now happening.
Judging from other crisis management episodes around the world, it is normal for both the Greek government and its people to feel let down by European neighbours who they feel under-appreciate the sacrifices made by its population, especially since these same creditors refused to lower interest rate on new loans. Equally, it is normal for the creditors to complain that it is Greece that is not doing enough to counter what is, after all, a home-grown problem.
In principle, these gaps need not be fatal. Yet the current attempts to bridge them are nowhere near enough. They would do little beyond, at best, prolonging for a few months an already unsustainable situation. More likely, they would be undermined rapidly by two recent developments that suggest that the current approach to crisis management in Greece is coming to its end.
First, and most importantly, the Greek government is losing control of the streets. As protests turn increasingly ugly, the pursuit of a national political consensus becomes even more elusive. This is especially true if all Mr Papandreou, or another leader, can offer is a step back to a discredited approach that involves sacrifices with no evidence of lasting benefits.
Second, even if Greece can deliver, European creditors fundamentally disagree among themselves as to how best to support the country — other than to push the IMF to lend more. Some, led by Germany, want fairer burden-sharing with the private sector, rather than to continue to fund both the needs of the Greek economy and full repayments to private lenders that are now exiting the country. But the ECB strongly opposes this, especially now that its balance sheet is contaminated by large holdings of Greek bonds.
Responding properly to all this is an engineering nightmare and a political headache. Critically, it now requires giving up on at least one, and more likely at least two, of the three principles that have underpinned the coalition’s approach to Greece: avoiding a debt restructuring, a currency devaluation and a change in the fiscal set up of the eurozone.
Europe faces a moment of truth. The sooner this is recognised, the greater the chance of shifting to a "plan B". If not the prospects are stark: the already-difficult outlook facing the three bail-out countries (Greece, Ireland and Portugal) will surely be compounded by a decade of internal economic implosion. The task must now be to limit fundamental contagion to countries that are yet to be bailed out (notably Spain), and to maintain the integrity of the Euro. But the time for action is fast running out.
The writer is Chief Executive and co-CIO of Pimco, the world’s leading bond manager.
Response by Daniel Gros
Argentina v. Greece : 5-nil?
Almost all independent observers of Greece have stressed from the beginning that Greece was facing a solvency, not a liquidity problem. This was also the case 10 years ago with Argentina; a country that had achieved financial stability by entering into a "quasi" monetary union using the US dollar and which had privatised every available public asset.
But the country during the late 1990s then ran a succession of twin deficits, both fiscal and external current account. When foreign creditors started to doubt the ability of the country to service the debt it had thus accumulated, the international community responded with very large financial support packages financed both by the International Monetary Fund and Spain because Argentina was supposed to face only a liquidity problem.
However, even a succession of three packages, of rapidly growing size, could not avert default because investors were not convinced, and the resistance of the population grew, along with the austerity efforts of the government. How should one assess the chances of Greece avoiding an Argentine scenario today? A quick look at the fundamentals (Greece today versus Argentina before the default) is not encouraging:
Debt level (% of GDP): GR: 150% v. ARG: 50 %
Fiscal deficit (% of GDP): GR: 12% v. ARG: 5 %
Current account deficit (% of GDP): GR: 10% v. ARG: 2 %
Growth (real GDP): GR: -3% v. ARG: -2 %
Deposit flight (% change in bank deposits): GR: -10% v. ARG: -7 %
On these five fundamental indicators of an impending crisis it is thus five to nil for Argentina. So where are we heading? As in Argentina in 2001 the population of Greece seems determined today to push the country towards the worst of all options: a disorderly default without having implemented first the structural reforms which would allow the country to emerge leaner and stronger from this "catharsis". There is very little Europe can do to avoid this outcome.
The writer is the director of the Centre for European Policy Studies, a Brussels-based think-tank.
Germany climbs down over Greece bailout demands
by Helen Pidd - Guardian
Agela Merkel admits defeat in struggle to extract money from private sector towards European Union rescue package
Angela Merkel has admitted defeat over Germany's plan to force private banks to contribute funds to a new bailout package designed to rescue the Greek economy. After a meeting with the French president, Nicolas Sarkozy, in Berlin on Thursday, the German chancellor said they had agreed that any contribution from private creditors to the package would have to be voluntary. "We want the participation of private creditors on a voluntary basis," said Merkel, stressing that there was no legal way in which banks could be forced to play along.
Sarkozy welcomed Germany's change of position, describing it as "a breakthrough". Merkel and Sarkozy both declined to set a date for the Greek deal to be finalised. But Sarkozy indicated that time was running out. "We want a quick fix … there is no time to waste," he said.
The summit was well received by financial markets, which have fallen sharply in recent days as investors feared that Greece would suffer a disorderly default. In London the FTSE 100 index erased early losses, and the euro strengthened against other major currencies. Greek government bonds also staged a small recovery. The yield, or interest rate, on the two-year Greek bond dropped to 28.6%, from over 30% early on Friday.
Merkel's admission was a significant climbdown from her earlier position. Berlin had lobbied noisily for the compulsory participation in a new Greek bailout of private lenders, many of whom stand to lose heavily if Greece defaults on its €300bn (£265bn) debts. Last year's first Greek bailout, part-funded by European taxpayers, was hugely unpopular in Germany, and Merkel was keen to send a message to voters that not just they, but also the banks, would be paying this time around.
Earlier this month European Union finance ministers were said to be considering a plan in which private creditors possessing Greek state bonds would be asked to cover €20bn – €35bn of the costs .
As Europe's paymaster, Germany had called for Greece's private creditors to swap their bonds for new ones with maturities that are seven years longer, but encountered fierce resistance to those plans from France, the European central bank and European commission. France in particular was adamant that trying to force private creditors into any Greek deal would be dangerous for the markets.
On Thursday the head of the eurozone, Jean-Claude Juncker, said that imposing losses on investors could trigger a European version of the Lehman Brothers bank collapse – a so-called "credit event". "It's a really ugly situation. The [German] idea is dangerous. It could provoke the gravest risk, that all three rating agencies declare a credit event and then there are big contagion risks for other countries," he said.
Merkel's meeting with Sarkozy on Friday morning in Berlin was the first face-to-face meeting between the two leaders in seven very rocky months in Franco-German relations. On Wednesday the French ambassador to Germany, Maurice Gourdault-Montagne, told a select group of German journalists that Berlin pays too little attention to its ties with Paris. The ambassador suggested Merkel did not give Sarkozky enough face time, pointing out that the last chancellor, Gerhard Schröder, agreed to more one-on-one meetings with his French counterpart when he was in power.
But at Thursday's press conference at the chancellery, Sarkozy heralded a "major breakthrough" with "our German friends". In three hours of talks, he and Merkel had at least agreed that there ideally should be some involvement on the private sector in the Greece bailout, he said. The deal was based on four principles: voluntary participation, speed, no payment default and agreement with the European central bank. Both leaders also stressed that Greece had to comply with its obligations.
The duo were keen to reach a consensus ahead of next week's EU summit in Brussels, which will see European leaders try to hammer out a Greek deal.
What if Greeks Decide They Don't Want to Be Rescued?
by Alen Mattich - Wall Street Journal
The European Union, European Central Bank and the International Monetary Fund are negotiating hard among themselves about how to structure debt relief for the Greek economy. The latest reports suggest they might have come up with a temporary deal among themselves. But what the EU, ECB and IMF want won't matter unless they get the Greek government to play as well. And that's by no means assured.
For one thing, Greeks are growing fed up with austerity and seem very unwilling to take on the still stricter conditions being demanded of them to win fresh funding and avoid default. The Greek economy has taken a beating during the past couple of years. Non-stop, large-scale political protests, routine general strikes and parliamentary rebellion have brought Athenian streets to a standstill. And Prime Minister George Papandreou's government is teetering.
Greeks are starting to question whether there might not be an easier way out of their crisis. And inevitably, Argentina's experience a decade ago has been attracting plenty of interest.
In the three years leading up to its crisis the Argentine economy struggled, contracting a total of 8.4% by the end of 2001. Strains became so great that the country defaulted on its sovereign debt, causing its economy to slump another 11% in 2002. But the unshackling of its currency from the dollar and subsequent devaluation also reignited growth. Since its 2002 low, Argentine gross domestic product will have expanded by an average annual 7.4% by the end of this year, according to IMF data. Crucially, Argentine output was back above its previous peak within three years of default.
Compare this with Greece's prospects. The IMF forecasts the Greek economy will have contracted 9.3% from its 2008 peak by the end of this year. Although the IMF expects Greece to start growing again next year, that is difficult to believe. The one constant of this crisis has been that all forecasts for Greece have been overly optimistic. Worse still, once Greece starts to grow, it is expected only to do so at an anemic rate of around 2% per year. By the end of 2016, the Greek economy will only just be back to end-2008 levels.
Greeks might well decide an Argentine solution is the only real option. In other words, an exit from the euro, default and devaluation. And maybe that's what the market is already anticipating. Barry Eichengreen, an economist at the University of California, Berkeley, famously argued that a euro-zone country couldn't leave the single currency because to do so would trigger "the mother of all financial crises." Long before the long political process necessary for any euro-zone country to leave the single currency was concluded, investors would have voted with their wallets. They'd dump the country's sovereign debt and flee its banks.
But this is pretty much what has already happened to Greece. Two-year Greek debt yields 28% while 10-year bonds are trading at less than half of face value. And for months now, depositors have been pulling funds out of Greek banks. Only the lifeline of yet more EU and IMF loans is keeping Greece in the euro. Loans that will have to be paid back. If Greeks come to think they're already near or have reached the worst-case outcome of a euro exit but are getting none of the upside, they may well start to agitate to leave the single currency.
That would put the EU and the ECB into a very difficult position. A Greek default and departure from the euro would risk a systemic crisis across Europe's financial sector because of the huge exposure of Europe's banks to Greek government debt. The EU doesn't want to give in to Greece because of the costs involved and for fear of feeding moral hazard. But as the financial crisis showed, punctiliousness goes by the wayside when the crunch becomes severe enough.
The Bank of England worried publicly about the consequences of bailing out Northern Rock but then, after the Lehman Brothers collapse, had no compunction about pumping enormous amounts of money into the rest of the U.K.'s banking sector. German, Dutch and Finnish politicians may be worried about how handing bottomless buckets of money to Greece will play out with their voters, but the alternative looks even uglier.
Ironically, were the Greeks to decide that a euro exit was not only possible, but desirable, the core EU, led by Germany, would almost certainly make huge concessions, including wholesale debt forgiveness. Of course before they did so, core euro-zone countries would have to weigh up the costs of letting Greece off the hook relative to another rescue of their banking sectors. And not just Greece. Ireland and Portugal and possibly Spain and Italy would demand some sort of easing of their national liabilities if they saw Greece getting too good a deal. This would potentially be catastrophic for the politicians making the concessions. But the more Greeks become convinced they can go it alone the better the deal the EU would have to serve up to prevent them from doing so.
Could core Europe do this without going the way of Ireland, becoming a backstop that itself goes bust under the crushing weight of others' debts? It'll be interesting to see who draws the line where in this Greek standoff.
Radiation spike halts work at Japan nuclear plant
by Hideyuki Sano - Reuters
A rise in radiation halted the clean-up of radioactive water at Japan's Fukushimi nuclear power station on Saturday hours after it got under way, a fresh setback to efforts to restore control over the quake-stricken plant.
The power plant has been leaking radiation into the atmosphere ever since the March 11 quake and tsunami and both China and South Korea have expressed concern over the possibility of further leaks into the sea. Tokyo Electric Power Company, the operator of the Fukushima Daiichi plant, said it expected to resume the clean-up within a week.
The plan hit a new hurdle as Japan marked 100 days since the earthquake and tsunami left nearly 24,000 dead or missing and knocked out cooling systems at the plant. Buddhist memorial services were held throughout the country on the day when the bereaved traditionally seek closure from grief.
A statement issued by the utility, known as Tepco, said the suspension was prompted by a faster than expected rise in radiation in a part of the system intended to absorb caesium. "At the moment, we haven't specified the reason," a Tepco spokesman told a news conference. "So we can't say when we can resume the operation. But I'd say it's not something that would take weeks."
The official said teams working at the plant believed the radiation rise could be linked either to sludge flowing into the machinery absorbing caesium or a monitoring error caused by nearby pipes carrying contaminated water. But a resumption, he said, was critical to deal with the highly radioactive water. Officials say 110,000 tons, the equivalent of 40 Olympic swimming pools -- is stored at the plant, 240 km (150 miles) northeast of Tokyo.
"Unless we can resume the operation within a week, we will have problems in disposing of the contaminated water," the official said. "But if this is caused by the reasons we are thinking, we can resume the operation within a week." The official said Tepco for the moment foresaw no delay in its overall plan to bring the Fukushima Daiichi plant fully under control by the end of the year. The plan, derided by some critics as too optimistic, calls for a shutdown of its three unstable reactors by January 2012.
Storing Contaminated Water
The company is fighting against time as the plant is running out of places to store the contaminated water. Amounts quickly accumulate as the company pumps in vast supplies to cool three reactors that went into meltdown after the tsunami disabled cooling systems. The cleanup operation is one of many steps to stabilize the reactors. It got under way only late on Friday after being delayed by a series of glitches.
Trade Minister Banri Kaieda, addressing a news conference, said he had told Tepco to resume the cleanup operation while upholding safety standards, but set no deadlines. He said government inspections showed all nuclear power plants in Japan had adequate safety measures against severe accidents and called on local governments to give the green light to restarting reactors.
Routine maintenance and public concern since the Fukushima accident have left only 19 of 54 reactors still functioning. "Power shortages are a big problem for the economy. I would like to seek the understanding of people who live near plants so we can restart power plants that are confirmed to be safe," he said.
Nuclear operators always seek local government approval in recognition of the importance of support from residents near the plant -- though such backing is not legally required. Opposition to nuclear power is growing, with one survey this week saying three-quarters of Japanese voters wanting to see a gradual phase out of nuclear power. The crisis has prompted the government to go back to "scratch" in considering the future of nuclear power.
Mainichi Shimbun reported on Saturday that Kunio Hiramatsu, mayor of Osaka, Japan's second largest city, said he would make a proposal to Kansai Electric Power, of which the city is a top shareholder, that the company eventually phase out nuclear power.
Fukushima: It's much worse than you think
by Dahr Jamail - Al Jazeera
Scientific experts believe Japan's nuclear disaster to be far worse than governments are revealing to the public.
"Fukushima is the biggest industrial catastrophe in the history of mankind," Arnold Gundersen, a former nuclear industry senior vice president, told Al Jazeera. Japan's 9.0 earthquake on March 11 caused a massive tsunami that crippled the cooling systems at the Tokyo Electric Power Company's (TEPCO) nuclear plant in Fukushima, Japan. It also led to hydrogen explosions and reactor meltdowns that forced evacuations of those living within a 20km radius of the plant.
Gundersen, a licensed reactor operator with 39 years of nuclear power engineering experience, managing and coordinating projects at 70 nuclear power plants around the US, says the Fukushima nuclear plant likely has more exposed reactor cores than commonly believed. "Fukushima has three nuclear reactors exposed and four fuel cores exposed," he said, "You probably have the equivalent of 20 nuclear reactor cores because of the fuel cores, and they are all in desperate need of being cooled, and there is no means to cool them effectively."
TEPCO has been spraying water on several of the reactors and fuel cores, but this has led to even greater problems, such as radiation being emitted into the air in steam and evaporated sea water - as well as generating hundreds of thousands of tons of highly radioactive sea water that has to be disposed of. "The problem is how to keep it cool," says Gundersen. "They are pouring in water and the question is what are they going to do with the waste that comes out of that system, because it is going to contain plutonium and uranium. Where do you put the water?"
Even though the plant is now shut down, fission products such as uranium continue to generate heat, and therefore require cooling. "The fuels are now a molten blob at the bottom of the reactor," Gundersen added. "TEPCO announced they had a melt through. A melt down is when the fuel collapses to the bottom of the reactor, and a melt through means it has melted through some layers. That blob is incredibly radioactive, and now you have water on top of it. The water picks up enormous amounts of radiation, so you add more water and you are generating hundreds of thousands of tons of highly radioactive water."
Independent scientists have been monitoring the locations of radioactive "hot spots" around Japan, and their findings are disconcerting. "We have 20 nuclear cores exposed, the fuel pools have several cores each, that is 20 times the potential to be released than Chernobyl," said Gundersen. "The data I'm seeing shows that we are finding hot spots further away than we had from Chernobyl, and the amount of radiation in many of them was the amount that caused areas to be declared no-man's-land for Chernobyl. We are seeing square kilometres being found 60 to 70 kilometres away from the reactor. You can't clean all this up. We still have radioactive wild boar in Germany, 30 years after Chernobyl."
Radiation monitors for children
Japan's Nuclear Emergency Response Headquarters finally admitted earlier this month that reactors 1, 2, and 3 at the Fukushima plant experienced full meltdowns. TEPCO announced that the accident probably released more radioactive material into the environment than Chernobyl, making it the worst nuclear accident on record.
Meanwhile, a nuclear waste advisor to the Japanese government reported that about 966 square kilometres near the power station - an area roughly 17 times the size of Manhattan - is now likely uninhabitable. In the US, physician Janette Sherman MD and epidemiologist Joseph Mangano published an essay shedding light on a 35 per cent spike in infant mortality in northwest cities that occurred after the Fukushima meltdown, and may well be the result of fallout from the stricken nuclear plant. The eight cities included in the report are San Jose, Berkeley, San Francisco, Sacramento, Santa Cruz, Portland, Seattle, and Boise, and the time frame of the report included the ten weeks immediately following the disaster.
"There is and should be concern about younger people being exposed, and the Japanese government will be giving out radiation monitors to children," Dr MV Ramana, a physicist with the Programme on Science and Global Security at Princeton University who specialises in issues of nuclear safety, told Al Jazeera. Dr Ramana explained that he believes the primary radiation threat continues to be mostly for residents living within 50km of the plant, but added: "There are going to be areas outside of the Japanese government's 20km mandatory evacuation zone where radiation is higher. So that could mean evacuation zones in those areas as well."
Gundersen points out that far more radiation has been released than has been reported. "They recalculated the amount of radiation released, but the news is really not talking about this," he said. "The new calculations show that within the first week of the accident, they released 2.3 times as much radiation as they thought they released in the first 80 days." According to Gundersen, the exposed reactors and fuel cores are continuing to release microns of caesium, strontium, and plutonium isotopes. These are referred to as "hot particles".
"We are discovering hot particles everywhere in Japan, even in Tokyo," he said. "Scientists are finding these everywhere. Over the last 90 days these hot particles have continued to fall and are being deposited in high concentrations. A lot of people are picking these up in car engine air filters." Radioactive air filters from cars in Fukushima prefecture and Tokyo are now common, and Gundersen says his sources are finding radioactive air filters in the greater Seattle area of the US as well.
The hot particles on them can eventually lead to cancer. "These get stuck in your lungs or GI tract, and they are a constant irritant," he explained, "One cigarette doesn't get you, but over time they do. These [hot particles] can cause cancer, but you can't measure them with a Geiger counter. Clearly people in Fukushima prefecture have breathed in a large amount of these particles. Clearly the upper West Coast of the US has people being affected. That area got hit pretty heavy in April."
Blame the US?
In reaction to the Fukushima catastrophe, Germany is phasing out all of its nuclear reactors over the next decade. In a referendum vote this Monday, 95 per cent of Italians voted in favour of blocking a nuclear power revival in their country. A recent newspaper poll in Japan shows nearly three-quarters of respondents favour a phase-out of nuclear power in Japan. Why have alarms not been sounded about radiation exposure in the US?
Nuclear operator Exelon Corporation has been among Barack Obama's biggest campaign donors, and is one of the largest employers in Illinois where Obama was senator. Exelon has donated more than $269,000 to his political campaigns, thus far. Obama also appointed Exelon CEO John Rowe to his Blue Ribbon Commission on America's Nuclear Future.
Dr Shoji Sawada is a theoretical particle physicist and Professor Emeritus at Nagoya University in Japan. He is concerned about the types of nuclear plants in his country, and the fact that most of them are of US design. "Most of the reactors in Japan were designed by US companies who did not care for the effects of earthquakes," Dr Sawada told Al Jazeera. "I think this problem applies to all nuclear power stations across Japan." Using nuclear power to produce electricity in Japan is a product of the nuclear policy of the US, something Dr Sawada feels is also a large component of the problem.
"Most of the Japanese scientists at that time, the mid-1950s, considered that the technology of nuclear energy was under development or not established enough, and that it was too early to be put to practical use," he explained. "The Japan Scientists Council recommended the Japanese government not use this technology yet, but the government accepted to use enriched uranium to fuel nuclear power stations, and was thus subjected to US government policy."
As a 13-year-old, Dr Sawada experienced the US nuclear attack against Japan from his home, situated just 1400 metres from the hypocentre of the Hiroshima bomb. "I think the Fukushima accident has caused the Japanese people to abandon the myth that nuclear power stations are safe," he said. "Now the opinions of the Japanese people have rapidly changed. Well beyond half the population believes Japan should move towards natural electricity."
A problem of infinite proportions
Dr Ramana expects the plant reactors and fuel cores to be cooled enough for a shutdown within two years. "But it is going to take a very long time before the fuel can be removed from the reactor," he added. "Dealing with the cracking and compromised structure and dealing with radiation in the area will take several years, there's no question about that." Dr Sawada is not as clear about how long a cold shutdown could take, and said the problem will be "the effects from caesium-137 that remains in the soil and the polluted water around the power station and underground. It will take a year, or more time, to deal with this".
Gundersen pointed out that the units are still leaking radiation. "They are still emitting radioactive gases and an enormous amount of radioactive liquid," he said. "It will be at least a year before it stops boiling, and until it stops boiling, it's going to be cranking out radioactive steam and liquids." Gundersen worries about more earthquake aftershocks, as well as how to cool two of the units. "Unit four is the most dangerous, it could topple," he said. "After the earthquake in Sumatra there was an 8.6 [aftershock] about 90 days later, so we are not out of the woods yet. And you're at a point where, if that happens, there is no science for this, no one has ever imagined having hot nuclear fuel lying outside the fuel pool. They've not figured out how to cool units three and four."
Gundersen's assessment of solving this crisis is grim. "Units one through three have nuclear waste on the floor, the melted core, that has plutonium in it, and that has to be removed from the environment for hundreds of thousands of years," he said. "Somehow, robotically, they will have to go in there and manage to put it in a container and store it for infinity, and that technology doesn't exist. Nobody knows how to pick up the molten core from the floor, there is no solution available now for picking that up from the floor."
Dr Sawada says that the creation of nuclear fission generates radioactive materials for which there is simply no knowledge informing us how to dispose of the radioactive waste safely. "Until we know how to safely dispose of the radioactive materials generated by nuclear plants, we should postpone these activities so as not to cause further harm to future generations," he explained. "To do otherwise is simply an immoral act, and that is my belief, both as a scientist and as a survivor of the Hiroshima atomic bombing."
Gundersen believes it will take experts at least ten years to design and implement the plan. "So ten to 15 years from now maybe we can say the reactors have been dismantled, and in the meantime you wind up contaminating the water," Gundersen said. "We are already seeing Strontium [at] 250 times the allowable limits in the water table at Fukushima. Contaminated water tables are incredibly difficult to clean. So I think we will have a contaminated aquifer in the area of the Fukushima site for a long, long time to come." Unfortunately, the history of nuclear disasters appears to back Gundersen's assessment.
"With Three Mile Island and Chernobyl, and now with Fukushima, you can pinpoint the exact day and time they started," he said, "But they never end."