The Power Of Illusion

As much as we like to believe we are rational beings, humans are most easily fooled by mass events.  Like our bovine brethren, we tend to run with the crowd.  For weeks now,  the world has patiently awaited for the statement coming out of the so-called European summit.  Even though, the constraints can be easily understood by anyone with even a rudimentary knowledge of mathematics, the powerful belief that the authorities will do something  kept everyone waiting for "the" solution.  The politicians, master manipulators as they are, obliged by releasing an ambitious plan to solve not only the Greek crisis but the potential Spanish, Italian, and maybe French crises as well.  Lost in the celebration is the fact that the same question remains: who pays for the losses?

1) According to the statement the banks will write down 50% of their Greek sovereign holdings in a voluntary deal (we assume this includes the ECB which will need to be recapitalized again).  The same deal they couldn't complete with a 20% haircut.  According to bloomberg the banks agreed to sign off under the threat of Greek insolvency.  We will patiently have to wait to see how many actually participate on the exchange which, don't forget, is voluntary.

2) If the banks lose money on the Greek bonds, they will have to raise capital.   This means issuing shares (incidentally, bank shares are up today which means many still don't understand MORE shares, ceteris paribus, means lower prices per share) either in the public markers or, God forbid, from their local governments.  Is Monsieur Sarcozy ready to bite that bullet? He wasn't last week, so it is reasonable that, with the pressure gone, either the banks or the the French government will try to dodge this one again during the not-so-public details phase.

3) How about leveraging the EFSF? The credit of this vehicle is already below that of Germany which means is no longer considered AAA by potential borrowers.  The more debt they issue, the less so.  European dreams of Chinese and Brazilian money coming in to save the day are just that.  The Chinese may buy a symbolic amount, but not more.  (Here is an article detailing Sarcozy's conversation with Hu Jintao, see if you can spot any numbers).

4) Finally, what about the reforms and long-term prospects for the weak economies of Europe?

• Even if the 50% haircut goes through, Greece will have an unsustainable debt to GDP of more than 150% and will remain under life-support from Europe for the foreseeable future.  Since they are still in the euro, they will not regain competitiveness.  Thus, it is unlikely that things will get better for the Greeks which may decide to give up anyway.
• Contrary to press releases, Italy has not committed to any meaningful reforms.  If they do commit, the first effect will be higher unemployment which the population is unlikely to support and will make the fiscal situation worse.  
• Spain is still mired in quasi-recession and continues to run a current account deficit.  The fiscal cuts touted by Sarcozy are mostly based on not paying some bills and other accounting gimmicks.
• Ireland, the poster child of self-sacrifice and fiscal rectitude is still suffering 14% unemployment and has yet to return to the public markets.

In essence, we have been treated one more time to a publicity stunt by the same people who said Greece didn't need a bailout, no Greek debt would be written off, Ireland was ok, Portugal was not Greece, etc.   Why are markets up? why not? is not like they actually know the future.