Stephen Pope Comments: Debt Trouble Show Crisis Not Over For Eurozone – Yahoo! Finance

Yahoo! Finance, December 16, 2009

Trouble in Greece, Ireland and Austria is making markets fret anew about the strength of Europe’s economic recovery — and underlining that the crisis is not over for the decade-old currency and the 16 countries that use it.

Greece and Ireland are trying to slash spending as they battle runaway deficits, while Austria has seized control of a bank partly because of its bad loans in Eastern Europe. Together, the bad news has overshadowed recent confirmation that the eurozone as a whole left recession behind with 0.4 percent growth in the third quarter.

Continuing fiscal and banking struggles in Dublin, Athens and Vienna demonstrate that the stress imposed by the crisis on the monetary union and the euro, launched in 1999, is far from over.

The euro reached a 16-month high of $1.5144 in late November, but fell as low as $1.4526 Tuesday, a 2 1/2-month low. The euro’s record high of $1.6038 was reached in July 2008.

Ireland and Greece both are running double-digit deficits and struggling with a basic duty of euro membership — to keep budget deficits within limits.

"Whether or not a debt crisis can be avoided in Greece remains to be seen, but the whole affair has once more raised questions about the political and structural mechanisms of the eurozone," said Neil Mellor, an analyst at Bank of New York Mellon.

Concerns about the creditworthiness of several eurozone countries had receded as the economy appeared to be improving over the summer. The European Central Bank, which oversees monetary policy for the euro countries, indicated it was ready to start phasing out its exceptional credit support to banks.

But worries about debt-weakened governments returned after Nov. 25 when Dubai World, a government investment company in Dubai with around $59 billion in debts, announced it was postponing debt payments. The emirate’s neighbor Abu Dhabi soon announced a $10 billion bailout.

Besides Greece and Ireland, Spain and Portugal also face scrutiny in bond markets. Worries have been compounded by the growing difficulties in Austrian banks, which do extensive business in formerly communist Eastern Europe where the recession has been particularly severe.

On Monday, the Austrian government took over Hypo Alpe Adria, a subsidiary of German bank BayernLB, which had suffered losses from bad loans in Eastern Europe.

"These banks are not of themselves a huge threat to Austria’s finances, but there will naturally be fears about the wider potential for Eastern European losses among European banks," said Kit Juckes, chief economist at ECU Group. "This will just add to concerns about the final extent of the bailout burden for European countries."

One debt ratings agency, Fitch, cut Greece’s credit worthiness last week. Another, Standard & Poor’s, has put Greece’s rating on watch, a signal that it may downgrade soon.

Spreads on Greece’s bonds — which measure the cost of insuring bonds against the risk that a nation might default on repayments — has vied with Ireland’s bonds as the most expensive in the eurozone. Last month, Greek bonds overtook the Irish when Greece’s newly elected government shocked markets by announcing an unexpectedly high deficit figure of 12.7 percent. European Union officials said Greece would have to fix its problems on its own.

New Prime Minister George Papandreou tried Monday to calm the markets with a speech detailing plans to reduce borrowing with new spending cuts, which some fear could ignite a volatile public. He vowed to shrink the deficit to the EU-required 3 percent by 2013.

Bond market doubters weren’t convinced. The 10-year yield spread of Greek government bonds versus German bonds, considered a benchmark of safety, stands at around 240 basis points, including a 30-point hike since Papandreou’s speech. That means investors are demanding increasingly higher interest payments — to compensate them for the perceived higher risk — before they’ll agree to hold Greek debt.

Things could have been far worse for Greece and Ireland if they were not euro members. The price paid during such crises is to see currency markets sharply devalue national currencies — an ugly experience as citizens see their ability to travel, buy imports or repay foreign-currency debt vanish.

"If you could attack those currencies, then you just have to look at the bond spreads as a proxy for what the currency would have done," said Stephen Pope, chief global market analyst at Cantor Fitzgerald.