Sunday, 20 November 2011
Is Germany being covertly pressured?
I wouldn’t be surprised if the USA and other western nations are putting immense pressure, behind the scenes, upon Germany to continue to bail-out broke European nations. Large financial institutions have sold financial insurance over Greek and other sovereign debt, in credit default swaps (CDSs) and other financial instruments. In the event of Greek default, those institutions guarantee to cover any losses incurred by holders of Greek government bonds. Those institutions are exposed to very large losses should a nation default on its sovereign debt.
The amount of outstanding CDSs and other financial insurance far exceeds the amount of debt in actual existence. In simple terms, speculators have insured bonds they do not own, expecting a default to trigger a pay-out. It's somewhat like buying a life insurance policy on an elderly ill patient – someone else - and hoping to profit, with the insurance company hoping to keep the premium. Banking, insurance and other large financial institutions have sold possibly more insurance over debt than they are able to cover. The attractive premium income entices them to take on the risk that Greece or another nation won’t default. But in their zeal for premium their contingent liabilities may have become far too high. Those financial obligations are so large that those institutions might be bankrupted if a default triggers claims. What happens when a financial insurer can’t meet their obligations?
Protection of those financial institutions is a matter of US national security. If those firms go bankrupt, the whole economy will suffer very serious consequences. They are “too big to fail”. That is why there is so much effort to “rearrange” the hopeless Greek financial situation without triggering a formal default.
If I were to default twice on my home mortgage, I would never be rescued twice. When a bankrupt is rescued, rescuers normally rescue them only once, if at all. Rescuers never give more money to a bankrupt who has failed again after rescue: except in Europe. The 109 billion Euro 2010 rescue was made on the basis that it would solve the Greek problem once and for all and prevent a Greek default. That bail-out failed. In 2011 Europe rescued Greece again, with a further 110 billion Euro package. It appears that preventing Greek default would now be impossible.
But if Greece formally defaults, those large financial institutions will be called upon to pay out possibly more than they possibly can, sending them bankrupt.
Therefore it would make sense that the US would stop at nothing to prevent Greek or other European default, and pressure Germany to stop at nothing to repeatedly bail out Greece. The whole US economy is at stake.
But Italy’s debt is in the trillions, beyond Germany’s resources.
For more market commentary join our free live market briefings or if you prefer, read more, at Options21.com; or follow my colleague Paul Wise's blog.
Posted by Nils Marchant