Europe Faces 'Lehman Moment'

Concerns about Greece roil financial markets.

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.”

New Government
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.”

‘Armageddon Scenarios’
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.

Sticking Point
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.

‘Ripple Effect’
“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.

 

Swap Spreads
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.

Government Bonds
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.

 

Euro, Swaps
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.”

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