StreetTalk With Bob Lenzner
Smart Money Is Short Debt Of Greece, Spain, Portugal And Japan
Robert Lenzner, 04.30.10, 05:00 PM EDT
But the sovereign debt crisis won't be another subprime meltdown.
Smart money went short the bonds of Greece, Portugal, Spain and Ireland when the price of buying protection against default was cheap, some weeks ago. The price of buying insurance against default has spiked now that the crisis is full blown and a $100 billion bailout of Greece is not a done deal.
The Smart Money, mostly hedge funds thinking ahead, were betting on the historic findings that over 800 years severe recessions are always followed by sovereign defaults. Smart Money had studied This Time is Different, a history of financial crises by Harvard professor Kenneth Rogoff and his co-author, Carmen Reinhart.
You want perspective on more than 2008-09, you have to read this book. One clear finding of Reinhart/ Rogoff is that sovereign debt default is in “a cyclical trough” based on a chart published by Hedgeye Risk Management this week. The percent of countries in default or restructuring is about the same as in 1930 as the depression took full force.
Smart Money is worried. It has seen the need for bailouts segue from a few billion dollars for a single hedge fund, LongTerm Capital in 1998, to trillions on behalf of banks, insurance companies and quasi-public institutions like Fannie Mae ( FNM - news - people ) to prevent an economic meltdown equal or worse than the 1930s. European Central Banks needed 27.5% of total European GDP to staunch the wounds, according to Jean-Claude Trichet, ECB chairman, at the Council on Foreign Relations this week. “The transmission of shocks were moving rapidly every half-day. There was no textbook to tell us what to do,” he said.
Nor was he forthcoming about the odds of a deal for Greece. At stake in the first instance are European bank loans to Greece ($190 billion), Portugal ($240 billion) and Spain ($840 billion). That's a nifty $1.2 trillion exposure to the economically vulnerable European nations. Faced by French banks like Societe Generale, German banks and British banks as well. A big problem, but not of the proportion of the subprime crisis, which morphed into prime mortgages, LBO loans, credit card and automobile debt--making Citigroup ( C - news - people ), Bank of America ( BAC - news - people ), Fannie Mae, Freddie Max, WAMU and others in effect insolvent. Still, a challenge to European bank balance sheets and further deterioration in European stock markets could be destabilizing.