Subprime Crisis Act II: The Greek Tragedy

Goldman's testimony was just a distraction. The real act was the country that gives us those letters to describe derivatives and volatilities.

Following last Thursday's report that Europe’s statistical office (Eurostat) had revised up the Greek 2009 budget deficit and Moody’s subsequent downgrade of Greece’s credit rating by one notch, another major rating agency S&P lowered Greece’s credit rating to BB+ from BBB+ and warned that bondholders could recover as little as 30 percent of their initial investment if the country restructures its debt.

That means Greece's credit standing is now "junk," or the sovereign equivalent of a subprime borrower.

The downgrad marked the first time a euro member has lost investment grade rating since the currency’s 1999 debut. S&P also reduced Portugal by two notches to A- from A+.

According to Bloomberg news, Greek 2-year note yields soared 505 basis points to almost 19% and Portugal’s jumped to 5.7% as credit-default swaps on Europe debt surged to a record. The yield on Greek 10-year bond climbed 45 basis points to 10%. That makes the Greek bond yield curve even more inverted, signalling a short-term tragedy and a long-term pain.

The fear in the market is that the sovereign credit crisis may spread to other euro members, notably the other PIIGS countries.

What's the way out?

According to Stratfor,

An EU-IMF bailout of Greece would ultimately give Athens the choice of becoming either an Argentina or a Latvia. A financial assistance program that does not involve substantial structural reform on Greece’s part would lead to a default a la Argentina. A bailout that forces Greece to get serious about reforms would mean Greece becomes an IMF-ward like Latvia, with default still a serious possibility down the line. In either case, Greece will essentially lose control over its destiny.

Yet another way out perhaps is to let Greece out of the euro pact quickly, so that it can persue its own independent monetary policy (i.e. print money).

Whatever it is, the European banks or other investors holding these sovereign debts are facing the pressure of a massive writedown, thereby weakening the already weakened European banking sector. This threatens the nascent global recovery currently underway, but shouldn't derail it.

See a more detailed analysis on why PIIGS crisis matters.