While many in the US would say we have our own socialist institutions, the attitudes and scope of the differences clearly make Europe look quite a bit more socialist. It may be this general attitude in Europe in dealing with the sovereign debt crisis that is actually exacerbating it.
There are certainly issues concerning the Greek debt restructuring that will effect the entire EU bond market. The ECB, which is the largest holder of Greek debt seems bent on not taking any losses in the restructuring. Draghi avoided the direct question twice as to whether the ECB is prepared to take losses on their Greek debt holdings and the vice chief emphasized that the restructuring was "PSI", Private Sector Involvement, hinting that the ECB would not be a party to any restructuring deal as they don't consider themselves to be "private holders" even though the debt they bought was clearly issued as private debt.
This raises the issue of the equality of treatment of creditors and any exclusion of ECB debt would have to be done by inserting specific procedures excluding the ECB in retroactive collective action clauses which would effect ALL Greek law bonds. This would shred the principle of comparability of treatment between creditors in the event of sovereign debt restructuring which has been a principle respected since its inception in 1956.
In reality, this tells bond investors that should another country require debt restructuring, their haircuts on the debt will be proportionately larger depending on how much of that specific debt the ECB holds. The more sovereign debt the ECB holds, the bigger the haircuts for private investors. This would discourage any bond buyer from buying sovereign debt in the EU, the exact opposite of what the EU most desperately needs and may explain why China and Japan have stayed at arms distance.
The Sovereign Downgrades
This week's downgrades are not a mere rating, these ratings are used to guide investment by all kinds of funds that may be and in many cases are barred from holding or buying debt that is not of a particular credit worthiness. This means the S&P rating action will likely FORCE many investment institutions to sell debt that is no longer rated within their guidelines that govern their investments. What I'm saying is it is not a matter of choice, they have rules in place that must be followed and may force them to sell debt holdings to comply.
This is where Germany's CDU ruling coalition/ Merkel may have just dropped the bomb that kills the bond market.
At the bottom of this FT article is the one paragraph that could kill the EU bond market.
"Speaking on the fringes of a start-of-year retreat of her Christian Union lawmakers in the city of Kiel, Ms Merkel said she would consider calls from her party colleagues for legislation to bar institutional investors such as insurance companies from being forced by their statutes to sell bonds when ratings were downgraded, or fell below investment grade."
Although the US made somewhat comparable remarks regarding how downgraded US debt should be viewed, it was not canonized in to law. This also is where we see the socialist mentality of the EU and how at almost every turn it has run afoul of democratic free market principles and thus has been very ineffective.
Whether the CDU pursues legislation or not, the mere hint of it may send debt holders scrambling to sell their debt before they are potentially caught in a trap that would cause major legal problems for them. If they start selling en masse, yields will rise quickly which will cause the ECB to buy more debt on the secondary market, which in turn will comeback to what was mentioned above about bond holder haircut severity being a function of how much debt the ECB holds, should Greece insert provisions excluding the ECB from retroactive collective action clauses.
Do you see the circle and the potential of a massive downward spiral?
Following this to its logical conclusion, yields on debt rise throughout the EU which in turn puts more countries in danger of default and in need of bailout cash that is just not there.
When I first started seeing these obvious horrendous decisions parties in the EU were making, I thought, "This is too obvious, I must not understand the bigger picture", but as the results have played out, I did understand and none of these horrendous decisions were hard to understand. Almost every summit has been a failure and has looked like there has been no communication whatsoever between the various players, I believe it's not only appearance, but fact.
In the end, it probably boils down to a simple problem at the heart of it all, the Euro-zone was a bad idea from the start and never had the structure or the imagination to put in place effective policy tools to deal with anything but a rosy economy.
While the SKEW index is new and unproven at this point (it is meant to signal the likelihood of a Black Swan event), I can't help but noticing it's recent moves higher (the higher the index, the more likely a Black Swan event will occur-115 is the average and represents a low probability of a Black Swan event).
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