European Crisis Continued

As I correctly predicted in my December 2010 blog posts, the European debt crisis is turning out to be even worse than 2010. It is a solvency issue rather than a liquidity issue. Some of these troubled countries such as Greece do not have strong manufacturing base that allows them to produce sufficient income to service the debts.

The Greek debt has recently been downgraded to junk status and the yields have soared. Credit default swaps indicate a 78% chance of a Greek default. Greece received $110 billion euro bailout last year but it is not nearly enough to meet obligations and is simply deferring the inevitable.

Both the equity and commodity markets have gone through a significant correction as predicted in my April 2011 posting. This is primarily because european banks have significant exposures zto european sovereign debts and any defaults or debt restructuring will translate into losses to these banks. Simply put, what may look like soveriegn debt crisis can easily spread to the banking sector, leading to another round of financial crisis.

Commercial banks in Europe hold about 90 billion euro of Greek debt or 27% of the total. Banks hold 20 billion euro of Irish public debt, and $42 billion euros of Portuguese debt. German and French banks are the biggest holders among european commercial banks.

Hence, Germany and France are in an awkward position. While they would not want to burden themselves by helping these troubled countries as two leading EU nations, their financial institutions are ultimately going to be affected negatively if these troubled European banks default or negotiate debt haricuts with creditors.