Friday, July 9, 2010

Virus as Antidote

After months of spectacular gyrations in equity, bond and forex markets, it seems the storm that rippled off from Greece's inability to roll over their sovereign debts has passed. Developed countries' rhetoric on cutting the fiscal deficits certainly contributed to the stabilisation process. But I think the real turning point came when the European countries and the IMF announced the trillion-dollar package to back Greece's as well as other EU members' sovereign debts on 10 May.

The announcement created the calming effect that allowed for the return of orderly functioning of markets.

When I look back at the turning point and the provisions of the package, however, I could not help but notice the irony in that the "antidote" prescribed is essentially sharing the same DNA as the "virus".

If we flash back 2 years to 2008 when Lehman Brothers' collapse brought on the first wave of the Financial Tsunami that swept across the world which accentuated the feeble fiscal health of economic entities from individual home owners to government treasuries, we would realise that the single most significant contributor to the Crisis was CDOs- Collateralised Debt Obligations. As the underlying financial assets of the CDOs turned bad, the market values of the securities tumbled and their owners (Lehman Brothers, Citibank, Merrill Lynch... etc. etc.) have to write-off the lost values. The huge losses eroded confidence in these financial institutions which, in a nutshell, eventually led to a near-complete meltdown in the entire global financial system.

What EU's trillion-dollar package entails is essentially the same , only on a larger scale- the trillion-dollar worth of funds will be pooled from participating countries and the money will be used to take up individual EU countries' sovereign bonds. Instead of financial institutions pooling their money and owning pieces of the CDOs, the package's participants are sovereign nations. Instead of home loans (sub-prime or otherwise) that were collatarised as the underlying assets, the package money is financing the EU countries' (junk status or otherwise) budget deficits- much of the deficit-spending in the past years were spent on backstopping the banks and financial institutions that were failing due to Lehman Saga.

It brought to mind the matryoshka doll...

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