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Friday, March 09, 2012 1:09 AM


Prepare for Major Haircuts on Portuguese Debt


Ambrose Evans-Pritchard at The Telegraph says Legal skull-duggery in Greece may doom Portugal.

I suggest that Portugal is doomed whether or not there is "Legal Skull-Duggery". However, it's perfectly fair to suggest that LSD will indeed make matters worse.

From Pritchard ...

Last month the European Central Bank exercised its droit du seigneur, exempting itself from loses on Greek bonds. The instant effect was to concentrate more loss on other bondholders. "This has set a major precedent," said Marchel Alexandrivich from Jefferies Fixed Income. "It does not matter how often the EU authorities repeat that Greece is a 'one-off' case, nobody in the markets believes them."

The ECB holds €220bn (£185bn) of Greek, Portuguese, Irish, Spanish, and Italian bonds. Its handling of Greece implicitly subordinates private creditors in each country. All have slipped a notch down the pecking order.


This might not matter too much if Greece were really a "one-off" case but markets are afraid that Portugal will tip into the same downward spiral as austerity starts to bite.

Citigroup expects the economy to contract by 5.7pc this year, warning that bondholders may face a 50pc haircut by the end of the year. Portugal's €78bn loan package from the EU-IMF Troika is already large enough to crowd out private creditors, reducing them to ever more junior status.

EU leaders said last June that "Greece is unique" and promises that haircuts would "not be replicated in Portugal". They have since pledged that the EU's new bail-out (ESM) fund will not have protected status.
ECB Lies

It's safe to stop right there. No one in their right mind can possibly believe EU leaders or the ECB. Certainly the markets do not believe in such fairy tales.

Portugal is interesting in that neither LTRO had much effect. For example, 10-Year Portuguese government bonds yield 13.86%. 2-year bonds yield 12.54%. Meanwhile German 10-year bonds yield 1.8% and German 2-year government bonds yield .16%.

Portugal cannot possibly survive on those spreads. Thus, what has to happen, will happen. Major haircuts are coming.

Pritchard notes fundamental reasons why.
Combined public and private debt is 360pc of GDP, 100 percentage points above Greece. This is a huge burden on a shrinking economic base. Its current account deficit was still 8pc of GDP last year, much like Greece. Both countries are overvalued by 20pc on a real effective exchange rate, though Portugal has barely begun to cut unit labour costs.

Dimitris Drakopoulos from Nomura said Portugal relied on "fiscal engineering" last year to massage deficit figures, raiding 3.5pc of GDP from private pension funds.

Matters will come to a head soon. The IMF must decide by September whether Portugal needs more money and debt relief. If Portugal now spirals into a Grecian vortex, large haircuts loom. This time EU leaders will have to accept that their own taxpayers will suffer losses - avoided until now - or violate their pledge.

Europe's handling of Greece has guaranteed that global funds will rush for Club Med exits at the first sign of trouble. The next spasm of the debt crisis will that much dangerous if it ever comes. As the saying goes: Hell hath no fury like an abused bondholder.
Bleeding Profusely From Help

Portugal is poised to blow up anytime now. Greece is already pricing in further writedowns. Expect Ireland and Spain to ask for writedowns.

Eventually voters in Germany, the Netherlands, Finland, or possibly even France will get fed up with these repeated bailouts at taxpayer expense and demand action. So will voters in Spain, Greece, Portugal, and Ireland, all bleeding profusely from "help".

It is quite amusing to watch these bald-faced liars at the ECB, EMU, and IMF, pretend everything is OK just as the sovereign debt default tsunami is inches from shore.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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