The Slow Train Wreck Continues.

Monti Presses Ahead Amid Warnings Euro Crisis Is Far From Over

David Blanchflower, a professor at Dartmouth College and a Bloomberg Television contributing editor, talks about the global labor market, wages and central bank policy. He speaks with Tom Keene on Bloomberg Television’s “Surveillance Midday.”

“Optimism should not give us a sense of comfort or lull us into a false sense of security,” International Monetary Fund Managing Director Christine Lagarde said today in a speech at the China Development Forum in Beijing. “We cannot go back to business as usual,” she said, urging vigilance on oil prices, debt levels, and the risk of slowing growth in emerging markets.

An easing of the crisis offered breathing room for Monti to seek an Italian labor-market overhaul and for euro-area ministers aiming to bolster euro bailout funding before a meeting at the end of the month. Still, urgency was underscored by an IMF warning that the Greek bailout held “exceptional risks” that could prompt a “disorderly” exit from the monetary union unless additional help is prepared.

‘Sovereign Default’

“The materialization of these risks would most likely require additional debt relief by the official sector and, short of that, lead to a sovereign default,” IMF staff wrote in a report released March 16. “In the absence of continued official support and access to” refinancing by the European Central Bank, “a disorderly euro exit would be unavoidable,” it said.

With billions of euros committed to hold Greece afloat and investors looking to see whether contagion could spread to Spain or Italy, the fragility of rescue efforts were reflected in bond yields last week. Spain’s 10-year yield climbed 20 basis points to 5.20 percent, the second weekly gain, while the yield on similar maturity Italian debt rose three basis points to 4.86 percent.

Investors have been encouraged by the Italian prime minister’s efforts to rein in the country’s debt since his government of non-politicians replaced Silvio Berlusconi’s administration last year.

Monti’s labor overhaul will include a revision of firing rules and an expansion of jobless benefits. The rules, which will distinguish between workers removed without just cause and those fired for disciplinary or economic reasons, are among the most contentious. Under article 18 of the Italian labor code, employers have to compensate and rehire any worker ruled to have been fired without just cause by a labor court.

Month’s End

Monti met yesterday with Confindustria head Emma Marcegaglia, Labor Minister Elsa Fornero, CGIL union leader Susanna Camusso, CISL union chief Raffaele Bonanni and UIL union head Luigi Angeletti, a spokesman for Confindustria said. The Italian leader has said he wants to pass labor legislation by the end of the month.

“We’ll get an agreement within about a week, although there may be some small changes to the present proposal before it’s all done,” Erik Nielsen, chief global economist at UniCredit SpA (UCG) in London, wrote in a note to clients today.

Even as focus shifted beyond Greece to other parts of the euro area, the IMF’s continuing concern about the Greek package illustrated the difficulty of implementing changes that officials in Brussels and Athens had been negotiating for months. Greece remains “accident prone,” the Washington-based institution’s staff said in the report.

Greek Election

The IMF reduced its contribution to the second Greek bailout because the operation poses what staff called “unprecedented financial risks” to its finances. One of the risks identified was the upcoming Greek election, to be held in April or May.

Lagarde has pushed European governments to boost their bailout fund in an effort to protectSpain and Italy from contagion. Euro finance ministers may decide to increase the region’s crisis fund to a total capacity of 692 billion euros when they meet on March 30, a euro-area official said March 16.

The ministers, who will meet in Copenhagen, are weighing what to do with the temporary European Financial Stability Facility and its permanent successor, the European Stability Mechanism. The 692 billion-euro figure represents the most attainable compromise between 500 billion euros, if policy makers change nothing, to a maximum of 940 billion euros, the official said.

Chancellor Angela Merkel on March 16 left the door open to boosting the euro-area backstop, saying a decision on reinforcing the firewall will be made before IMF meetings next month. Ministers have discussed “combination possibilities” for the EFSF and the ESM ahead of their meeting.

“What’s clear is that we need to settle on a position with a view to the IMF’s spring meeting because the topic will surely come up and because there have been offers by the international community,” Merkel said. “You can count on us setting the course by the end of March.” Assuming Greece is not gone by then.

Greece In The Red Zone.

Failure of Greek debt deal could cost $1 trillion!

Decision day for the Greek debt crisis is drawing near, and insiders are predicting that if things go awry it could cost the world economy $1 trillion.

Greece’s credit rating was cut to selective default by Standard & Poor’s after the bell on Monday, reflecting the implementation of collective action clauses (CACs) on its debt.  Greece is in the middle of one of the largest sovereign debt restructurings ever and needs to secure significant private sector participation rate; CACs are designed to forcibly increase that rate.

According to S&P, the Greek government retroactively inserted CACs into the documentation of certain series of its sovereign debt on February 23, two days after the Troika agreed on the terms for a second bailout package.  This retroactive implementation substantially changed the terms of the deal and diminished investors’ bargaining power in the face of a restructuring, causing the downgrade, S&P said.

Greece needs to fulfill certain conditions in order to receive the next tranche of money and avoid a disorderly default.  Among those is the successful implementation of the so-called PSI (private sector involvement) deal, which is supposed to be voluntary.  In practice, Greece is executing a bond restructuring that will see bondholders take an approximately 70% haircut on the net present value of their bonds while the average maturity will be significantly extended, reducing shorter-term funding requirements.

For the PSI to succeed, the Troika (made up by the EU Commission, the ECB, and the IMF) is expecting Greece to secure the participation of 95% of private bondholders.  Experts at Barclays believe Greece could come short, and thus would use retroactive CACs that could require a 66% participation rate to force all bondholders to take the deal.

“In our opinion, Greece’s retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what we consider to be a distressed debt restructuring,” read S&P’s post-market release.

Consummation of the debt exchange would result in a credit upgrade, S&P announced, and would take Greece’s credit rating to CCC.  “In this context, any potential upgrade to the ‘CCC’ category rating would reflect our view of Greece’s uncertain economic growth prospects and still large government debt, even after the debt restructuring is concluded.”

A failure to secure a high enough participation rate could well lead to an outright default, S&P warned, given the Hellenic Republic’s lack of access to capital markets.  Bondholders have until about March 12 to participate, according to S&P.

Greece faces a hard deadline of March 20, date when it is scheduled to pay €14.5 billion in bond redemptions.  On Monday, German members of parliament passed a bill approving the second Greek bailout.  After Angela Merkel’s victory at the polls, investors will have to keep their eyes on Dutch and Finnish parliamentary votes on the bailout.

In a confidential memo that has just surfaced, the industry group representing bond holders has said that the consequences of such a default could be $1 trillion in losses. “When combined with the strong likelihood that a disorderly Greek default would lead to the hurried exit of Greece from the Eurozone, this financial shock to the [European Central Bank] could raise significant stability issues about the monetary union,” the International Institute of Finance’s memo said, according to a copy posted on a Greek news website.

Even with the potential damage, it is not clear if all the bond holders will sign on, and Greece said it will only go ahead if it gets 75% participation. Many of the bonds are currently held by hedge funds who bought them up on the cheap and who are now disappointed with the level of the cuts that Greece is insisting they take. The IIF put out a statement Monday listing all the bond holders who are willing to take the deal.

Bloomberg estimated that they only account for 20% of the total participants needed. Greece’s finance minister told Bloomberg Television this is the only chance bond holders will get. “This is the best offer because this is the only one, the only existing offer,” Evangelos Venizelos said.

If they don’t take it, today’s stock market declines are going to look like small potatoes.