Ireland's Debt Crisis

Ireland: Over the past 3 weeks, Ireland’s 10 year debt has risen from 5.5%. The rise in their borrowing rates ties into recent plans on the part of Ireland to rescue their large banks, which are working through a bit of a home lending mess of their own. The concern is that Ireland, in the process of saving its banks, is jeopardizing the fiscal health of the country.


In September, Irish banks had €55 bil of bank debt maturing, which was paid back, mostly to British, French and German banks by borrowing from the ECB. Ireland did have a chance to push bank losses onto the bond holders, but instead chose to let the banks borrow money from the ECB. In turn, the government is now guaranteeing the debts of the banks. It is estimated that Ireland will need to absorb at least €85 bil. of losses, which is equal to 55% of their GDP. That would be like the US taking on $8 trillion of losses onto the federal government!


This is an evolving situation, as the ultimate losses which will fall onto the banks, will ultimately land on the Irish government. Essentially, the country is insolvent. The genesis of the banks losses have been loans to real estate developers. The second phase of the banks problems are going to kick in as Ireland’s over-indebted households face hardships similar to the US’s housing crisis. Supposedly, about 12% off all Irish mortgages are underwater, and it is expected that this number could double to 25%. There are two factors which are holding the Irish housing market together: first off, in Europe, lenders have recourse to borrowers, and there is a huge stigma, (which supposedly follows them around for life), attached to those who default on their debts. Secondly, banks are still lending money into the housing market at a rate of 5%. With the external debt costs of Ireland at 8%, and long term bank debt yielding over 20% (Allied Irish Bank), it is only a matter of time before the banks stop lending money at 5%.


Even if the ECB lends money to the Irish banks at 5%, this is an untenable situation, and can only lead to default, someone is going to have to forgive some debts to this island nation. Apparently Ireland has accumulated enough cash to get themselves through the year, but it will be interesting to see what happens when they have to roll over some of their debt. 10 year Irish debt is quoted at 8.63%, and as these costs rise, it will become apparent that the continuing spiral of high rate interest expenses, on debt equal to approximately 120% of GDP, (once the bank losses are added on), is not sustainable. For the moment, the ECB has quietly lent the Irish banks the money the need without much of a commotion. Supposedly, the ECB has planted themselves at various institutions in Ireland to monitor the unfolding situation. The article in the Irish Times suggests that Ireland has surrendered control over their banks to the ECB.


The takeaway from this situation is to understand that there is another problem brewing in the EU. At some point, when it becomes apparent that the ECB will be absorbing these losses, a commotion will break out, and the risk on trade will be off.


* This brings us to the unfolding situation in the various risk markets, which are starting to go through various phases of convulsions, at these very overbought markets are starting to feel the effects of gravity. Here is a synopsis of what is going on:


a> Silver – traded up to 29.34 yesterday, from a previous days close of 27.69, and then collapsed to 26.40, before ending the day at 26.90. At its high yesterday, the market was pretty close to that trend line resistance in yesterday’s attachment. Today’s action has been contained by yesterday’s dramatic range, and as such, is an inside day, which is usually followed by some dramatic action one way or the other. My guess is that we put in a top yesterday, and will trade off from here, to at least 24, and possibly 20 over the next week or two.


b> Gold mimicked Silver’s action, making a new high at 1424 yesterday, and is precariously floating near its all time high. Neither Gold nor silver has broken down below its steep up channel.


c> Yen – The Japanese Yen weakened, trading over 82 yen/dollar, and this is my trigger to abandon the remainder of my holdings in Yen. Over the course of the next few weeks, I expect the Yen to weaken further, and have entered into small trading positions accordingly.


d> Bonds – broke down below recent support levels. However, shorter duration instruments, which have the support of the Fed, remain well within their channels. I am standing aside on this market, and respecting the weakness. With the Fed still in play however, I am not going to short this market.


e> Stocks dropped lower by less than 2%, and that might be all that was needed to sweep away the speculative longs in the futures. Breakdown levels which would indicate a more significant short term top are around 1180 in the S&P. For now the S&P remains in its up trend.


f> The Euro is hanging onto its 137 support area, briefly dipping to 136.7, and then back up (last at 137.81). The charts suggest that a high was registered a few days ago at 142.82. The upward correction now is likely to fall short of that top, and this upward correction could be a good shorting opportunity. In the meantime, watch for a close below 136.50 as a sign that the Euro has resumed its decline.