Greek crisisWhat began as an uptick in Greek bond yields in late September 2009 billowed into the battle of the Euro's life. The 11-year-old currency sunk to 14-month lows last week as capital markets harshly rejected Greece's ability to honor sovereign debt commitments on account of its exorbitantly under reported fiscal deficits. Ratings agencies, hurting from being chastised over lax rating rigor in the run up to the sub prime debacle, slashed Greece's sovereign debt to junk. This meant the premiums the debt-laden country would need to pay lenders spiked even further out of its reach, just as bonds in the amount of €8.5 billion were fast coming due on May 19.

The scent of a Euro nation bankruptcy wafted in the air, drawing speculative attack.

Eurozone leaders floated hints of aid proposals, but bungled messages of confidence with inter-nation bickering. Germany, economic powerhouse of the 16-nation block and principal provider of most any aid package, was hesitant to untie its purse strings without additional conditions. An ill-timed regional election in the country's largest voting district split Chancellor Angela Merkel's attention between voter hesitation to pay Greece's bill and Eurozone-wide efforts to show solidarity, hinting at a political stall while the clock ticked and speculative dogs swarmed. Greek 10-year bonds yield spiked to 11.24% and its credit default swaps reached par with the likes of Nicaragua and Pakistan. Worse, trigger-happy rating agencies turned their ratings cuts to other Eurozone countries with sizable fiscal deficits, Spain and Portugal. Suddenly contagion was on everyone's tongue. The Euro received the beating of a lifetime - EURUSD hit 1.2520 with talk of parity by yearend 2010.
 
One aid package - first totaling €30 billion, then €110 billion - passed to a cold reception from markets, and only after the Greek parliament ushered in draconian austerity measures which brought days of increasingly violent protests to the streets of Athens.

This weekend, things were different. A grueling 48-hour emergency session of the Eu finance ministers stretching into the morning hours produced an unprecedented aid package totaling €720 billion, nearly $1 trillion. Clever interpretation of the Maastricht Treaty and promises of the European Central Bank to back all Eurozone-issued bonds (read: quantitative easing) meant €60 billion of the package can be released immediately out of EU emergency funds, an additional €440 billion will be available in a few weeks via a special purpose vehicle guaranteed by the EU's Council of Economy and Finance, and the International Monetary Fund will front an additional €250 billion. This is on top of the €110 billion in aid to Greece, finalized Sunday.

Besting America's shock-and-awe $700 billion bailout, the EU rescue package soothed over markets Monday morning, buoying the Euro back over 1.3000 to the dollar in its biggest 2-day rally since March 2009. The amount is titanic. Greece, Spain, Portugal, Ireland and Italy have a total of $215 billion coming due in the coming 3 months - with Italy accounting for a $126 billion of that amount - but at €720bn, the stabilization fund can easily fund the entire issuance of Eurozone government bonds due for the remainder of 2010 (est. at €550 billion according to Danske Bank).

Taking a lesson from the negative market reaction following the ECB President Jean-Claude Trichet's press conference last week, this ECB will back bonds issued by the 27-nation bloc to pay for this package, ensuring all bonds carrying AAA ratings and making the debt as cheap as possible. The ECB took a step further, attacking liquidity concerns by managing a sweeping coordination with the Federal Reserve, Bank of England, Bank of Japan, Bank of Canada and the Swiss National Bank to re-establish the temporary U.S. dollar liquidity swap facilities.

Market reception was positive, but not euphoric, to the package. Sovereign bond spreads have recovered with the ECB's purchases and the Euro buoyed initially, but uncertainty took over. The mammoth bailout places the ECB as a buyer of last resort for sovereign debt - officially allowing the bank free reign over bond spreads using an endless balance sheet. ECB's Trichet "fiercely" asserted the ECB's independence from political meddling and Merkel vowed the moves do not qualify as quantitative easing, stating the bond purchases will be "sterilized" in time to prevent an expansion of the ECB balance sheet. But the fact that few "real money" buyers are following the ECB's lead for the moment is testament to the fact that are unsure of the ECB's moves. Little has been revealed about the target bond purchases to be made or the target spreads to be achieved before the ECB declares the markets functional and forfeits its newfound powers. Markets are additionally concerned about how the bloc corrects the kind of faulty adherence to Maastricht criteria which led to these past weeks of turmoil.

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  • German Chancellor Angela Merkel:
    "The significance of the euro goes beyond its function as a currency, it is a symbol for peace in the union as well... The banks failed, they called for rescue, they pulled the world economy into a deep hole. We got into debt to deal with that, and now the banks are speculating against these states. This is a struggle of politics against the markets … but I am sure that we will win this struggle."

  • Mark Lai, credit analyst at Credit Agricole:
    "While the market response reflects investors' relief over the announced measures, this does nothing toward longer-term real fundamental implications, a much tougher stance is needed to enforce the 1992 Maastricht Treaty's four convergence criteria for joining the European Union, including a maximum deficit/gross domestic product of 3%, debt/GDP of 60%, among others. The real challenge for problematic EU sovereigns hasn't even begun yet."