From Greek Tragedy to Italian Soap Opera

October was certainly a big month for markets, with big announcements and big movements in the price of financial assets. The Dow ended the month up 9.5% - the third biggest percentage monthly gain in its 115 year history. The European Summit overshadowed events in October, with its announcement on 26 October. As expected, a much bigger rescue plan for Greece, the European banks and sovereigns was announced. From a rescue fund of €440 billion, the headline number is now around €1.2 trillion, depending on the leverage. Essentially the plan is as follows: Private investors in Greek debt would have their debt restructured, giving them a 50% discount in the value of their holdings. In addition, up to €130 billion would be made available for Greece, with the end objective a reduction in Greek debt from around 150% of GDP today (according to the IMF) to 120% of GDP by 2020.     Leveraging up the current rescue fund (the EFSF) by around four to five times, to around €1 trillion, through the provision of credit insurance (for example, guaranteeing only the first 25% of a default would effectively lever the fund by four times) and the establishment of programs for other investors to participate.   Some measures to help the capital structure of Euro banks, including the possibility of loans from the EFSF to banks who cannot obtain the necessary private or government funding.    In addition to this, the European Central Bank (ECB) may continue to use its balance sheet to purchase bonds. So, we should all feel better about our investments, right? Well just as it looked like we had some common sense resolutions out of the European Summit to stabilise markets, the Greek Prime Minister, George Papandreou, stunned everyone on 1 November by announcing a public referendum on the EU rescue plan for Greece. We then had a subsequent back down on the referendum and the promise to form a coalition Greek Government (with Papandreou stepping down), that would approve the current Greek rescue package and then hold elections in February 2012. The G20 came and went in Cannes, without any major announcements other than a “hurry up” to Europe to turn talk into action. Meanwhile, over in Italy (Europe’s third biggest economy) there is more unrest about Berlusconi’s leadership as Italian 10 year bonds trade at over 6.4%. This is a Euro era record high, reflecting concern about Italy’s finances. As I write this, the risk being priced in can be seen in the following chart comparing Italian and German 10 year bond rates.