Wednesday, April 14, 2010

Is the Break-Up of the 'American Monetary Union' Just Ahead?

The spread on Greek debt versus German bunds is almost  back to 400 basis points.

ZeroHedge comments, "The half-life of any good news out of Greece is now less than 24 hours". This is a sign of not only how precarious things are in Greece but throughout the world. All serious analysts following the PIIGS situation know that Portugal and Spain are in worse shape than Greece, and if Greece is an explosion waiting to happen, Spain is a nuclear explosion.

Back on this side of the Atlantic, the picture is not much prettier for state and local governments. The names being bandied about  on various insider lists as being in serious trouble  are California, Florida, Nevada and Arizona. At the the city level, Detroit and Los Angeles top most lists.

This does not mean that those cities and states not on insider lists are not vulnerable to a debt problem. Most cities and states have extremely opaque financials, and some are likely to have huge unfunded pension liabilities. This sets up severe problems for the entire municipal bond market, as it is difficult to understand who is solvent and who is not.

The weaker Greece becomes, the more likely sophisticated players will slowly and quietly move out of U.S. municipal bond positions. More publicly, Nouriel Roubini is already raising alarms in a public fashion about state and local debt. With those kinds of warnings and the Lehman crisis fresh in everyones mind, it won't take too many pieces  of headline crisis news out of the Euro zone, combined with negative news stateside for a freeze up of the entire municipal market.

The question then becomes whether the Federal Reserve monetizes the state and city debt out of the crisis, which will oviously have very serious inflationary consequences (Think gold climbing $100 per day), or  will Bernanke pass (unlikely) and the states start issuing script (as California has in the past), which will, as Roubini suggests, lead to  the breakup of the 'American Monetay Union.'

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