As if the market does not already have enough uncertainty, today we see a shocking note from Morgan Stanley (NYSE:MS) to its clients. Morgan Stanley’s Joachim Fels sent a note to clients talking about how the markets will come to grips with the so called “comprehensive solution” presented at the EU summit a two weeks ago. Fels believes that when Chancellor Merkel and President Sarkozy raised the possibility of a country leaving the Euro, a Pandora’s Box was opened. He goes on to talk about how this could potentially lead to runs on “sovereign and banks in peripheral countries that make everything we have seen so far in this crisis look benign.” Below you can see the whole note. It is definitely an interesting read.
Full Note from Morgan Stanley’s Joachim Fels sent to clients
The Emperor has no clothes. This coming week markets are likely to continue to grapple with the notion that the ‘comprehensive solution’ presented after the EU Summit on October 26 is neither comprehensive nor a solution. First, bank recapitalisation was always about curing the symptoms rather than the disease – sovereign risk. And by giving banks until mid-2012 to meet the capital ratio target, governments have likely set in motion a wave of deleveraging that could have severe economic and market consequences. Second, the leveraged EFSF may still turn into a bazooka, but so far it looks more like a water pistol. We continue to doubt that investors will find the insurance and SPIV constructs appealing, and as the G-20 meeting this Thursday and Friday made clear, non-European governments also stand to be convinced that co-investing with the EFSF make sense. But perhaps euro area finance ministers will unveil some more reassuring details on the construct after their meeting this Monday/Tuesday – don’t hold your breath though. Third, the Greek political saga continues and even though the prime minister won the confidence vote in the early hours of Saturday, the second bail-out and debt restructuring package still needs to be approved and likely new elections late this or early next year could spring additional uncertainties. And fourth, but not least, while the ECB cut rates on Thursday, ECB President Draghi made it clear in the press conference that the bond purchase programme remains temporary and limited (see the quote of the week below), suggesting that hopes for large-scale monetary financing remain just that, at least for now.
Another Pandora’s Box opened? However, my main takeaway from last week and my main worry for the weeks and months ahead is that Chancellor Merkel and President Sarkozy, in response to the idea of a Greek referendum on the bail-out package, raised the possibility of a country leaving the euro – so far a taboo in European political circles. This is the second time in less than four months that European leaders could have opened a Pandora’s Box: on July 21, the decision to involve the private sector in the Greek bailout signaled that euro area government debt is no longer risk-free and thus sparked massive contagion into Spanish and Italian debt markets. This past week, by raising the possibility that a country might (be forced to) leave the euro, core European governments may have set in motion a sequence of events which could potentially lead to runs on sovereigns and banks in peripheral countries that make everything we have seen so far in this crisis look benign. But maybe I’m too pessimistic after another long week.