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Turmoil in Greece threatens to derail economic recovery, upend November elections

By Jeff Benjamin

May 27, 2012 6:01 am ET 

As the question of Greece’s abandoning the eurozone increasingly shifts from “if” to “when,” speculation mounts about what impact a European crisis would have on the U.S. economy and the upcoming presidential election.

“In the U.S. right now, our economy is barely chugging along, and an economy moving at a subpar growth rate can handle very little in the way of shocks to the system,” said Lance Roberts, chief economist at StreetTalk Advisors, which manages $475 million in assets.

Translation: The ripple effects of the Greek debt crisis easily could reach the U.S. by the November elections, and a weak economy never bodes well for the incumbent.

Brian Gendreau, a market strategist at Cetera Financial Group Inc. and a professor of finance at the University of Florida, said, however, that it almost doesn’t matter how President Barack Obama reacts to the crisis overseas — unless it affects Americans directly.

“People vote with their pocketbooks, so it won’t matter how Obama responded to the crisis in Europe, because that’s too remote for most voters,” he said.

Rex Macey, chief investment officer of Wilmington Trust Investment Advisors, part of a $77 billion trust and advisory firm, argued that a European economic crisis can only hurt Mr. Obama.

“If the issue foremost on voters’ minds at the time of the election is the economy, and the world is looking worse and moving in the wrong direction, then the voters will favor the businessman over the community organizer,” he said. “But if the economy is looking good, people might be more focused on social issues like gay marriage.”

Even though a Greek departure from the eurozone isn’t expected within the next few weeks, it is considered inevitable by many, which is why the handicapping and preparation about what comes next already has started.

“If the U.S. economy … and the rest of the world were healthy, Greece [an economy about the size of Massachusetts] wouldn’t be a problem, but right now, it’s like a bunch of people with weakened immune systems being around someone with the flu,” Mr. Macey said.

“We are back to fears of a global slowdown,” he said.

Greek voters will go to the polls June 17 for a runoff election to determine a majority party in parliament, following a May 6 vote that left the legislature split over how to deal with austerity measures connected to a $160 billion bailout package.

Although most economists and market watchers concur that swift and severe austerity is the best course of action for Greece, the smart money is on voters’ favoring something that resembles more government social support, not less.

“WANT IT BOTH WAYS”

“The population in Greece is certainly not clamoring to leave the euro, but they are clamoring against the austerity measures, which means they want it both ways,” said Fran Rodilosso, manager of credit portfolios at Market Vectors, a unit of Van Eck Global.

“I think there are incentives for Greece not leaving the euro, but on the other side, it’s getting more expensive to keep them in,” Mr. Rodilosso said.

The challenges following a Greek exit from the euro could be extensive.

“Two of the biggest problems with [a Greek exit] are that the eurozone wasn’t designed to allow any country to exit, nor is there a precedent for such action,” said Jon Short, managing director and head of global wealth management at Pacific Investment Management Co. LLC.

“A Greek exit will be expensive and messy, and the uncertainty in Europe will probably linger for some time,” he said. “From a U.S. perspective, that will probably lead to the continued flight to quality you see reflected in a 10-year Treasury yield well under 2%, even though the U.S. economy has its own considerable structural challenges, including a good dose of its own policy and political confusion.”

The contagion effect of a Greek exit includes concerns that similarly debt-laden countries such as Italy and Spain, with much larger economies than Greece’s, will follow suit. And the potential consequences could be a wake-up call for a debt-burdened country such as the United States.

“We will be facing the same issues here in the United States starting in 2013,” Mr. Macey said in reference to the year-end “fiscal cliff” that will combine higher tax rates, reduced unemployment benefits, spending cuts, the end of a payroll tax cut and the start of new taxes enacted as part of the health care reform law.

“If Congress does nothing, we will have austerity thrust upon us, and that fiscal cliff will either be recessionary or will contract the economy,” he said.

By Jason Kephart

May 13, 2012 6:01 am ET

Securities and Exchange Commission Chairman Mary Schapiro is not backing down from her stance that the money market fund industry needs additional reform.

“We have a legitimate concern over the risks posed by stable net asset values and it’s not hypothetical,” Ms. Schapiro told more than 1,500 attendees of the Investment Company Institute’s general-membership meeting inWashingtonon Friday. “We saw what happened in 2008. It had a profound effect on broker-dealers and financial advisers.”

Ms. Schapiro was referring to the infamous “breaking of the buck” by the Primary Reserve Fund in September 2008. As Lehman Brothers Holdings Inc. collapsed, the fund’s holding of the bank’s short-term debt caused the net asset value of its shares to fall below $1, sparking a run on money market funds. The Federal Reserve and the Treasury Department stepped in and stopped the run with a temporary guarantee of the $1 share price.

“We know we don’t have those tools anymore,” Ms. Schapiro said. “We have to step in and confront this head-on.”

The mutual fund industry is resisting Ms. Schapiro’s efforts to impose further regulation, arguing that it would hurt investors and impede financing for businesses, as well as state and local governments, and undermine the economic recovery.

NO BACKING DOWN

Ms. Schapiro’s speech appeared to do little to soften that resistance.

“The level of rhetoric was substantially diminished this time around, but it continues to be an ongoing issue,” was all that Susan Wyderko, president of the Mutual Fund Directors Forum, would say about Ms. Schapiro’s comments.

Karrie McMillan, general counsel for the ICI, was not available to comment on Ms. Schapiro’s remarks.

“I think the remarks [Ms.] Schapiro made stand on their own,” ICI spokeswoman Rachel McTague wrote in an e-mail.

The mutual fund industry has maintained that reforms enacted in 2010, which put restrictions on the length and quality of commercial paper in which money market funds could invest in, among other things, were enough to shore up the funds.

The SEC is considering further changes to buttress the value of money funds. The ones being most seriously considered are forcing money market funds to use a floating net asset value, as do other mutual funds, or requiring them to keep a capital buffer in place to act as a backstop in case of any Lehman-like blowups.

Ms. Schapiro’s comments suggest she favors the idea of a floating NAV.

“I want money market funds to be reflective of the fact that they are investment products, and the value does fluctuate,” she said.

Still, she said that neither of those options is “set in ink” and won’t be even if, or when, a formal proposal is put forward.

“We’re always open to having discussions with the industry,” she said. “We’re counting on the industry to engage constructively on solutions.”

“The reforms we put into place in 2010 were very positive and have worked well,” Ms. Schapiro said. “We still come in every morning when there’s been a problem — like the sovereign debt crisis inEurope— and ask, “How are money market funds being affected?’”

Ms. Schapiro said that’s one question that keeps her up at night.

“One of the things that happened after 2008 was commentators asking, “Where were the regulators?’” she said. “We can’t sit by when we see systematic risks and not have a discussion about it. I see a problem, I think it’s a threat to our system, I have to ask how we can try to fix it.”

By Jason Kephart

May 6, 2012 6:01 am ET

This could be a hot, dry summer for municipal bonds, as demand for new issues is anticipated to outstrip supply and drive up prices.

RBC Capital Markets projects that municipalities will return approximately $140 billion to municipal bond holders through distributions and return of principal over the next four months, while issuing only $120 billion in new bonds, leaving a $20 billion reinvestment gap, which it called a “dramatic supply/demand mismatch” in a research note issued last week.

J.P. Morgan Securities LLC projects an even larger gap — $29 billion — the equivalent of about 10% of the $300 billion municipal bond fund market.

“There is a lot more demand than supply right now, and it’s just going to get more severe over the summer,” said John Miller, chief investment officer at Nuveen Investments Inc.

FALLING SHORT

The supply shortage continues a trend that began last year when net new issuance of municipal bonds slowed. While the total volume of municipal bonds issued through April is almost double what it was over the comparable period last year, more than two-thirds of the deals have been refinances, leaving the net number of new municipal bonds available falling short yet again.

“It’s a function of the fact that smart municipalities are cutting back,” said Ronald Bernardi, president of Bernardi Securities Inc., a municipal bond broker-dealer.

Another driver of demand is the possibility of higher taxes after the November presidential election.

“The overall demand, coupled with the potential for tax in-creases, is making municipals attractive,” said Chad Carlson, a wealth manager at Balasa Dinverno Foltz LLC.

Some advisers are being more cautious, however, given last summer’s municipal bond rally.

“There’s just not a lot of juice left in that orange,” said Brian Kazanchy, chairman of the investment committee at Regent Atlantic Capital LLC. “Municipals could continue to do well, but they’ve just gone up so much already.”

Demand for municipal bonds was so strong last summer that the asset class posted an 11% return for the year, second only to the performance of Treasuries. That run has continued this year, with the S&P Municipal Bond Investment Grade Index, a popular benchmark for municipal funds, posting a return of 2.28% through the end of April.

While a record-low supply of municipal bonds was partly the reason for last year’s rally, the real driver was a surge of demand after the stretch from November 2010 to May 2011 during which a record $43 billion was withdrawn from muni bond mutual funds. During that period, when redemptions forced sales on the broad but very illiquid muni bond market, the average muni bond fund was down 2.5%.

The impetus for the withdrawals, of course, was analyst Meredith Whitney’s highly publicized prediction that billions of dollars of municipal bonds were in jeopardy as municipalities teetered on default. When those predictions failed to materialize, money started to flow back into municipal bond funds, which fueled last year’s rally.

Even though the crisis in confidence seems to have passed, investors have returned only about $30 billion of their $43 billion in net outflows.

SUPPLY AND DEMAND

The performance of municipal bonds, more than any other asset class, rests on the mechanics of supply and demand, because about three-quarters of the market is owned by retail investors, said John Mousseau, a managing director at Cumberland Advisors LLC, a wealth management firm that oversees more than $2 billion in assets. “The tax-free space is so dominated by individual investors that it makes it very susceptible to swings in flows.”

While the unique supply-and-demand characteristics of municipal bonds paint a rosy fundamental picture for the asset class, munis remain susceptible to rising interest rates. If Treasury yields start to tick up this summer, new tax-free bonds will have to follow suit, translating into a loss of principal for existing bonds.

An alternative risk, of course, is if munis rally and yields decline, investors looking to the bonds solely for income may be disappointed.