Do French Elections Matter On This Side Of The Pond?

Just about a month ago in the wake of the latest Greek bailout both French President Sarkozy and former French Finance Minister and now IMF head Christine LaGrande were declaring in lockstep, that “the problem is solved” and “economic spring is in the air.”

Well here we are a month on and the Spanish stock market is all but collapsed, the Italian’s are but a step behind with trading in Italian banking stocks having to be halted on a daily basis lest they fall to zero on any given day.  Credit Default Swaps (CDS) on Spanish debt are spiking dramatically as yields rise to the dreaded 7% level.  Look soon for shorting of European banks to be banned once again.

Both Sarkozy and LaGrande it would seem are betting heavily on successful Spanish and Italian bond auctions this coming Thursday.  If the bid to cover ratio comes in at something resembling Bear Sterns final attempt to stay afloat (30% of bond face value) all bets are off for a peaceful summer in the Euro zone.

While LaGrande’s tenure at the IMF may be resting on the auction’s outcome, for all intents and purposes, successful or not Sarkozy’s goose seems to be already cooked.  All that is left is for the actual ballots to be counted before the fork is stuck in and the declaration of  “its done” to be pronounced.

So why should we care that the French, not know for their political acumen, are about to elect a far left wing Socialist in the person of one Francois Hollande?  Hollande is taking the all to predictable socialist path, while paying lip service to deficit reduction he campaigns on expanding government spending and subsidizing hundreds of thousands of new government jobs, all financed of course by massive increases in taxation.  With his ever-increasing lead in the polls, little wonder that over here, Obama is on the same track.

This brings us of course to the realm of unintended consequences.  Up to this point the technocrats in Brussels have managed to forestall the looming disaster only through the close alliance between France’s Sarkozy and Germany’s Chancellor Merkel.  Sarkozy’s passing from the political stage all but guarantees the end of this Franco-German alliance.  Hollande has made no secret of his contempt for Merkel and Germany’s resistance to the issuance of so called Euro Bonds to finance the ongoing deterioration of the PIIGS.

The EU has already rised dithering until the last moment before reaching so-called solutions to an art form. Any break in Franco-German cooperation may well make any further agreements, particularly in regards to Spain, all but impossible.

The triggering of CDS over the latest Greek bailout and 70% haircuts for the bond holders is a far from settled issue as most of the outstanding bonds are covered under British law not Greek, and as such don’t allow for such losses of principal without triggering the CDS.  The issue is already in the courts.  If a similar credit event occurs in Spain or Italy it will be disastrous not only for European banks but for US banks as well.  Particularly for Bank of America, which has underwritten the vast majority of Europe’s CDS.  They don’t have the capital to pay off on all those insurance policies and quite frankly they never did.  Such an event would of course bring to the fore that most toxic of political questions in the run up to our own elections.  Is Bank of America To Big To Fail?  If it fails the cascade into the rest of the US financial structure may be catastrophic, if it is, and the Administration, the Congress and the FED return to the well one more time with another, even more massive round of bailing out the banks and quantitative easing and its incipient inflation, how will the American voters react?

Obama and company are of course hoping that any such event can be held off until after the election.  If they loose that bet Obama will join Sarkozy in the cooking pot before November gets here.  Even if they win that very risky bet, I doubt that Obama’s or any administration could survive the political backlash of either a deflationary implosion of a massive bank failure or an inflationary explosion brought on by the US taxpayer being put on the hook for Europe’s failure by bailing out the To Big To Fail once again.

But then the creation of new and dreadful wars has always been the political elite's one size fits all solution to financial crisis.