Euro Area Risks Breakup

By Bo Nielsen

Feb. 27 (Bloomberg) -- Hayman Advisors LP, the firm that earned $500 million betting on the U.S. subprime mortgage-market collapse, says Europe’s monetary union is about to fall apart.

Richard Howard, a managing director for global markets at Dallas-based Hayman, said Germany may opt to shore up its own economy, Europe’s biggest, rather than bail out fellow euro nations such as Austria, Italy and Spain as their banks sag under the weight of bad debts. That might lead to defaults and compel Germany to renounce the euro, he said.

“People said subprime could never blow up but it did and now they’re saying the exact same thing about the eurozone,” said Howard. “There’s no stopping what is now a downward spiral.” He declined to discuss his investments.

Hayman joins a growing number of investors seeing the possibility of a breakup of the $12 trillion euro bloc, conceived more than 10 years ago to cut unemployment, tame inflation and create a rival to the dollar. Societe Generale SA said this week Germany may refuse a bailout in an election year. ABN Amro Holding NV said Feb. 17 the crisis is “Europe’s subprime.”

Euro-region bank loans to Eastern Europe topped $1.3 trillion in the third quarter last year, or about 9 percent of the bloc’s gross domestic product, ING Groep NV said Feb. 18, citing Bank for International Settlements data. Now lenders face losses after extending credit to finance everything from industrial development to domestic real estate.

Debt-Default Insurance

Irish banks and foreign banks operating in Ireland together took on debt equivalent to 11 times the nation’s gross domestic product, Dutch-bank credit reached seven times GDP and Belgium four times, according to BNP Paribas SA.

As concern intensified that the loans won’t be repaid, the cost to insure against defaults jumped six-fold to records since August. Credit-default swaps on Ireland climbed to a record 395.8 basis points, from less than 50 basis points in September, according to CMA DataVision. Austrian swaps traded at 265 basis points, compared with less than 25 points six months ago.

The breakup may occur as investors shun all but the safest government bonds, said Hayman, which in 2006 was among the first to bet against Wall Street’s rush to securitize the debt of the least creditworthy U.S. borrowers, correctly predicting a slump in home values that sparked the global credit crisis.

Investor demand for the lowest-risk securities already drove the difference in yield, or spread, between Greek, Austrian and Spanish 10-year bonds and German bunds, Europe’s benchmark government securities, to the widest since the euro’s debut.

Steinbrueck, Soros

German Finance Minister Peer Steinbrueck said Feb. 18 euro countries would “show our ability to act” should countries face difficulties paying debt. Billionaire investor George Soros said Feb. 17 he doesn’t expect a breakup of the region.

The World Bank, the European Bank for Reconstruction and Development and the European Investment Bank will provide up to 24.5 billion euros ($31 billion) to help central and east European banks and businesses cope with the crisis.

European Central Bank officials also said solutions can be found that will ensure cohesion of the region. Executive Board Member Lorenzo Bini Smaghi said Feb. 21 that European Union rules permit the EU “as a whole” to aid states in “economic difficulty.” ECB President Jean-Claude Trichet said a day earlier “there is no weak link of the euro area.”

“The argument that the euro zone will find a solution contains some sense if the assumption is that the situation isn’t that bad,” said Howard. “But the more dire it gets, the less are the consequences of departing from the euro.”

Shrinking Economies

German GDP contracted 2.1 percent in the fourth quarter, the biggest decline since 1987, the Federal Statistics Office said on Feb. 25. The economy will shrink by 2.5 percent this year, with France contracting 1.9 percent and the euro-region 2 percent, according to an International Monetary Fund report on Jan. 28.

European governments, which committed more than 1.2 trillion euros to rescue ailing banks as the recession eroded tax revenue, will require more cash as defaults occur, Howard said. Faced with the prospect of a deepening recession, Germany and France may be reluctant to bail out euro-region members such as Spain and Italy, Howard said.

“Because of the size of this crisis and because of the linkage with Eastern Europe, I think we need to see more broad- minded thinking coming out of the big European countries, in particular Germany,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview today in London. “Germany has got to create demand for many countries in Europe that have a strong need for some help coming out of elsewhere.”

German Elections

The German government, facing elections in September, might refuse requests for help amid political pressure to spend money at home, Societe Generale said in a Feb. 24 report.

“A bailout of a debtor country from a surplus country like Germany would be like opening the box of Pandora,” former Bundesbank President Karl Otto Poehl said in London yesterday. “It’s a very dangerous course that we will enter” and “I’m very much against it, many people in Germany are against it, but the political pressure will increase,”