Last week, Moody’s stated that Greece’s 2011 bailout will weaken Europe’s strongest countries’ credit ratings and result in a Greek default. The rating agency went on to say that even though the European Union made the process of dealing with defaulting members easier, the final adopted measures could lead to the creditor countries’ downgrades because of the inevitability of future bailouts. Greece’s local- and foreign-currency bond ratings were dropped from Caa1 to Ca.

The new rating is one level above default – the equivalent of assigning them a developing outlook…

Greek Debt Relief From Private Sector Debt Swap

The EU approved a rescue plan that combines 109 billion euros in fresh financing with an expected 37 billion euros in debt relief from the private sector through a debt swap. The program, in conjunction with the Institute of International Finance’s statement of a distressed exchange of Greek debt, almost guarantees a default but includes the option to roll over the defaulted debt into a longer maturity.

The EU is now formally committed to filling the Greek financing gap for as long as the Greek government adheres to its austere budget consolidation program. After the rollover of private debt, the majority of the Greek government’s remaining debt will be taken care of.

The same is the case for Ireland and Portugal; as long as these two countries follow the statutes of their budget programs, they’ll be able to refinance their debt as it falls due, at low interest rates from the European Financial Stability Facility (EFSF).

Because of this safety net, the markets can’t hurt the countries’ solvency positions by raising bond yields.

However, all is not stable across the pond. Greece could still prove to be a pariah to the European Union if it fails to stick to the austere budgetary guidelines it agreed to. The EU would then have to provide more financing or the Greek government would default on its official debt and presumably leave the Union. This scenario is still very much in play.

The EU’s Bailout Blueprint

Other EU members with a large amount of debt won’t fare well with this perceived bailout blueprint.

For bigger but non-AAA members of the Union, specifically Italy and Spain, Moody’s believes the negatives of this program will outweigh the positives and affect future ratings.

This will do little to help the EU’s third- and fourth-largest countries respectively, which have seen bond yields soar in recent weeks. The warning came despite the EU’s insistence that the Greek debt swap is unique and won’t be applied to other countries.

It’s known that the EFSF doesn’t have enough money to deal with Italy and Spain. However, the EFSF can be proactive and provide more capital if the banking sectors of these countries should need it. Even with this ability,  there’s still a lack of funding to sufficiently tackle the problem.

Until adequate funding is available, the possible catastrophes stemming from Spain and Italy won’t be removed. At some time in the near future, the EU will have to increase the funding available to the EFSF by a great deal or it will be de ja vu all over again.

What to take away from this bleak outlook? Investment U’s own Chief Investment Analyst, Alexander Green, believes that the best way to play this is by investing in an exchange-traded fund that bets against the euro, such as the Market Vectors Double Short Euro ETN (NYSE:DRR).

Good investing,

by Jason Jenkins, Investment U Research

NYSE:DRR