I don't like to say 'I told you so', but I told you so!

In my 2010 predictions, I suggested that Greece and Ireland would come under the spotlight this year. 'There's nowhere for the smaller, more vulnerable Euro players to hide', I said.

What I didn't realise, of course, was that this Lehmanesque-type event would have a kind of domino effect on the rest of Europe. Now people are talking about the implosion of the Euro system itself - the collapse of the Euro currency, and a whole host of resulting geopolitical ramifications. 

But before you choke on your wheaties, let's get a sense of perspective here. Bank debt has in some way been substituted at the sovereign or country level by national / government debt, and many countries' Central Banks have even been guaranteeing bank bonds. This is a classic example of the so-called 'moral hazard' at work. But what we're starting to realise now is that nothing is, in fact, 'too big to fail' (with the possible exception of the USA).

So this brings me to the next point. Namely, that hedge funds and banks' prop desks are almost certainly the main protagonists in the current explosion of the PIGS bond spreads. Not by selling illiquid and hard to borrow government bonds, but by buying insurance protection called Credit Default Swaps (CDS) on the underlying bonds, or a deliverable basket thereof. This is difficult to get one's head around, but suffice it to say that it allows an awful lot of people to employ a significant amount of leverage against these failing economies.

Is that such a bad thing? Well, when I opined on these pages that the EC was right to call for more accountability on the percentage of short sales of company shares, I didn't exactly feel the love out there. So when I call for more limits on the amount of leveraged short sales of government debt, I'm sure the reaction will be the same. However, the swift disintegration of the so-called Club Med bond markets, and the ripple effect through the rest of Europe, will cost future generations a great deal more in taxes (not to mention the potential for considerable social unrest).

You might argue that these countries were borrowing beyond their means, and had it coming to them anyway, but the markets are giving no-one the time to get their house in order. So this problem is going to run and run. Greece and the others have been rumbled. The ECB is left having to continue to provide liquidity to the lesser members' banks, like a recovering addict being given methadone. It ain't pretty. Add in a good pinch of double leverage, and you have a recipe for disaster. And that's why last year's bull correction may well become this year's PIGSTY!

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