Over the last several months, the

world has watched the events in Europe unfold with a sense of disbelief mixed in

with a measure of anxiety. The disbelief comes from the fact that many investors

must be asking themselves how the world could be confronting yet another credit

crisis -- when we just seemed to be finished papering over the last one. The

anxiety comes from the fact that there are some prognosticators who believe that

Greece is just the tip of the iceberg -- and other European nations such as

Portugal, Italy, Ireland, and Spain are next on the bailout list. Many observers

believe that the very existence of the Euro and the European Union is being

called into question.

Greece's citizens are finding out

firsthand the implications of a government that has allowed a disregard for

fiscal discipline to run unchecked. The cost is real. Greece is trying to take

corrective measures to deal with its debt crisis by enacting wage rollbacks,

pension benefit reductions, cuts to government programs and higher taxes. This

is a tall order at the best of times let alone when your fellow members of the

European Union (i.e. your bankers) are facing reluctant voters at home who would

rather see Greece kicked out of the European Union.

The recent aid package announced

this past weekend in which almost $145 billion (more than twice the originally

proposed $58 billion) in loans would be used to prop up Greece over the next

three years. It was supposed to have calmed the markets. Instead, the markets

have shrugged it off and Greek interest rates are still rising. In part, nobody

seems to believe that the Greeks can deliver on their promised return to fiscal

responsibility. The Euro has continued to fall and the response by the Greek

population is one of shock and anger.

As the Greek government has tried

to implement very tough spending controls, its citizens have responded with

anger. Last month, Greece's air force showed its displeasure as several members

of the air force decided to "take an unscheduled day off" and the country has

seen some violent protests.

Most individuals in North America

might believe that this is a European problem and does not impact them. For the

most part this is true -- thus far. What we are seeing is a general aversion to

sovereign credit. The markets are telling governments that "We are not confident

in your abilities to pay back the money that you owe". If this aversion

continues, governments will have to offer greater incentive to investors in

order to sell their debt. Recently, before the aid package was announced, Greek

two-year bonds were seen yielding 18% -indicating that the markets viewed them

as being high risk.

The shockwaves from the Greek debt

crisis have sent the yields on corporate bonds higher as investors have decided

to reign in their appetite for risk assets. The Euro has tumbled, the US dollar

seems to be regaining some respect and investors have shrugged off a fairly

decent performance from corporations that have reported recent quarterly

earnings.

Ironically, only a few short weeks

ago, Greece was able to float a bond issue to investors that saw such

significant demand that it was oversubscribed. But this was not to last as these

bonds quickly began trading for less than their issue price -- a sign that some

investors underestimated the extent of the Greek debt crisis.

The real issue that has not gotten

so much attention is the level of debt exposure the commercial banking industry

has to debt issued by the PIIGS. The chart below shows that the European banks

have over $2 trillion in debt exposure to the PIIGS group of countries.

This is one of the real reasons

(along with trying to maintain the credibility of the Euro) that the European

Union countries have no choice but to try to stabilize the sovereign debt

crisis.For those who think this is a European problem, we have to look at the

involvement of the International Monetary Fund (IMF) which will contribute about

30% of the funds to Greece. The largest shareholder in the IMF is the US which

means US taxpayers will be contributing a large portion of the rescue package.

It is perhaps amazing that this

issue has not come to the front in political discussion yet in the US. For that

matter, Canadians are also seemingly quiet on this issue. Given how much

political backlash there was for bailing out GM, the banks or other industries

during the financial crisis - this is surprising.

The crisis in Greece is nowhere

near the size of the one that enveloped the financial markets nearly two years

ago -- but it is significant. The question is whether or not this crisis will

become a contagion.

For investors, there are always

winners and losers in every crisis -- and opportunity to be had. The problem is

that too many investors were caught flat footed by this crisis as it has been

bubbling for some time. Hence, the violent reaction we are now seeing in the

financial markets.

As we have commented before,

complacency levels had set in amongst investors over the last several months and

we know from history, that complacency is often replaced with panic.

Pacifica

Partners Capital Management
Suite 213 5455 152nd St
Surrey, BC,

Canada
V3S 5A5

Tel: 604.576.8908
Tol Free: 1.877.576.8908
Fax:

604.574.2096

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