The debt markets could get dicey again in a few weeks or months as the political situation in Europe continues to have greater dysfunction and turmoil with new elections. As the needed austerity programs take hold, the unions and others are up in arms over having to live within the means of their countries for the first time in a generation. The labor laws in much of Europe have been structured such that it is essentially to fire anyone and if there is a layoff, the redundancy pay is prohibitive. As a result the cost to produce in much of Europe is higher than most of the world and inefficiency prevails. In Italy most companies stay small because the economics of growing just do not work. Between the labor laws and the bureaucracy, and the massive corruption brought about by the restrictive laws, it is not worth building a sizable business. In Greece it is similar and almost impossible to start a new company. In Spain as in Italy and Greece and elsewhere, there is little change in a workers lifestyle to be employed or unemployed. You get a wage or you get social welfare of similar amounts in many cases. I had a Spanish doctor tell me over a year ago, that 20% unemployment was not really a problem because workers get unemployment, full healthcare and other benefits. She told how you would never know there was widespread unemployment if you saw how crowed the restaurants are. That is the policies that got Spain into the mess it is in.

It is highly likely that Hollande will win in France and try to undo the debt agreements just put in place. He intends to raise the minimum wage and to materially ramp up public sector hiring. The exact opposite of what is required to save France form becoming Spain. The Dutch government fell. It was one of the few strong economies. The Italian unions are starting to push back against labor law changes. The UK is in recession and pressure will mount against Cameron. Greece is never going to achieve it targets for debt reduction and labor law changes sufficient to really solve its problems. Ireland is trying, but it is unclear if they will succeed especially if the UK goes into a deeper recession. While Draghi and the other technocrats are working hard to fix the mess, the politics are slowly going to overwhelm the needed reforms. Europe is at a major crossroads in its economic policies and future, and while Germany has been able to push everyone to make needed reforms, the unions and austerity is making the politics too hard to succeed long term. The entire social and political compact that has been in place for two generations is now being ripped apart, and that is not something that happens without major political and social disruption.

Strikes will likely increase. Violence could increase as the economic pain ratchets up. With the large Muslim populations now in France, Holland and other countries, there is a large under class that is potentially going to explode again in the types of riots we saw in France. It is also ripe for more terror actions and other violent acts. In short, the social fabric is being torn to save it and reformulate it and that is always filled with high risk in any society. Especially one like Europe where there is a brew of extremely strong unions and a large disenfranchised immigrant population.

The result is the ECB bailout of the banks has run its course and there is not likely another one coming. It prevented Lehman II, but left the banks still very weak. The ECB also cannot keep bailing out countries. The French banks are still weak and not prone to aggressive action to deal with the decisions to fix their own issues. The major US banks are far more solid now and far more capable of the sorts of aggressive actions they have been taking to build their franchises. It is highly likely the US major banks will steal more and more market share from the big French banks and even the German banks. That will just weaken the Europeans even more. With weak banks that were the basis for most European corporate borrowing, it will be the US banks and investment banks who step in with capital markets solutions that we are used to here in the US for capital raising.

The concern is as the European mess continues and potential deteriorates again into political fights, and strikes and possibly riots, it will leave mainly the IMF to step in. The IMF has tight rules for proving help. That means more tough medicine. If things do deteriorate again, then the debt markets will again get messy. Treasuries will remain at very low yields. However spreads on CMBS and other debt could get more volatile.

In China, the BOP scandal has upset the Chinese government and business world far more than is apparent. He was just the most obvious of the many doing the same sorts of things his wife and he were doing. Many top business and government people are now very fearful that there could be major crackdowns or political issues and things could get messy. This is supposedly leading to more Chinese moving capital out of China and setting themselves to flee to the US or Canada. It is very hard to really know what is going on, but something is amiss.

All of this disruption, combined with all of the black swans of Iran, the election, the year end sequester kicking in, the end of the tax cuts and other issues, will continue to make the debt markets subject to potential disruption as the year goes on.

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Joel Ross

Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.