9/22/2011 7:30 PM ET|
If Greece defaults . . . then what?
Nobody wants a Greek default now. But sometime in 2012, Greece will want one -- and so will Germany. The question for investors is what will happen to the euro.
It looks like Greece won't default. Yet.
Certainly not before next week. (How's that for optimism?) And almost certainly not before December.
But the financial markets are still pricing in a default by Greece on its government debt -- and all the chaos that would produce in the Greek economy and banking system, rippling outward to the rest of Europe and then the world -- sometime within the next five years.
Want to know when? I think you can get a pretty good idea by looking at the self-interest of the major parties involved: Greece and Germany. Greece will default when the self-interest of Greece is clearly weighted toward default or when the self-interest of Germany is clearly weighted toward allowing a default.
The self-interest of Germany argues for a relatively early default. Not December, but in the first half of 2012. The self-interest of Greece argues for a somewhat later default. Say, halfway through 2012 or a bit later. But both point toward 2012.
A 2012 timeline
Everybody -- myself included -- looks at the pain and disruption that would be caused by a Greek default and says, "Nobody wants that to happen."
A Greek default would be much larger than other recent defaults, like the one in Argentina in 2001 or in Russia in 1998. Greek public debt now comes to about $500 billion. Argentina's debt when it defaulted was $82 billion, and Russia's was $79 billion. The size of Greece's public debt assures that the consequences of a Greek default would ravage its economy.
Inside Greece, banks would face huge losses on bonds in their portfolios and would have to close their doors until somebody -- who? -- recapitalized them. The economy would grind to a halt. Some projections put the contraction in the gross domestic product at more than of 25%. ATMs would stop working. Business credit would dry up, and businesses would shut their doors. The government would be unable to pay its bills.
But the damage wouldn't stop at Greece's borders. Bond buyers would flee Italian and Spanish government bonds, requiring the European Central Bank and the European Financial Stability Facility -- if it's set up by then -- to pour billions into buying those bonds to support the markets.
European banks would take a huge hit as the value of Greek government and corporate debt in their portfolios plunged. Big banks and insurance companies in Germany had a total exposure of $33 billion to Greek government and corporate debt as of the end of March, according to the Bank for International Settlements. French banks had exposure to Greek public and private debt of almost $80 billion.
That exposure is not spread evenly. In France, much of it is concentrated at three big banks: Crédit Agricole (CRARF, news), Société Générale (SCGLY, news)and BNP Paribas (BNPQY, news). In Germany, the government set up bad banks as part of its bailout of Hypo Real Estate Holding and WestLB. Those bad banks hold more than half of all the Greek debt held by German banks and would undoubtedly need another infusion of taxpayer cash.
How bad would it get?
Exactly how far the damage would go depends on to which degree that bond markets would punish the bonds of Portugal, Ireland, Italy and Spain, which, along with Greece, make up the so-called PIIGS group. The exposure of U.S. banks to Greek debt alone is relatively small. But U.S. banks have $670 billion in total exposure to the PIIGS group.
And it depends on whether a default would force Greece out of the euro. That's not an inevitable result. Greece could default on its huge debt to banks, but pay its relatively smaller debt to international creditors such as the International Monetary Fund, the European Union, and the ECB. Those institutions might even see a capital infusion into Greek banks -- along with a process that rolled up bad banks under new, perhaps overseas ownership -- as a better alternative than the end of the European Monetary Union. The consequences of a collapse of the euro would be huge on even a strong economy such as Germany's. UBS estimates that a collapse of the euro that left Germany on its own could produce a loss of as much as 20% to 25% of German GDP in the first year after a breakup.
Those scenarios seem so grim that it's hard to imagine any rational politician steering his or her country into such a storm. And that's been the strongest argument -- one that I've made on more than one occasion -- for saying that Greece won't default and that Europe will figure out a way to rescue the country from its debt spiral.
There is another way to look at the "Why would Greece default?" question. IMF economists studying past sovereign defaults came to a conclusion that turns any approach to answering this question on its head. It turns out that in past defaults -- including defaults by Argentina, Ecuador and Indonesia -- a country defaulted when it saw that a default was in its best interest.
When a default could help Greece
There are lots of ways of defining "best interest." Greek politicians could decide that default is in the best interest of the ruling PASOK socialist party of Prime Minister George Papandreou or of the opposition New Democracy party if it would help them win the election on the horizon. The government might decide that it's in Greece's best interest to default if the demands of the Troika -- the IMU, the EU and ECB -- have become so onerous Greece can't meet them. Greek leaders in and out of government might decide that the level of violence in the streets had reached a height that made a default the less-worse alternative.
Economists also discovered a less-subjective measure that had a high predictive value in indicating when a country would default. It relies on something called the primary budget surplus. A country shows a primary budget surplus when its budget, without the interest that it is paying on its debt, is in the black. At that point, a deeply indebted country that has cut spending, raised taxes, and instituted other austerity measures may decide that the best way out of its hole is to eliminate those interest payments by defaulting on its debt. After all, payments to creditors are the problem, right? (Please note, I'm not talking about the accuracy or even the rationality of this view. If a country was deeply economically uncompetitive going into the crisis, it almost certainly still is at this point, and writing off its debt isn't a permanent fix.)
And guess what? Current projections show that Greece is likely to be running a primary budget surplus by sometime in 2012. Of course, it will still be struggling to pay the interest on its debt -- with just about no chance of significantly reducing that debt. At that point, defaulting on its debt starts to seem in Greece's self-interest, even against a backdrop of dire consequences.
That timing gets even more convincing when you add in the self-interest of the European countries that are footing the bill to rescue Greece month in and month out. There doesn't seem to be any end to this demand on their taxpayers. The costs of the rescue are deeply unpopular in most of the countries -- notably the Netherlands, Finland and Germany -- that are paying the bills. The Greek rescue looks like it could bring down Angela Merkel's government in Germany.
And did I mention there seems to be no end to the money taxpayers are being asked to pay out?
At some point, the self-interest seesaw in one or more of these countries will tip toward a Greek default -- even given the disastrous international finance scenario I painted above. It doesn't have to tip in every country in the eurozone. In fact, if it tips in Germany alone, it would be decisive because the eurozone doesn't have the financial muscle to rescue Greece and control the threat to Italy without Germany.
Germany is already preparing
It's important for investors trying to understand how the Greek debt crisis will play out to realize that Germany is far along with its plan to deal with the consequences of a Greek default. It created bad banks to handle the worst portfolio problems of its shakiest banks as part of its solution to the global financial crisis of 2008. Its biggest banks, Deutsche Bank (DB, news)and Commerzbank (CRZBY, news) hold a comparatively small $4.7 billion in Greek debt. Truth is, Germany sees an open-ended commitment by the ECB to prop up the bonds of Greece, Italy and Spain as a one-way ticket to financial hell.
At the same time, I think Germany understands that it is in its own self-interest not to destroy the euro. The economic consequences of giving up a weak currency for a strong Deutsche Mark on German exports would be immensely negative. And it would be extremely hard to prevent the current crisis from engulfing not just Italy, but also France, without the eurozone.
But once the European Financial Stability Facility is in operation and Germany's Plan B to stabilize its banks is in place, I'd expect to see Germany begin discussions with Greece, the ECB and other eurozone members on how to let Greece default and yet preserve the euro.
Those discussions would be in Germany's self-interest -- and in the interest of Greece, too.
Look for them sometime in early 2012. Look to see if the steps to control the spread of the consequences of any Greek default to Italy, etc. are credible. That's the key to the reaction of global financial markets.
At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did not own shares of any stock mentioned in this column as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.
Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market-beating Jubak's Picks portfolio; the writer of the Jubak's Picks blog; and the senior markets editor at MoneyShow.com. Get a free 60-day trial subscription to JAM, his premium investment letter, by using this code: MSN60 when you register at the Jubak Asset Management website.
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The Greek people, the ones that will suffer from austerity, did not borrow the money. The Greek government borrowed the money in order to fund programs to enrich the lives of their citizens, and themselves, and g e t e l e c t e d, the same as in the U.S.
It is the Achilles' heel of democracy coupled with capitalism, something that China does not suffer from. If you check out the resumes of the Chinese leadership, they are almost all engineers (who design and make things), not lawyers (who argue with each other and are willing to take money from practically any source, even Fox News. ;^)
The solution is to get the control out of the hands of the politicians being funded by too-big-to-fail banks and corporations. A simple solution, but almost impossible to achieve in the US., or elsewhere. Those are exactly the very powerful entities that fund campaigns, and therefore, control the government.
tmpst05 is right. But careful analysis is not the long suite of your average gobal citizen. Still there are many more good people than bad in almost any society, including the U.S. If the good people of the earth controlled the world,....well, either things would greatly improve or they would no longer remain good, I'm not sure which.... (power corrupts, absolute power corrupts absol...well, you know) If we could all keep our faith instead of panicking, we could get through almost anything, and perhaps even emerge better and wiser from the experience.
The Greeks have consumed more than they have produced for decades. They've borrowed the difference. Their problem is that their lenders (suckers) aren't going to subsidize the Greek lifestyle any longer.
You think everyone is entitled to a job " with decent pay and health care for themselves and their children"? Well, what if as a country, you don't produce enough to pay for that? That's Greece's problem.
What do you propose? Perhaps America should try to borrow even more from our unborn grandchildren to bail them out?
You are right on. One only has to look at the crimes in our major cities. I can't imagine the rioting for cash, food and other needed items. Yes, with all that the ACLU has accomplished, our country will turn into savages.
If the American people start rioting, it won't be because anyone is starving. That just doesn't happen in this country. Just look around; the poor are the most overweight class in an obese country.
If there are riots, it will be a vivid confirmation that our government has made helpless dependents out of the self-entitled masses. Shame on all of them.
If Greece defaults, then the DNC can default....oh wait...they've been doing that for years and having the American taxpayer take the fall. Cut Dem programs that are a waste such as Dept of Education, Planned Parenthood, NEA and PBS.. No one will miss them.
If Greece defaults . . . then what?
Then I bail out of my rental condo in New Jersey and start looking for a cheap one in Thessaloniki. Hey, Greek finances may be in the crapper, but, their coastline and islands will always be gorgeous. There are worse places to retire you know, like Orlando.
On a slightly more serious note...
I do find the commies in Greece to be a hoot! Let me get this straight- we the Citizens of Greece, call something like 30 hrs/week full time. We mandate 4-6 weeks vacation
(paid) for all workers. We use high barriers to entry and insane regulation to drive out all dynamic forward looking industry and commerce. We spend WAY more than we collect in Taxes and just charge it like an 1890's housewife at Macy's.
Then when the bill comes due we riot and burn our own country down (a la south central LA circa Rodney King) followed by refusing to go to work and throwing what ammounts to a tempertantrum of screaming, crying and hitting/kicking the floor and furniture while in line with mom (EU) at the bank (Germany).
We follow up with accusations that those dirty bankers
"did this too us"
How dare they lend us money they knew we would flush down the toilet and could not pay back and then expect us to actually pay it back - or even just balance our books.
HOW DARE ANYBODY TELL THE GREEKS THAT KEYNESIAN ECONOMICS CAN NOT BE USED FOREVER WITHOUT CONSEQUENCE! Every body (like Paul Krugmann) knows that there is never a down side to borrowing $$ and using it to live an unsustaionable life style.
Disgusted628: If the American people start rioting, it won't be because anyone is starving. That just doesn't happen in this country. Just look around; the poor are the most overweight class in an obese countryI thought the same thing in up until 2007 about banks going into default and crumbling needing to use the FDIC to pay depositors back. "Banks just don't go bankrupt anymore these days," I told my new-hire class I was training in 2005-6ish. Boy was I a fool.
tank it !
don't care anymore...
tired of hearing about it...
do it or don't do it...just shut up about it already !
Who were the idiots that let Greece get into this dire financial situation? They were the international bankers who were so impressed with their multi-million dollar bonuses that they thought they were infallible. Stupid-Stupid-Stupid. Any fledging banker who has completed credit analysis 101 could have seen this coming years ago. Have bankers forgot how to say "NO"?
This is especially true for the U.S. beginning shortly after WWII. Since then we've been relying entirely to much on borrowing future growth to fuel present growth. It works but only for so long. This is a key reason why we're trudging along anemically in the U.S. right now. If we slip back into recession, which is more likely than not in my opinion, climbing back out of it will be even more difficult. Our federal gov't has run out of ways to put off necessary structural changes than we'll have to embrace sooner or later.
The Greece crisis is troubling because it exposes debt fueled growth that simply, in no way can be sustained. Hopefully the U.S. will wake up before the contagion reaches our shores. Most developed country's citizens are realistically looking at much lower standards of living, less income and entitlements over the coming century. Like an earlier post mentioned, we only have so many natural resources to spread around to a growing base of demand. Like it or not there is no quick and easy way for us to escape this mess. Begin preparing for a different lifestyle now or be forced to do so in the future. Whether we like it or not, it will very likely happen.
Jim, the problem with your timetable is that the bond markets have already repriced Greek debt, and the result of this repricing has already fallen on the holders of those bonds. Thus the French banks are already insolvent, or close to it without further Central Bank intervention. So the results are already there, and the Europeans are scrambling to contain it.
Unfortunately, there isn't enough transparency to know who or what is holding the exposure to this, considering the CDS market shifting the hot potatos around like crazy. Best to not be holding any financial stocks, at least, until (as Warren Buffet says) the tide goes out and we see who's been swimming naked.
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