I’m saying “when,” not “if,” because it seems like most financial analysts think it’s only a matter of time. Anyway, on one hand, you have people who seem to think a global financial apocalypse is nigh. On the other hand, you have people (mostly European politicians) who insist that everything will be fine? What’s the most realistic scenario for what happens when Greece finally says “Forget it. We can’t pay.”?
The main worry is that banks in other countries, many of whom hold a lot of Greek debt, will suddenly find a sizable chunk of their assets are worthless, and we’ll end up with a repeat of the previous financial crisis, when the same thing happened with mortgage backed securities.
Yes and no.
Greece is less likely to default (as in “sorry, but when you call for payment I won’t answe the phone”) as much as it will organize an orderly default - banks and other bondholders will be approached to acept writedowns, reschedules, andsuc. Instead of paying 5% interest and pay off in 5 years, what say we make it 3%, we promise to pay 80% of the bond face value in 10 years?
Banks holding the bonds will take a serious hit. W’ve already seen panic selling of stocks in banks that allegedly have very high exposure… but this likely means a few years of losses as the banks recapitalize (rebuild their assets to ensure they have the pool of money to keep operating.)
Like the US meltdown, only smaller, there’s the risk of freeze-up. A lot of banks exist on trust; they cash each others’ cheques, honor bank card transactions, payroll deposits, etc. Businesses work on lines of credit where they pay bills, etc. from tranfers from their banks’ accounts. The assumption that at the end of the day, when they tally it all up, the banks will all have enough money to easily pay up any differences. If any bank begins to worry that others will not pay it, they will stop honoring transactions or ask for cash up front. This is where the government has to step in to guarantee all transactions, and then of course prop up the banks that in the end do not have the money to settle these debts.
Meanwhile, Grece still either (a) needs to borrow more or (b) stops paying its operating bills, or © cuts spending across the board - “all you employees, your slary is now half what it used to be!” or (d) creates a new currency, the Greek “Floater”, and converts all internal payments to that and the currency suddenly is worth half what it used to be…
Plus, consider every business - a Greek airline has sold tickets, suddenly its bank account contains Floaters rather than Euros, but it still has to pay for jet fuel for the return flight in Euros; and the local airport is going to charge world price for its fuel. A car dealer owes Euros to the Mercedes or BMW factory, but can only sell cars in Floaters or else can’t sell them at all… Food, gasoline, etc. all double in real price; you’re a Greek landlord, what are your choices for raising the rent, if your tenants have less money than before… The repercussions will take years and untold hardships before settling into the new reality. All those civil servants who thought they retired on cushy pensions at 53 - tough bananas for them…
Banks that need to rebuild their capital base are going to be risk-averse and charge higher rates to lend money, so it will be harder in Europe to borrow money and there will be less available to borrow. A bank needs X% of their capital base in hard cash assets. If they lost a lot of that, they have less to lend. So business expansion and consumer spending will be lower across europe until everythings ettles out.
Finally, Greece is just the wost of a bad bunch - Spain, Portugal, Ireland, and possibly Italy may have the same problems only not so bad. Once bitten, twice shy - these countries are far worse at spending more than they take in, compared to the USA and its petty squabbles. They need to borrow money just to keep operating, and the worse Greece gets, the more likely bankers will be wary or extending even more credit to them - forcing them to cut back bigtime too, thus shrining their economies.
The moral of the story - spend like a drunken sailor and you will, like him, get a serious hangover when the party ends.
Actually, Spain, Portugal, and Ireland all had pretty much balanced their budgets–until they propped up their banks who had invested far too much in bad securities such as CDOs. Contrast Iceland. Iceland is widely considered to have defaulted on its debt. No, the bank of Iceland defaulted. The government guaranteed losses only for inhabitants of Iceland, to the consternation and cost of everyone else. But their economy has largely recovered. Thanks, among other things, to a social safety net that left everyone with some buying power.
Iceland had the great benefit that they were small enough that although their default as pretty total, it wasn’t very big on a global scale.
The same move attempted by one or more larger Euro-area countries would have a much bigger effect.
It’s not so much Greece, but the contagion effects to Europe and beyond. If Greece writes off 50% of its debt, one wonders if Portugal, say, might be tempted too. The potential domino effect of bigger and bigger countries defaulting is alarming.
You might think “meh, it’s mostly Euro banks who lent to these countries”, but a lot of them insured against default with CDSes. The people who issued those CDSes are going to lose out too, and they include American banks. Plus the general loss of confidence between institutions, because all of them will wonder how exposed they other guy is. Similar to 2008, in other words. Could be worse than 2008.
There are also the political effects to be considered - if Greece defaults, after receiving tens of billions of Euros in bailouts, no-one’s going to be funding any more bailouts for a very long time. Likewise the proposed Eurobonds will be dead on arrival, unless Greece (and probably others) get kicked out of the Eurozone.
This could push Portugal over the edge even if they decide not to jump - no-one lends money (at any reasonable rate) to a debtor suspected of being on the edge of collapse, so the non-default choices reduce to crippling austerity or a Eurozone exit that would allow them to print their own money. Then the spotlight moves on to Spain and Italy.
A Spanish or Italian default would probably bring down the European banking system, with massive consequences for the world economy, never mind Europe’s. And while you can blame the bankers for investing in “bad securities such as CDOs” you can hardly fault them for putting their money in Eurozone government debt.
Hence the all the insistence that default is unthinkable. But Greece looks like it’s reached the point where it simply cannot cover its debts, even if its government and citizens do everything the ECB asks of them. (Most of the other vulnerable countries probably aren’t there yet, but avoiding it requires the willingness of the financial markets to lend, the willingness of their citizens to endure long-term austerity and some sort of recovery in the world economy). Barring further bailouts (which the Germans are increasingly unwilling to fund), the Good Fairy arriving from China (or somewhere) or an unlikely rebound in the Greek economy, the crunch is looking imminent. Right now, if you want to insure your Greek debt for one year, it’ll cost you 48 cents on the dollar.
Clearly, Greece needs income.
Merkel should order all Germans to vacation in Greece-also, pay German retirees to move there.
Mandate that all EU vacationers should go there.
And mandate that olive oil from Greece should be served at all restaurants.
The problems of the Spanish and Irish banks are not CDOs, it is and was clasic real estate lending. CDOs have pretty much fuck all to do with the problems of the Mediterranean banks and the Irish. It’s plain old classic fuck ups there.
The Icelandic default they’ve managed out because they’re small. Greece going could be manageable if the Continentals organize things right, but one has doubts about that.
The saving grace is Spain and Portugal (and Ireland) can tell pretty good stories about responding in a straight up fashion to the crisis. They had good budgeting as mentioned, and into the crisis have been managing things. The Greeks lied their way into this disaster and they cotinue to delay badly needed market reforms to their corrupt fiasco of a pseudo-European system.
If they default in a way that ECB and the Eurozone govs, particularly Germany don’t step in to proect the German and French banks - and pension funds which will take a huge hit (my retirement savings for example, it’s public money ) then we are fucked.