Four of the top five articles on Zerohedge.com are currently outlining the Greek Crisis. Is this important to the rest of the world or to you personally? Yes and there is no qualifying “but” to be considered. The future of the world will be defined by one of two factors in the next few weeks:
- The Greek default.
- The impending world war.
The Greek default will result in the collapse of European banks and shortly thereafter, the United States banking system. The only reason that the EU has not collapsed yet is the transfer of over $800 billion to the European Central Bank by the Federal Reserve since December 1, 2011. Once the financial system collapses, the great equalizer will soon follow: world war.
Whether the upcoming war starts prior to an economic collapse depends on other factors that are receiving some attention in the media: gas/oil prices, Israel, a nuclear Iran and even Syria. Unfortunately the most pressing of the causes for war is being ignored or misunderstood which is the Greek default. Soon to be followed by the Portuguese, Irish, Spanish or Italian default.
First, “quantifying” the fallout from a disorderly default, based on the one thing that everyone always forgets (as was the case in Bank of America)- contingent liabilities:
- Direct losses on Greek debt holdings (€73 billion) that would probably result from a generalized default on Greek debt (owed to both private and public sector creditors);
- Sizeable potential losses by the ECB: we estimate that ECB exposure to Greece (€177 billion) is over 200% of the ECB’s capital base;
- The likely need to provide substantial additional support to both Portugal and Ireland (government and well as banks) to convince market participants that these countries were indeed fully insulated from Greece (possibly a combined €380 billion over a 5 year horizon);
- The likely need to provide substantial support to Spain and Italy to stem contagion there (possibly another €350 billion of combined support from the EFSF/ESM and IMF);
- The ECB would be directly damaged by a Greek default, but would come under pressure to significantly expand its SMP (currently €219 billion) to support sovereign debt markets;
- There would be sizeable bank recapitalization costs, which could easily be €160 billion. Private investors would be very leery to provide additional equity, thus leaving governments with the choice of either funding the equity themselves, or seeing banks achieve improved ratios through even sharper deleveraging;
- There would be lost tax revenues from weaker Euro Area growth and higher interest payments from higher debt levels implied in providing additional lending;
- There would be lower tax revenues resulting from lower global growth. The global growth implications of a disorderly default are, ex ante, hard to quantify.
Lehman Brothers was far smaller than Greece and its demise was supposedly well anticipated. It is very hard to be confident about how producers and consumers in the Euro Area and beyond will respond when such an extreme event as a disorderly sovereign default occurs.
Another day, another reminder that all those who listened to “pundit” calls for loading up on Greek 1 year bonds which hit 100% for the first time ever in September of last year, are now broke to quite broke. As of this morning the Greek 1 Year Bond has just passed 1000% and was down to just 20.5 in cash terms, further making the case for a Greek redefault in just over a year, as pre-petition bondholders make it abundanatly clear they don’t expect to collect much more than one cash coupon in the “fresh start” country. In other news, Greek CDS just hit a new all time high of 77 pts, and the basis package is at a record of 98.5. It appears that the IIF fearmongering has not stopped all those who wish to have a basis package going into Thursday from doing just that (because for the cheap seats, CDS prices go up when there are more buyers than sellers).
An Important Week
I recall the early days of the Greek crisis when everyone asked why Greece was so important because it is such a small country. I responded that they had a total of $1.1 trillion in debt (sovereign, municipal, corporate, bank and derivatives) and I remember the blank stares. Now, if the newest bailout goes through, they will have more than $1.3 trillion in debt and while they could not pay the initial amount they certainly cannot pay any larger amounts so that it can clearly be stated that what is going on is the central banks of Europe and the ECB/EU lending money to Greece only as a conduit to pay back their own banking institutions. If you object to my math here recall that as the private sector involvement reduces the notational amount of sovereign debt but that the Greek banks are also going to be lent money so that the decrease in sovereign debt which excludes the ECB/EIB and IMF debt is not the headline bandied about in the press. So we have the hard date of March 9 when either the threshold for the exchange is met or not, the imposition of the CAC clause or not, the next “Question” to the ISDA if the CAC is triggered asking if there has been a credit event to trigger the CDS contracts, the possible consequences of a CDS trigger, the decision on the bailout funds by the EU and finally the March 20 hard date when Greece must make its bond payments or default. Regardless of your opinion, it may now be stated precisely, that there is a lot of risk on the table and on that basis alone I would assume a quite defensive position until this all gets played out. The risk/reward ratio is now strongly slanted towards Risk.
In what should come as a surprise to nobody, German banks have announced that they will accept the terms of the Greek PSI whose outcome is due on Thursday. Because as Reuters points out, German banks already have had the time and opportunity to park the bulk of their Greek exposure with the failed German bad bank, which is explicitly funded by the government (thus making the cost to the German government even higher): “While Greek sovereign debt owned by German lenders has a face value of roughly 15 billion euros ($20 billion), in most cases they have already written down that value in their books by about three quarters. FMS Wertmanagement, the biggest creditor with an exposure of nominally more than 8 billion euros, will accept the deal, a person close to the lender said on Monday. FMS, the bad bank set up to hold the toxic assets of bailed-out former bluechip lender Hypo Real Estate, is to formally decide on accepting the debt cut later this week, the person said.” German banks… German banks… where else have we seen this today? Oh yes: “Die Welt said that more than half of the 800 lenders that tapped the ECB’s 3Y LTRO last week were German, consisting mainly of small savings and cooperative banks.” Thank you Jim Reid – so while Bundebank’s Jens Weidmann huffs and puffs about the LTRO, it is his own banks are the biggest beneficiaries, in no small part to hedge against Greek exposure. But yes – at least following the absorption of tens of billions in intermediary capital via a variety of channels, German banks can now accept a 70%+ haircut, even if they continue to complain about it in the process: “Commerzbank, which had originally invested almost 3 billion euros in Greek sovereign bonds but has written down its exposure to 800 million, said last month it had little choice but to take part in the bond swap. At the time, chief executive Martin Blessing said: “The voluntariness (of the Greek debt swap) is about as voluntary as a confession at a Spanish inquisition trial.”” The Spanish Inquisition appears to have won yet again.