It's De Facto Default for Greece

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The debt crisis in Greece looks like it is finally going to be resolved now that an S&P downgrade of the country's debt to junk status on April 27th has brought the crisis to a head. The eurozone leadership will finally have to stop its denial and provide Greece with funding to roll over its debts. Calm will be then be restored to the markets - at least for a while.

The inept handling of the situation in Greece seems reminiscent of the U.S. government's refusal to bail out Lehman Brothers. That act of political obliviousness led to a crash of the entire world financial system. Greece will have some sort of bailout however, so the more apt analogy would perhaps be the collapse of Bear Stearns. The markets were calmed when the U.S. Fed and Treasury arranged for JP Morgan to buy Bear Stearns at a fire sale price. If they were handling the Greek debt crisis, they probably would have solved it by having Goldman Sachs purchase the country at a 90% discount. Because of the brokered deal by the feds, Bear Stearns never officially went under, although in reality it did because it was no longer capable of independently functioning. If some bailout program is necessary to roll over Greece's government debt or allow it to make interest payments on it, Greece has for all intensive purposes defaulted.

The reaction of the euro zone leadership to Greece's problems seem inexplicable to anyone from the outside. It is definitely a shoot yourself in the foot to punish the other guy approach. A potential bailout for Greece is very unpopular among the electorate in Germany and there will be regional elections there on May 9th. It's the Germans that have been holding up the aid package. German banks have an estimated $45 billion in exposure to Greek debt (France is even higher, holding $75 billion in Greek loans), so an official Greek default would potentially cost Germany more than a bailout. Almost all of Greece's debt is held outside the country and the rest of the eurozone is heavily exposed. It's enough to make you wonder if big banks anywhere in the world ever apply any credit standards to their loans.

The market disaster yesterday seems to have woken the EU from its comatose state of deep denial and fast-tracked handling of a Greek aid package. The euro (FXE) hit a new yearly low of 131.63 and looks like its may have taken out a possible triple bottom. Stocks got hammered on bourses across the continent. Greece itself was down 6.7% and it reacted by instituting a two-month ban on short selling (the U.S. did the same for financial stocks after Lehman collapsed).  Portugal, which had its credit downgraded two notches by S&P, dropped 5.4% and is getting hit hard again today. Italian stocks suffered similar damage. The CAC-40 in France, the Dax in Germany and the FTSE in the UK fell 3.8%, 2.7% and 2.6% respectively. Five-year credit default swaps (CDSs) reached 840 basis points for Greek debt, 430 basis points for Portuguese debt, 270 basis points for Irish debt and 225 points on Spanish debt. The spread between German 10-year governments and equivalent Greek debt rose to 9.63%. Interest rates on two-year Greek governments rose to 18%.

When the EU created the euro currency union, it didn't plan on how to handle debt crises in member states. This was the case even though it allowed some countries with checkered fiscal pasts to become part of the eurozone.  EU leadership (or more appropriately lack thereof) has continued to avoid this issue throughout the entire Greek debt crisis so far. The obvious solution of using dollarization - letting a country continue to use the euro, but not be a part of the credit union - has seemingly not occurred to them. Instead, the tried and true bailout solution will once again by utilized. As became evident in the U.S. during the Credit Crisis, one bailout is never enough. There is already talk about raising the Greek loan guarantees from the EU and IMF from 45 billion euros to 100 to 120 billion euros and extending them over a three-year period. This bailout for Greece will likely just be just one of many and Greece itself will just be the first country to be bailed out.

EFTs that are useful for trading the current crisis in Europe include: EZU (euro monetary union), GUR (emerging Europe), VGK (European stocks), EWI (Italy) and EWP (Spain).

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
 http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.