Friday, May 20, 2011
The Day Greece Collapses
First the news from Athens: Since my last post on the German newspaper report of a Greek default, there have been some talks in Brussels about restructuring. They've even come up with some new names for it.. my personal favorite is "re-profiling", which is another way of calling insolvent loans something other than insolvent. Jean-Claude Junker, the chair of the EU finance ministers, came up with that one. But the reaction from the EU powers that be was swift and ugly: there will be no restructuring, default, re-profiling or whatever else it's termed.. they must be forced to pay it all back with interest. The president of the European Central Bank, one Jean-Claude Trichet, angrily stormed out of a meeting when Junker brought up the possibility of "re-profiling". Germany's Jurgen Stark pointed out (correctly) that any restructuring would be catastrophic for Greece's banks and opposed default in any way, shape or form. Many have suggested that in exchange for more bailout money, Greece should put up government owned companies and even land. Greece rightly rejected this. The talks are ongoing, but it looks like very little will get done. Then today, Norway and a couple of other small nations refused to cough up their part of development funds for Greece because the Greeks did'nt get to their budget targets in the bailout agreement. Another small torpedo came from the ratings agency Fitch, which (again) downgraded Greek Government debt from BB+ to B+.. which is still pretty generous. After hours, the other ratings agency S&P downgraded one of France's largest banks, Credite Agricole, due to "Greek exposure". Slowly but surely, the Europeans and Greeks are coming to the painful realization that this absurd notion of solving a problem of debt with more of it is bound to fail.
So-- this brings up the $64,000 question.. how and when ? Some of it depends on how-- there are two possibilities here.
Scenario One is a negotiated default whereby creditors are given the choice of accepting a large (50-60%) haircut or are asked to accept a smaller haircut and a time extension to repay what remains after the hair cut. If given enough time, the foreign banks can prepare by sufficiently capitalizing themselves (in other words, bracing for the losses). Greece itself would suffer tremendously; within months the (already high) unemployment rate of 15.8% would likely double. In this scenario, some sort of EU backing for some (not all) Greek banks would also become necessary. Believe it or not, this is the best of the two scenarios for the EU bankers.
Scenario Two involves a meltdown in Greece-- riots, protests and strikes reach a point where Greece becomes ungovernable, with the government unable to do anything to help the situation. Should this type of scenario play out, I look for the Greek Army to throw out the (incompetent) civilian government. The military only handed over power back to the civilians in the early 1980's. It could easily happen again. At this point, there begins a chain reaction: depositors will immediately empty out any money they have in Greek banks-- if the Army allowed them to even open for business. This will cause a large number of Greek banks (and the loans they took out from other EU banks) to go under. The Greek stock market probably would'nt even bother opening. In the rest of Europe, the stock markets will take a nasty fall, and the ECB (possibly with an assist from Bernanke's Fed) will have to take extraordinary steps to (very quietly) save some large EU banks. The Euro would tank as investors pile out of the Euro and into the US Dollar and Swiss Franc. Talks would begin with the Greek military junta. Ultimately, I think that the new military government will pull an Iceland-- they'll let their own banks go under & announce a 75% haircut of foreign owned debt or something like this. If the bankers can stall the junta for a few weeks, the EU banks will have had time to prepare themselves and will survive this. Greece will enter a depression; unemployment doubles within months. Because Greece instantly pitches so much of it's debt, this is the best scenario for the Greeks despite the Depression. Greece will recover; as prices of everything in Greece fall, tourists will flock there as never before.
My guess-- this happens before the end of 2012 and that it's Scenario Two. But rest assured.. one of the two are absolutely inevitable. A more grim scenario is detailed here by the Telegraph's Andrew Lilico: http://blogs.telegraph.co.uk/finance/andrewlilico/100010332/what-happens-when-greece-defaults/
While I'm on my European kick, I'm going to pile on a little more doom and gloom here, which comes from Spain, where the unemployment rate is already at a Hoover-esque 21%. There have been growing protests in large cities, so far not too large or violent, but indeed growing in size. Also this weekend there will be an election there, which will replace state level governments. You see in Spain, much of their debt is at their state level. What's feared here is that when the new governors take over these states, the first thing they'll do is to announce that the previous leaders left a far, far bigger debt pile than previously acknowledged. While Spain's bonds have held up pretty well so far this year, I'm thinking that some of it is due to undercover purchases of their bonds by other central banks and not the open markets... except for today, when they had what was essentially a failed auction, a serious event in the bond trading world. After this auction, their bonds sunk (meaning their interest rates went up). While Greece's collapse would be painful and dangerous to the EU banking system, Spain's collapse would be fatal due to the size of it's debts: http://themeanoldinvestor.blogspot.com/2010/05/update-523-worst-case-scenario.html