Last week, the new Greek finance minister tried to renegotiate the bailout plan the country had agreed to with the rest of the EU, by suggesting weaker austerity. After that overture was rebuffed, the Greek government–the one that revealed the prior administration had been falsifying the national accounts for years, triggering the current crisis–was found to be preparing legislation for a necessary parliamentary vote that incorporated the weaker austerity measures the EU had rejected. Apparently, Greece was planning to ratify the weaker terms and then present the rest of the Eu with a fait accompli.
Now it appears the Greek government may not have the votes to pass any austerity plan.
It’s hard to know which side to have sympathy for–Greece, which merrily used its EU membership to run up bills it knew it never could pay, or the rest of the EU, which fudged its membership criteria to get Greece in and which seems to have known what Greece was up to, but just underestimated the extent of the fraud.
I think the EU has two objectives:
–it wants to avoid having its banks forced to write down the Greek government bonds they’re stuffed to the gills with; and
–it wants to avoid setting a precedent that Ireland and Portugal, if not Italy and Spain, could reasonably expect to follow.
Greece, on the other hand, seems to fully appreciate the maxim that if you owe $20,000 to the bank you’re in trouble; if you owe $200 million, the bank is in trouble.
Today’s development is that large French banks have “voluntarily” proposed to roll over much of their Greek debt for thirty years, while reducing interest and reinvesting a large part of the coupon payments into new Greek sovereign debt.
A wildcard in these proceedings is credit default swaps–how large, who owns them and what are the precise terms. History tells us that Continental European banks tend to be the ultimate “dumb money,” which would lead to the surmise that there are a lot of CDSs and European banks are on the losing side in case of default.
The burning question, then, would be about the terms. Let’s say the EU as a whole reaches an internal agreement about Greek debt that it believes solves the problem without requiring the banks to write down any of their Greek bondholdings. What happens if the rating agencies declare that despite this legal paper shuffling, the solution is in fact a default. Does this trigger the credit default swaps? My experience says “Yes” is probably the correct answer, but I don’t know.
It seems to me we’re entering the final innings of the game. The outcome is still in doubt, and no one is leaving the ballpark.
From an equity investing point of view, I think the negative effects of an ugly outcome to the Greek situation will be felt mainly in European financial companies and in firms doing most of their business in Europe. A good portion of the ugliness has to already be discounted in global stock prices. Still, this is an issue to watch carefully to make sure the ripples don’t spread far wider than one might expect.
What about the exposure of U.S. Money market funds to European bank obligations? I understand, for example, that FDRXX, Fidelity’s huge MM fund, has significant (more than 50%) exposure to EuroPaper. What is your assessment of that risk? And can you suggest a safer repository for my cash than the hole in my back yard that I am currently considering?
Investing your money into BRIC countries is the way to go today in my opinion. The US economy is up only thanks to the fact the Chinese bought most of the US treasury bonds in the past 2 years. Currently only the German gvmt. can be treated as zero risk. Most of Greece’s debt will be forgiven in exchange for islands and a couple of privatization tenders.
Thanks for your comment. It’s an important question.
My short answer is that I don’t know enough to say anything with confidence.
The EU countries seem to me to face two unpalatable choices in solving the crisis in Greece quickly:
they can either take responsibility for paying off Greek debt, in which case political leaders are in trouble at home and they face the prospect of Ireland or other countries asking for the same treatment; or
they can push for Greece’s creditors to take part of the pain by taking losses and restructuring their loans, in which case their home financial institutions may not have enough equity on their balance sheets to stand in the first rank of world banks.
The EU appears to be trying a third way–to force Greece to devote most of its resources to repaying the debt, while lending it enough new money to keep it afloat for the many years it will take to do so. Greek citizens, understandably, enjoyed spending other people’s money but don’t think much of this plan.
The consensus is that ultimately Greece will default and EU banks will have to recognize in their accounting statements losses that, economically speaking, they have already suffered. There’s an emperor’s-new-clothes aspect to this. Unless/until this happens, the world pretends that the EU banks’ capital is adequate; and neither the EU governments nor existing shareholders have to stump up more money to get the banks’ balance sheets looking healthier.
My guess–which is not one I’d advise anyone to act on–about bank commercial paper is that the EU banks’ ability to borrow at low rates post-Greek default will be impaired but won’t disappear. Existing agreements will run their course and be settled at the end of their two- or three-month terms. Money market funds will decide whether to continue to lend to the EU banks or not. At the same time, EU bank customers may shift trade or other short-term financing business away from EU banks to, say, the EU branches of US banks. In this case, the commercial paper business will shift as well.
When Lehman failed, I was genuinely shocked to see the risks money market funds were taking in their quest for extra yield–like holding sub-prime mortgage securities. In all but one case (I think), the parents of the money market funds bought back the sketchy paper at par and absorbed the losses themselves rather than break the buck. It would be akin to regulatory suicide to be doing this sort of reckless, prospectus-violating lending again. So I don’t think Greek default is Lehman redux. But, as I’ve said a couple of times already, I haven’t done enough research to know. And since my background in in equities, not fixed income, I wouldn’t bank on my opinion, even if I had one.