If you are Greek you may have nothing left to lose, but you are certainly not free from having to pay for the excessive borrowing of the past. The Greek Government has passed widespread austerity measures to appease the European Central Bank and insure the funding of $11 billion in aid needed to cover the cost of running the country through the month of October. The austerity measures consisting of tax increases and wage freezes are crippling the middle class and ruining any chance for economic growth.
Total Greek public debt is about 370 billion euros, or $500 billion. When compared to Argentina’s debt of $82 billion when it defaulted in 2001 the Greek debt problem appears massive. The size of the Greek crisis is on par with the Lehman Brothers bankruptcy which had approximately $600 billion in assets at the time of its collapse.
Much like the Lehman Brothers bankruptcy the real consequence of a default which threatens the World economy is the fear of economic contagion and a crisis of confidence. The Eurozone's inability to calm the market uncertainty of the Greek situation has threatened the entire European Union and its current financial standing.
The European Union's uncertain course of action has caused a run on European sovereigns and banks as trading counter-parties try and protect against losses and hedge funds seek to make billions by purchasing Credit Default Swaps (CDS) and shorting stocks, bonds and currencies.
A recent Merrill Lynch report on the subject stated:
“We believe losses could be substantially larger through deleveraging and second-round effects, contagion from failure of individual banks from or outside the periphery, exposures of the nonbank financial sector.”
Most Greek debt is currently trading around 40 cents on the dollar whereas on average most banks and other holders of Greek debt have only written down their positions by only 21%. The good news is that some of the shortfall for the banks may be mitigated by their CDS positions which will cover up some of the additional losses.
It is difficult to quantify and track the level of CDS positions which may be cushioning some of the shortfall in loss provisioning since these derivative contracts are made off market and unregulated to a certain extent. However, the overall market is gigantic. The aggregate volume of CDS on global sovereign debt was $2.83 trillion as of Sept. 16, according to the Depository Trust & Clearing Corp.
The effects of contagion are already being seen. In particular, French banks have been attacked due to their exposure to Greek debt. However, the fact of the matter is that even if Greece were to default it would only result in a minimal impact on French banks' tier one capital ratios. Furthermore, Germany's banks have a much higher position in Greek bonds according to the EU's stress test report showing an exposure to Greek debt equivalent to 12% of tier 1 capital - still a defendable level.
The current rescue package simply isn't enough to save Greece which has too much of a debt load at 186% of GDP ($54,000 per Greek). The austerity measures are making it even more difficult for the economy to recover. Any additional recovery measures would simply be throwing good money after bad as the Greek's have no ability to repay the mounting debt. Many have argued that Greece should default paying 40-50 cents on the dollar - a level which will allow Greece to recover without crippling the European banking industry.
The market has responded drastically. Euro-area bank credit default swap spreads have doubled to about 300 basis points, and European bank stocks have plunged nearly 30 percent since early August.
Government officials and advisors have used buzz words such as "ring fence" and "firewall" to describe the necessary measures required to contain the Greek bond run from spreading through the entire Eurozone.
Potential solutions include ways to strengthen their 440 billion euro European Financial Stability Fund (EFSF), possibly leveraging it to the tune of 1-2 trillion euros. Germany, Europe's largest economy, has been against such methods as it would threaten the fund's AAA credit rating and break various rules set forth in the governing documents of the European Union.
Why continue to bailout Greece when the banks and sovereign nations have enough wherewithal to withstand a Greek default? The answer is the fear of the knock on effects to other over levered countries that may pose a more serious threat to the European Union.
The only solution is to act quickly before market forces become too great to counteract with policy measures. In order to act quickly, European nations would need to avoid political confrontations and a wholesale re-writing of the European Union's constitution.
The European Union's uncertain course of action has caused a run on European sovereigns and banks as trading counter-parties try and protect against losses and hedge funds seek to make billions by purchasing Credit Default Swaps (CDS) and shorting stocks, bonds and currencies.
A recent Merrill Lynch report on the subject stated:
“We believe losses could be substantially larger through deleveraging and second-round effects, contagion from failure of individual banks from or outside the periphery, exposures of the nonbank financial sector.”
Most Greek debt is currently trading around 40 cents on the dollar whereas on average most banks and other holders of Greek debt have only written down their positions by only 21%. The good news is that some of the shortfall for the banks may be mitigated by their CDS positions which will cover up some of the additional losses.
It is difficult to quantify and track the level of CDS positions which may be cushioning some of the shortfall in loss provisioning since these derivative contracts are made off market and unregulated to a certain extent. However, the overall market is gigantic. The aggregate volume of CDS on global sovereign debt was $2.83 trillion as of Sept. 16, according to the Depository Trust & Clearing Corp.
The effects of contagion are already being seen. In particular, French banks have been attacked due to their exposure to Greek debt. However, the fact of the matter is that even if Greece were to default it would only result in a minimal impact on French banks' tier one capital ratios. Furthermore, Germany's banks have a much higher position in Greek bonds according to the EU's stress test report showing an exposure to Greek debt equivalent to 12% of tier 1 capital - still a defendable level.
The current rescue package simply isn't enough to save Greece which has too much of a debt load at 186% of GDP ($54,000 per Greek). The austerity measures are making it even more difficult for the economy to recover. Any additional recovery measures would simply be throwing good money after bad as the Greek's have no ability to repay the mounting debt. Many have argued that Greece should default paying 40-50 cents on the dollar - a level which will allow Greece to recover without crippling the European banking industry.
The market has responded drastically. Euro-area bank credit default swap spreads have doubled to about 300 basis points, and European bank stocks have plunged nearly 30 percent since early August.
Government officials and advisors have used buzz words such as "ring fence" and "firewall" to describe the necessary measures required to contain the Greek bond run from spreading through the entire Eurozone.
Potential solutions include ways to strengthen their 440 billion euro European Financial Stability Fund (EFSF), possibly leveraging it to the tune of 1-2 trillion euros. Germany, Europe's largest economy, has been against such methods as it would threaten the fund's AAA credit rating and break various rules set forth in the governing documents of the European Union.
Why continue to bailout Greece when the banks and sovereign nations have enough wherewithal to withstand a Greek default? The answer is the fear of the knock on effects to other over levered countries that may pose a more serious threat to the European Union.
The only solution is to act quickly before market forces become too great to counteract with policy measures. In order to act quickly, European nations would need to avoid political confrontations and a wholesale re-writing of the European Union's constitution.
Fears that the EFSF is not adequate enough to deal with the crisis are well founded, but efforts to lever the fund or to use complicated financial engineering (i.e. the SPV structure) will not be easily agreed amongst member states. Attempts to chase these solutions may cause further delay and irreparable damage to the financial system.
Banking institutions are some of the most levered vehicles in the World and are specifically designed to allocate capital. Why try to recreate the fractional reserve banking model when it already exists?
U.S. and European banks have raised roughly $100 billion in extra equity capital this year, according to Institute of International Finance calculations, however, this is not enough to quill market fears of bank liquidity. Moreover, bank lending rates are still muted. Capital ratios need to be increased to not only prove that the banks are solvent, but more importantly that they are liquid enough to sustain market pressures.
Healthy banks would be able to withstand the necessary sovereign defaults while also having the capability to buy future sovereign debt offerings. The central banks can support these measures by providing cheap financing to the banks to incentivize the continued funding of sovereign debt.
There would still be political hurdles to overcome. The biggest banks are generally located in the most powerful European countries. Bailouts of these institutions will be looked upon more favorably within these countries then the perspective bailout of a foreign nation. Why should the German's pay for the excesses of Greece? The bailout of sovereign institutions would mitigate against this type of questioning.
George Soros laid out a plan along these lines in a recent issue of the Financial Times. There may be a good reason why he has been moving up the World's richest people list.
George Soros - How to Avoid Another Depression
Banking institutions are some of the most levered vehicles in the World and are specifically designed to allocate capital. Why try to recreate the fractional reserve banking model when it already exists?
U.S. and European banks have raised roughly $100 billion in extra equity capital this year, according to Institute of International Finance calculations, however, this is not enough to quill market fears of bank liquidity. Moreover, bank lending rates are still muted. Capital ratios need to be increased to not only prove that the banks are solvent, but more importantly that they are liquid enough to sustain market pressures.
Healthy banks would be able to withstand the necessary sovereign defaults while also having the capability to buy future sovereign debt offerings. The central banks can support these measures by providing cheap financing to the banks to incentivize the continued funding of sovereign debt.
There would still be political hurdles to overcome. The biggest banks are generally located in the most powerful European countries. Bailouts of these institutions will be looked upon more favorably within these countries then the perspective bailout of a foreign nation. Why should the German's pay for the excesses of Greece? The bailout of sovereign institutions would mitigate against this type of questioning.
George Soros laid out a plan along these lines in a recent issue of the Financial Times. There may be a good reason why he has been moving up the World's richest people list.
George Soros - How to Avoid Another Depression
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