Belmont Club

Is it Default of Greece or Is Something Else to Blame?

The Europeans have decided to lend Greece more money, but conceded that bondholders might have to take a haircut. In the words of the WSJ “The euro zone’s leaders agreed Thursday to more than €100 billion ($144 billion) in new financing for Greece, and new measures to prevent its debt crisis from metastasizing across the Continent, accepting as they did a plan that would trigger the first debt default by a nation using the common currency.” It is a default by some other name, but what will be its consequences?

In an agreement reached here after hours of haggling, and a whirlwind trip Wednesday to Berlin by the French president, the leaders committed to providing billions more in new loans to Greece. But they extracted a price: Greece’s private-sector creditors would have to accept a bond exchange that gives them less than originally promised.

The euro zone had long insisted that none of its 17 members could contemplate not repaying its debt, but Greece was reeling under its huge burden and its woes were threatening to engulf other countries.

Megan McArdle doesn’t think it will even slow down investor doubts over Spain, Portugal or Italy. Writing in the Atlantic, she said “basically, both the Greek bonds owned by banks and insurers, and the loans Greece has received from the European stabilization fund, will have their terms extended as far as possible. The ratings agencies are going to call this a selective default.”

The spreads on Spanish, Italian, Irish, and Portuguese bonds are not widening because investors think that Greece needs a debt swap, or because the solons of Brussels haven’t made enough announcements about the virtues of budget-cutting. They’re widening because there are questions about whether these countries–or Europe–have the economic means or the political will to ensure that investors get paid back.

However one puts it, the debt held by Greek bondholders has just been written down, and with it the asset base of its holders. Since those same bondholders have Spanish, Portuguese or Italian debt, it follows that the market should lower the value of their companies, for if they could [not] be protected from Greece’s fecklessness by the European Union, what chance have they of escaping from the far larger follies of the bigger countries? None.

McArdle writes, “of course, maybe I’m missing something. But I’ll be surprised if this even buys the periphery much breathing room.”Damian Reece at the Telegraph argues that the political risk may long have been priced into the market and that all anyone hopes for is that Greece gets enough cheap money to keep breathing a while longer. In that view Greece defaulted a long time ago and news that the bankrupt can keep paying something still is just pure gravy. Armageddon is still scheduled to happen but the music to which it comes promises to be real nice and entertaining. Best of all, the intro should delay it for a while. He wrote,

The biggest difference with 2008 is the amount of cash in the system, be it banks’ own liquidity buffers having been forced up by regulators, or the liquidity being made available by central banks. At the very least that buys the system time, should things deteriorate from here. Two months? Two weeks? I don’t know. But markets are better prepared this time, but time is certainly running out.

Update: From this Al Jazeera video it seems things are just as I thought above, but with one significant difference. The Greek Crisis has spurred the EU to wire things up even more tightly. They’re talking about a “fiscal union”. More power to the pols. This seems like a conceptual mistake. Rather than segmenting the risks and designing parts to snap away under risks, they’ve welded things together. The system is now like a paratrooper braced for landing with his knees locked

Nobody’s going to be fooled by the legalistic hairsplitting over the true nature of the Greek default nor under any illusions that it will help the banks escape the risk they face with Spain, Italy and Portugal. In fact, the subtext of this Euro-spin is that the banks are now on their own, that they cannot expect taxpayer cover except in the case of Greece. That means if Italy goes down, then the banks go down. Is there any other way?

While that is good, there will be inevitable consequences to the value of the European financial institutions. They have lost a large value of the Greek portfolio and told that’s all she wrote. Parenthetically, the involvement of the IMF must mean that the US taxpayer footed some unspecified bill for this whole act. Which wouldn’t matter if it actually accomplished anything besides throwing dollar bills at Godzilla in an effort to slow it down.

What are the odds Godzilla will slow down besides for taking time to laugh? Stay tuned for the next exciting episode of “EU Asked For It!”