Is Greece Lehman II?

Over the weekend came this news from the WSJ:

French Finance Minister Christine Lagarde signaled Paris might support a rescheduling of Greek debt, warning that Greece is at risk of default if it doesn’t do more to bring its public finances into order.

The comments mark a shift in France’s position in a debate that has pitted Germany and other euro-zone governments against the European Central Bank, which opposes any form of restructuring of Greek debt.

French support for proposals to extend the maturities of Greek debt—a so-called soft restructuring—would leave the ECB isolated in its opposition and possibly force it to accept a compromise.

“What we certainly don’t want is a state bankruptcy, a default, in Europe,” Ms. Lagarde said in an interview published Friday in Austria’s Der Standard newspaper. “You can use a lot of words—reprofiling, restructuring, re-this, re-that—but what there won’t be is a restructuring of Greek debt.” At the same time, she said: “We would accept anything that is based on a voluntary accommodation by banks.”

“If the banks decided unilaterally after contacting the Greek authorities to offer a lengthening of the repayment time frame, she wouldn’t be against it,” Ms. Lagarde’s spokesman said.

Germany and other euro-area states have warmed to the idea of extending maturities—which is technically considered a default by the credit-ratings agencies—given the size of Greece’s debt burden and its bleak economic prospects.

Hmmm. That’s an understated if ever I’ve heard one. Maturity extension is default.

Anyway, there is lot’s a great discussion around the world on what the fallout will be. At the UK Telegraph, Andrew Lilico offers a chain of events that makes the word ‘contagion’ positively inviting:

  • Every bank in Greece will instantly go insolvent.
  • The Greek government will nationalise every bank in Greece.
  • The Greek government will forbid withdrawals from Greek banks.
  • To prevent Greek depositors from rioting on the streets, Argentina-2002-style … the Greek government will declare a curfew, perhaps even general martial law.
  • Greece will redenominate all its debts into “New Drachmas”…
  • The New Drachma will devalue by some 30-70 per cent…effectively defaulting 0n 50 per cent or more of all Greek euro-denominated debts.
  • The Irish will, within a few days, walk away from the debts of its banking system.
  • The Portuguese government will wait to see whether there is chaos in Greece before deciding whether to default in turn.
  • A number of French and German banks will make sufficient losses that they no longer meet regulatory capital adequacy requirements.
  • The European Central Bank will become insolvent, given its very high exposure to Greek government debt, and to Greek banking sector and Irish banking sector debt.
  • The French and German governments will meet to decide whether (a) to recapitalise the ECB, or (b) to allow the ECB to print money to restore its solvency…
  • They will recapitalise, and recapitalise their own banks, but declare an end to all bailouts.
  • There will be carnage in the market for Spanish banking sector bonds, as bondholders anticipate imposed debt-equity swaps.
  • This assumption will prove justified, as the Spaniards choose to over-ride the structure of current bond contracts in the Spanish banking sector, recapitalising a number of banks via debt-equity swaps.
  • Bondholders will take the Spanish Banking Sector to the European Court of Human Rights…
  • Attention will turn to the British banks. Then we shall see…

As over the top as this sounds, it sounds roughly right to me in the event that sorting out Europe’s imbalances is left to markets.

But this is surely not a realistic scenario. The financial links exposed by the Lehman failure are painfully obvious to policy-makers now, which is surely why they declared as a group that there’d be “no more Lehmans” and why Greece has so far lurched from one bailout to the next. In any case, at this point Lagarde seems to be testing the wind for “voluntary accommodation” from creditors, not throwing Greece to the wolves.

Yet, as Steven Pearlstein of the Washington Post points out, the Europeans are stuck:

There are several problems with this diagnosis and prescription.

The most obvious is that Greece is already caught in the early stages of a debt spiral. The austerity measures necessary to bring Greece’s government budget into balance have caused such a deep recession, and tax revenues have fallen so steeply, that the primary deficit is increasing, not decreasing. History shows that once such a dynamic gets going, it is self-reinforcing and very hard to pull out of. A similar dynamic seems to be taking hold in Ireland, Portugal and even Spain, where economies are shrinking and unemployment continues to rise to alarming levels.

…I spoke with Bill Rhodes, the former Citigroup executive who played a central role in every sovereign debt crisis of the past 30 years and who has written a book about his experiences, “Banker to the World.” Rhodes knows how to drive a hard bargain with profligate countries, but he also knows when it’s foolish to push them too hard and load them up with too much debt service. And that’s exactly what Rhodes sees happening with Greece, Ireland and Portugal.

The question isn’t whether creditors will take a haircut. The question is whether they’ll take a small one now or a big one later.

Alan Beattie at Eurointelligence has a similar line with greater subtlety:

Contrasting experiences from the neighbouring Latin American countries of Argentina and Uruguay in the early 2000s suggest that a one-off voluntary deal can help a country if it is faced with a genuine liquidity crisis, but if it has to be followed by more fundamental restructuring it can end up doing more harm than good.

The happy outcome was Uruguay which, appropriately enough, suffered a massive withdrawal of Argentine deposits from its banking system as the Argentine government slid towards sovereign bankruptcy at the end of 2001, and from a general increase in risk premia on Latin American assets. Uruguay’s 2003 sovereign debt restructuring, accompanied by an IMF rescue programme, was closer to a reprofiling. It extended maturities on all sovereign debt denominated in foreign currency, then equivalent to about half the total, but led to a reduction of only about 8 per cent in the net present value. The offer achieved more than 90 per cent acceptance rate, and together with tough but not quixotic fiscal restraint – a primary fiscal surplus of around 3 per cent – Uruguay restored favourable debt dynamics and avoided further default.

The cautionary tale was Argentina, one of whose most egregious mistakes in the run-up to bankruptcy was the voluntary bond “megaswap” of June 2001. The swap rescheduled about $30bn of sovereign debt, smoothing the big hump of interest and principal payments coming due in the next few years to beyond 2005. But in order to be voluntary given the state of the economy, the terms had to be sufficiently generous with the consequence that the net present value of the exchanged part of Argentina’s debt stock rose by 28 per cent. The only effect it had – apart from earning nearly $100m in fees for the investment banks that arranged it – was to enlarge the stock that had to be restructured when the inevitable came.

… The lessons should be obvious. Voluntary swaps can work, but only in a liquidity crisis. Uruguay, despite some underlying problems in its banking sector which were exposed by the crisis, had reasonable growth performance and political commitment to economic reform. In an insolvency crisis such as Argentina, they are likely to make things worse.

Given that Greece appears insolvent under all but the most optimistic growth and revenue assumptions, the Latin American experience of the 2000s would argue against a voluntary reprofiling in favour of a more substantial reduction in NPV.

One hopes that ultimately this ends in some new European fiscal integration or in a collective mechanism for refinancing the banks that stand to take the losses. But the parallels with 2008 and Lehman brothers are really quite uncomfortable. We have a solvency crisis based around a debt deflation being treated as a liquidity issue. Bond rates that have rocketed to impossible levels on expectation of default. Politics at odds with regulators on what to do. Ideals at odds with practicality. And behind it all a European and global banking system that is so interlinked, doing the right thing may prove calamitous.

And there is definitely a sense that only crisis will push the Europeans to finally find an integrated solution.

On that, I’ll leave you with a quote from Doug Noland over the weekend:

And the backdrop really turns uncertain when one ponders a repeat of last year’s scenario where Greek debt problems turn systemic through a dislocation in the CDS market.  And if, once again, such a development leads to euro weakness, the resulting boost to the dollar could further catch players on the wrong side of various “carry trades” and other bets gone astray.  As I noted above, the end of QE2 doesn’t have to mean liquidity issues for the marketplace.  Then again, the end of quantitative easing becomes a major market liquidity event if the marketplace is in the midst of a serious bout of speculative de-risking and de-leveraging.  Much to contemplate and analyze over the coming days and weeks.

David Llewellyn-Smith


  1. very interesting times. I’ve built up a small amount of funds to take advantage of the likely volatility in the weeks/month ahead as QE2 winds down and Greece/Spain blows up.

    Not a good time to be long equities, for sure.

    • Yup…agreed. Throw in the Japanese earthquake aftermath/recession and possible China issues to add a little more flavor to that mix…

  2. All I can see is that the coke can that was initially kicked down the road has developed into a bloody 44 gal drum (and it is full).

    As far as Germany / France is concerned their initial debt to GDP (prior to the GFC) was quite low. That is now not the case, as the indirect guarantees imputed within the EEC has risen enormously..

    The domino’s are starting to get into one line. What previously was to be a small hit to the wealthier Countries, has risen dramatically.

    The demonstrations in all the Countries are against austerity measures… not for them!

    The public are not concerned about the overall debt, just their debt and the fact that they have to pay all of it off with unemployment high and scant resources.

    If each Country had the brass where-for-alls and follow Iceland’s lead this would have ended a year ago.

    Instead we have idiots and fools running the economic malaise with a license to print more to protect the bondholders and demand more austerity and more taxes… and then .. ..

    this is the punchline …

    the EU civil servants members demand a rather large pay increase and therefore more money from member Countries… just love their so called democracy!

    They all seem like pompous twats to moi` and they are followed closely by the US.

    Yes Prince, both the EU and the US are providing a wealth of manure, that can be spread are and wide.

  3. From what I’ve read Greece, Ireland and Portugal are essentially bankrupt and Spain, Belgium and Italy are about to join them. The debt load is to the tune of $4 trillion, an amount Germany and France won’t be able to keep financing without bankrupting themselves.

    Can China buy additional debt? Probably not, because as it cuts back on US Treasuries it is buying gold, silver and commodities.

    The Keynesian model, which is to print money and credit forever, won’t solve the problem. Europe is buggered. The system of unifying cultures and economies has effectively failed.

    “The bankrupt have to be allowed to fail. Too big to fail has to come to an end. The world financial system has to be purged and the only way to do that is to call an international meeting and revalue and devalue all currencies against one another and have a multilateral default on unpayable debt. Then nations can decide what the new world reserve currency will be and whether it will be gold backed.” – The International Forecaster.

  4. The problem with Greece is that it will never collect enough tax from its citizens to pay back the debt. The tax collection system in Greece is a joke.

    So they have a Government willing to pay out welfare and generous entitlements to anyone that wants them, but they dont have a proper taxation system

    And we wonder why they went broke?

    Its irnoic that Greece – the cradle and birthplace of democracy – will become the graveyard for the modern welfare state and the democractic bribery that elections have brought to western democracies in last 30 years.

    • Starvos, Greeks have always looked at ways of avoiding tax – it’s in their genes. I’m not saying this is right, but this is not the reason Greece has gone down the toilet. Cast your mind back 10+ years ago and Greece was an affordable place to visit and the people who lived there were very content. I know this, and probably like you, still have relatives that live in Greece. But they were sold a dream – a dream to host the Olympics and become part of the European Union. But this came at a deadly price.

      The International Forecaster best sums up the situation:

      “Greece hid its sovereign debt over the past decade by entering into 13 currency swaps contracts with Goldman Sachs. These transactions were based on a group of currencies versus the euro as well as a swap versus the US dollar and Swiss franc. The National Bank of Greece (off the books) put some of these swaps in motion. All the swaps were securitised and sold by Goldman Sachs.” Welcome to the world of derivatives.

      “These dealings were illegal and their depth unknown. Bloomberg has sued the ECB and asked the EU to stop the ECB from blocking the disclosure of documents that would clarify what actually took place. These documents will prove how sovereign debt was hidden. Disclosure by the ECB would show all of the nefarious activities they’ve been involved in to keep nations and banks from collapsing.”

      “Not only did the politicians and the Greek National Bank commit fraud, but also so did the ECB. In response the ECB has implied that if they have to expose these fraudulent deals the whole European financial system would collapse. This is why the documents will never be produced and why the fraudsters will never be brought to justice.“

      “As you can see these kinds of problems are rife worldwide in the financial communities and with central banks. The corruption runs so deep that in order to expunge it the whole world financial system would have to be taken down and replaced by sovereign central banks, whose currencies would have to be backed by gold.”

      “These bankers knew exactly what they were doing in having purchased politicians to do their bidding. Now the problems are manifest and can no longer be hidden. The amounts of money made by Goldman Sachs and JPMorgan Chase has been colossal.”

      “If default happens it will expose exactly what has gone on in Greece and other countries, because it all ties into a vast criminal financial network. Any system that is forced to function in grey areas has something to hide. There are things that they shouldn’t be doing. Maybe the Greeks do not realise it, but they are an extremely important catalyst in exposing this ongoing fraud.”

  5. I just keep thinking how bloody clever the Swiss banks were, in getting their 20% exposure to Greece’s debt, down to nothing about 2 1/2( Jan 10) years ago before all of this come to the fore. How bloody clever to have stayed away from the Euro, and in the meantime enjoyed the benefits that came with the Euro, but none of the downside.

  6. Yes it is an ongoing fraud, and the Greeks do realize it.
    The west controls the most overvalued currencies in the world. They also control through pension funds, banks snd trading companies most of the worlds resources. Essentially this had given rise to a class of people perculiar to cities such as London, New York, Frankfurt, Zurich who don’t actually contribute anything to society by producing anything or using their hands to build anything such as shelter. They are essentially socio pathic parasites who will eventually destroy the host.

  7. If Greece goes off the Euro, the resulting mess will be so horrible that Ireland, Portugal and Spain will decide to accept anything the EC ask them to do.

    To break away from the Euro, the Greek Government will confiscate all bank deposits (in Euro), and reissue them with the new currency. However, the ‘black economy’ will still operate in Euro, the devaluation will be around 50% per month. using the early stages of Zimbabwe hyperinflation as a guide. Wages for government employees and pension will be paid out in the new currency, however all the shops will want to be paid in Euro. Nobody will turn up to work, as they’ll be too busy looting and burning down government buildings. Copper wires and drainage pipes will be stripped away for scraps, public transportation will stop along with electricity, water, gas and garbage collection. In a few months, it’ll become a third world country.

    After a few years of chaos and losing about 80% of their GDP, a newly elected Greek government will once again beg to be part of the EU.

    • If Greece avoid the austerity needed by going Drachmas. Spain, Portugal and Ireland will be onboard as well.

      Some Dutch, French, German and Italian bankers will be waving the flag.

  8. My hope is that the authorities ..whoever that maybe in coming months..take a large stick to the credit default swap market and tax it to death. I consider the CDS to be the ultimate weapon of ( mass) wealth destruction here and dealing it with it makes the politicians look they are doing something to rein in the nefarious investment banks.