Notes on a Greek exit

This afternoon Mike Smith confirmed what MB readers already know. From the SMH:

ANZ said that current volatile conditions in global markets have seen wholesale funding market for Australian banks freeze again.

“Right now, markets are closed again, and this is what happens in this sort of situation,” ANZ Chief Executive Mike Smith said after a speech to a business group.

The fallout form the growing Grexit crisis is becoming very serious and we are only at the beginning of events. Needless to say, it is worth taking some time to think about what the next phases in the crisis will be. On that score, find below notes from several recent US bank conference calls.

First up is JP Morgan:

• Greece people seem to believe what Syriza promotes (i.e. stay in EMU but no austerity) and don’t appear to understand the nature of the upcoming elections (EU referendum).
• Anti-EU commentators essentially say that a real wage compression should happen via a nominal exchange rate adjustment rather than through domestic deflation. If Greece is subsidised by the core no adjustment needs to occur and Greece becomes a Southern Italy.
• Upshot is that Greece doesn’t leave EMU on its own but needs to be kicked out. The latter requires a kick-out via the Target2.
• Greek exit is disruptive but much less disruptive compared to 2 years ago given write-downs, PSI etc.
• 5-10% additional GDP decline for Greece on top of the 7-8% GDP decline that would happen if Greece stays in the EMU. Cumulative GDP decline from peak would be 30% – roughly in line with US in the 1930s.
• 2% EU wide GDP decline. Peak to through expected at 1% without exit so would bring it up to 3%. Still milder than the pre-LEH phase when GDP fell 5.5%.
• Substantial policy response is required: deposit wide guarantees, bank recap funding, ECB needs to lend on unlimited and virtually uncollateralised basis, SMP needs to be reactivated to stabilise Spain and Italy sovereign bond market. If that isn’t enough, capital controls will be introduced.
• Markets are still too complacent. This is a 50/50 probability with contagion and growth effects presenting significant headwinds to risk assets.

Citi is more sanguine:

• Greek exit is now likely. Will be catastrophic for Greece but its contagion impact is contained as the ECB steps in.
• Greece can’t stay in. Junker indicated that Greece may be given more time but austerity measures are non-negotiable. But a default within the EMU isn’t an option.
• Exit modality: Introduce New Drachma (60% cheaper) and debt is converted (i.e. default)
• EU and global growth impact is very small unless policy fails to contain Greece impact to rest of PIGS.
• Greece is simply too small to matter (2% GDP). Non-resident EU exposure has been handed off to Greek banks or to authorities (EFSF, IMF, national central bank). EUR 300bn+ overall exposure therefore lie with official sector.
• Growth forecasts: Global GDP growth 2.6% in 12 and 3% in 13, EU -1% in 12 and -0.2% 13, Greece (in case they stay in) -6.5% in 2012, -2.4% in 2013.
• ECB has tools to act. Question of willingness.
• Not a question of inflation policy. Estimate that the non-inflationary amount of liquidity than can be added is EUR 3.5trn.
• ECB knows about systemic risks. LTRO has been a good exercising ground.