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Archive for May 22nd, 2012

Why Portugal May Be the Next Greece

Posted by Admin on May 22, 2012

Why Portugal May Be the Next Greece


By Michael Sivy | @MFSivy | March 27, 2012








(MORE: The Most Important Man in Europe)







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Is a Greek Exit from the Euro Inevitable?

Posted by Admin on May 22, 2012

Is a Greek Exit from the Euro Inevitable?

By Michael Schuman | @MichaelSchuman | May 21, 2012

Kostas Tsironis / AP

For 2½ years, the world has been watching and waiting to see if debt-laden Greece can remain in the euro zone. Many have been doubtful since the beginning of the debt crisis. Greece’s government debt is simply too burdensome, the fiscal adjustment imposed on Athens is too severe, the Greeks are too resistant to the tough reforms that are necessary and the rest of Europe is too bullheaded to change its approach to suit reality. But for 2½ years, Greece has nevertheless managed to scrape by and remain in the monetary union, thanks to two European Union–IMF bailouts (totaling $300 billion), which have kept Greece on life support, and repeated promises to reform by Greece’s major political parties.

Now, however, the Greek debt crisis may finally be reaching the endgame. The likelihood of a Greek exit from the euro zone has been growing, and that has scary consequences for the rest of Europe as well as the global economy.

(PHOTOS: Protests in Athens)

The spiral toward disaster has been tipped off by Greek politics. A general election earlier this month eliminated what little hope remained that Athens could press through with the painful austerity measures and structural reforms demanded by the euro zone in return for bailout cash. The fractured result made it impossible for a government to form, and a new election has been called for June 17. But even if that poll brings some political stability, the odds that the bailout can go ahead as planned are practically zero. A vast majority of the votes in the last election went to parties that either want to renegotiate the terms of the bailout or ditch the agreement entirely. Whether the bailout scheme can continue will depend on the willingness of the rest of Europe to make concessions to Greece in a better, softer rescue agreement and the willingness of Athens’ politicians to agree to new terms. These are very open questions.

The problem is that without that rescue money, Greece will very likely have to exit the euro zone. The Greek government would quickly run out of money to function, leaving Athens no choice but to return to its national currency, the drachma. This scenario could unfold with surprising speed. Here are Bank of America/Merrill Lynch analysts on that score:

If no government is in place before June, when the next instalment from the EU/IMF is due, we estimate that Greece would run out of money sometime between the end of June and early July, at which point a return to the drachma seems to us inevitable.

Even if the Greek government gets its act together and the bailouts continue, there is another force steadily pushing Greece out of the euro zone. Greeks are removing their deposits from Greek banks. They have been doing this for a while, but the pace seems to have accelerated recently. In just one day last week, Greeks yanked some $900 million of deposits from the banks. This process is quaintly called a “bank jog,” but it is much more dangerous than a quiet run through a park. It is effectively a slow-motion run on banks, and a natural consequence of the uncertainty surrounding Greece’s tenuous position in the euro zone. If Greece is forced to ditch the euro and return to the drachma, Greeks know full well that their drachmas will be sharply devalued relative to the euro. So keeping their money in Greek banks now could result in a big hit to their welfare. Instead of facing that risk, Greeks are withdrawing money from banks to preserve their wealth.

(MORE: After the Fall: Greece’s Former Prime Minister Assesses the State of His Nation)

That makes sense from the standpoint of the Greek saver, but not for the banking sector. As Greek banks empty of euros, the financial system comes closer to failure. So far, the European Central Bank has been plugging the hole by acting as a lender of last resort to the Greek banking system. But there is a limit to how much financing the ECB might be willing to inject. Gavyn Davies of the Financial Times did a great job of explaining how this bank run is happening, and why the ECB could eventually fail to contain it:

The problem is that [ECB support for Greek banks] potentially exposes the ECB to much bigger losses than anything which has been contemplated so far by the core economies. Up to now, the ECB has been willing to inject liquidity to cover the financing needs of the periphery banks as the inter-bank market has dried up. If instead, they have to contemplate providing semi-permanent funds to cover large further withdrawals of bank deposits, the size and timescale of the injection becomes extraordinarily large.

If the ECB doesn’t continue to finance Greek banks, Athens could be forced to withdraw from the euro zone and restore its currency. That on its own would be destabilizing. But even more worrisome, the bank jog in Greece has the potential to become a euro zone–wide bank run. Seeing what’s going on in Greece, depositors in other weak euro-zone economies (Portugal, Spain, Italy) have the same incentive to yank money out of their banks. That could end with the total unraveling of the monetary union. The fears that this theoretical scenario will become reality are increasing in Europe. Here’s how economist Paul Krugman explained it in the New York Times:


(MORE: Will Greece Need Another Election to Form a Government?)

How can the euro zone stop this from happening? It will require a degree of political commitment and policy flexibility so far absent from the zone’s approach to the debt crisis. When a national government confronts a run on banks, the way to solve it is to guarantee deposits and ensure that banks have enough cash to meet withdrawals. The problem with the euro is that individual national governments don’t have control over their own money. So the euro zone as a whole has to step in and back up the banks like a national government would. The euro zone likely requires some sort of guarantee scheme akin to the U.S.’s Federal Deposit Insurance Corp. But supporting the euro banking system is this way might demand yet more resources from stronger euro-zone economies like Germany. It would also probably entail more E.U.-level control over national banking sectors. Both steps would prove difficult.

More broadly, Europe can squelch the bank jog if it shows more commitment to the euro and keeping Greece in the union. The longer this period of uncertainty over Greece’s status drags on, the more deposits will flee Greece, and the more likely a euro exit becomes.

Clearly, a Greek exit from the euro zone would be traumatic for Greece and the rest of Europe, and send shock waves through global financial markets. But can a Greek exit from the monetary union really take down the euro itself? That’s a topic for another post …

MORE: Election of French President François Hollande Heralds End to Austerity

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Posted by Admin on May 22, 2012


By MICHAEL SIVY | – 4 hrs ago



(PHOTOS: Protests in Athens)

The most likely domino effect, therefore — and the one most widely expected — is that debts to non-Greek creditors are compromised after Greece switches to the drachma. Either there would be lawsuits over which currency to use, or borrowers would default on the loans, or the lenders would be forced to accept reductions in the amount of the loan that has to be repaid, in order to avoid outright defaults. Whichever outcome occurs, the lenders lose money. Just as in the U.S. mortgage-lending crisis, once some banks lose enough money to become troubled, the contamination spreads to other banks, because they all lend to each other.


(MORE: Why Portugal May Be the Next Greece)

But what if Greece’s exit from the euro zone causes other kinds of domino effects that don’t have obvious precedents? The fallout could be a lot harder to control. As I see it, there are two possible scenarios that aren’t getting the attention they should.

Derivatives could set off a global chain reaction. Most people have heard of the complex, “synthetic” financial securities known as derivatives, which Warren Buffett famously referred to as “financial weapons of mass destruction.” In the case of bonds, these are known as credit derivatives. They include all sorts of loans secured by bonds, as well as incredibly complicated vehicles that amount to insurance policies if the bonds default. No one really knows how much of this stuff is sloshing around the international financial system, but the total value for all types of bonds was estimated at more than $50 trillion in 2008 and has continued to grow rapidly since then. Trouble is, if the bonds underlying these derivatives become questionable, all the derivatives become uncertain, too, even if they add up to far more than the value of the bonds themselves. Moreover, some of the synthetic investments based on Greek bonds could be governed by Greek law, some by British law (if anything originated in London), and some by U.S. law (if Wall Street was involved).


What if one legal system accepts the conversion of euro loans into drachmas and another one doesn’t? Everything could be thrown into the courts for months. Even worse, if synthetic investments secured by Greek bonds become untrustworthy, why would anyone trust similarly complex investments involving Spanish bonds or Italian bonds?


Greece recovers quickly and all the other troubled countries want out of the euro zone too. At the opposite end of the spectrum is the possibility that Greece abandons the euro and bounces back surprisingly fast. Paradoxically, that could cause another sort of disaster. Both Argentina and Iceland suffered currency collapses, and after a horrible year or two, both rebounded and were better off than if they had fought to save a failing currency. Analysts point out that both countries were big exporters of grain, meat or fish, and that sales boomed after currencies were devalued. But Greece, in its own way, could profit from a similar recovery — a rebound in tourism. A 30% drop in the exchange rate might make a vacation in Greece the best deal in years.


So why would that be bad? Think of what it would mean for the other countries in the euro zone. How could the Italian government persuade its people of the need for higher taxes or the Spanish government explain soaring unemployment if Greece were obviously better off outside of the euro zone. Result: The entire European Union might unravel, with financial consequences many times greater than those resulting from Greece alone.

I’m certainly not predicting an extreme, doomsday scenario as the most likely outcome of a Greek exit. But it is important to realize just how unpredictable this situation is. In my own stock portfolio, I eliminated all the banks a long time ago and have largely stuck with financially strong companies that deal in essential goods — such as oil & gas, consumer staples and pharmaceuticals. The euro created a financial entity comparable in scale to the U.S., and if it gets into serious trouble the financial effects could be world-shaking.

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