The markets did not react well to the Friday combo plate of weaker than expected European growth, Chinese tightening ahead of the anticipated schedule, and less than convincing remarks regarding what if anything the EU intends to do about its little looming sovereign debt crisis. And top it off by having Greece PM Papandreou launch a blistering attack on his would-be rescuers, accusing them of stoking the crisis psychology that was working to his country’s disadvantage.
Now some grandstanding at home is probably necessary, given that Greece is almost certain to be subjected to daunting austerity measures and some lack of sovereignity. But snapping at the hand that has yet to feed you is not very smart. Swedish Lex, in comments, has indicated that this sort of behavior could scuttle the rescue operation.
But as much as there are ample reasons to suspect a bailout will not come together in time, there is one big reason to think that the powers that be will perceive it to be necessary: a Greek default would push the European banks over the edge. The large institutions were thinly capitalized in the good times, and have recognized even less of the losses sitting on their books than their US peers. John Mauldin quotes Lisa Hintz of Moody’s:
The recent credit crisis was over a few trillion in bad, mostly US, mortgage debts, with most of that at US banks. Greek debt is $350 billion, with about $270 billion of that spread among just three European countries and their banks. Make no mistake, a Greek default is another potential credit crisis in the making. As noted above, it is not just the writedown of Greek debt; it is the mark-to-market of other sovereign debt.
That would bankrupt the bulk of the European banking system, which is why it is unlikely to be allowed to happen. Just as the Fed (under Volker!) allowed US banks to mark up Latin American debt that had defaulted to its original loan value (and only slowly did they write it down; it took many years), I think the same thing will happen in Europe. Or the ECB will provide liquidity. Or there may be any of several other measures to keep things moving along. But real mark-to-market? Unlikely.
Yves here. This is to remind readers that as much as the press and the pols are depicting the Greek/Club Med problem as the the spendthrift vs. prudent nations, the problem not just the prospective extension of credit, but all the debt from these countries and their banks now sitting on the books of institutions in France, Germany, Switzerland, and Holland.
Bruce Krasting raises a related issue: that a lot of economists are focusing on external debt of the various wobbly countries, but that may not be the best metric for a looming crisis:
In the early 80’s damn near every country South of Texas went belly up. I know. I ran part of Citi’s FX biz during that period. All my public and private sector Latin American customers were shut out of the capital markets. Their existing debts traded for pennies on the dollar.
From my seat I saw that the problems always started with the domestic banks. Their offshore funding lines were canceled one by one. They could not reduce their balance sheets fast enough; they went to the local Central Bank who said “No Mas” and the next day all the lights went out.
Things are much different today than 30 years ago. But there are some similarities. Financial institutions in every country have enormous cross border exposure. If you want to measure solvency it is appropriate to base the calculation on a country’s net external debt number. But if you want to measure a country’s liquidity risk you have to look at the gross number.
Yves again. Of course, there is also a separate and yawning political problem: if you think bank bailouts went over badly in the plutocratic US, imagine how popular they would be in Europe. So trying to persuade the average German voter that a rescue of Greece is really in his best interest, because the collateral damage to European banks and the blowback to the real economy would be even more costly, is not a message politicians appear able to deliver successfully.
This makes for great theater, save for the wee complicating factor that we all have a stake in the outcome.