X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
What happens when Greece finally goes bust? - Outside View by MoneyWeek

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

What happens when Greece finally goes bust?
Jun 23, 2011

Greece is bust and on the verge of default.

So tell us something new, you say. The headlines have been full of Greece's troubles for ages.

The question is: why is Greece panicking markets now?

It's because markets had assumed that Europe's bosses would do all they could to avert disaster.

With Germany and the European Central Bank at loggerheads, that now looks increasingly doubtful.

So what will it really mean for investors if Greece goes bust?

A Greek default is just a matter of how and when

A quick recap: Greece was bailed out a year ago to the tune of €110bn. The government promised to slash the budget deficit - the annual shortfall of state spending minus the tax take.

Yet lenders still didn't believe the country could service its existing borrowings. The debt pile Greece had already built up was just too great.

So they slashed the value of Greek government bonds, driving up the yield. If Greece tried to borrow today, it would have to pay up to 30% a year. That indicates just how little faith investors have in the country's ability to repay any loans.

And small wonder. By the end of this year, the Greek government will owe over 150% of the country's annual output, reckons the International Monetary Fund (IMF). By 2016, even with huge state spending cuts, that figure will only have fallen to 146%. History shows that once a country's debt/GDP ratio rises above 150%, a default is just a matter of time.

In other words, Greece is about as bust as can be. Trouble is, Europe's finest can't agree on what to do about it. The European Central Bank (ECB) wants to keep 'extending and pretending', ie give Greece more eurozone taxpayers' money to buy it time while it knocks its finances into shape.

But Germany isn't keen. It wants private investors in Greek debt to take some of the pain as well. And the Germans are trying to delay a second bail-out package until September, according to Reuters yesterday.

Unfortunately, time is fast running out. Protests against cuts on the streets of Athens are getting nasty, and could pull the government down. That increases the risk of a 'disorderly' default, where Greece just turns around and tells its creditors and the rest of the eurozone where to stick their austerity.

Could Greece become Europe's Lehman Brothers?

What happens then? Let's look at who's got what on the line.

At the end of 2010, according to data from the Bank of International Settlements (BIS), Italian banks held $2.3bn of Greek debt, and UK lenders were in for $3.4bn. They should be able to cope with those losses.

But then the numbers get much scarier. French lenders held $15bn of Greek sovereign bonds, while German banks were exposed to more than $23bn. The total for European banks was $52bn.

This doesn't include the ECB, which itself has bought €47bn-worth of Greek bonds in a failed attempt to boost confidence in the country. "It's become an enormous… dumping ground for bad loans", notes Matthias Brendel of Spiegel Online. "No expert can say how it can jettison these without dealing a fatal blow to the European banking system."

On top of this, exposure to Greek banks in emerging Europe "is rife", says Joseph Cottrell on FT Alphaville. "Greece's banking sector is largely Romania's and Bulgaria's banking sector."

What does this mean? Subsidiaries of Greek banks in these countries have accounted for a large slice of domestic lending. As these subsidiaries are forced to send more money back home, the "least bad outcome", says Nomura, is that lending will collapse in Romania and Bulgaria. That would be damaging for growth.

But if those Greek bank subsidiaries run out of money, they in turn could be forced to default. And in a mad scramble for cash, that could lead to the worst-case scenario: "a fire sale of emerging European assets".

And then there's the question of what happens to all the credit default swaps (CDS) written as insurance against Greece going bust. If Greece defaults, would the banks who wrote this insurance be able to pay out?

This may all sound familiar. That's because you've seen it before. "The probability of a eurozone Lehman [Brothers] moment is increasing", says Neil Mackinnon at VTB Capital. "Markets are looking at a scenario of a Greek debt default becoming disorderly".

The big worry is that, as happened with the Lehman collapse in 2008, banks will stop trusting one another as fears over exposure to the country's debt contaminate the eurozone.

'Counterparty risk' will become an issue once again, as banks that once looked OK have their capital eaten up by Greece-related debts going bad. So banks will stop dealing with each other - which is key to a functioning economy - in case they don't get their money back.

It's like finally picking a winner at Royal Ascot but finding the bookie can't pay out. In turn, that would undermine your own finances.

How the dollar could benefit from Europe's woes

You're getting the - very, very messy - picture by now. And it's likely to prove bad news for the euro, as John Stepek noted last week: The battle for Greece looks set to slam the euro.

So where are the safe havens? Clearly, gold is one. If ever there's a time to stick with it, now is that time, as Dominic Frisby was saying yesterday: What the '70s bull run can teach us about today's gold market.

The other is less obvious. America is hardly trouble-free, as reflected by the weak dollar. But compared with Europe's looming woes, US problems are "small beer", reckons Charles Dumas at Lombard Street Research. "The euroland outlook has to be dollar-positive for the balance of 2011."

We'll be looking in depth at ways to take advantage of a stronger dollar in a future issue of MoneyWeek magazine. Meanwhile, if you're looking to trade currencies direct, spread betting is one way to do it. It's certainly not without risk.

This article is authored by MoneyWeek, the UKs best selling financial magazine. MoneyWeek offers intelligent, easy-to-read analysis of the financial news, with practical investment advice.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "What happens when Greece finally goes bust?". Click here!

  

More Views on News

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

What They Forgot to Tell You About Sensex at One Lakh (Profit Hunter)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

How I Got My Wife To Invest In Mutual Funds... (Outside View)

Jul 20, 2018

PersonalFN brings to you a real-life case of how husband and wife engaged in a sensible money-talk post-marriage to build a solid mutual fund portfolio.

Our Newest "Fixer-Upper" (Vivek Kaul's Diary)

Jul 20, 2018

Bill Bonner talks in detail about US president been accused of treason, biggest debt default in China, the problem of growing inflation and the trade war.

The 'Profitable' Ola and Uber You Can lnvest In Right Now (Profit Hunter)

Jul 20, 2018

Here's is a business in small cap space that is asset-light and yet profitable - A serious contender for the list of future blue chips.

More Views on News

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

ICICI Pru Mutual Fund Tarakki Karega! - The Unethical Way?(Outside View)

Jul 11, 2018

PersonalFN explains how ICICI Prudential Mutual Fund flouted the norms of related party transactions while subscribing to the IPO of ICICI Securities.

PPF v/s Mutual Funds: Which Is Better?(Outside View)

Jul 10, 2018

PersonalFN highlights the key points of distinction between PPF and mutual funds.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jul 20, 2018 (Close)

MARKET STATS