Jun 11

Why a Greek Default May Be Good for the Markets


OK, now that I have successfully shocked you.  I will attempt to make the case for the benefits of Greece, the cradle of democracy, defaulting.  You see, I think the players in this Greek drama will be forced to don their masks and agree with that proposition sooner or later.

First, the downside of a Greek default and we’ve heard plenty of them.   Might it be another Lehman moment?  Not exactly, as this is a country defaulting not a financial.  But, it would cause losses in European banks, with downgrades a plenty, banks perhaps being liquidated by their regulators and counter party issues causing the credit derivative markets to hiccup, money market fund holdings of Euro banks would be hit, and it might begin a domino of defaults with Ireland, Portugal, Spain and Italy next.  Reuters recently did a good summary of these terrible possible events.

However, this really reminds me of someone being told of all the horrible things that will happen if they drive their car off a cliff.  So, the likely reaction is not to drive off a cliff…or atleast build an exit ramp before you get to it.  And that exit ramp is what may be in the offing.

While the ECB, France and Germany remind Greece to pass austerity measures, Greece reminds those three powerful players that they and their banks own the most exposure to Greek debt.  This dance macabre reminds one of a variation on an old saying, “if you owe the bank $100, they own you; but if you owe the bank $1 trillion, you own the bank.”  The Euro players say “do this” and we will keep you from defaulting, while the Greeks say keep us from defaulting and we might do “some of that.”  It is a fascinating game to watch, but one that, I think, all the players will grow tired of.

More likely, the Euro players are meeting with the largest holders of Greek debt (including the ECB) and deciding: (1) how to recapitalize the ECB after the Greek default and (2) how to prop up and then recapitalize certain Euro banks after the Greek default.  Think “sub prime mortgage problem” as the firestarter behind the fall of key players, resulting in a bailout of key financials, and instead replace “sub prime mortgages” with “Greek debt”, and you get the picture.

So, this game of chicken will go on until the Euro players have had enough AND have a plan of their own for dealing with default.  At that point, the Greeks can default, markets can go crazy and economies will suffer.  Only this time, the leaders will be better prepared to cushion the problems…although there will be problems.  And, Greece may even be forced to reject the Euro as its currency….it all depends upon what the exit ramp before the cliff looks like.

Once Greece defaults “the sun will come up tomorrow” over a slightly changed world economic landscape.  Markets will clear and eventually find new levels.  There will be some rather severe changes for some countries – how can that not be in Greece and other countries who are unable to service their debt?  But, much will be learned and the next country default will be even better handled by all involved.

And, perhaps, just perhaps, the beacon of democracy called the United States will learn something from the experience of the cradle of democracy.  Unless you’ve got a really good exit ramp (plan) in place, don’t even think of a “restricted default” by not coming to some agreement on a revised debt limit.