Two on Greece, the Eurozone, and the IMF
What we don't know might hurt us.
I’ve run across a couple of articles on the Greek credit crisis, the Eurozone, and the IMF that I wanted to bring to your attention. First, from Andrew Lilico at The Telegraph on what happens when Greece defaults:
It is when, not if. Financial markets merely aren’t sure whether it’ll be tomorrow, a month’s time, a year’s time, or two years’ time (it won’t be longer than that). Given that the ECB has played the “final card” it employed to force a bailout upon the Irish – threatening to bankrupt the country’s banking sector – presumably we will now see either another Greek bailout or default within days.
and continues with a list of a dozen or so likely outcomes including a domino effect on Ireland and Portugal and insolvency for the European Central Bank. Not a pretty list. Hat tip: Megan McArdle
The other piece is a post from former chief economist at the IMF Simon Johnson on why the French want the next managing director of the IMF to be French so badly:
If Ms. Lagarde becomes managing director she can directly influence the terms of IMF involvement – and based on her negotiating position to date within the eurozone, we can presume she will lean towards more money, easier terms, and above all no losses for the banks that made foolish loans.
Increasingly it looks like the eurozone leadership, under French guidance, will go for the Full Bailout option, in which all Greek debt is bought up by the IMF, by the European Central Bank, and by other eurozone entities. This debt will be held to maturity – and any creditor who did not yet sell will be made whole (those who already sold at a loss are out of luck).
Unfortunately, the IMF is extremely Euro-centric and there appears to be an unwritten rule that a European will always head the IMF. Under present circumstances that’s likely to mean that American, Japanese, and poorer countries’ money will be used to paper over the incompetence of European banks.
When you look at the amount of debt incurred by Ireland and Greece, it is not clear to me that they could ever pay it all back. How they do it w/o French and German banks also taking a hit is beyond me.
Steve
Get somebody else to take the hit, I think.
And as I suggested in my earlier related post it’s possible that Dutch and Luxembourger banks may be even more at risk.
There is no way to pay the total debt off. Banks will have to take a haircut which given the amount of debt and the leverage ratio’s on the banks means the banksgo under. That is a problem, maybe a big problem but it is a manageable problem.
The unknown is what happens with CDS’s. CDS are unregulated ‘insurance’ bought and sold by the banks to insure that they would get paid if loans go bad. CDS are the excuse banks had for making way, way too many bad loans to too many people who could not pay. “No problem, we are insured” they would say.
But there is no clearing house for the CDS even though the CDS’s are traded all the time between banks. No one really knows what the counter-party risk is since who the counter-parties is not clear.
The nominal value of all CDS’s is estimated at $600 trillion. The total world GDP is only $60 trillion. There is not enough money in the world to pay off the CDS’s if they were to come do.
Give banks haircuts on their loans and the CDS’s insurance policies on those loans have to pay off. And that means who gets to pay for the bad loans is whoever currently owns that CDS. But no clearing house, no regulations at all on them (Thank you Phil Gramm!) means no one really knows who would actually have to pay.
So the Greeks restructure their debt giving the banks a 25% haircut (which is the historical and proper outcome for banks who make bad loans) and boom your local bank goes under. The ‘insurance’ has become detonation cord wrapped around the words banking system. If you in any way try to NOT pay the banks off in full, BOOM goes the economy.
And for wiring the economy to blow, the banks collect fees on every CDS they write and sell. Cha-ching!
Nicely played Mr Banker, Don Corleone could not have done it any better.