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When the bail-outs don’t work, what then? Part 2

Political economy | When the bail-outs don’t work, what then? Part 2 Anthony Harrington

What happens if Greece defaults? Andreas Whittam-Smith argues, in an article in The Independent, that those who claim that a Greek default will have much the same effect on the global economy as the demise of Lehman Brothers have got it wrong. Yes, European banks have a very uncomfortable exposure to Greek debt, but, unlike when Lehman went down, this shouldn’t poison the world’s credit markets and lead to another almighty credit crunch. Why? Because there is total visibility of where the Greek debt sits, he argues:

“In the case of Lehman, nobody knew which banks were holding what amounts of dud securities. So suspicion fell on every institution. There was no presumption of innocence. Banks stopped lending to each other. A credit famine developed. But in the case of Greece, the holders of Greek debts are well-known and clearly identified. The Belgian financial institution, Dexia, is the most exposed, followed by a Portuguese bank and two German units, Commerzbank and Postbank. Then comes a long list known to everybody. As far as UK banks are concerned, Royal Bank of Scotland, HSBC and Barclays each have minor exposures. We can see exactly who has got the stuff and who hasn't.”

Besides, he goes on to argue, the banks are now much better capitalized. In fact more than one commentator has suggested that the real driver behind the EU’s continued bail-out strategy has been a recognition by national finance ministers, particularly German and French finance ministers, that their banks needed time to get their balance sheets into the kind of shape that would allow them to survive a Greek default.

This is a bit cynical since it suggests that no one at a senior level ever seriously believed that Greece could pay down its debt. If I were a Greek on the streets of Athens, that notion would raise my level of rage considerably and be a very strong reason for me to call for an immediate default, since I am being asked to endure much pain for no personal gain.

The miracle cure?

I prefer to believe that politicians generally believe their own fabrications. It’s the human way and it makes kidding yourself that much easier. So it is more likely that everyone working strenuously to provide Greece with yet another bail-out really does believe that buying time will cure the problem eventually, even if there is a little voice in their heads that says “and if it doesn’t, at least our banks will be in better shape…”.

Whittam-Smith points out that after a Greek default the money that is currently being found to bail out Greece, and which winds up back in the coffers of European banks in the form of Greek debt payments, could simply be channelled directly to the banks as emergency liquidity assistance. That would solve the banking problem without adding to the debt burden of future generations of Greeks, which it is doing at present. For an alternative upbeat assessment of how Greece’s departure might not be a catastrophe after all, see Ian Fraser’s account of a recent speech by Willem Buiter. Ian also provides a reference to an excellent commentary on Greece made to CNN Money by the financier Jim Rogers on his (Ian’s) website.

Viewed as the same money recycling back to the banks but this time without going via Greece, the case for default looks like a winner. However, there are one or two messy bits remaining, not least of which is that every private debt in Greece, from home mortgages to business loans, is currently denominated in euros. That could be taken care of by hyperinflation in Greece, which is a very likely possibility since, as many have pointed out, if Greece bombs out of the Eurozone and returns to a national currency, the value of the new drachma is likely to set new records for a downward spiral. (What you don’t want as a Greek debtor in that situation is to have your debt continue to be denominated in euros, or you’d go from needing a suitcase full of drachmas to pay your monthly mortgage, to needing several trailer loads. You’d want the debt to be transformed into drachmas. The initial debt would look huge, but after a few months of hyperinflation it would become vanishingly small.)

The default would have to happen suddenly, or every Greek with a euro account would dash to transfer their money to a non-Greek bank. The pandemonium that would ensue would make the run on Northern Rock in the UK, with patient account holders queuing round the block to get their money out, look quaintly British. The Greek government would need the army on the streets and barbed wire in front of its banks.

The matter of Target2 Greek debt

I won’t rehash the “Hans Werner Sinn versus the rest” argument here, having covered it in a three part blog (Part 1 here) already. But suffice it to point out that capital flights out of a country bump up its Target2 deficit with the ECB. In Greece’s case that deficit is already approaching the 300 billion euros it already owes and a massive capital flight would raise that level substantially (and is probably doing so already since Greeks are not stupid). The ECB chief economist Jurgen Stark has called the Target2 balances “a purely accounting matter – unless (the country concerned) leaves the euro”. That “unless” does not bode well either for Greece or the rest of the Eurozone.

Target2 defaults would fall on each member country to make good, with the debt being apportioned according to the ratio of its funding of the ECB – and this is quite apart from the defaulted sovereign debt which national banks would be saddled with. Swallowing that much debt will chill Europe’s economy like the North Wind in winter. The default would also, of course, be a tectonic shift in the geology of the Eurozone with, potentially, un-looked-for consequences on a grand scale. Anyone calling for a Greek default now should brace up for this…

Further reading on Greek debt, the eurozone and political economy:


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