This might be a really basic question, but: Why can’t they just restructure Greece’s debt into a partial default and move on? Why does it necessarily threaten the Euro? For example, Greece can simply default on the debt that is being held by private investors, and not on the bonds being held by EU govts. Now certainly Greece’s borrowing costs will rise, but I don’t see how the Euro would be in trouble…
not sure if you can just “segregate” the defaults based on holders. but in any case, its not the threat of a Greece default (they are technically already in default), but what happens to the other countries (i.e. Italy, Spain) and how the Eurozone will react. The Euro is threatened because they can’t come to a cohesive decision to get their house in order. If everybody was under one fiscal regime, they can simply print money, but because they can’t (or won’t) at the current moment, ppl just assume the Euro will break up and the world will collapse. disclosure i’m long 1 Euro bank. my call is the Euro will get itself together after some more pain and foot dragging. Some banks will also recapitalize not necessarily because any other country is going to default (Italy/Spain will not default), but because it gives the Eurozone the necessary confidence and strength to move on etc… Yours Truly, Pauly D
i like the good really simple question cause they are stimulating http://en.wikipedia.org/wiki/European_sovereign_debt_crisis Danger of default Further information: Sovereign default Without a bailout agreement, there was a possibility that Greece would prefer to default on some of its debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring. Analysts gave a wide range of default probabilities, estimating a 25% to 90% chance of a default or restructuring.[65][66] A default would most likely have taken the form of a restructuring where Greece would pay creditors, which include the up to €110 billion 2010 Greece bailout participants i.e. Eurozone governments and IMF, only a portion of what they were owed, perhaps 50 or 25 percent.[67] It has been claimed that this could destabilise the Euro Interbank Offered Rate, which is backed by government securities.[68] Some experts have nonetheless argued that the best option at this stage for Greece is to engineer an “orderly default” on Greece’s public debt which would allow Athens to withdraw simultaneously from the eurozone and reintroduce a national currency, such as its historical drachma, at a debased rate [69] (essentially, coining money). Economists who favor this approach to solve the Greek debt crisis typically argue that a delay in organising an orderly default would wind up hurting EU lenders and neighboring European countries even more.[70] At the moment, because Greece is a member of the eurozone, it cannot unilaterally stimulate its economy with monetary policy. For example, the U.S. Federal Reserve expanded its balance sheet by over $1.3 trillion USD since the global financial crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt.[71] Greece represents only 2.5% of the eurozone economy.[72] Despite its size, the danger is that a default by Greece will cause investors to lose faith in other eurozone countries. This concern is focused on Portugal and Ireland, both of whom have high debt and deficit issues.[73] Italy also has a high debt, but its budget position is better than the European average, and it is not considered among the countries most at risk.[74] Recent rumours raised by speculators about a Spanish bail-out were dismissed by Spanish Prime Minister José Luis Rodríguez Zapatero as “complete insanity” and “intolerable”.[75] Spain has a comparatively low debt among advanced economies, at only 53% of GDP in 2010, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece,[76] and it doesn’t face a risk of default.[77] Spain and Italy are far larger and more central economies than Greece; both countries have most of their debt controlled internally, and are in a better fiscal situation than Greece and Portugal, making a default unlikely unless the situation gets far more severe.[78]
i guess the concern is the contagion spreading
Spain or Italy, or even Ireland, would cause troubles. The issue is “if Greece goes, what’s to stop the others from falling.” And if the ECB saves the other countries, why can’t it save Greece. There’s no real precedent for making decisions like that since the creation of the Euro. Therefore, there’s a concern that the fate of Greece determines the fate of the others, even if the size of Greece’s debts is relatively small.
Greece, Protugal, and Ireland are small potatoes; the real issue is further contagion/spread of this fiscal crisis into Spain and Italy. The top 5 Eurozones economies in order are Germany, France, Italy, Spain, and Netherlands. If Italy or Spain were to “fail” they would be no rescue package within the eurozone that would fix that.
and italy has been stubborn in responding
Thing is though, the contagion is a worry because the governments are holding each others’ debt, so if Greece defaults, then Spain has a bigger chance of doing so as the value of their assets drop. But as long as they agree to honor the debt they are holding of each other, and default on the rest, that should lower the chances of a larger crisis right? Or is part of the problem that private investors like banks would not be happy with that arrangement and they’re pressuring govts to honor their obligations?
@Palantir My understanding is that is it not the governments that are exposed to each other’s debts (at least not directly) but rather the banks. The problem can be traced to the way in which risk weightings for bank capital was suggested under Basel II (if I am not mistaken). SInce the weighting of government debt was 0% the banks went crazy and took on European govt debt. The problem now is that given what is happening with the pricing of this debt not just for Greece but for Italy, Spain, Portugal, etc, the banks have been taken it on the chin. The ECB through it’s facility has been buying up worthless paper to keep the banks propped up (much like what happened here). The issue is really whether the ECB can increase the funding for its facility. Currently faced with backlash from citizens, it is very difficult for member states to increase funding. AS far as the banks are concerned, I am fairly positive that they bought CDS protection on their exposure. For them, it is a double whammy. ECB buys their bonds @ par and in case of a default they get a payout unless of course their counterparty goes under. My 2C
C3Po Wrote: ------------------------------------------------------- > My understanding is that is it not the governments > that are exposed to each other’s debts (at least > not directly) but rather the banks. This. It’s a bank crisis, not a sovereign crisis. First the French banks go, then German, then we’ll see how well the US banks are insulated.
Yes… the concern in Europe is that sovereign defaults or restructuring in the periphery will sink banks in the core. The next step in the chain is that companies in the core that depend on banks for access to credit and or capital will not be able to do so. US corporations have lots of cash on their balance sheets. One of the good things about that is that they can last for a little while if banks start to have problems again. In my view, this is the main reason they have been storing cash. After 2008, they don’t want to be so dependent on banks anymore: it’s worth the drag on returns to have a much larger cushion. I don’t know what German or French companies are like… can anyone here speak to that? Are they flush with cash the way US corporations are? If so, the danger to the economy (but not to the banks) is reduced.
Interesting, didn’t pick that up, I was thinking that the risk of ‘contagion’ was because countries were holding each others’ debts. So effectively, if it’s a banking crisis, then it would be more similar to our own subprime crisis, but in this case the subprime debt is sovereign?
Precisely!
Yes. Although, I don’t think that the sovereign debt’s risk is magnified by the whole ABS/CDO concerns the way the mortgages were. Sovereign debt is substantially easier to value, because it’s a straight bond, even if the chances and timing and form of default are still uncertain. Effectively people thought they were getting bonds that were as safe Bunds but with higher interest rates. The analogy is that crappy mortgages were stamped AAA in an ABS structure, and therefore fishy mortgages were considered about as safe as US Treasurys. Similarly, Greek debt was considered as safe as German debt, but paying more. In both cases, there was an assumption that in a crisis, the central bank (Fed or ECB) would come to the rescue because of the dual mandate in the Fed’s case, and European desire to keep the Euro together, in the ECB’s case. A very similar process. But there are a few differences. Sovereigns can tax more to raise money. Mortgage holders can’t. Mortgages holders have collateral (the home) and most have an embedded put (just walk away). Sovereigns don’t have collateral. They might have a put, but the consequences of exercising it are extreme for them. There are a small number of sovereign countries vs. 10s of 1000s of individual mortgage holders. This makes negotiating settlements and monitoring compliance substantially more practical (though still politically difficult). Finally, having seen 2008 happen in the US, it is inconceivable that the Europeans have not at least considered this scenario and what the possible set of actions might be. In 2008, what was happening was (though should not have been) “unthinkable,” and so policymakers were under extreme time pressure to consider scenarios that they had not spent any time planning for. This time, the time pressure will still be on, but every policymaker should have at least considered the question of “what if it comes to a systemic collapse.”
@bchadwick You make some great points. I would argue that in a convoluted way that Sovereign do have collateral in the form a printing press and of course “full faith and credit”. (not that I agree with it). Whilst the Europeans know only too well the outcome of a systemic collapse the only way out for them ay least in the short to intermediate term is to inject capital. This is easier said than done. IMHO, unless they agree to form a fiscal and monetary union, the desired goal cannot be achieved. Europeans are not “homogenous” in the same way as the US or China or Brazil. Additionally, there are some deep rooted and age old problems (cultural, social and economic) that will prevent them from forming a fiscal union. I may be proved wrong but I am willing to bet against it.
yes i agree with all this but the big wart in all this is the fact that the euro zone bonds/businesses were perceived to have lower risk and now that is proving not to be the case…it is not simple to unravel this onion …who will pay for wgat? greece leaves euro and return to drachma …economist esitmate cost to GDP is 50% and 20% annually as they restructure their economy… germany leaves euro and return DM …everyone flies to germany as a flight to safety and the math become 1 from many leaves none… greece and germany stays and they restructure greece and take implement austerity measure in PII_S gradually…more likely but the german voting pop need to get comfie with the idea
bchadwick Wrote: ------------------------------------------------------- > Effectively people thought they were getting bonds > that were as safe Bunds but with higher interest > rates. The analogy is that crappy mortgages were > stamped AAA in an ABS structure, and therefore > fishy mortgages were considered about as safe as > US Treasurys. Reasonable approximation. Greed vs fear never goes away. People will always want to earn rent on their assets while no one wants to assume risk. > Sovereigns can tax more to raise money. Mortgage > holders can’t. Actually this I disagree with mostly because of the wording. Can Greece tax more and bring down their deficit? What about Spain or Italy? When these countries try to get out of their problems that way they hurt their economies and the debt ratios get WORSE not better. The problem is that these countries are not actually “sovereign” in the sense of sovereign over their own currency. They gave that up with the Euro. If they were actually sovereign none of this would be an issue and they would have a situation similar to the US and Japan where there is a substantial stock of public debt available for holdings in savings accounts but there is no possibility of a run on the bank. Interestingly take a look at German CDS blowing out even though they are AAA because of this dynamic. Germany is as vulnerable as any other European common currency country giving the structural deficiencies of the Euro. > Finally, having seen 2008 happen in the US, it is > inconceivable that the Europeans have not at least > considered this scenario and what the possible set > of actions might be. In 2008, what was happening > was (though should not have been) “unthinkable,” > and so policymakers were under extreme time > pressure to consider scenarios that they had not > spent any time planning for. This time, the time > pressure will still be on, but every policymaker > should have at least considered the question of > “what if it comes to a systemic collapse.” I agree with this. Culturally Europe is much different and seems unlikely to me to let a major institution fail like Lehman. Many countries were actually very surprised when the US took that (idiotic) action. If/when Greece goes down I believe they will ring-fence the rest at whatever political cost to the ECB. The country leaders are fighting how to package the whole thing politically to keep themselves elected.
Dwight Wrote: ------------------------------------------------------- > bchadwick Wrote: > -------------------------------------------------- > > > Sovereigns can tax more to raise money. > Mortgage > > holders can’t. > > Actually this I disagree with mostly because of > the wording. Can Greece tax more and bring down > their deficit? What about Spain or Italy? When > these countries try to get out of their problems > that way they hurt their economies and the debt > ratios get WORSE not better. > Sovereigns can tax to raise money. That’s what it means to be sovereign. In this particular situation, there are additional constraints that make raising taxes an ineffective and impractical solution. Sovereignty makes you the supreme lawmaker of the land, but you can’t repeal the laws of physics nor (some of) the laws of economics. I think we basically agree and, as you said, are quibbling a bit over wording. > The problem is that these countries are not > actually “sovereign” in the sense of sovereign > over their own currency. They gave that up with > the Euro. If they were actually sovereign none of > this would be an issue and they would have a > situation similar to the US and Japan where there > is a substantial stock of public debt available > for holdings in savings accounts but there is no > possibility of a run on the bank. Interestingly > take a look at German CDS blowing out even though > they are AAA because of this dynamic. Germany is > as vulnerable as any other European common > currency country giving the structural > deficiencies of the Euro. > Yes, this is also a wording issue. In a monetary sense Euro countries are actually more suzerains than sovereigns, but they are still ultimately the sovereigns, because they can choose to leave the Euro (the Confederate States of America were not allowed to do this, though they might still say they were allowed to do it; just not able to do it). But the main reason we call it sovereign bonds is just because sovereign bonds are generally understood to be “bonds issued by a country’s government.” Supranational trade and monetary arrangements make this cloudy, and this is similar to the political philosophical debate about whether a sovereign has the authority to restrict itself, and if it can’t, where is sovereignty located? When a country hands its monetary authority over to another central bank, whether by currency union, or by maintaining a peg or currency board, is it still a sovereign country. In the case of East Germany, it isn’t. East Germany can’t withdraw from Germany without getting approval from the rest of Germany. But in the case of Greece and the Euro, maybe it can. It depends on the details of the treaty, which I don’t know fully, but which I understand does allow for a withdrawal; it just doesn’t specify a mechanism for it. Ultimately it gets down to the same mess about whether God is powerful enough to do something that even God can’t undo, and if so, what is it that is more powerful than God; if not, then God is not all-powerful.
i don’t think we can say this is a sovereign crisis or a banking crisis - i think its both as they are exposed to the same risks. from that NYTimes web of debt owing/owed posted last year (so i can’t say for sure whether the amounts remain accurate), Greece owes Ireland net $7.7B and Portugal $9.6B. If Ireland and Portugal have to write off 50% of that debt, they have just lost 0.4% and 1.7% of their assets. Ireland owes Portugal net $16.6B (or 5.8% of their BS) and Portgual owes Spain net $58B (or 5.3% of their BS). http://www.nytimes.com/interactive/2010/05/02/weekinreview/02marsh.html I know these figures are dated by a year, but i assume the exposures are still there in some way or form. as for the banks, well their solvency is dependent on the hits they take from sovereign debt combined with the hits they take on earnings and the declining market value of all assets. a worsening banking picture leads to worsening degree of recession in the EU which in turn worsens the banking picture. banking and sovereigns have always had this relationship. the biggest issue is that the ECB is the decision maker on easing and bailouts and morally cannot jump in and save any country that isn’t pulling their weight. think of it like this, because we are in a world economy is it right to expect the U.S., Japan and EU to step in and completely and utterly save any country on the brink of or in recession. we do this through the IMF and World Bank but the goal of the IMF and World Bank isn’t to prevent recession everywhere, it is to assist those who ask for help and accept terms to receive said help. there are often difficult consequences to deal with when accepting IMF dollars. the same must be said of the EU heads and ECB.
The 800 Trillion pound elephant in the room is the counterparty risk. As ZH pointed out this morning, US banks may be hedged against European exposure, but that’s only assuming their counterparties can make good if/when defaults occur.