Greek Shocker
Today was another one of those moments in the history of finance that will be recorded as a “shocker”. The Greek Prime Minister Alexis Tsipras, in an attempt to save his political career, is playing the ultimate brinksmanship by putting the fate of the European debt relief package up to the Greek voters. By calling a referendum, he effectively dismantles the negotiations process and destroys his credibility with the rest of Europe.
The issues are simple yet complex. In a simple sense, a rejection of the bailout package will generate a default on Greek sovereign debt and trigger a departure from the euro. Anyone holding Greek debt will have to mark down its value severely and reflect the loss in their books. Given the number of European banks and hedge funds that hold the debt you run the risk of seeing key institutions in the financial system need new investor capital to avert closure. In the case of some hedge funds, it will be straight out failure.
With the banks and stock exchange closed for the week, and the referendum happening over the weekend, we’ve created the perfect storm for a financial shocker. Placed on top of a holiday week for the U.S. and you’re increasing the market volatility even further.
While the risk of bank failure sounds similar to the Lehman Collapse of 2008, it is a vastly different situation. First off, the total amount of Greek debt we are discussing is only $360 billion. That sounds like a big number, but in the age of trillion dollar balance sheets it isn’t. Second, this has been in the works for years now, giving key institutions a long time to sort out their reserves and plan for this contingency, or simply get rid of the investment. Not that they would have done it well, but at least it has been done.
In the end, this is most likely to blow over by the end of the summer and make way for the positive effects of the growing and massive economies around the world. The damage to the euro, and the implications for future exits by rogue economies, would persist for years. And Greece will again issue debt, this time denominated in grape leaves.
The complexity is fear, and the reaction to fear, which is based in the unknown. A default by a euro denominated country has never happened. The follow-on effects are simply too subtle and complex to predict. So in typical investor fashion, every asset is punished until a resolution is in hand. Historically, it takes only a couple of weeks to recover from such a shock (Bloomberg, “A Freight Train of Unknowns Confronts Investors with Greece“). But in that rare occasion, such as 1987 or 2008, the recovery can take up to a year.
Time will tell, but until we see a true shift in fundamentals, we view this as a nasty but passing storm.
David Matias.
