Notes From Underground: From the Arctic comes brain freeze

As the G7 summit broke up on Saturday (sans communique), most of the media releases concerned themselves with the Greek and European debt drama. All of the releases through the media place great belief in the Greek government’s ability to cut their deficit to 3% during a three-year period. The repitition of this belief in a fantasy challenges the credibility of those who make financial policy in the developed world.

We know that they are trying to stem the possibility of contagion throughout the PIIGS, but the more they pretend the greatest the risk becomes. A constant criticism we have of financial leaders is their continued belief in flawed models rather then real world activity. The markets keep telling the policy makers they have no respect for their statements and want to see action. The Greek situation is creating a serious negative feedback loop for the Greek budgetary process as higher interest rates on long term debt is draining more money out of the budget.

This spring brings the rollover of a large chunk of Greek debt. The market will exact a huge price to prevent a default, but this price will be a huge drain on the Greek treasury. The most recent numbers we have seen is that the need will be to borrow 53 billion euros. Even with most of the loan done in shorter durations, the interst on the debt will be an overall 12.95 billion euros, or 5.3% of total output. As the markets push Greek rates higher, the cost will escalate as the economy shrinks because of the severe budget constraints. When we get comments from Geithner and others that they have full faith in the Greeks to meet their promises, we know they have brain freeze.

The further problem is that many large European banks are the owners of a large amount of Greek public and private debt. We include a chart from the BIS depicting which countries’ banks have the largest exposure. The situation is not very promising regardless of what the global financial leaders continue to say in order to buy some time. The equity an commodity markets had a late rally on Friday hoping that some real support program would be put in place. We await, but from our standpoint hope is not a policy.


6 Responses to “Notes From Underground: From the Arctic comes brain freeze”

  1. GaryP Says:

    This is obviously a short term crisis for the Euro Zone (and may be a long-term disaster if Greece falls in chaos, seemingly the most likely outcome based on the response of Greek unions) but should the US see this as a dress rehersal for our fate in the (near?) future?
    Prominent voices (Deutche Bank/Niall Ferguson) are using that description (dress rehersal for US) for the Greek situation.
    The Euro Zone has no easy solutions. They can easily temporarily rescue Greece but without the political will to implement effective change by the Greek people, what is the point. In addition, the moral hazard for the EU of bailing out Greece sans reform would, almost certainly, lead to similar behavior in the remainer of the “porcine” countries.
    Similarly, the challenge to the US is how to prevent state defaults in states, such as California, without allowing these states to continue the un-sustainable policies that brought them to the brink of default (also caused principly by public unions).
    I don’t think either the EU or the US have the political will to do what needs to be done. I guess we’ll see.

  2. ec Says:

    As the chart show, banks own about 300 billion euros in loans. As of now they are probably caring them at 100%. With a default they would have to mark them down to the real value and the individual governments would have to step in and help the banks plus it would rattle the credit market. In the end it will be cheaper for France, Germany, Switzerland etc. to come up with the money after they extract an arm and a leg from Greece. They might wait until the euro gets to a value that they like for exports. It will be the same situation for each of the Piigs.

  3. yra Says:

    ec is right on point –just a matter of what political concessions can be extracted—

  4. spdbrnr34 Says:

    It’s all about “happy talk” to calm market fears, even when the happy talk is so obviously wrong/misguided/non-trustworthy. We got tons of it from Ben B during the housing bubble, and even more from him & Paulsen even as the cracks started to show in mid 07, early 08.

  5. yra Says:

    spdbrnr—I would not disagree but that is of course when the entrenched elites earn their “pay”.But I would caution that the U.S. model will not easy fit onto Europe—It was easier for Ben and Hank to calm the U.S. states then it will be for Trichet and the poilitical elite of Europe to hold sway over disgruntled Bavarian Burghers

  6. yra Says:

    oh and I too love South Pacific and I think the Germans would like to wah all those PIIGS right out of their hair

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