As the ruling class fight over another bailout, is Greece another Lehman’s – that’s the question that has been raised in the financial markets over the last few weeks by financial analysts and more mainstream commentators.
The size of European (excluding Greece) banks’ exposure[i] to Greece’s public and private debt is much smaller than the losses on Lehman’s brothers – $130 billion to Greece compared to $631 billion losses on Lehman’s. About $67 billion of this is exposure to Greek government debt. Greek banks have a larger exposure to Greek government debt at about $88 billion. We have outlined strategies to deal with the debt crisis in Europe and Greece previously[ii] but a default of Greek government debt would bankrupt the Greek banking system and lead to most of the $130 billion exposure held by other European banks being crystallised into losses – this would be partially offset by about $40 billion insurance held by these banks on Greek debt which has been issued by mainly US banks who would then suffer that loss.
The real problem is that Greece, like Bear Stearns in 2007 was to the credit crunch, is the start and tip of the iceberg. If a default happens in Greece then it sets a precedent for how events could unravel in Ireland and Portugal. To that group of countries must be added Spain who we believe will need some kind of bailout within the next year[iii]. European banks exposure to Ireland is $463 billion, to Portugal $194 billion and to Spain $642 billion. Add to this that large parts of this exposure is insured with insurance bought from US banks who will then carry a major part of the losses and you have a Lehman’s on a much larger scale. It is also likely that the debt/default crisis could spill over into other countries in Europe making the problem even larger. A new freeze in global credit would occur leading to a deep second recession.
This is why the ruling class is fighting furiously over the terms of a second bailout for Greece. Estimates put Greece’s 2012-14 financing gap at as much as 170 billion euros ($243 billion). It would be filled by about 45 billion euros of loans, plus 57 billion euros in unspent aid from the 2010 bailout, roughly 30 billion euros in asset-sale proceeds and about 30 billion euros from creditors. This 30 billion from creditors would take the form of losses on Greek government bonds.
The European Central Bank (ECF) fearing that this will become a common way to reduce the debt burden of stretched countries such as Ireland, Portugal and possibly Spain are fighting to make these losses voluntarily. While Germany under pressure from its people to not take the full burden of any further bailouts was until recently wanting to force bond holders to take a loss (haircut). The ECF is hoping that the credit agencies will not see a voluntarily agreement as a credit event that would trigger further downgrades a country’s debt and lead to losses on insurance provided by US banks.
Indications are that the credit agencies would see these voluntary agreements as credit events and it would be very difficult in any case to get such an agreement from a variety of bond holders which range from banks to insurance companies and pension funds who come from not just Europe but the rest of the world. This means that the negotiations between the ECB, European Union and International Monetary Fund on the second bailout for Greece due to start in July 1st will unlikely produce a satisfactory outcome for both camps.
Default looks inevitable in Greece no matter the vote of confidence Papandreou or if the new austerity package is passed by the parliament: either as part of a rescue package; through bankruptcy of the economy or through the resistance of the Greek people. The last case is the most favourable for the Greek people as it will be under their control rather through more imposed austerity.
[i] All figures are from the Bank of International Settlement report on bank exposures at end 2010.
The views expressed are the author’s own.