Greek Crisis Unlikely To Set Off A Chain Reaction Of Defaults

Still reeling from the subprime fiasco, witnesses to the ongoing Greek debt drama may be experiencing a sense of deja vu. Yet even without intervention, a chain-reaction of …

Still reeling from the subprime fiasco, witnesses to the ongoing Greek debt drama may be experiencing a sense of deja vu. Yet even without intervention, a chain-reaction of defaults in the region is unlikely, whereas a bail-out could encourage fiscal recklessness among other EU members. See the following article from Money Morning for more on this.

The Greek debt crisis is starting to display an uncanny resemblance to the subprime crisis that sank the U.S. housing market, sent the global economy into a tailspin and touched off the worst financial crisis since the Great Depression.

Indeed, Greece has behaved very much like a subprime country:

  • It has borrowed more money than it can possibly repay – all the while lying to everybody about its true state of affairs.
  • “Liar loans” have been made, in Greece’s case, to enable the country to “cook the books” with regard to its budget deficits.
  • New problems continue to emerge – apart from the liar loans – making it impossible to be sure all the troubles have been unveiled.
  • And as was the case with the subprime-mortgage crisis, embattled Wall Street investment-banking-giant Goldman Sachs Group Inc. (NYSE: GS) appears to have been intimately involved in the business.

And the similarities don’t end there.

Why Bailouts Can Bite Back

Bailouts of a single-such miscreant are possible, but nobody wants to undertake them because of the distaste created by the miscreant’s past and present activities.

Just as Lehman Brothers Holdings Inc. (OTC: LEHMQ) executives kept voting themselves giant bonuses as the company was tottering into bankruptcy, so, too, do Greek-public-sector workers go on strike after strike to protect their right to retire with a full pension more than a decade earlier than ordinary German workers.

As with the subprime miscreants, the temptation is strong to let the borrower go to the wall … except for one thing – the deep-seated fears that the miscreant’s demise will touch off a “domino effect” among other weak borrowers, several of which may be endangered if Greece is allowed to fail.

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But a bailout attempt may not be the answer, either. Horrifyingly, because of the exposure that French and German banks have to Greece and the rest of southern Europe, there is a very real prospect of the entire global banking system collapsing – with incalculable danger to the world economy – if things are done wrong.

The main factor that separates the Greek debt crisis from the U.S. subprime-mortgage crisis is that the danger of a “contagion” spreading if Greece goes bankrupt appears to be less.

Portugal – generally viewed as the next-most-obvious defaulter after Greece – has a considerably lower debt load (at 90% of gross domestic product, or GDP) and a considerably narrower deficit (at 9% of GDP). In fact, Portugal’s deficit is actually less than the budget shortfalls of Great Britain and the United States. More important, Portugal’s affairs have been run with a probity and conservatism lacking in Greece – the latter having viewed the European Union that it joined in 1981 as an ideal funder for its idle and corrupt socialist fantasies.

The poorer countries of Eastern Europe – most notably Romania and Bulgaria, which both joined the EU in 2007 – have made certain (by virtually every measure imaginable) that Greece will no longer be ranked as the EU’s poorest member.

Unfortunately, the mere addition of less-affluent countries doesn’t mean that Greece is any better run. Indeed – except for moments of extreme post-communist fantasy in Romania, Bulgaria and Hungary – nowhere else in Europe is anything as badly run as it is in the Hellenic Republic. Certainly Italy isn’t: That southern European country had too much debt going into the crisis, but is currently well managed. It carefully avoided foolish “stimulus” during the recession and – as a result – has a budget deficit that The Economist expects to reach a mere 5.3% of GDP in 2010.

The calculus is thus different from that of the subprime crisis.

U.S. Subprime Crisis – Part II?

Whereas the fall of Lehman Brothers caused a justified concern that the whole of Wall Street was in the same predicament, a Greek default would cause “contagion” only in the minds of fevered hedge-fund speculators, without any solid basis in reality. There would be no need for the euro to break up (whether or not Greece abandoned its attempt to remain a member) and no particular strain on the EU as a whole.

That suggests that the German attitude – an opposition to a Greek bailout – is probably the economically better approach.

Indeed, the German government has perceived quite correctly the problem with a Greek rescue. Whereas, with the U.S financial crisis, there was no danger that the Wall Street bailout would produce subsequent outbreaks of subprime-mortgage lending (though the determination by the U.S. Federal Housing Administration to keep lending in the downturn appears to have done so, at great-and-increasing expense to U.S. taxpayers), the “moral-hazard” danger of a Greek bailout is immense. All over southern and Eastern Europe, there are substantial minorities of the population for which the possibility of a bailout by German taxpayers is an invitation to total government-spending profligacy.

For an illustration of this problem, take a look at Hungary from 2002 to 2008. The Socialist government of Ferenc Gyurcsányran mad for six years, under the theory that EU membership – achieved in 2004 – meant they would never have to pay for their crazed spending.  However, Hungary is by no means the most profligate of the Eastern European members of the EU – Romania and Bulgaria are certainly worse. Moreover, Italy and Spain both have huge minorities, often in control of those countries’ governments, which if bailouts were acceptable would find the temptation to expand government spending at Germany’s expense pretty well irresistible. A Greek bailout could thus lead to bad fiscal behavior among so large a proportion of the EU that future rescues would become systemically impossible.

This is the paradox of the Greek-debt situation: It seems to be understood by German Chancellor Angela Merkel, but by almost nobody else involved.

The Road Ahead

A Greek default offers few dangers – Portuguese or Italian debt would become huge “Buys” at the prices they would reach in that case, but the EU and the European euro would be unaffected, or even strengthened. However, a Greek rescue would bring huge long-term perils – and given the spending propensities of the less-responsible elements of the European left, “long-term” means no more than four to five years away.

With apologies to Lord Nathan Rothschild, the message for outside investors in European stocks and bonds is quite clear: Buy on a Greek default, sell on a rescue.

This article has been republished from Money Morning. You can also view this article at
Money Morning, an investment news and analysis site.

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