Chandler: Uncertainty and contagion at work with Greece

Marc Chandler had some good comments on the Greek debt crisis this morning. The main issues, he believes, are contagion and uncertainty, especially as it pertains to sovereign debt infecting the private sector and vice versa. He said:

There is a high degree of uncertainty surrounding how the Greek debt situation is to be resolved.  It is clear that some effort is underway.  The suggestion that something could be forthcoming as early as tomorrow has triggered a dramatic narrowing of the interest rate premiums that not only the Mediterranean countries pay over Germany, but also other countries including Belgium and Austria.  That, in turn, illustrates the contagion that was at work.  We have argued that the Europeans are stuck in a terrible dilemma.  On one hand, they have done little so far in a crisis that has been brewing since last October and the contagion has spread. On other hand to bail out Greece poses all sorts of problems.  For example, how can any material support be given for Greece, when a country like Ireland has taken harsher steps to address its fiscal situation than Greece?  Isn’t that an example of rewarding the profligate and punishing hard work?   In order to build the scarce resource of credibility, Greece needed to demonstrate that it is indeed implementing its program.  The EU has demanded periodic checks–starting next month with the next check in May – and then quarterly.  Assistance now, prior even to the first check-up, risks undermining rather than enhancing credibility and underscores the moral hazard. 

There are practical difficulties at work too.   Sweden and the UK do not seem keen to have the EU fund a bailout of a euro zone member and seem to prefer the IMF or the euro zone to act if necessary.  The problem of the lack of political unity also rears its ugly head again because of competing turfs.  Consider the European solution to the lack of an executive.  Now it has three presidents:  Van Rompuy, the president of the European Council (who is talking about "an economic government and greater control of national budgets), Zapatero, Spain’s Premier who is also the rotating president of the EU and Barroso the President of the European Commission.  Germany appears to be taking a lead in the discussions, but it is being moved not, as some official claimed, because of the negative impact on the euro.  The euro is still well above nearly any measure of PPP and it has simply unwound some (at ~$1.38 around 62.8%) of the gains scored since last March’s lows.  Surely a weaker euro is helpful to the periphery of Europe and even France, who has complained recently about the euro’s strength.  The real driver here is not that the private debt problem is becoming a sovereign debt problem, but the opposite–the sovereign debt problem is threatening to renew the private sector banking crisis.  Consider the BIS data that is cited in press reports today:  German bank exposure to Greece is 43 bln euros, to Portugal 47 bln euros, to Ireland 193 bln euros and to Spain 240 bln euros.

Of course, everyone is focused on the sovereign here. What about Greek banks? Along with Irish and Italian banks as well as Spanish savings banks, they have been a major user of the ECB’s refinancing facility. FT Alphaville pointed out that, when you take bank asset size into account, the Greeks are the biggest user of ECB liquidity. Here’s a chart from a December post there.

The interesting bit is that the Greek banks don’t seem to have an immediate funding crisis on their hands since the lions share of liabilities come from their deposit base. UBS analysts speculate that the banks are merely using the ECB to receive low cost funding with Greek sovereign debt assets as collateral. That makes the Greek sovereign debt crisis a Greek bank crisis then – as this funding source may disappear with sovereign credit downgrades.

Now, if you were a Greek resident, you have to feel a bit panicky about the safety of your hard-earned savings given this scenario (see Guardian article).  So, we could easily see the sovereign debt crisis spill over into bank runs. And if Greek banks implode, there is going to be a knock-on effect for other weak banking sectors like the Austrian or Irish. This is how contagion works.

Let’s not forget that Greek banks do have some funding needs.  How are they going to roll over repo debt if the sovereign is having trouble? Rumours are starting that counterparties are not rolling over repo arrangements; this is exactly how Bear Stearns failed.

Needless to say, this whole situation is a mess. But, given the political constraints, I am not sure what the best way out would be.