It bears remembering that the German banks are very exposed to the periphery as we contemplate the Spiegel article on Greece’s alleged desire to defect from the euro zone.
Here is what the debt situation in the periphery looks like for German banks.
Before we talk about this, let’s talk about why this is relevant.
The rumours out of Germany that Greece is considering withdrawal from the euro-zone are being denied vigorously by EU and Greek officials. But, where there is smoke, there is fire. Clearly, it is in Greece’s best interest to allow these rumours to persist. Not only has it savaged the single currency, it also gives the Greeks leverage in terms of negotiating a better bailout package.
Win Thin is right when he writes:
it seems more likely that Greece may be playing a game of chicken with euro zone policy makers in order to negotiate a more favorable aid package, with perhaps an extension of duration on its debt, or loosening up of tough austerity measures. In other words, Greece is using the threat of a potential collapse of the euro zone as a means to get concessions from the core euro zone in attempt to quell the rising complaints of the Greek people. Both Greece and the euro zone will be worse off if they choose the scorched earth solution. From a game theory perspective, the question is whether the two sides can come up with a cooperative solution.
Portugal has received a better bailout package than Greece because it is more clear now that the terms given to Greece won’t work. Nevertheless, it is likely that even the terms Portugal have received will not work for Greece as austerity and internal devaluation set out an impossible task for Greece in reducing deficits and growing enough to reduce debt. A default is likely. The question is when, under what terms, and whether it is a unilateral or a managed default. The logic from the last comprehensive post I wrote on the sovereign debt crisis handicapping scenarios is still operative:
Internal devaluation and austerity is not a solution. They are politically unsustainable. It is obvious to most that defaults are coming. For Greece, sovereign default is a foregone conclusion. For Ireland, by dint of its socialisation of bank losses onto taxpayers, sovereign default is a real possibility. In Spain, bank losses have not been socialised and so the sovereign remains relatively healthy. However, Spanish banks have been slow to recognize losses and that means many contingent liabilities keep the market for Spanish government bonds in a state of stress. Portugal is well above the Maastricht 3/60 hurdles and contagion has spread to Belgium, Italy and France. Meanwhile, the public in countries like Slovakia and Finland want no part of future bailouts, while the public in countries like Greece and Spain are fed up with double digit unemployment and the prospect of a decade more.
–The European Sovereign Debt Crisis, Dec 2010
The Germans know that they will take hits. Their aim is to extend this as much as possible while their export led recovery helps to recapitalise their banking system.
Greece has a solvency problem. The Irish banks have a solvency problem that has become the Irish government’s solvency problem. Portugal and Spain have liquidity problems. The austerity and the defaults will be negative for growth in the periphery but will also boomerang to infect the euro zone core. Growth across the euro zone and in the UK will be weak. That’s my take on the situation.
–The Irish stress tests and euro zone options: monetisation, default, or break-up, Mar 2011
For the Germans, delay is good because a default down the line may be more manageable than one in the near future. So the Spiegel article warning of the dire consequences of a Greek withdrawal from the euro zone must be considered with that in mind. Greece is a sideshow, though. Clearly, it is an Irish default which is most worrying to the Germans because the exposure is huge and the possibility of default is too.
As to solutions, I think the one put forward by Gary Evans and Peter Allen is a credible solution to Europe’s debt crisis. And I suspect this is the kind of arrangement we will eventually see. For now, it is ECB monetisation and bailouts that rule the roost. Eventually, though, defaults are coming. Greece will be first in line. A euro zone break up, however, is still an outlier in terms of likely scenarios.
Source: Euro Crisis – Spiegel
P.S. – I think the Greeks are following the (cynical) strategy I laid out for Ireland in early 2009.
Ireland must threaten to leave now if it wants to maximize any EU help it expects to receive, before the scope of other EU banking crises become apparent. Weakness in the financial sector has infected all of the Eurozone members. I have mentioned that Austria has a weak banking system (see posts here and here). But, there is even growing evidence that Germany too has a fragile banking system. To be clear: this is an ‘every nation for itself’ strategy pitting Eurozone members against each other, where those nations savvy enough to request help sooner are likely to benefit at the expense of others. The question is whether the Germans would go along with this. If they do not, tensions will rise and that will change the calculus for Portugal, Italy, Ireland, Greece, and Spain. I don’t have a view on this as yet because the situation is still evolving. However, I lean toward believing the Eurozone will remain intact even while individual nations or banking systems collapse.
As events occur in Eurozone banking, I will keep you abreast on developments.
The Irish missed their chance to do this before their banking system completely collapsed. Now defaulting on bank debt is their best hope to prevent the ravages of austerity. It’s two years late but the Greeks could be reaching for the nuclear option – withdrawal from the euro zone. Let’s see what happens.