Greece—What matters and What does Not

Dealing with incorrect facts leads to incorrect conclusions

By Mark Grant

The bond market is heading East while the equity markets heads West because they have two totally different focuses at present. I have seen this often enough in my almost four decades on Wall Street and I am always amused when this differentiation takes place. It is really just a reaction to what either market is staring at that causes this phenomenon to take place and, eventually, one market proves to be correct while the other gallops along to catch up. The stock markets seem buoyed by the possibility of the more EU friendly government to win this Sunday’s election and they are taking comfort in the hope for support of the world’s major central banks and the possibility of more easing; a new or redefined QE3. The fixed income people are concentrating on the possibility of a systemic financial shock, the recession in Europe that will affect the United States and the plight of the European banks. In my experience the bond markets generally get it right and get there first and I expect nothing different this time.

Let us calmly consider the facts as we can ferret them out and change our focus to reality and not what we are spoon fed by the Europeans. Greece has a total debt of about $1.3 trillion. This is composed of their sovereign debt, which Europe counts, and then their $90 billion in derivatives, their Federally guaranteed regional debt, their sovereign guaranteed bank and corporate debt, their obligations to the EU and finally their loans at the other central banks. It is just simple addition and not my opinion; I am just counting all of the liabilities while Europe does not. Then if you take their GDP and divide it by their total debt you get a debt to GDP ratio of around 453%. You may claim, and somewhat correctly, there is value in some of their assets which would be an off-set in case of actual default but the problem here is that they are a sovereign nation so how one would lay claim to any Greeks assets would be quite problematical.

In any event the amount of money that Greece owes cannot be paid back. They do not have enough assets, they certainly do not have enough cash flow or revenues and the situation was manipulated by Greece and allowed by the European Union as other factors were more important and overshadowed the burgeoning deficit. So now Greece is stuck and Europe is stuck and it matters very little really who will be elected on Sunday as there is no way out of this trap except continuing cash payments from the other European nations. Because the charity that has been given comes with strings attached there is one group that is more friendly to Europe and one that is less friendly and the reality is that Greece will try to soak up as much money as they can from the EU and when the money is stopped then Greece will default because there is no other choice regardless of anyone’s politics. It is then the default that is the real issue, the only important issue really, because the size of the debt will cause ripples and possibly large waves all across the financial landscape. It will hit the ECB, the banks on the other side of the derivatives contracts, all of the Greek banks who are really in default at present and being carried by Europe as well as the nation and the Greek default will spread the infection in many places that we cannot imagine because so much is hidden and tucked away in the European financial system. There is only one way out of this mess and that is if Europe keeps handing Greece money like one does to some aged aunt that cannot support herself but that is a family decision while Greece requires 16 other family members to support here jointly and the politics in many of these nations, including Germany, is making it difficult for the charade to continue.

The countries in Europe cannot call it charity because various governments would be thrown out of office and so the “loans;” continue. Both pending political winners in Greece want to re-negotiate the loans so that a friendly group or a less friendly group is possibly something at the margin but that would be all. The debt cannot be repaid. Then the calculation is made by Europe as to the potential damage and more money may be offered, any changes in terms will make very little difference, as Greece sinks further into its financial sinkhole. Consequently it will either be debt forgiveness (charity) or Europe refusing to pay any longer and default. The bond markets are getting the joke while the equity markets don’t understand the sentence leading to the punch line and hence the different reactions. Again; it is all a matter of focus.

So the Greek elections come and go and someone takes over or there is no government and new elections are called. In the meantime either Europe hands Greece more money or Greece defaults. It is at the point of default where consequences require central bank action and where even the best made plans may careen out of control because so much information has been hidden and not accounted for so that their consequences were not considered. Dealing with incorrect facts leads to incorrect conclusions and this is my greatest fear at present for all of the financial markets; that the pending default, it will most likely come, will not have been assessed in the manner that was needed because Europe did not allow all of the necessary data to be correctly appreciated.

Greek Defaults

• 366 B.C.
• 1826 (50% of the time since independence Greece has been in defualt)
• 1843
• 1860
• 1894
• 1932

So the most likely scenario is not debt forgiveness, which would cure the problem but is not politically feasibly in many European nations but default and default within the Eurozone initially. Then Greece will be forced to return to the Drachma and devalue and the default will cause bank runs and money flowing into Germany and the United States as the only viable safe haven bets. Central bank intervention will help in the short term but will not cure the longer term solvency issues and the European banks, at 300% larger than their sovereign nations that support them, may well overcome the European Union’s capacity including their ability to print money which will become of less and less value given what supports it. It won’t be Doomsday and it won’t happen overnight but there will be more than enough shocks to wake-up the casual observer.

This is where I think we are heading and I do not think the arrival date is too far off now!