Policy makers are saying that they will not let Greece to default. Does that mean they are not looking at the other side? What if Greece defaults? Will that lead to unprecedented loss to world’s financial system or the small country like Greece, with population less than that of New York, will not have much impact?
Well, the problem is not with the size of the Greek population or Greek economy. The problem lies with intertwined derivatives contract of Greek debt. Better economies of Euro, France and Germany are at risk as their banks have highest exposure to the Greek market. Any default by Greece will be a welcome call for the default by other countries too, most vulnerable are other nations of PIIGS (Portugal, Ireland, Italy, Greece, Spain).
Greece has a population of just over 11 million people. Compare that to the New York City metropolitan area population estimated at 18.9 million. It may seem strange that Greece’s travails might greatly affect the global economy, but the potential repercussions from a Greek default become more significant when considering leverage and derivatives. Data from the International Monetary Fund (IMF) show that German banks are heavily leveraged, holding 32 Euros of loans for every Euro of capital they have on hand. Other banks are leveraged to the hilt as well. Belgian banks are leveraged 30-1, and French banks are leveraged 26-1. Lehman’s leverage at the time of its collapse was 31-1.
Only if, or when, Greece defaults will we know who ultimately has sold insurance against that default. In 2008, it was a surprise to find out that AIG had sold a massive amount of insurance against the downgrade of sub-prime mortgages, and the federal government had to come to the rescue, to the tune of close to $200 billion.
An article by Brand Edmonds on ‘ US is too big to fail ’ says many things about affect of Greek debt on US, here is an extract:
The global macro-investment outlook has proven to be very tricky in 2011, with even the largest and most successful hedge funds suffering large losses so far this year. If Greece defaults and we learn of massive exposure by major American financial institutions, more shocks will be in store.
Since the 2008 crisis, we have seen an implosion of sub-prime and other private debt replaced by an explosion of U.S. government public debt — currently $14+ trillion — and this is coupled with the very real risk that US could default on our debt payments in August if the US politicians continue to play a high stakes game of fiscal chicken and are unable to increase the debt limit.
Still there is lack of transparency on data available on derivatives and exposure by the authorities and they are reluctant not to do much in order to increase the transparency.
As Micheal Hudson writes in his article Whither Greece – Without a national referendum Iceland-style, EU dictates cannot be binding for more. :
My friend David Kelley likes to cite Molly Ivins’ quip: ‘It’s hard to convince people that you are killing them for their own good.’ The EU’s attempt to do this didn’t succeed in Iceland. And like the Icelanders, the Greek protesters have had their fill of neoliberal learned ignorance that austerity, unemployment and shrinking markets are the path to prosperity, not deeper poverty. So we must ask what motivates central banks to promote tunnel-visioned managers who follow the orders and logic of a system that imposes needless suffering and waste – all to pursue the banal obsession that banks must not lose money?
One must conclude that the EU’s new central planners (isn’t that what Hayek said was the Road to Serfdom?) are acting as class warriors by demanding that all losses are to be suffered by economies imposing debt deflation and permitting creditors to grab assets – as if this won’t make the problem worse. This ECB hard line is backed by U.S. Treasury Secretary Geithner, evidently so that U.S. institutions not lose their bets on derivative plays they have written up…