By Christina J. Kostopoulou
We had to add “reprofile” into our dictionaries since the word default may trigger all sorts of credit default swaps. The truth though remains: Greece is about to default no matter how they call it, raising concerns that Spain and Portugal will soon follow. European officials have been saying that they will hold the Euro zone together no matter what and they not going to “boot” Greece out, or Portugal, if it comes to that, but it remains to be seen what we going to say in a year from now and weather Greece is going to be out or not. It’s obvious that Europeans don’t have a real game plan; they rather improvise as the game goes along.
Euro was always been a political currency, a political union, not an economic and if we look closer to what major European politicians have said is that eventually Greece, Portugal and other countries that face problems may have to give up some of their sovereignty so that Brussels steps in and take control. The question of course is how this is going to play out with Greece’s and Portugal’s voters. Given some of the protests we have seen so far, we can imagine the social revolt this would arise.
If Greece defaults all Greek bank dept is immediately zero. The Greek government will have to nationalize every Greek bank. They are not going to allow anybody to take out deposits in Euros but only in Drachmas. That’s at least a 50% haircut. If Greece defaults on its dept, what’s the point of keeping the dept? Nobody is going to lend Greece any money so it might as well default on all of it, or in a big portion of it so that is more manageable. European banks, but Finish and German in particular, will have to write the dept down, which means that the European Central Bank will also have to write the dept down. Now the ECB may be forced to print more money, otherwise every Euro zone country will have to contribute money to the ECB to recapitalize the bank.
If Greece was in isolation Europe would have simply thrown the country out of the Euro zone. The problem of Greece though is contagious and it seems that it doesn’t even stop in Europe. American banks have written a lot of credit default swaps to their banks, have them on their books at zero because they’ll buy a swap here, they’ll sell a swap there, creating a “balance.” Only that this balance is real as long as these counterparties are good, otherwise banks are out of balance.
Just like the subprime crisis that started in California and eventually expanded in all of the United States and the rest of the world, the European crisis will also be contagious and have a significant impact beyond its borders.
