Greece Fire
Grease fires are dangerous because they are hard to put out, burn very hot, and are easily spread. Europe’s Greece fire has been burning for well over a year, despite attempts by the ECB and IMF to put it out. Last week, Greece’s financial crisis intensified as debate continued over efforts intended to avoid the Eurozone’s first sovereign default. This intensification was signaled by a plunge in the value of the debt of peripheral European countries. And it has spread to other nations as seen in last week’s announcement from ratings agency Moody’s that it is putting three of France’s biggest banks on review for a possible downgrade due to their high exposure to Greece’s debt. However, we think the Greece fire is not likely to be all that dangerous to post U.S. investors.
The Next Lehman Brothers?
The Bank for International Settlements collects data from banks around the world and provides data on foreign banks’ lending to the Greek government, Greek banks and the private sector combined. Fortunately, U.S. banks hold an insignificant amount of Greek debt relative to their total assets. However,this is not true for European banks. As of year-end 2010, German lenders are the biggest foreign owners of Greek government bonds with $23 billion in holdings last year. While French banks have less Greek government debt, with holdings of $15 billion, they lead the group of Greek creditors with overall lending that includes companies and individuals amounting to $57
billion. These are not insignificant sums.
The fear among some market participants is that the default or restructuring of Greece’s debt will trigger a series of financial institution defaults and a financial crisis throughout Europe and beyond. This potential path echoes the chain reaction that followed the bankruptcy of Lehman Brothers in September 2008 that led to a global financial crisis. Under current rules, most banks do not have to hold capital against losses on sovereign bonds because they are considered to be very safe. A default,
where the bondholders would suffer a loss on their Greek bonds, may trigger a capital squeeze for some European banks already struggling to meet the new, tougher “Basel III” capital requirements that were enacted to build up a buffer to avoid just such an outcome. This risk increased with rioting and political instability in Athens last week when Greek Prime Minister George Papandreou offered to resign leaving questions as to who may have the authority to agree to the terms of any bailout that may lack popular support. These events prompted Moody’s Investor Services to announce the review of three major French banks for a credit rating downgrade, and Greek bond yields soared as did the cost to insure against a Greek default.
While the exposure to Greece is not that big by itself, by adding the other troubled peripheral European countries debt, namely Portugal and Ireland, on to it the numbers become significant. Although these countries have very different probabilities of default, they all tend to move together. A default for Greece would likely lead to the same for Ireland and Portugal.
In addition, a way that a Greek default could affect U.S. investors is through the impact on money market funds. Many large money market funds around the world hold certificates of deposit, commercial paper, and other short-term obligations of the European banks with exposure to Greek debt. This is raising worries that a Greek default might trigger many money funds to “break the buck,” or fall below $1, as happened in September 2008 after the failure of Lehman Brothers triggered losses on assets held by many money market funds.
