Soon to be front page news again will be Greece and their insolvency. The question will remain (for a time) whether or not they stay in the Eurozone, leave by choice or get “kicked out”. I am not even sure if being forced out is a legal option, we may see.
The latest pieces of news has been a claim that Greece will be funded with a monthly credit card payment of 5 billion euros by Russia …then denied by Russia. The other news was “federal Greece”, after raiding pension plans is now confiscating local reserves for the “good of the nation”. The populace is getting very antsy as demonstrations and violence have begun to erupt.
Let’s look at the second piece of news first as it was most predictable, as was the reaction. Of course “confiscation” of balances were going to occur sooner or later, this was a given and also a given to spread elsewhere. History is strewn with precedent where bankrupt governments scratch and claw at anything they can get their hands on, did anyone not expect this? Greece is mathematically broke and in the same boat as a homeowner who lost a job. They are digging into retirement balances, the credit cards are all maxed out, they have already borrowed from relatives and are in the process of selling their furniture and anything else not nailed down. They are broke, any monies lent to them might as well have been placed on a bonfire for the heat value because they will not be paid back.
Which leads us to the 5 billion euros Russia allegedly will “forward” or lend to Greece. If this is true, it’s another masterful move by Mr. Putin! NATO sanctions will run out within the next 60 days and must be renewed (voted on) in order to be renewed. NATO participants must vote unanimously to renew the sanctions, Mr. Putin may have pulled a page right out of American politics …just buy a vote and go on down the road? I suspected this would happen, if true, even though it buys a little time (maybe a month or two), it does not change the big picture at all. Greece is broke, they cannot nor will they ever pay back what has been borrowed (especially post 2012 debt). They will default one way or the other and sooner rather than later.
So why does tiny Greece matter to anything in the grand scheme. Going back to my last article “The Mother of All Margin Calls” is at the root of it. Greek debt even to this day when everyone knows Greece will not ever make good on their debt, is carried on the books of bank portfolios at 100%. It doesn’t matter that trades are done at less than 50% of par or much less, Greek debt is used as “tier one” capital …and HERE LIES THE PROBLEM!
Let’s look at this from two different angles. First from a “carrying” standpoint and then from “lending” standpoint. They both arrive at the same ugly destination but via different routes. French and German bank portfolios are stocked full with Greek sovereign debt, if they marked these even close to reality the losses will be staggering. Remember, this is “tier one” capital considered as “good as gold”. How will they replace the holes punched into their collateral structure? I would also remind you, The ECB itself hold 100 billion euros worth of Greek debt, how does the issuer of the currency account for a 50% haircut? Or even a complete wipeout? Where will the new capital come from? Remember, “margins” are already razor thin and in some cases under capitalization exists even WITH this fake accounting!
Looking at this from another angle, since the Greek debt is tier one capital, banks can, and already have lent amounts up to ten times value …OFF of the Greek debt! The problem is not just the “writedown” and need to raise new capital, much of what has been lent out and levered off of the Greek debt will need to be “called in”. What does this do to the markets and the real economy? Obviously, forced sales of financial instruments will occur as well as real businesses being closed as their funding structure is called in and pulled out from under them. A death spiral is caused both financially and economically which will not be stopped and will only spread like a wildfire!
There is one more angle to look at and that angle is the derivatives created off of the Greek debt. Looking at credit default swaps, there is no doubt “someone” will have to pay when the “insurance” is claimed. CDS in many instances happens to be 10 times or more the underlying debt itself so these 350 billion euros may very well have insurance outstanding of 3.5 trillion euros. Who has this kind of money to pay up? In many cases (think Deutsche bank and others?), banks actually holding Greek debt in their portfolio are also issuers rather than buyers of CDS, this is called a “Texas hedge” with double or more exposure!
Going full circle, we looked at the Fed’s reverse repo agreements spiking in volume, this can only be explained by the need for “collateral” for the financial system. What will a Greek default do? It will create the need for even more collateral, and LOTS OF IT to keep the façade of solvency intact. Though Greece is not a big player, think of them as a minor repair for the car of the couple who have maxed out all avenues of credit. Even a small hiccup is enough to upset this margined cart because of insufficient capital, Greece fits the description! They are by no means all by themselves, the entire financial system is Greece to one extent or another. Greece is only the canary that will expose and impose margin calls across the globe. I would like to mention one more canary in this coal mine, bookies are no longer taking bets on Greece’s default and exit from the Eurozone …it is now that obvious!