Greece is like the friend who’s always maxing out her credit cards and always has some new plan to deal with the mounting interest, only Greece is a country and most of it’s debt holders are other countries! While this situations is nuanced and no one really knows how it will impact markets long-term, we found a few good backgrounders on what’s happened and why it matters.
But why are financial markets, including those in the U.S., concerned with what happens in Greece? And will the current actions really have an effect?
In order to understand why the world is so focused on the possible debt default of a small economy, it is important to understand the links of the international financial system. Much of the debt Greece has issued is held by European banks. The International Monetary Fund, or IMF, estimates that 65 percent of the outstanding amount of Greek government debt is held by institutions outside of Greece. According to the Bank for International Settlements, or BIS, European banks hold a little over $136 billion in Greek debt, public and private. Breaking that number down, it comes to $84 billion in private debt and $52 billion in government debt. Obviously a default on Greek government bonds would seriously affect banks in Europe.
French banks hold $56 billion of Greek debt, and $15 billion of that is government debt issued by the Greek government. German banks hold $34 billion of the total Greek debt, or nearly 25 percent. This is the reason Germany and France have been leading efforts to develop and maintain aid to the troubled nation. Default or even restructuring of Greek debt would have serious implications for the financial health of many European banks.
Recently, The European Central Bank conducted stress tests of the banks in Europe, and eight banks failed. The stress test consists of assessing how the banks would fare under different economic scenarios, and if the banks become insolvent under these scenarios, they fail the stress test. The fact that eight banks failed the tests, which have been scrutinized for being too lax in the assumptions they make, indicate a very fragile banking system in Europe. If Greece was to default, or even dramatically restructure their debt, this could cause a shock to the European financial system that would not only be felt in Europe, but the U.S., too.
Banks in the U.S. are exposed to European banks and derivatives. Even if a bank in New York City does not hold a bond issued by the Greek government, they would no doubt be adversely affected by a default or restructuring. Given the fact that many banks here are still climbing their way out of the financial crisis, a default in Greece could very easily send shock waves through the international financial system. The system is is still recovering from the 2008 crisis, and further troubles could lead to a wave of failures of banks and other financial institutions.
This is not the first time a default in Europe has led to a crisis abroad, reaching the United States. In 1931, Germany defaulted on their government bonds they had issued to fund their reparation payments for World War I. At the time, banks in New York City were the main lenders to Germany, with over $1 billion dollars in loans active at the time of default. This was a substantial amount of funds at the time. My own research, coauthored with Gary Richardson, finds that no banks in New York City failed or refused account activity to their clients in Germany. Instead, they honored deposit accounts on behalf of foreign clients, restructured their loan payments, and even extended lines of credit to German clients. This created the feeling that banks in the U.S. were not in danger of contagion of the events in Germany. Unfortunately, this time, the banks in New York don’t seem to be in the position to absorb that kind of a crisis, no matter what they are saying publicly.
Here’s another piece from the NYTimes.
The question of how to save Greece, debated for more than five years, is the European Union’s recurring nightmare. After the country’s citizens voted to reject the terms of a new bailout by international creditors, Greece is now veering closer to leaving the 19-nation eurozone and abandoning the shared currency, a move that could destabilize the region and reverberate around the globe.
When borrowers — whether they are countries, companies or individuals — do not pay their debts on time, they are in default. For practical purposes, then, Greece — which on Tuesday failed to make a scheduled debt repayment of about 1.5 billion euros, or $1.7 billion, to the I.M.F. — has defaulted.
The I.M.F., however, does not use term default. It instead places countries that miss their payments in what it calls arrears.
Semantics aside, missing the payment might lead to a situation in which other large Greek debts are classified as being in default.
Since Greece’s debt crisis began in 2010, most international banks and foreign investors have sold their Greek bonds and other holdings, so they are no longer vulnerable to what happens in Greece. (Some private investors who subsequently plowed back into Greek bonds, betting on a comeback, regret that decision.)
Mr. Tsipras had argued that voting no in a referendum on Sunday to harsh austerity measures like pension cuts would strengthen the country’s bargaining power. He has banked on a theory that, without a bailout, Greece leaving the eurozone would be too detrimental to the continent.
As part of the fallout from the referendum, the country’s finance minister, Yanis Varoufakis, abruptly resigned. He had played a central role in rallying votes for a no vote in the referendum, but his resignation appeared to be the first move at conciliation by the government toward the country’s creditors.
If Greece has received billions in bailouts, why is there still a crisis?
The money was supposed to buy Greece time to stabilize its finances and quell market fears that the euro union itself could break up. While it has helped, Greece’s economic problems haven’t gone away. The economy has shrunk by a quarter in five years, and unemployment is above 25 percent.
The bailout money mainly goes toward paying off Greece’s international loans, rather than making its way into the economy. And the government still has a staggering debt load that it cannot begin to pay down unless a recovery takes hold.
How likely is there to be a ‘Grexit’?
At the height of the debt crisis a few years ago, many experts worried that Greece’s problems would spill over to the rest of the world. If Greece defaulted on its debt and exited the eurozone, they argued, it might create global financial shocks bigger than the collapse of Lehman Brothers did.
Now, however, some people believe that if Greece were to leave the currency union, known as a “Grexit,” it wouldn’t be such a catastrophe. Europe has put up safeguards to limit the so-called financial contagion, in an effort to keep the problems from spreading to other countries. Greece, just a tiny part of the eurozone economy, could regain financial autonomy by leaving, these people contend — and the eurozone would actually be better off without a country that seems to constantly need its neighbors’ support.
Here’s a blog post from the WSJ.
More than 61% of Greeks voted “no” in a referendum on whether to accept creditors’ demands, setting the country on a collision course with the rest of the eurozone.
Voters were asked to vote on economic policy demands from creditors including the International Monetary Fund and the European Central Bank.
On Monday morning, Greek finance minister Yanis Varoufakis resigned, saying he had been made aware “of a certain preference by some Eurogroup participants, and assorted ‘partners’, for my… ‘absence’ from its meetings.”
European markets opened lower on Monday but the losses were not as steep as many investors and analysts had feared.
http://blogs.wsj.com/moneybeat/2015/07/06/yanis-varoufakis-in-his-own-words/?mod=trending_now_2
Normally, finance ministers tend to resign through formal letters or somber press conferences. Not so for Yanis Varoufakis, who has resigned as Greece’s finance minister via his blog.
