There Will Never Be A Good Time For Greece To Default

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 |  Includes: SDS, SPY
by: Peter Tchir
I have been a proponent that Greece should default sooner rather than later for a long time. At first most people argued that Greece would never have to default. Now many people argue that Greece should default, but now isn’t a good time. The argument goes that Europe needs time to prepare for the default or the risk of contagion is too high.
My view is that Europe needs to let Greece default. Europe needs to abandon the existing perimeter and fall back to a more defensible position. Europe doesn’t need to collapse, but it does need to retreat to a core, stronger position, where it can dig in its heels and defend itself. Battles are not lost because every soldier is killed, battles are lost when morale gets so low that the soldiers give up and flee for their lives. Wars are won when isolated, broken units are captured or killed. I think Europe has to take the pain now, or risk further pain.
My argument against “waiting for a better time” is that it may never come. Europe has squandered the last year. Europe was in much better shape to deal with a Greek default last year than they are now. Contagion was a concern back then with regard to Ireland and Portugal, now it is a reality. Only the darkest of the doom and gloom crowd believed that contagion could really spread to Spain and Italy, yet now that risk is palpable. Banks were more worried about fighting Dodd-Frank, raising dividends and creating almost record bonus pools, not trying to convince employees that the firm’s are solvent.

Stock Market
5yr Yields
5yr CDS
Country
9/30/10
9/23/11
Chg
9/30/10
9/23/11
Chg
9/30/10
9/23/11
Chg
Germany
6,229
5,196
-17%
1.48%
0.91%
-0.57%
39
108
69
France
3,715
2,810
-24%
1.75%
1.75%
0.00%
79
196
117
Italy
20,505
13,665
-33%
2.82%
4.98%
2.16%
194
518
324
Spain
10,514
7,997
-24%
3.33%
4.43%
1.10%
228
414
186
Portugal
7,508
5,722
-24%
5.23%
14.11%
8.88%
410
1158
748
UK
5,548
5,067
-9%
1.61%
1.32%
-0.29%
66
96
30
USA
1,141
1,136
0%
1.27%
0.87%
-0.40%
49
56
7
Japan
9,369
8,560
-9%
0.27%
0.35%
0.08%
61
142
81
China
22,358
17,668
-21%
67
173
106
Brazil
69,430
53,230
-23%
2.31%
2.68%
0.37%
115
203
88
Click to enlarge

Contagion in many ways has already hit. EU stocks are down over 20% in the past 12 months in most cases. Germany has performed better than the rest, but that is a very large drop. And the market in Europe as a whole is in a bear market. The U.K. with its proximity to Europe, and Japan with the earthquake are also lower, but the U.S. stock market has remained relatively unscathed (despite what you might be reading about how our sell-off is overdone). China and Brazil are experiencing some troubles in their own stock markets. In spite of the hype of the BRIC’s coming to the rescue, they may be too busy taking care of themselves. It is worth noting that the EUR/USD exchange rate was 1.36 on September 30 last year, and is 1.35 now, so it is not all about exchange rates.

The credit story is more bleak and stark. Credit has clearly picked the safe havens, the next Greece, and those in between. Italy and Spain are now trading almost where Portugal was a year ago. How much easier would it have been for Italy to withstand a Greek default when it’s five-year bonds were trading at Bunds + 134 instead of Bunds + 407. CDS has blown out across the board, including the allegedly cash rich China. But there is a “basis” swap element as the CDS trades in a currency different than what the country uses (ie, all eurozone CDS trades in dollars).

It is hard to look at the data and not at the bold steps of letting Greece default, which should've been taken last year when countries were in better shape. It is also clear that the contagion has occurred without a default. Portugal has clearly moved to the plagued group and Italy and Spain are trying to fight it off.
Last September, the eurozone and the U.S. had posted second quarter GDP growth of about 0.9%. This year, both the eurozone and U.S. only had 0.2% growth in the second quarter. At the risk of being ridiculed by proper economists, you cannot guarantee that GDP growth will be even worse or in contraction if we wait any longer for Greece to default.
It also worth pointing out that at the time, the ECB was only an amateur at overpaying for bonds. It has since purchased even more bonds well above the current market price. All that purchasing power would be nice to have now, but it has been spent. They can always spend more, but the ECB would be much stronger if it wasn’t sitting on such a big inventory of losing positions that clearly did little to stem the crisis.
What about the banks? Don’t we need to wait so the banks can be stronger?

Stock Price
5yr CDS
9/30/10
9/23/11
Chg
9/30/10
9/23/11
Chg
Deutsche Bank (NYSE:DB)
40.15
23.17
-42%
105
200
95
SocGen (OTCPK:SCGLF)
42.25
16.65
-61%
125
375
250
Dexia (OTCPK:DXBGY)
3.06
1.31
-57%
700
RBS (NYSE:RBS)
47.21
22.83
-52%
178
394
216
Barclays (NYSE:BCS)
310.75
146.00
-53%
125
244
119
Intesa (OTCPK:ISNPY)
2.23
1.01
-55%
133
459
326
Bank of America (NYSE:BAC)
13.10
6.31
-52%
165
391
226
Morgan Stanley (NYSE:MS)
24.68
13.72
-44%
178
435
257
JP Morgan (NYSE:JPM)
38.06
29.59
-22%
84
153
69
Click to enlarge

It doesn’t take a rocket scientist to see that the banks squandered a year to improve their capital base. BAC wasn’t selling cheap options to Warren Buffett when its stock was at 13. The SocGen CEO wasn’t on TV trying to convince investors that they had no funding or capital problems when his stock was at 42. The banks are even worse off than most of the countries, but why should anyone assume that waiting will make it easier for them to digest a Greek default?

To me, it seems that a lot has already been priced in and that the contagion is occurring whether we want it to or not, so we may as well let Greece default now and figure out how much has already been priced in and how to really stop the contagion from spreading to Italy and Spain and to banks that deserve to be saved. Let’s just admit it is Gangrene and that it has already spread farther than is safe, but it is still better to cut off an arm to save the body. If we keep waiting it may not be possible to save the patient. The patient is getting weaker by the day, and being blind to that is just as big and just as dangerous as letting Greece default now.

Disclosure: I am short SPY.