Banks' Scare Tactic: 'Disorderly' Greek Default

Includes: FXE, GREK
by: Avery Goodman

The Institute of International Finance (NYSE:IIF) is a bank-owned and controlled entity that proffers opinions on economic events. It recently published a report which warns against the alleged catastrophic consequences of a overt and honest Greek default. According to the IIF, allowing Greece to default will cause the virtual implosion of the world's banking system.

This type of fear-mongering is not new. In 2008, former Goldman Sachs Chairman and Bush Administration Treasury Secretary Henry Paulson succeeded in frightening the US Congress into passing a $800 billion dollar bailout of banks that later became known as "TARP." He even went so far as to try to get complete discretion over how and to whom the money would be handed out! Congressmen and Senators, being deficient in economic knowledge, after a bit of resistance, were duly frightened out of their wits by threats of martial law and and ended up doing as they were told.

Having been so successful in the past, the banking industry apparently believes that fear mongering is the best policy. The IIF staff report, for example, states the following:

"There would be lower tax revenues resulting from lower global growth. The global growth implications of a disorderly default are, ex ante, hard to quantify. Lehman Brothers was far smaller than Greece and its demise was supposedly well anticipated. It is very hard to be confident about how producers and consumers in the Euro Area and beyond will respond when such an extreme event as a disorderly sovereign default occurs."

Let's try to be nice, and just say that the statement is inaccurate. Lehman Brothers was NOT smaller than Greece. It was one of the world's biggest investment banks, in the middle of a web of tens of trillions of dollars worth of notional derivatives obligations. Far more important, everyone who lived through late 2008 knows that Lehman Brothers was NOT well anticipated. It was a complete surprise to the vast majority of people.

Only one hedge fund operator and some other select people, including your author, expected Lehman Brothers to collapse. An infamous, but well read "big bank analyst," who still makes numerous appearances on CNBC and other media circuses, had a "buy" rating on the company to the very end. Even at the end, rather than predicting its demise, he forecast a scramble by prospective buyers, to merge with Lehman or otherwise purchase it. The market was clueless.

The default of Greece, in contrast, has been anticipated for several years. Rather than listening to those who gain from shifting the cost of their foolishness onto the backs of taxpayers, look at the facts. A Greek default is not some kind of "possible" event that may happen in the future. Greece has already defaulted. Non-payment of 70% of any debt, by any standard, is a default, whether or not creditors are pressured into "agreeing" to it.

The Hellenic Republic has been living on handouts from the EU and other countries through the IMF. It has been bankrupt for several years. Almost everyone expects this covert default to morph into an overt default at some point. The primary difference is that, in covert default, the taxpayers of Europe and, secondarily, those of the USA and the UK (through the IMF) pay the price by higher taxes or currency debasement. In an honest default, the people who took the risk pay the price.

Greece is not the first nation in history to default, and it won't be the last. The world did not end when Argentina defaulted in 2002, or when a myriad of other nations before and after defaulted. Financial asset values will fall for a while. Bankers who foolishly allowed Greece to borrow too much money from their banking institutions will take losses. Some may go bankrupt. Some may be forced out of offices and lucrative jobs, when their respective governments take over their banks. Some bankers will be forced to raise capital by selling assets. Most bankers will suffer reduced or non-existent bonuses this year and next.

But, then, there's the Euro... Would a more honest version of a Greek default result in the breakup of the Euro zone? Not very likely, although it is a possibility. The euro is, after all, an irredeemable fiat currency that is not backed by gold, but is dependent upon debt. The value of the Euro is dependent on the value of the debts held by its central bank and the willingness of foreigners and Europeans to labor in order to earn or pay back Euros.

The ECB has been engaged in a policy of market manipulation involving the buying of sovereign bonds. It will lose a lot of theoretical capital as a result of the loss of confidence that may arise out of falling asset values. It may need to be recapitalized. The ECB will no longer be able to do business with Greece after such losses. Greece will be forced to leave the EMU because banks, in a fiat currency world, must trade with the central bank.

Greece will need to reintroduce some sort of national currency. Currency controls may be needed during the initial phase of drachma reintroduction, in order to slow the sharp decline in the value of the new drachma. But, this won't be catastrophic. Iceland is much smaller and has fewer resources to draw upon. It faced similar problems. Although it did not need to reintroduce a currency, its existing currency came under severe attack and depreciated to about 1/3rd of its value in a matter of days after its major banks collapsed. Yet, the world did not end for Iceland's people, and that country is recovering fast now.

Bankruptcy is never a desirable circumstance. Nor is it fair to stiff a creditor, whether it be an actual person or a bank. But, with only bad choices available, creditors should take the hit rather than taxpayers, and casino-bank derivatives dealers should be forced to pay on credit default obligations. An overt default by the Hellenic Republic will certainly be traumatic, but it is preferable to the covert default now being engineered.

The question is not one of trauma. There will be trauma either way. The question is upon whose back the pain will rest? The problems inherent in an honest Greek default are manageable. Dishonest default simply forces losses upon the innocent. It is time for organizations owned by banking institutions, like the ISDA and IIF, to stop trying to sow fear in the hearts of policy-makers. This tactic, of shifting the costs of bad decision-making onto the population as a whole, is growing old.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.