The Fallout Of A Euro Breakup

Includes: ERO, EU, EZU, FXE, IEV
by: Skyler Greene

Since the start of the European crisis, rumors of its demise have been flying around constantly. First came suggestions that Greece would leave the euro, an action which various analysts predicted would either avoid a sovereign debt crisis or cause one. Then came predictions that Germany might leave the euro, an idea that was largely killed after Merkel gave up some concessions at the summit.

But now a key issue has arisen: the idea of taxpayers in one country paying for the mistakes of another country rubs some people the wrong way. Especially German economists:

About 160 academics published a petition Thursday calling on German citizens to put pressure on Chancellor Angela Merkel to block any further moves toward European integration that would make German taxpayers foot the bill for the debts of other euro-zone countries.

This sentiment isn't just limited to Germany. Finland recently stated that they'd "rather leave the euro" than be responsible for paying down other countries' debt:

Finland will not hang itself to the euro at any cost and we are prepared for all scenarios. Collective responsibility for other countries' debt, economics and risks; this is not what we should be prepared for.
- Finnish Finance Minister Jutta Urpilainen

One Ring To Lead Them All

While it has been suggested that having certain countries leave the euro might be beneficial, unilateral decisions by Germany or Finland to leave the euro would be extremely damaging.

Why? It's pretty easy to think through. It would cause a chain reaction. If you let one of the kids at the table get away with not eating their vegetables, pretty soon you're not going to have any kids eating vegetables at all. If I'm, say, Belgium -- or Austria -- or whoever -- look at it from my perspective. If Finland (or Germany) can just skip on out of the euro party, that leaves me stuck with a larger share of the Spain/Italy/Greece debt. I definitely don't want a larger share of that debt, especially not when I can just follow the lead of Finland/Germany and walk away from the table.

One ring of the telephone from Finland, saying "we're leaving," and the entire eurozone could quickly dissolve.

Potential Fallout

When British Deputy Prime Minister Nick Clegg stated that a Greek exit could set off a chain reaction that would be "strongly felt" in Britain's banking sector, he might've been understating it just a bit.

If the euro did indeed collapse, it would cause a lot of problems. If the euro went bye-bye, it would raise significant issues for euro-denominated contracts. The greatest effect would be seen in -- you guessed it -- big US banks like JPMorgan (NYSE:JPM):

[I]n recently released highlights from its so-called living will, JPMorgan Chase & Co. revealed that $50 billion in losses could hypothetically bring down the bank. [...] What are the odds that JPMorgan would lose no more than $50 billion on assets of $4 trillion, much of which is complex derivatives, in a euro-area breakup, an event that would easily be the biggest financial crisis in world history?

The euro is considered to be a failed experiment. Coordinating a regional currency without concurrently coordinating fiscal policy created significant problems, as we've seen. It seems fairly likely that this failed experiment will be ended in one of two ways: either the euro will survive with much stricter central control of fiscal policy, or the euro will dissolve. As described above, a disorderly breakup could create havoc in the global markets.


On the bright side, some analysts (like those at Vanguard) seem to think that any potential euro breakup would occur in an orderly manner. Investors might do well to watch the situation and carefully monitor positions in banks with significant European exposure. While any company with European exposure would be affected, it makes sense to pay more attention to financials than blue chips. (I'm reasonably certain that Coke and toothpaste will continue to be bought in Europe, even if in a different currency.) US financials are back in the risk-on game, thanks to ZIRP, and a potential European dissolution would test just how strong the banks really are.

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