Seeking Alpha
Long/short equity, deep value, special situations, contrarian
Profile| Send Message|
( followers)  

When the Greek problem became apparent around 2010, it was already too late. Spreads were already rising for some time and worries about the Greek economy were already a daily topic of conversation as early as 2008. For some odd reason however, everybody thought nothing would happen, because until that time, nothing indeed had happened.

So when the markets asked a very high yield from Greece, the European Union, the IMF and the ECB teamed up to save the day, in what today is called the troika. Actually it was the first time something like this ever happen. Never before had the world seen such an international consortium of such financial fire power like this.

So this troika looked at the Greek situation and decided that Greece would be able to make it, just as long as it got some help from its friends. So it laid out a plan, whereby Greece would be put on the path to growth and sustainability, as long as it did not default on its debt. So in order for this not to happen, it decided to roll over Greece's debt, until such time that Greece would be able to return to the markets and the troika could get the money back.

So it rolled over about 180 billion euros in Greek debt and gave the market (European banks) a break. The banks got top euro for their bonds, compared with what they would have gotten in the secondary market. But the troika was not worried, for its models told it that Greece would once again be sustainable, and at some point in the future, it would get its money back.

But then a funny thing happened. The models did not work. So it decided that indeed Greek debt was not sustainable and in order for the troika to get its money back, someone had to take a loss. So the troika orchestrated (meaning a lot of political arm-twisting toward the banks) the biggest orderly debt relief program the world had ever seen. About 100 billion euros of debt was wiped clean from Greece's books.

But even after this, there was still a problem. Greece's debt was still about 140% of GDP with no primary surplus in sight. Also something else happened, the projections for the Greek economy were way off. Economic contraction was always 2-3 times higher than what the projected models called for. So year after year, the figures were way off and Greek debt sustainability never happened.

To make a long story short, it finally figured out why the models did not work. I mean, the modules were correct, but no one told that to the Greek economy. See, the Greek economy contracted more than it should have and obviously the sustainability models did not compute. No one for example imagined that the Greek economy would contract by 7% in 2012 alone. Nor did anyone realize that Greece would experience a Great Depression like GDP contraction and unemployment.

So all of a sudden, it woke up to reality and realize that additional debt relief was warranted. The only question was, who will take the lose? The answer is the troika.

As reported by Reuters yesterday, the IMF has had enough and does not want to give any more money to the Greek project. Besides the fact that its budget is stretched, it cannot go against its own bylaws. Those bylaws call for loans to be made only to countries that are deemed solvent and pass debt sustainability tests. How the IFM figured that Greece's debt was sustainable in the first place is a another question, but putting that aside, today it understands that Greek debt is not sustainable. Therefore, it is now pushing for other official Greek creditors to take a haircut.

The problem of course is that Germany is budging. Besides the fact that German elections are near, how are leaders going to explain to their taxpayers that they have to take a loss? But as Wolfgang Schaueble has said and so have I, Germany has more to lose from a euro break-up than anyone else. So what ever happens, no one wants to kick Greece out. Therefore, the official sector will have to take a hit.

However, there are more things to consider here. Just because the official sector has to take a hit, does not mean that private creditors wont take an additional hit also. Remember, there are still about 100 billion euros of Greek debt in the hands of the market. In order for Greece to have a chance at sustainability, it needs at least (bare minimum)100 billion euros in additional write-downs. Who will take this loss is not sure at this time. One thing is for sure, the IMF wont take a loss, for that will create a bad precedent. Therefore, European governments and private creditors will have to foot the bill.

Because Greece is not a big economy, there wont be any implications for the markets if additional debt is written down. A problem will arise when additional economies like Spain, Italy, and Ireland, will need debt relief also. Again, the sector that will lose the most is the banks.

The entire European money center banking complex holds massive amounts of European sovereign debt. And even if it has sold some Italian debt recently, it can't sell all of it. But even if non Italian banks sell 100% of their Italian holdings, we still have to worry about Italian banks, for they are at the other side of the trade.

Like I said in a recent piece, it is no coincidence that the major European banking power houses have lost anywhere from 70% to 95% of their value. The market is way ahead of most of us on this and it is no surprise that Deutsche Bank (NYSE:DB), Commerzbank (OTCPK:CRZBY), Credit Agricole (OTCPK:CRARY), UBS AG (NYSE:UBS) and Credit Suisse Group (NYSE:CS) have gone nowhere all these years.

Silvio Berlusconi said recently that "bailout conditions would lead the Italian economy to collapse." He is absolutely correct. The same applies for Spain and any other country that dares to undertake the draconian style policies that were forced upon Greece.

But what is one to do, since countries are still piling up debt? There is only one thing to do: sovereign debt relief and capital infusions in the banking system.

That will cause massive losses to the shareholders of the European baking complex. As I see it, there is nothing else one can do. If Europe tries to impose Greek style fiscal policies on Italy and Spain, their economies will collapse, as will the banks and the problem will not be solved and the banks will need to be recapitalized anyway.

They said Greece would not be allowed to default, but it did. And those who believed those that said it can not default, paid with massive loses continuing to hold banks. Those who think it will not happen to another European country will also lose as much.

Granted this is a scenario that will play out over the coming years, but it never hurts to have the big picture ahead of time.

For those invested in the European money center banking complex, you have been warned.

Source: Greek 'Official Sector Involvement' And European Sovereign Debt Write-Down Alert