Cliff Wachtel's  Instablog

More On What Could Happen If The Greek Austerity Vote Fails, And Why Greece Will Get Cash Anyway, In The Coming Weeks

In our recent post, WHY WHATEVER HAPPENS IN GREECE IS IRRELEVANT, we dealt briefly with the severity of contagion risks posed by a Greek (or any other PIIGS nation) default, and thus argued that the Troika (EU/ECB/IMF) simply won’t let it happen, regardless of what it takes. Greece will get the cash to stay solvent, pay its bondholders, and avoid the risk of global collapse until banks affected can build up more cash reserves to absorb the losses and governments can complete bank bailout and funding plans so that they will be ready to maintain market faith in their banking systems and thus possibly avoid a collapse like that seen in late 2008-early 2009.

Below we elaborate on what is likely to happen in the event of a default by Greece or any other of the PIIGS block before such plans are in place, just so you understand why the relevant policy makers from Berlin to Washington and even Beijing will do all they can to stop, or more likely, just delay and minimize, what may become history’s greatest global economic collapse.

Once Greece or any other of the PIIGS default in any way, the following will likely happen in quick succession, and markets will begin to price them in at first news of default.

The short version, a massive asset selloff and rush into the safest haven assets, as a vast cloud of uncertainty about which nations and banks are or at real risk of insolvency settles over markets, causing them to panic and plunge in ways similar to that seen in the aftermath of the Lehman Bros. bank collapse.

Those who foolishly claim otherwise because the size or reach of Greek/Portuguese/Irish debt is small enough to be absorbed are completely missing the contagion risk or domino effect that ANY PIIGS default can cause.

Highlights of the ensuing global financial train wreck include:

1. Greek Banks Nationalized or Closed: Greek government bonds form a large portion of their capital. At minimum, that means a credit crunch in areas of Eastern Europe like Bulgaria, where Greek banks are major players. It’s unclear which banks would then be affected by problems that causes. However this is likely to be the least of the problems that follow.

1. Core European, US Banks Hit Hard:

a)       French, German, and UK banks have the largest exposure to the estimated $53 bln in Greek debt held by European banks.

b)       CDS Exposure “Guessing Game”, Global Credit Freeze: US financial institutions are reported to have in total nearly the same exposure to a Greek default as French and German banks combined, from insuring Greek bondholders against default and from holding Greek short term paper in their money market funds. Again, it’s unclear which additional banks would be affected by the hits these would take. What is clear is that unlike the mere uncertainty surrounding EU and US banks could itself be enough to freeze interbank lending and thus global credit. That’s all you need for financial market to nose dive.

c)       Remember, there is no central CDS exchange, and thus it’s impossible to get reliable picture of the extent of exposure these and other derivatives have created, though there are reports that the risks of these as yet unknown and unregulated instruments may be staggering. For example Blogger Reggie Middleton cited World Bank data here claiming JP Morgan alone had notional derivative exposure nearly 6 times that of the entire US GDP.

1. Other PIIGS Become Instant Default Risks: With the assumed EU guarantee against default now discredited,  credit markets will see higher risk in PIIGS bonds and demand higher compensation. At least some the PIIGS will see their bond prices plunge, yields explode higher, and be effectively shut out of credit markets, making their own insolvency only a matter of time.  That of course means:

1. Repeat the above step as once again uncertainty over additional bank and sovereign exposure to these defaults and solvency spreads, deeper credit freezes, etc.

1. The above of course means consumer spending, jobs, and every other growth metric plunges, etc. At best a repeat of late 2008- early 2009, only this time governments and economies are deeper in debt and less capable of responding.