bachagabriel's  Instablog

While the views on whether the Greek exit will happen or not are conflicting, it is clear that the whole European banking system is in need of major support from policy makers. It is well agreed that the greatest impact of a Greece exit would not be the losses related to direct exposure to the Greek market, but the consequences it will have on weaker European sovereigns. The contagion from this event will affect two main factors: funding issues associated with higher yields for riskier European countries, and liquidity issues due to deposit flight from banks. The most critical event that will directly affect the "Grexit" is the Greek election that will take place on June 17th and the most desirable outcome according to analysts would be a managed exit from the EMU. It is believed that Greece will leave the euro zone on January 1st 2013 and will immediately stop paying interest on government debt. In the event of a Greek exit, it will be critical to contain the contagion that poses a very serious threat to the euro zone and to global growth that was amplified with the private sector's involvement in the debt restructuring in March 2012.

The main response should first of all be focused on supporting the banking sector by providing unlimited liquidity in the short-term to counter deposit outflows and second on controlling the cost of capital for other sovereigns such as Spain and Italy. Should a bigger country such as Italy or Spain be hit with similar problems, its impact on the euro zone and on the world would be catastrophic. This should be done using the LTROs and SMPs, lowering rates and extending support to Portugal and Ireland beyond 2013. A final step would be to establish a firewall to deter deposit flight such as implementing a euro-wide deposit insurance.

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