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Greece - The Risk Is Forex

From Zero Hedge (RC Whalen):

Mike Pento pinged me yesterday and asked about US bank exposure to Greece, etc. The short answer is that most US banks don't have any significant external credit exposure to foreign nations or obligors. But the top US banking institutions and corporates do have loans/exposures to Greek entities that will be negatively impacted by an EU withdrawal and, with it, currency devaluation. Think JPM, C, MS, GS, GE among top names that may have such exposures.

In the 1990s, when I was working in Mexico as a consultant and newsletter publisher, that nation was still in the throes of dealing with currency crises and devaluations. The dollar was the currency for business, lending and investing, with the peso a means of exchange only for local transactions. Mexicans in all walks of life knew to immediately move their assets into cash dollars on payday, especially at the end of a presidential term in office.

Nations such as Argentina today are still fighting that same battle in terms of debt and devaluation. And this is the operative model for Greece and the other high debt, higher inflation nations of southern Europe as they exit the EU. When Greece exits the EU, it will lose access to subsidies from the ECB and the global capital markets. The cradle of human civilization will be living on cash with no access to credit or foreign exchange to fund imports besides what is earned from exports. Imports and debt service will compete for limited amounts of foreign exchange.

If you are a foreign bank or corporate with exposure to any Greek obligor, the key question is whether that debt can be serviced in terms of foreign exchange. Whether the obligor can pay in financial terms or not is of concern, but in a post-devaluation Greece, whether the obligor can access foreign exchange to make the payment becomes the gating item.

As the German government ponders how and when to cut-off the Greek central bank from further "foreign exchange" in the form of euro credit from the ECB, this decision augers at least a haircut for lenders with exposure to Greek borrowers. At a minimum, you will probably need to mark down the carry value of the exposure by the percentage currency devaluation after Greece exits.

So say the new drachma is worth 25% of the value of the euro, the dollar or euro loans to Greek public or private obligors would needed to be written down 75%, unless the obligor had sufficient foreign currency assets outside Greece to remain current on debt service. There are some significant Greek obligors with assets outside the country, but it remains to be seen how the evolving radicalization of the political life of the country will affect private obligors.

We will only learn about these currency risk exposures as and when the creditors disclose same to investors. In the meantime, we'll have lots of fun watching media spin their wheels over the game of "find the risk" since we really got no data. But, again, the operative model here is Argentina and 1980s-1990s Mexico, so look for large % losses on any exposures that do exist. But these same positions may also recover value depending on the medium term outcome in Greece. Thus are new markets made.

When the new Greek currency stabilizes, most likely with relatively high interest rates to defend the weak, tiny currency from global capital, investors will have some interesting opportunities. Again, Latin America and Eastern Europe of the 1980s-1990s are key examples. But banks and corporates with exposure in Greece will be on the losing side of this event and in a way we have not needed to think about in many years of artificial boom and now bust. Call it the return of currency risk.