Tag Archives: Greece

Euro Leaders Ready For Another Vacation.

Europe is on the brink again. The region’s debt crisis flared today, as fears intensified that Spain would be next in line for a government bailout.

 

A recession is deepening in Spain, the fourth-largest economy that uses the euro currency, and a growing number of its regional governments are seeking financial lifelines to make ends meet. The interest rate on Spanish government bonds soared in a sign of waning market confidence in the country’s ability to pay off its debts.

 The prospect of bailing out Spain is worrisome for Europe because the potential cost far exceeds what’s available in existing emergency funds. Financial markets are also growing uneasy about Italy, another major European economy with large debts and a feeble economy.

Stocks today,  fell sharply across Europe and around the world. The euro slipped just below $1.21 against the dollar, its lowest reading since June 2010. The interest rate on its 10-year bond hit 7.56 percent in the morning, its highest level since Spain joined the euro in 1999.

Spain’s central bank said today that the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as a growing number of regional governments ask federal authorities for assistance. The eastern region of Valencia revealed Friday it would need a bailout from the central Madrid government. Over the weekend, the southern region of Murcia said it may also need help.

Spain has already required an emergency loan package of up to €100 billion ($121 billion) to bail out its banks. But that aid hasn’t quelled markets because the government is ultimately liable to repay the money. It had been hoped that responsibility for repayments would shift from the government to the banks. But that shift is a long way off — a pan-European banking authority would have to be created first and that could be years away.

Yet it is far more than Spain’s struggle that has unnerved markets.

Greece is still struggling with a mountain of debt and international creditors will visit the country tomorrow to check on the country’s attempts to reform its economy. There is concern that officials from the European Commission, European Central Bank and the International Monetary Fund will find that Greece is not living up to the terms of its bailouts and could withhold future funds.

Italy has also been caught up in fears that it may be pushed into asking for aid. Italy’s economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of €1.9 trillion ($2.32 trillion) — the biggest in the Eurozone after Greece. Interest rates on Italy’s government bonds rose steeply Monday while its stock market dropped 2.76 percent.

The collapse in stock prices in Italy and Spain prompted regulators to introduce temporary bans on short-selling — a practice where traders sell stocks they don’t already own in the hope they can make a profit if the stock falls in price.

Pascal Lamy, director of the World Trade Organization, said after a meeting with French President Francois Holland that the situation in Europe is ‘‘difficult, very difficult, very difficult, very difficult.’’

Ireland, Greece and Portugal have already taken bailout loans after they could no longer afford to borrow on bond markets. Yet those countries are tiny compared to Italy and Spain, the third- and fourth-largest economies in the Eurozone. Analysts say a full bailout for both could strain the other Eurozone countries’ financial resources.

Spain has already received a commitment of up to €100 billion from other Eurozone countries to bail out its banks, which suffered heavy losses from bad real estate loans. Eurozone finance ministers signed off on the aid Friday and said €30 billion would be made available right away. But that incremental step cuts little ice with investors. If Spain’s borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue.

 ‘‘Events since Friday have been a clear wake-up call to anyone who thought that the Spanish bank rescue package had bought a calm summer for the euro crisis,’’ analyst Carsten Brzeski said.

The Eurozone’s bailout fund, the European Stability Mechanism, has only €500 billion in lending power, with €100 billion potentially committed to Greece. Italy and Spain together have debt burdens of around €2.5 trillion. And the ESM hasn’t yet been ratified by member states plus Eurozone governments have made it clear they won’t put more money into the pot.

 

That once again pushes the European Central Bank into the frontline against the crisis.

On Saturday, Spain’s Foreign Minister José Manuel García Margallo pleaded for help, saying that only the European Central Bank could halt the panic. But the ECB has shown little willingness to restart its program to purchase the government bonds of financially troubled countries. The central bank has already bought more than €200 billion in bonds since May 2010, with little lasting impact on the crisis.

The central bank has also cut its benchmark interest rates to a record low of 0.75 percent in the hope of kick-starting lending. Yet many economists question how much stimulus this provides as the rates are already very low — and no one wants to borrow anyway.

There has been speculation the ECB could eventually have to follow the Bank of England and the U.S. Federal Reserve and embark on a program of ‘‘quantitative easing’’ — buying up financial assets across the Eurozone to increase the supply of money. That could assist governments by driving down borrowing costs as well.

But so-called QE is fraught with potential legal trouble for the ECB — a European treaty forbids it from helping governments borrow.

In the case of Greece, the country is dependent on foreign bailout loans to pay its bills. A cutoff of aid over its inability to meet the loan conditions would leave it without any source of financing — and could push it to exit the euro so it can print its own money to cover its debts. Really?

 

Germany’s economy minister, Phillip Roesler, said the prospect of Greece leaving the euro was now so familiar it had ‘‘lost its horror’’ and that he was skeptical Athens would meet conditions for continuing rescue money.

The deteriorating situation follows a summit June 28-29 that many hoped would convince markets political leaders were getting a handle on things. The summit agreed on easier access to bailout money and to set up a single banking regulator that could take the burden of bank bailouts off national governments. Yet many of those changes will take months or years to introduce — and there has been no increase in bailout money.

It is an echo of a similar summit in July 2011, when leaders agreed on a second bailout and debt reduction for Greece, only to see borrowing costs spike dramatically as leaders headed off for August vacations.

Stephen Lewis, chief economist at Monument Securites Ltd, said that ‘‘events are following a pattern often repeated in the course of the Eurozone’s troubles, in which the powers-that-be hail progress only to see confidence, almost instantaneously, plumb fresh depths.’’

Must be time for another vacation, I guess.


Elite Financiers Speak. No One Listens.

If anyone thinks for one minute that there isn’t a private competition among the elite financiers and investment bankers, about who can speak in the most arcane, cultivated, scholarly and lettered style, you haven’t been listening to Goldman-Sax bankers lately:

Goldman’s Themos Fiotakis and Huw Pill, doing their best Bernanke and Greenspan imitations, made the following comments yesterday about the Greek election:

“Overall, Greece will remain a source of uncertainty due to its macro-dynamics. The country is undergoing extreme economic pressures that are likely above and beyond austerity; prolonged uncertainty have led to a multi-year suppression in confidence and a collapse in credit growth, which has helped compressed the private sector, create supply shortages and has contributed to the lack of investment or privatization efforts, higher structural unemployment and persistent inflation currently observed. Unless this uncertainty of tail events is lifted over Greece, moderate solutions will be prone to marginalization, while extreme and populist views could become ever so prevalent.”

Let me translate:

Greece is screwed. Their economy is worse than any austerity measures can fix. Greeks have no confidence. Investors have no confidence. There is no credit available to Greece. Businesses are failing because they can’t borrow money. Because businesses are failing, there are shortages. Because no one has confidence, no one will lend any money. Unemployment is really bad and getting worse, because there are no jobs. Money is worth nothing, so things aren’t really worth what they cost. All of these conditions result from poor fiscal and political leadership and corrupt banks. If no one can fix these conditions quickly, austerity (meaning going without) will not work. If it continues or gets worse, extremists and fascists could take over the government. The end.

It doesn’t surprise me that when people are exposed to that kind of Sax-speak, they tune out. I had to read that first paragraph like, five times before I understood what they were saying. Bernanke, while an improvement over Greenspan, talks like this all the time. No wonder Congress has no idea what’s going on. And, God forbid any of them from whispering to the next guy with a “Huh?” These guys don’t roll out of bed really smart to begin with, so we should not be amazed, I guess.

I wonder whether the G-Sax boys will be as eloquent and arcane when they try to describe the financial disaster after it hits next year, or will they simply say, “Oh. Holy Shit!”

No. I forgot. They will all be in St. Barts.


Greece Is Lost, And So Is Europe.

There was much hoopla and relief on Wall Street and in European markets today as it appeared that Greece got some religion and voted a conservative party in to power.

A party who has contended that they would support the austerity requirements of the latest round of bailouts and keep Greece in the Union. So, to many investors, the European financial crisis appeared to have been abated for at least the time being, and maybe everything will turn out alright after all.

Here is the truth. Greece will be forced to return to the drachma and devalue, and the default will cause bank runs and money flowing into Germany and the United States as the only viable safe haven bets.  It doesn’t matter which party wins. Greece will default because there is no other choice regardless of anyone’s politics.

It will hit the European Central Bank, the banks on the other side of the derivatives contracts, all of the Greek banks who are really in default at present and being carried by Europe as well as the nation, and the Greek default will spread the infection in many places that we cannot imagine because so much is hidden and tucked away in the European financial system.

Not unlike, I suppose, Nouriel Roubini, the New York University economist, who said the subprime-debt sky was falling for a long time before it fell, I have been hammering this message home since early January.

Greece cannot afford to pay off their regional debt, and various schemes to avoid the bad guys from taking over will not work nor will the attempt to roll the problem over to the rest of Europe by Germany succeed.

One thing is for sure. The Germans will not allow their cost of funding to rise or their standard of living to decline to help the nations that have gotten themselves in trouble.

As a result, Europe is headed for a bad recession with lots of shocks to the system, and it will happen in the next four months unless there is debt forgiveness, or Europe keeps handing them money like they are a ward of the state. Neither is likely to happen.


Grexit Day!

So, the burning question of the day is who will prevail in Athens?

As Greek voters prepare to the go to the polls on Sunday and central banks around the world prepare to enter crisis mode if far left-wing candidate Alexis Tsipras wins and reneges on the country’s bailout package, thus threatening euro zone solidarity, the Greek economy may slip into something resembling medieval Europe‘s Dark Ages.

All of the money managers in the U.S. and around the globe will have a busy afternoon and evening watching and waiting and finally executing their market calls. BlackBerries and iPhones will be at the ready during Father’s Day barbecues. Most predict a future for the Euro, though admittedly fraught with weakness and instability.

In recent days, international companies have been divesting their Greek branches. French supermarket giant Carrefour SA  sold its Greek branch to its local partner at a loss, Coca Cola’s Greek operations were downgraded by Moody’s Investors Service, and various import-export insurance companies have stopped covering transactions with Greek companies.

In addition, Greece risks blackouts as Russian gas giant Gazprom has said it will cut the country off if it does not pay its bills by June 22 

While international companies have withdrawn from Greece, the Greeks themselves have stopped buying everything from clothing to medicine.

The only things that have been selling well recently have been staple foods like pasta and canned goods, which have been flying off the shelves. Greeks are stocking up on non-perishable food in panic-buying mode as they prepare for shadowy worst-case-scenarios following the election. A quiet rush on banks has been occurring, with $1 billion in deposits leaving Greek banks each day for some time.

As for the euro itself, it may not really matter much, at least in the medium term, as most money managers are betting that the euro, the currency of 17 nations from the Baltic to the Mediterranean, will eventually weaken, whatever the outcome on Sunday.

“The hundred billion bought us two hours of relief, and then interest rates began to go up again and markets began to zoom in on Italy,” says one money manager, referring to last weekend’s 100 billion euro bailout for Spanish banks. “It has become a systemic issue. Until we see a lasting resolution of those doubts, we feel the euro will remain under pressure.”

If the left-wing parties win in Greece and back away from austerity, prompting a default or a disorderly exit from the euro, “we would expect the euro to drop like a stone,” says another money manager. “The consequences would be dramatic.” The currency could sink to parity with the dollar, he says.

The larger point is that whatever happens in Athens, doubts about Spain and Italy will only continue to grow. Those nations’ debt loads are large, and both are increasingly seen as unable to make the kind of changes that will persuade investors to keep buying their debt.

The ultimate answer is for European governments, led by Germany, to agree on concrete and credible steps toward greater fiscal and political integration, including the issuance of broader euro zone debt. That would eventually allow Spain and Italy to borrow what they need with Continent wide backing. In addition, leaders should come up with a euro zone wide bank guarantee to avert full-scale bank runs in shaky countries.

Ultimately, the market will force policy makers’ hands. But with 17 parties sitting at the table, the decisions are glacial. The markets move in a rapid-fire fashion. The stakes are increasing every day. 


You Can Run, But You Can’t Hide.

Europe is desperately working to prop up Spain’s wobbling banks, but the European leaders still face a problem that plagues the Continent’s increasingly vulnerable financial institutions; an addiction to borrowed money that provides day-to-day survival financing.

 

Analysts are now saying that one of France’s biggest banks, Crédit Agricole, could face heavy losses in their lending exposure to Greece.

Italy, whose fragile economy is even bigger than Spain’s and whose banks also rely heavily on borrowed money to get by, is in serious trouble as well. In Spain’s case, the flight of foreign money to safer harbors, combined with a portfolio of real estate loans that has deteriorated along with the economy, led to the collapse of the mortgage lender, Bankia. It was their failure that set off the current contagion.

“I think you are lying.”

Europe claims that this latest bailout — worth up to 100 billion euros that will be distributed to Spain’s weakest banks via the government in the form of loans, adding to their long-term debt — can resolve the problem. I think they are either lying or in denial, or both. Heavy emphasis on the lying part.

Investors and analysts worry that highly indebted banks in other weak countries like Italy might face constraints similar to those of Spain in the months ahead.

Last month, the ratings agency Moody’s Investors Service downgraded the credit standing of 26 Italian banks, including two of the country’s largest, UniCredit and Intesa Sanpaolo. Moody’s warned that Italy’s most recent economic slump was creating more failed loans and making it very difficult for banks to replenish their coffers through short-term borrowing.

Because they have yet to experience a colossal real estate bust, Italian banks have long been viewed as healthier than their bailed-out counterparts in Ireland and Spain. And bankers in Italy were quick to argue in recent days that Italian banks should not be compared with those of Spain.

Italy may not have the mortgage exposure that the Spanish banks have, but as economic activity throughout the region came to a near halt, the worry was that bad loans and a possible flight of deposits from Italy would pose a new threat to banks that already were barely getting by on thin cushions of capital. And Italian banks cannot avoid the stigma of the government’s own staggering debt load. Italy’s national debt is 120 percent of its gross domestic product, second only to Greece among euro zone countries.

Also hanging over Europe’s banks are the losses that will hit them when (not if) Greece leaves the euro currency union, throwing most of their euro-denominated loans into a state of default. Banks in France and Germany would be hurt the most, as they have been longstanding lenders to Greece.

For decades, the loans that European banks made to individuals, corporations and their own spendthrift governments far exceeded the deposits they were able to collect — the money that typically serves as a bank’s main source of ready funds. To plug this funding gap, which analysts estimate to be about 1.3 trillion euros, European banks borrowed heavily from foreign banks and money market funds. That is why European banks have an average loan-to-deposit ratio exceeding 110 percent — meaning that on any given day, they owe more money than they have on hand.

This, as you might have guessed, is not a really good thing for a bank.  


Greeks Work Things Out.

This amazing video shows us how the Greek government discusses their issues and the civilized way they sort out differences. Maybe the rest of Europe should take note.

This footage quickly prompted state prosecutor Eleni Raikou to order the immediate arrest of Ilias Kasidiaris. The 31-year-old, who was elected to the 300-seat Athens parliament in the country’s inconclusive election last month, is the most vocal opponent of suggestions that Chrysi Avgi is a violent organization with a history of attacks on Greece’s most vulnerable and burgeoning population of immigrants.

By early afternoon, the neo-fascist party had refused to condemn the incident despite Dimitris Tsiodras, a spokesman in the interim government, describing it as “an attack against every democratic citizen”.

http://www.guardian.co.uk/world/video/2012/jun/07/greek-golden-dawn-mp-hits-opponent-tv-video

Yeah – you guys keep working things out this way and the future is yours.


Obama Goes All Firefighter.

As much as I would like to write about all of the other crazy things that are going on, the European banking thing is the gift that keeps on giving.

Now of course, the Obama administration is stepping up efforts to push Europe to deal with this debt crisis, so that he won’t have to just 5 months prior to the election. Actually, what he is trying to avoid is dealing with the pressures on the US banking system as they build to a crescendo more like 3 months prior to the election.

If the clowns in the Romney camp had any brains, they would be building a huge media plan focused on “How Obama got us into this mess.”

So, hoping to avoid a similar disaster to 2008, the administration is holding private meetings, urging officials in the 17-nation euro zone to take swifter action to calm markets, reassure depositors about their banks’ health, and prevent some of Europe’s largest countries from suffocating under high borrowing costs and weak economic growth.

They think that the lessons learned from the 2008 financial crisis includes acting quickly and decisively to stabilize the financial system and prevent investor panic.

As an example, the administration wants Europe to use the continent’s rescue fund— now around €700 billion ($866 billion)—to provide assistance to governments struggling with soaring borrowing costs. Allowing the rescue fund to directly recapitalize banks, instead of forcing the struggling governments to borrow first from the rescue fund, would help prevent bank failures and enable the banks to continue lending, which would help support economic growth, the officials believe. Under this approach, the governments wouldn’t have to boost their own debt loads by borrowing from the fund.

How this works, by the way, is that the U.S. yells directly at the International Monetary Fund, in which it is the largest shareholder. The IMF has been urging Europe to use the rescue fund for that purpose, but the idea is opposed by Germany because they rightfully fear they will be left holding a huge bag of defaults.

The administration has also pushed Europe to build a larger rescue fund, or so-called firewall, believing a bigger war chest would ease investors’ concerns about governments beyond long-troubled Greece. But, that won’t work this time as investors are now much more cynical than they were in 2007, and they no longer trust governments to get their bailouts right.

And, to further complicate the situation, (as we have faithfully reported here) risks are rising that the financial turbulence in Spain—Europe’s fourth-largest economy—could deepen even before Greek voters go to the polls in two weeks to decide their fate in the currency union.

On Wednesday, Mr. Obama and leaders from Germany, France and Italy held an hour-long videoconference to discuss the euro-zone crisis, following up on a meeting of the Group of Eight major advanced economies hosted by the White House just one week ago.

These meetings were planned before Spain’s borrowing costs shot up this week. But they underscored the administration’s rising worry about how the euro-zone crisis could drag down the weak U.S. recovery for the third straight spring.

In a Gallup poll released Thursday, 71% of Americans said they are at least somewhat concerned about the effect of the European financial crisis, but only 16% said they understood the danger to the US markets . The data suggested worries could rise as the troubles weighed on U.S. markets and gained more attention in the U.S. Among the 16% of people who said they are paying very close attention to the news about Europe’s financial situation, 95% said they are concerned. Unfortunately, that still means only 15% of the US population is concerned about this very serious and impossibly huge disaster waiting just off-shore.

What those 15% fear is that a cascading crisis across the European banking system, triggered by Spain, or Greece, or another unseen banking revelation, could cross the Atlantic and hit the U.S. financial system. As we said in a prior post, we have a $39 billion KNOWN exposure to the European banks. Almost any result imaginable will translate into less business investment and hiring and less bank lending, triggering yet another, and deeper recession.

I love him, but this one will belong exclusively to Obama. Better act NOW.


A Run On Greek Banks. What’s Next?

Last Wednesday, a senior judge was sworn in to act as a caretaker for the Greek government for 30 days while the country figures out what to do next.

Council of State head Panagiotis Pikrammenos, 67, was appointed to head Greece‘s caretaker government for a month.

He has no mandate to make any binding commitments and is just keeping the throne warm until the new election, which is scheduled for June 17. The craziness has caused major international creditors and Greeks themselves to make a run on banks, withdrawing hundreds of millions of Euros from Greek banks since the May 6 election.

About €700 million ($898 million) in deposits have left Greek banks since May 7, the day after the election, President Karolos Papoulias told party leaders after being briefed by central bank governor George Provopoulos. “The situation in the banks is very difficult,” Papoulias said according to a transcript of the meeting’s minutes released Tuesday night. “Mr. Provopoulos told me that of course there is no panic, but there is great fear which could turn into panic.”

It’s not like people are standing in lines at banks in Athens, but Greeks have been gradually withdrawing their savings over the past two years as the country’s financial crisis deepened, and either sending the money abroad or keeping it in their mattresses.

The May 6 election made it clear that the majority of Greeks refuse any and all austerity deals and would rather exit the Eurozone and revert to the Drachma.

Greece is being kept afloat by bailout loans from other Eurozone countries and the International Monetary Fund, and losing them would lead to state coffers running out of money, including reserves for pensions, health care and salaries. No one knows how the June elections will affect the payment of these obligations. Try to imagine being in that situation.

The Germans are hoping beyond hope that cooler heads prevail in June, but the evidence seems to be mounting that the left has most of the Greek voter sentiment, and all of the economic analysts’ reports encouraging Greece to exit the Euro is not helping. Germany and the rest of Europe will be caught holding a heavy bag and 50% of the unemployed and over-educated Greek youth will be on their way to England or Germany seeking jobs and welfare.

The stage is clearly set for a default and a disorderly exit and return to the Drachma. Then, the road may be cleared for a return to economic stability and growth, but the resulting government will definitely have a mandate to implement a socialist agenda.

Investors will undoubtedly conclude that Italy, Spain, Portugal and Ireland will follow Greece’s lead (why not?) and should begin a rapid and massive withdrawal of deposits from European banks.  Otherwise known as a bank run. What will the U.S. banks do in response, or in anticipation of the inevitable?

Stay tuned. It WILL be entertaining.


European Bank Run Has Started!

In the last 7 days, searches for the phrase “bank run” on Google hit an all-time high, surpassing even the first days following the collapse of Lehman Brothers in 2008.

The analysts’ conclusion is that a bank run is under way in Europe.

The fear of bank runs is deeply ingrained in all economists who know anything about the genesis of the Great Depression in the United States in the early 1930s. Then, the failure of the Bank of United States in December 1930 led to multiple bank runs across the country. Bank failures in the following two years wiped out personal savings and greatly exacerbated the collapse of demand in the economy.

The classic account of the crisis, by Milton Friedman and Anna Schwartz, concluded that the collapse was largely the fault of the Federal Reserve, which failed to provide enough liquidity to keep the banks functioning and thus end the panic.

On Monday, Gavyn Davies, who chairs Fulcrum Asset Management, and is an adviser to the British government, wrote in the Financial Times: “A bank run is now happening within the Eurozone. So far, it has been relatively slow and prolonged, but it is a run nonetheless. And last week, it showed signs of accelerating sharply, in a way which demands an urgent response from policy-makers.”

On Tuesday, a report from Citigroup analyst Matt King who took Greece, Ireland, and Portugal’s documented withdrawal rates and applied them to Spain and Italy, said, In Greece, Ireland, and Portugal, foreign deposits have fallen by an average of 52 percent, and foreign government bond holdings by an average of 33 percent, from their peaks.” Further, he said, “The same move in Spain and Italy, taking into account the fall that has taken place already, would imply a further $272.17 billion and $270.9 billion in capital flight respectively, skewed towards deposits in the case of Spain, and towards government bonds in the case of Italy….Economic deterioration, ratings downgrades and especially a Greek exit would almost certainly, significantly accelerate the timescale and increase the amounts of these outflows.”

Wednesday saw the release of a report from Nomura analysts showing that the exodus of funds wasn’t limited to banks and had been increasing since March: Portfolio investments saw a net outflow of $44.58 billion (compared with February net inflows of $24.2 billion). The main reason behind the negative overall portfolio flows was the activity of Eurozone investors, who bought $76.43 billion of foreign assets, mainly bonds and money market instruments. This is the largest foreign investments in almost 1.5 years.

There was further proof of the capital racing out of most of the EU on Thursday as the Financial Times reported: Some of Europe’s biggest fund managers have confirmed they are dumping euro assets amid rising fears over a possible Greek exit from the Eurozone and single currency turmoil.

And, Friday’s news of Bankia, Spain’s 4th largest bank, suspending its stock and Moody’s downgrade of some Nordic banks which many had assumed safe has only added fuel to the fire. Get ready, folks. If you haven’t already, sell those bank stocks and run  to the nearest exit. 

Because, now, America’s banks are starting to get ready for Mr. Toad’s wild ride! And, it won’t be pretty.


A Crisis of Massive Proportion.

Well, we had the obligatory G-8 meeting at Camp David last weekend,

and appropriate lip service was paid to keeping Greece in the euro zone, but the economists who are watching the continuing financial crisis in Europe are rapidly coming to two conclusions: 1) Greece is likely to abandon the common euro currency now used by 17 European countries. And 2) there will be a damaging domino effect throughout most of Europe.

One of the effects of this abandonment results from the impending Greek revival of its traditional currency, the Drachma. Salaries and prices within Greece would be converted from euros to drachmas, and the drachma would be allowed to depreciate to make the Greek economy more competitive.

The problem comes with debts that are denominated in euros, especially if the lenders are outside of Greece. These lenders would naturally resist being repaid with less valuable drachmas. However, if Greek borrowers have to repay the loans with euros, the debt would become more expensive for them to pay off after the drachma is devalued.

The most likely result therefore, is that debts to non-Greek creditors would become useless after Greece switches to the drachma.

(Shocked face here – I believe we predicted this back in January).

After all of the inevitable lawsuits, defaults, forced reductions in repayment, the lenders end up holding an empty bag and losing big money. Just as in the U.S. banking crisis of 2007-2008, once some banks lose enough money to become troubled, the contagion spreads to other banks, because they are all tethered to one another as co-parties.

The Central Bank and the IMF would step in and try to stabilize the situation, and Germany would take its lumps (and perhaps a few islands) and after a couple of years on the Drachma, Greece stabilizes itself and life goes on. Sounds ugly, but generally benign, right? Unless you happen to be a Greek, that is. But what else might happen?

Well, there is always our friend, the derivative, and it could easily set off a global chain reaction. You know derivatives, right? They are the complex, “synthetic” financial securities, which Warren Buffett famously referred to as “financial weapons of mass destruction.” And which recently caused Jamie Dimon some embarrassment and a $2B loss.

In the case of government bonds, these instruments are known as credit derivatives. They include all sorts of loans secured by bonds as well as incredibly complicated vehicles that amount to insurance policies if the bonds default, like CDS. No one really knows how much of this stuff is sloshing around the international financial system, but the total value for all types of bonds was estimated at more than $50 trillion in 2008 and has continued to grow rapidly since then.

Trouble is, if the bonds underlying these derivatives become questionable, all the derivatives become uncertain too, even if they add up to far more than the value of the bonds themselves. Moreover, some of the synthetic investments based on Greek bonds could be governed by Greek law, some by British law (if anything originated in London) and some by U.S. law (if Wall Street was involved).

What if one legal system accepts the conversion of euro loans into drachmas and another doesn’t? Everything could be thrown into the courts for months. Even worse, if synthetic investments secured by Greek bonds become untrustworthy, why would anyone trust similarly complex investments involving Spanish bonds or Italian bonds?

The result of a meltdown in the world of derivative investments could cause far more chaos than simple bond defaults, because at the very least, it would be almost impossible to figure out who owed how much to whom.

So, let’s say Greece recovers quickly, and Italy, Spain, Ireland and Portugal want out of the euro zone too. There is the very real possibility that Greece abandons the euro and bounces back surprisingly fast. In fact, that is exactly what we urged them to do back in January.

But, our recommendation while good for Greece, would cause another sort of disaster, potentially much, much larger than the one facing the Greeks. Both Argentina and Iceland suffered currency collapses, but after a horrible year or two, they each rebounded and were better off than if they had fought to save a failing currency. Analysts point out that both countries were big exporters of grain, meat or fish and those sales boomed after currencies were devalued.

Greece, in its own way, could profit from a similar recovery — a rebound in tourism. A 30% drop in the exchange rate might make a vacation in Greece the best deal in years. Even for Germans.

Good for Greece, but not so good for Europe and really bad for the U.S.  How could the Italian government convince its people of the need for higher taxes or the Spanish government explain soaring unemployment if Greece were obviously better off outside the euro zone? They couldn’t and wouldn’t even try. In order to remain in office, any politician worth his salt would say, “Hey. Let’s follow Greece’s lead.” Then the entire European Union would likely unravel, with Germany leading the way and with Global financial consequences many times greater than those resulting from Greece alone.

U.S banks are deeply invested in the European outcome and are in the impossible position of needing to hold their positions otherwise risk a banking panic of global proportions. The best they can do now is hope and pray, neither of which has ever been a really good strategy. However, the best you can do now is to sell all your bank stocks and watch the show safely from the sidelines.

And, what a show it is bound to be.