Wednesday, May 25, 2011

Facing The Music

Here we go.....
"I am forced to speak openly," Damanaki was quoted as saying in a statement by the semi-official Athens News Agency. "Either we agree with our lenders to a programme of tough sacrifices ... or we return to the drachma."
Do it.

Here's what happens if they do:

The Drachma would be devalued against the Euro. Sovereign debt denominated in the Euro would be recast into Drachmas, instantly haircutting them by whatever the devaluation is.

The Eurozone folks will scream. No matter; what enforcement mechanism to prevent this do the ECB and Eurozone folks have have? None, other than an armed invasion. And therein lies the solution for Greece - their external debt which has become impossible to pay suddenly becomes payable, as it's cut by 20, 30, even 50% overnight. This is a forced restructuring crammed down the creditor's throats.

Greece is forced to cut spending to match their tax revenues as borrowing will remain prohibitively expensive. This has to happen anyway - everywhere, not just in Greece. Doing that is going to suck. There's no avoiding the fact that it is going to suck nor is what has to happen avoidable on an indefinite forward basis. The sooner Greece runs a primary surplus the sooner the damage stops compounding.

To those who claim this sort of adjustment is "unjust", please square it with what Obama did to GM bondholders, who were forced at government gunpoint to agree to a roughly 70% devaluation. I know, I know, it's a sovereign .vs. a corporation. Or is it, when a firm has been effectively nationalized? Hmmm....

Contrary to the screaming in the media and elsewhere, Greek banks survive this. Their currency is converted; they get "haircut" but only in purchasing power, not numerically (think about it.) On the other hand foreign institutions take it up the ass. French and German banks, in particular, are deeply exposed to this, as is the ECB itself. Is this enough to throw the chessboard to the floor? To calculate that you need to know what the actual leverage ratio is on these institutions and how much actual capital they have to absorb losses. Can you come up with those numbers and defend them? I can't, and I presume the reason I can't is that the "interested parties" want me to be unable to do so. I am therefore forced to assume that material numbers of large French and German banks would detonate if this happened.

The Greek people's standard of living gets hit. Hard. This is unavoidable too. When you make $20,000 and spend another $10k on your credit cards a return to spending less than $20,000 so you can pay down the debt, or defaulting on the accumulated debt, is inevitable. It is better to choose the "when" yourself than to have it chosen for you. This move by Greece would be a choice to elect "now" as the time to do that.

The CDS written against these bonds will trigger, of course. Who's holding that risk and do they have any money? We know the answer from the last time around on the second part - no, they do not have the money. Did any of the regulatory institutions fix this since 2008? We know the answer to that too: No, they did not. Therefore we must assume the money does not exist, the swaps cannot be paid, and much hilarity will immediately ensue.


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