The Real Cost of a Greek Default
Oct 4th 2011 2:15PM
Updated Oct 4th 2011 2:24PM
Rome wasn't built in a day and apparently Greece can't collapse in a timely manner.
Dominating the headlines every day, Greece continues to tick closer to at least a partial default on its debt and the panic surrounding its potential default is crippling global stock markets.
Greek five-year credit default swaps, which measure the likelihood that Greece will default on its debt obligations within the next five years, crossed 6,750 basis points last week. This implies an almost certain chance of default. Credit default swaps are traded over the counter, with very little liquidity, and dabbled in only by large investment firms. And yet, nearly all of them are implying that a Greek default is a foregone conclusion.
Therefore, rather than going against the grain, which I often advocate, it's time we face the fact that Greece is going to default. Instead of worrying about the when, let's concern ourselves with the true cost of a Greek default.
The tangible costs
First, there are the up-front and clear costs of a Greek default; I like to call them tangible costs. Although it's incredibly unlikely that Greece will declare a full-fledged bankruptcy, it's quite plausible that it may default on up to half of its 340 billion euros in sovereign debt.
One thing to remember about this debt is that it's highly concentrated. Outside of Greek banks like National Bank of Greece (NYS: NBG) , only a handful of European banks own a meaningful amount of Greek debt, with the top 40 holders owning 74% of all outstanding debt. Do note there are some big names on this list:
Greek Debt Exposure in Billions of Euro
Total Assets as of 12/31/10
|Deutsche Bank (NYS: DB)||1.6||1,905.60|
|ING (NYS: ING)||1.4||1,242.80|
|RBS (NYS: RBS)||1.1||1,453.60|
Source: Barclays Capital, Morningstar.
Also note just how miniscule these debt writedowns would be in relation to the total assets of each bank based on last year's year-end figures. I'm not saying shareholders of BNP Paribas or Deutsche Bank wouldn't suffer losses from a default, but these banks are capitalized to the extent that a Greek default has almost been built into their corporate strategy.
Now let's take a look at the intangible costs of a Greek default.
Possibly the biggest question mark surrounding an orderly or chaotic default of Greece revolves around those aforementioned pesky credit default swaps. Because CDS are traded over the counter, there's no good way to measure the real value tied up in them. Most analyst estimates currently range from as low as 3.5 billion euros to as high as 55.4 billion. With the actual numbers likely falling somewhere in between, these figures don't represent a death knell for most European banks.
Many focus their concern on the ability of Ireland's and Portugal's financial systems to absorb the shock of a Greek default.
Based on the results of a stress test conducted in late March, which called for 34 billion euros in additional capital, and the 64 billion euros the Irish government already injected, it seems likely that Ireland's government will remain more than willing to inject capital into the financial system. Add to this the fact that the Irish government forced the nationalization of Ireland's two largest banks -- Allied Irish Banks, which will soon be merged with EBS, and Bank of Ireland (NYS: IRE) -- and I believe you have a recipe for an ugly survival. Please note I said survival, not success.
The big question mark here is little ol' Portugal. While not exactly on sound footing, all hope may not be lost. Although Portugal's soaring lending rates have cut it off from the remainder of Europe, its banks, with the assistance of 12 billion euros from the European Union and the offer of higher interest rates to customers, have witnessed 10 consecutive months of increasing deposits, according to Bank of Portugal. Don't fall over, but private deposits are now at nearly 127 billion euros -- a record high. Things may not be as bad as once predicted for Portuguese banks.
Clearly, there are other intangibles that can't be quantified, like panic and volatility. The cost of Lehman Brothers in 2008 wasn't so much the bankruptcy itself as it was the shock that something so representative of big business could go under. But we also need to remember that the stock market rebounded with amazing vigor off of those lows once the dust settled. We can't control the emotions of others, but we can remember that sound minds do eventually prevail.
The bottom line
Although I know this will be highly controversial, I'm calling a Greek default largely negligible on the world economy. Bank writedowns will occur, but it's nothing they won't be able to survive. In fact, Bank of America (NYS: BAC) recently took a bigger writedown to settle lawsuits relating to mortgage-backed securities originating from its Countrywide Financial unit than nearly any European bank would have to take based on Greek debt writedowns. As long as Italy and Spain can avoid an Irish- or Portuguese-styled financial collapse, I don't see the worldwide economy plunging into recession. So without further ado, I say, with a heavy heart and sound logic, "Greece, hurry up and default already!"
Have you changed your investing strategy because of a potential debt default by Greece? Share your thoughts in the comments below and sound off on whether I'm nuts, right on, or perhaps a little bit of both.
At the time this article was published Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. He sometimes believes failure is the only option. You can follow him on CAPS under the screen name TMFUltraLong. The Motley Fool owns shares of National Bank of Greece and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that will always bail you out.
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