Wednesday, June 15, 2011

Is Greece fast approaching the point of no return?

The Greek debt crisis highlights the contribution to financial instability caused by national financial regulators having an information monopoly on financial institutions' current asset and liability-level data and why this information monopoly must come to an end.

Without access to this data, market participants do not know if restructuring the Greece debt is a serious problem.

The ECB suggests that through the mechanism of contagion or the interconnectedness of the financial system it is.  If there really is a significant contagion problem, then it is not limited to European banks, but also extends globally.

Three years after the credit crisis began, the ECB has put the question of which banks are solvent and which are not back on the table.  This is a question that ring-fencing retail and investment banking does not answer.  This is a question that higher capital requirements does not answer.  The only way to answer this question is to have the underlying bank asset and liability-level data.

According to an article on MarketWatch, which focused only on the direct and indirect exposure to Greece itself and not to the exposures to the rest of the global financial system that might be negatively impacted by a Greece restructuring,
U.S. banks had total exposure of $41 billion to Greece by the end of 2010, according to the latest figures from the Bank for International Settlements issued June 9. Most of the financial commitments appear to be indirect. 
About 83% is tied to “guarantees” that range from protection for sellers of credit derivative contracts to other obligations owed to third parties. Still the data are murky, according economic consultant Kash Mansori. 
“We don’t know exactly what the form of exposure is,” said Mansori, who authors the Street Light blog. “We can only make educated guesses.” 
He thinks U.S. banks are mostly exposed to Greek’s financial crisis through credit-default swaps, which essentially are insurance contracts. Mansori believes U.S. banks largely sold these deals to European banks, which own bonds issued by Greek banks and the Greek government.
Or is restructuring the Greece debt not a problem at all.  Since Greece's ability to repay its debt has been in doubt for almost two years, financial institutions should have taken the opportunity to adequately reserve for the potential restructuring.  Presumably, the national financial regulators should have insisted upon this if the financial institutions had not done this voluntarily.

When market participants do not know something in a situation like a potential debt restructuring with potentially significant contagion elements, they assume the worst.  By definition, this in turn leads to more market volatility and financial instability.  This financial instability is avoidable if the knowable facts are made available.

In the case of Greece, would the knowable facts show a serious problem or a minor bump in the road?

A Guardian column neatly summarizes the instability caused by the financial market's not having access to all the readily knowable facts.
Greeks rioted , the country's prime minister offered to resign and the yield on Greek two-year sovereign bonds hit 28%. Meanwhile, the Dow Jones industrial average fell 190 points at one stage. Markets are carrying a simple message: we fear politicians and policymakers are losing control of the plot. The long-feared "Lehman moment" – an uncontrolled debt default by Greece, with the impact being felt across the eurozone banking system – suddenly seems a horrible possibility
Investors' worries are understandable. The past month has seen the European Central Bank and eurozone politicians squabble over the design of the next bailout package for Athens. Private sector investors must share some pain, says German finance minister Wolfgang Schäuble, if German taxpayers' money is to be dispatched. Unacceptable, says the ECB, we cannot allow anything that looks like a debt default, it would be too dangerous. 
That squabble over the design of a bailout that wasn't meant to be necessary (Greece was supposed to be borrowing in the market by now, according to last year's plan A) suddenly looks a sideshow. If Greece doesn't have an effective government capable of imposing the austerity measures demanded by its lenders, the game is close to up. 
A unity administration in Athens might allow bailout talks to resume, but by then investors might have zero faith that the next package of loans could succeed where the last one failed. More austerity, even if the Greeks could be coerced into accepting more pay cuts and more state sell-offs, might simply damage the economy further. 
Default, then, seems to be looming one way or another. The best policy would be to try control the damage by ensuring the impact of the rest of the eurozone banking system is as soft as possible. That assumes, of course, that damage-control is still an option. The point of no return is fast approaching.

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