One banking analyst's depressing description of what happens to the European banking system after a disorderly Greek default
This morning, it looks like a deal is on.
Overnight, the putative European banking tax has risen. Yesterday it was €30bn; today it's €50bn This tax will be either accompanied by or substituted for, a bond exchange programme. The bond exchange programme will, 'encourage,' private owners of Greek debt to swap what they've got for new 30 year bonds. And there's another €71bn in bail-out funds from the IMF and other countries in the eurozone.
Is this enough? Hopefully. As European Commission President José Manuel Barroso pointed out yesterday, "the situation is very serious."
However, with the exception of the bank tax, it looks like more of the same.
The notion of a voluntary rollover of bonds has been knocking around for weeks and risks being seen as a default in the eyes of ratings agencies. And the increase in the bailout fund may not be enough. For the fund to put a final end to speculation on the euro's breakup, it would arguably need to cover not only Greece, but Portugal, Ireland, Spain, Italy and Belgium. For this to be the case, Dirk Hoffman- Becking, a senior analyst at Bernstein Research, estimates that the support fund would need to increase by €270bn, not €71bn.
Hoffman-Becking, along with former EU Commissioner Mario Monti and Ambrose Evans Pritchard of the Telegraph, think Eurobonds are the real solution. But Eurobonds are not on the table.
The risks of a Greek default for European banks (and by implication European banking jobs) and European economies are huge. In the event that the latest package is insufficient, Hoffman-Becking helpfully outlines the likely outcome in four stages, which we've summarised below:
'Step 1: Greek Banks Default
With €50bn in holdings of Greek debt and €28bn in equity, a default and
subsequent write-down by 40-50% would wipe out the Greek banks equity base and force their default. Direct fallout among foreign banks should be manageable.
Step 2: Deposit Runs in other Periphery Countries
As depositors in the other countries watch Greek banks failing, they will probably withdraw deposits. If there's a 10% withdrawal across Portugal, Spain, Italy and Belgium, banks in these countries would face a €620bn funding hole.
Step 3: The ECB stops supporting periphery banks and contagion reaches the rest of Europe.
As their funding needs increase, the ECB may decide it cannot accept periphery banks' collateral any more. This would lead to the default of periphery banks and to other European banks writing down their exposures. Liquidity would freeze for all but the best capitalised.
Step 4: The Euro breaks up.
Without support from the ECB or Eurozone countries, periphery countries exit the Eurozone. Arguments among core countries over who is to blame result in a full break-up. German banks suffer heavily as their assets get devalued to new local currencies and their liabilities (of around €200bn) rise as they have to be paid back in Deutschmark.
The return of the Deutschmark strangles German exports. German labour unit costs become uncompetitive and wage moderation resumes, impacting consumption. Germany goes into recession and could end up politically isolated as it's blamed for the crisis.
Source: Bernstein Research
