Greek default? Wall Street says don't risk it
Letting Athens leave the eurozone isn’t worth the risk to a fragile global economy, experts say.
Former U.S. Treasury Secretary Larry Summers said this is like pulling the thread of a sweater: It could tear off or unravel.
NEW YORK — Top executives on Wall Street and senior policymakers in Washington are warning their European counterparts not to let Greece default and leave the eurozone, fearing the market reaction at a time of sluggish growth in the U.S. and instability in the global economy.
Some say they are not as freaked out as they were in 2012 about the prospect of always-in-crisis Greece getting kicked out of the eurozone, which could happen if a deal isn’t reached quickly. Some would even like to let the Greeks go and move on with life.
But then people mention Lehman Brothers. And the Russian default. And even an assassination in Sarajevo in 1914. And theoretical discussion of how better prepared the world is for a Greek exit quickly turns into fevered rumination on how it still might spark global financial Armageddon.
The bottom line: Wall Street and Washington want to keep Greece in the eurozone because no one really knows what might happen otherwise. And with the U.S. economy wobbling again, China slowing and the Middle East a short step from full-blown crisis, adding a Greek wild card to the deck is too scary a thought.
“We are certainly better off than we were when this was happening three or four years ago,” said Larry Summers, the former U.S. Treasury secretary. “But the world vastly underestimated the impact of the Russian default, the subprime crisis and the risk of letting Lehman go. This is like pulling the thread of a sweater. It could tear off with no consequence. Or it could unravel entirely and set off something very big.”
The fear that a Greek default and exit from the eurozone could spark a market panic that might destroy the currency union itself and ripple around the world is also held at the highest levels of the Obama administration. Administration officials mostly share the view of European Commission President Jean-Claude Juncker, who told POLITICO this week that a Greek exit could “lead us to consequences that people don’t know the amplitude about.”
Administration officials are publicly and privately pressing Greece and its European creditors to come up with some kind of deal by the end of the week, though that deadline now appears to be slipping. Such a deal would release $7.6 billion to allow Greece to continue to pay its bills, at least until the next reckoning over the nation’s $273 billion bailout hits this summer.
Treasury Secretary Jack Lew last week warned that if Greece were to leave the eurozone, it would cause severe economic hardship for the nation’s 11 million citizens and could destabilize markets.
“I have said consistently that no one should think that all of the risk of a change like that is predictable in advance,” Lew told Bloomberg Television. “And even if the contagion risk is much less now than it was in 2012 and earlier, it would not be a good thing in a world economy just recovering from a deep recession to have that kind of uncertainty introduced.”
The U.S. has no direct role in talks between Greek officials, led by finance minister Yanis Varoufakis, and creditors from the European Stability Mechanism, the European Central Bank and the International Monetary Fund. But Treasury officials continue to press all sides to come to terms before a finance ministers meeting in Riga, Latvia, on Friday.
Reports Wednesday suggested no deal is likely to emerge before the Friday meeting and that Greece could stumble along until June without defaulting. But if no agreement is reached by then, European lenders could refuse to release any more bailout money to Greece, which could, in turn, quickly run out of cash to pay its bills. Greece this week ordered local governments to start keeping cash with the nation’s central bank, a move reminiscent of the Argentinian collapse in 2002.
If Greece can’t unlock new bailout funds it could lead the nation to default on its loans and set the stage for a Greek exit — or “Grexit” — the widely used portmanteau word for the country leaving the currency union.
A senior Treasury official told POLITICO that he expected a deal ultimately would be reached. He said that the alternative could conceivably set the stage for other nations to leave the common currency. This could then lead to the collapse of the currency itself, deep recession across Europe and days — if not weeks — of volatile market reaction that could damage investor and business confidence enough to derail a U.S. economy that is growing only about 2 percent at best right now.
None of these frightening outcomes are at all certain, the Treasury official said. And it remains quite possible that Greece could leave the euro with relatively little impact. But the uncertainty remains so high that a deal must be reached, said the official, who declined to be quoted directly or identified by name in order to speak freely about highly sensitive talks.
Another senior Washington policymaker said the risk associated with a Greek exit alone was not especially high. But this person added that market events rarely happen in a vacuum and that a Greek exit coupled with a foreign policy problem or a mistake by the U.S. Federal Reserve in interest rate policy could tilt markets and the global economy back toward recession or worse.
“No one thing creates pure panic, but you could easily have two or three viable candidates that could move in parallel with each other — geopolitical or monetary — that could create a very powerful effect,” said the policymaker, who also requested anonymity.
Investors got a taste of just how risky a Greek default and possible euro exit could be last Friday when reports that a deal might not be reached helped spark a global sell-off that at one point saw the Dow Jones Industrial Average down over 300 points. Interest rates on Greek debt also rose to two-year highs.
Rates on other European debt, including the debts of Portugal and Italy, also initially rose before ECB buying kicked in, suggesting that if Greece falls, investors could then start to punish other nations viewed as vulnerable to default. Spiking rates could turn once manageable debt loads into crushing burdens.
Fears over this kind of vicious cycle leave many big Wall Street money managers and executives skeptical of the argument that the world is now prepared for a Greek exit and that such an outcome might actually be preferable to going through these near misses over and over.
These money managers say that if Greece does wind up leaving the eurozone, it will probably not be a “Grexit” at all. That phrase, they say, connotes an orderly process in which the country’s euros are carefully replaced with drachma and nobody panics and pulls all their money out of the bank.
Instead, many Wall Street executives say it’s more likely that a Greek departure would be an accident — now known on Wall Street as a “Graccident” — in which the county is forced out of the eurozone by bank runs and a collapse in investor confidence.
“If a ‘Graccident’ were to occur, it would be very messy,” said Mohamed A. El-Erian, chief economic adviser at global money management firm Allianz. “And the global economy is still too fragile to take a major shock. The good news is that Europe has done a lot to increase its defenses against contagion. But it could still be very dangerous to stumble into an accident.”
In a recent note to clients, UBS analyst Paul Donovan warned of investor complacency over the possibility of a Greek exit. “Investors seem to have embraced the belief that if Greece were to walk away from the euro, it would walk alone with minimum contagion to other countries. This belief is dangerous,” he wrote. “The contagion risk after a possible Greek exit arises if bank depositors elsewhere in the euro area believe that a physical euro note held ‘under the mattress’ at home today is worth more than a euro in a bank — because a euro in a bank might be forcibly converted into a national currency tomorrow.”
Not all Wall Street analysts or executives share this view.
In fact, some argue that the time has come to recognize that Greece, particularly under its leftist Syriza government led by Prime Minister Alexis Tsipras, is never going to enact serious fiscal reforms no matter what it says publicly and will eventually default on its debt.
The case for not caring much about a “Grexit” holds that most of the nation’s debt is now held by other countries rather than banks, making financial system failures less likely. Meanwhile, European economic growth is picking up and should be able to withstand a period of turbulence, this line of thinking holds. And Greece has a tiny economy whose collapse would cause localized pain but register barely a blip around the globe.
Some top executives on Wall Street argue that it would be much worse for creditors to cave in to demands for more lenient terms from Greek’s anti-austerity political leaders. Because that would mean other debtor nations would also soon clamor for relief. Better to rip the bandage off and put an end to the charade that Greece will ever pay back all its loans.
“In 2012, if Greece blew up, it would have posed serious systemic risk,” said one Wall Street chief executive who declined to be identified by name. “But now, the private sector has nowhere near what anyone would dream of calling systemic exposure. In fact, any capitulation by creditors of any significant magnitude would be the real source of systemic risk.”
This executive added that a Greek exit could actually boost global markets because “you kick Greece out and the world realizes this is not a systemic problem and the euro rallies because they just got rid of the weakest link.”
But the more widely held view — in Washington and on Wall Street — is that while Europe has, indeed, built more firewalls and reduced private-sector exposure to Greek debt, the unknown reaction to a “Grexit” is potentially much worse than the annoyingly familiar and increasingly tiresome rounds of angst-ridden talks between Greece and its creditors.
“If Greece leaves, it will never be possible to say again that exit is impossible, and if exit is always possible then you put increasing pressure on the weaker countries,” said Summers. “Of course, it’s also not tenable for the euro area to firmly establish that exit is impossible, or no country will feel any disciplinary pressure. So the matter is quite delicate, and we all have to hope and push for a mutually satisfactory conclusion.”
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