The coming Grexit tragedy is really a European farce

14/12/2014

By John Dizard

Europe, as in the sovereign and systemic risk playground, is becoming interesting again for US speculators. Thanks to Dodd-Frank, that now only means hedge funds and those investing on their personal accounts, not the proprietary desks of the banks. If you went by the headlines, we would have the rise of Greece’s leftwing Syriza coalition to thank for the opportunity, but, in truth, the next year was going to be volatile even without their entertaining policy statements.

What Syriza’s leaders, and, for that matter, many of the eurosceptics do not fully grasp is that a confrontation with a hostile Greek government may be useful for the eurocracy and for some of the member governments. A stormy Greek exit from the euro would not pose a systemic risk to the survival of the euro area now, as it really did in 2011 and 2012.

On the contrary, the “Grexit” moment, which would start with capital controls, accompanied by limits on bank cash withdrawals and funds transfers out of Greece, might even support a further compression in the credit spreads on other peripheral sovereign bonds, as well as peripheral bank funding costs. The mainstream political parties in Portugal, Spain, and Italy could use the pictures of street demos, bank lines and chatter of devalued savings to fend off their populist challengers. Once Greece has been seen to be punished by the German voters, they might even go along with the scale of sovereign bond buying that the European Central Bank has been hoping for.

Also, a Greek crisis would draw away attention from much bigger problems, such as the inability of the French government, or even its opposition, to present a real reform programme, let alone implement it. A Syriza government, or even an unstable non-Syriza government, could distract the market’s attention from Italy’s inescapable debt trap.

From the eurocracy’s point of view, a mini blowout of peripheral sovereign and bank spreads in the early part of next year, before the scheduled Greek government funding crisis in March, would provide an opportunity to make a trap for euro bears. German officials are particularly hostile to Anglo-Saxon speculators, with their perpetual plotting to have high-speed trading of short-selling positions, or whatever it is they do.

The serious macro people see this coming. As one of them puts it, “OK, let’s say you want to short peripheral sovereigns in advance of the Greek crisis. How do you borrow the bonds to sell them short? If you try to do it in any real size, the institution, such as, say a Dutch or French insurance company that has the bonds to lend, will have been discouraged by their regulators from doing (long) term lending.

“If you borrow them short term, you can be caught in a squeeze when the loan is called in. If you try to do it through derivatives, the bank or dealer will have the same problem, or even worse, because they will have another set of regulators overseeing them.”

And those are just the problems with setting up short sales of non-Greek peripheral bonds. Even more care would have to be taken with avoiding execution risk and compliance risk with pre-crisis short positions in Greek government and bank securities. Any Greek government worth its airtime would blame speculators and their co-conspirators for any bad Grexit consequences, and the eurocrats would “help” by sifting through the paper and electronic trails.

Quite apart from the logistical problems with executing a euro-peripheral-sovereign short sale, anyone with a eurozone presence can expect to be the object of attention from the authorities, who will be trying hard to find evidence of wrongdoing. This is an ideological risk, not a legal risk, and one that is hard for Americans to understand.

Too bad, because the coming Greek crisis has been set up quite neatly, whether by coincidence or design. While I would not be the first person to have doubts about the Greek state’s accounting protocols, it does appear to have a primary surplus, for now. There are €22.5bn of state obligations coming due next year, with the most immediate problem being the €2.5bn maturing in March. Most of the restructured state debt only needs to be repaid after 2023.

The Greek banking system has very little dependency on the ECB for its liquidity. The uncollateralised ECB facilities that they have now, about 7.5 per cent of their funding, or €25bn, are supported by Greek government guarantees that are supposed to go away by the beginning of March.

So despite the headlines, Greek government and bank system debts do not pose a systemic risk to the euro area. Unlike, say, those of Italy or Spain. If you are looking for anyone who has an interest in setting off a new Greek crisis, do not search Wall Street or the City of London. Rather, look to Brussels, Frankfurt and the other European capitals where there is a populist threat to be seen off.

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