Deflect and Absorb: Measuring the Greek Afterburn on American Markets

In examining the implication of the Greek debt crisis on the American financial markets, there are several points that continue to go unnoticed. Underneath the veneer of market hysteria reports, with some suggesting that a collapse of the Greek financial structure is proof of the vulnerability of the GSEs, it appears a good time to put everything in perspective. First, take a deep breath. Now, the GSEs are vulnerable, to be sure, so they don’t need help from Greece to collapse, but that is another column. To quote the above report: “There’s a growing sense that the $146bn bailout package arranged by the EU and the IMF will be difficult to implement and that the crisis will spread through Europe to other highly indebted nations such as Spain, Portugal, and Ireland.” To be precise, the exact amount is yet to be decided as at a summit of EU heads of state on May 7, the IMF Executive Board is expected to approve a stand-by bailout of $40bn, more than 30 times the Greek IMF quota. The implication of these recent events brings up market trepidations that Greece lacks the fiscal austerity to fully restore its operations once provided a bailout. This is true in this country as well, but that’s where the similarities end (oh, if only markets reacted rationally). However, this notion of spread contagion is a bit more iffy. For one Spain, Portugal and Ireland were in troubled waters well before things came to a head in Greece. At a risk management conference in London last year, an economist at BNP Paribas said off-the-record, “the only difference between Iceland [where the banking system had recently collapsed] and Ireland is one letter and two years.” Having spent the last eight years covering these markets, I can hold this to be true. Iceland fell amid end-of-the-world calls, though unobtainable containment was eventually reached. So let’s put the International Monetary Fund guidelines for Greece into context. The target of reducing the budget deficit to less than 3% of GDP is deferred by two years to 2014,while the economy is now expected to contract (in real terms) by -4% this year and by a further -2.6% next year before the resumption of modest growth of 1.1% in 2012. Fitch Ratings estimates that the revisions imply that Greek government debt will peak at around 150% of GDP before declining from 2014 onwards. Now, that’s a statistic with chest hair. Especially since these early models of financial discipline project cutting back on public services (read mass lay-offs), Greece’s only true industry after tourism. But this is what really interesting, as all of these calls go up to investigate Greece being sold bad structured products that brought it so completely into debt, is it is easy to forget that years ago Greece was already sending up red flags. Greeks, like Italians have a continental-wide reputation for not filing taxes, as those country’s coffers show. This is certainly an opportunity for the entire country to realize that the world gave a credit card to a college student. “The financial support for Greece provides a window of opportunity for the Greek authorities to implement radical fiscal and structural reform necessary to secure sustainable economic growth and solvency,” said Chris Pryce, Fitch’s lead analyst on Greece. “However, the political challenge of implementing and sustaining such a program should not be under-estimated against the backdrop of a potentially prolonged and deep recession.” So while the credit rating agencies continue to downgrade this and that, when it comes to Greece, and leave things with terminology such as “negative outlook,” consider that Fitch’s current triple-B minus sovereign rating on Greece reflects the current assessment that solvency is not beyond reach. If this entire message is extrapolated to our shores, where non-manufacturing industry makes up a much larger percentage of an economy expecting a slowing rate of growth—but not negative numbers—then the overall impact of Greece seems largely isolated to equities markets. “Based on the run-up in option prices, there’s more news and volatility to come,” said Deutsche Bank analysts. “Money has flowed out of the Euro and into safety, and that puts it squarely in the US Treasury market.” Considering that the trading strategy in March included staying away from US Treasuries, even in such a risk averse environment, the market appears irrevocably entrenched in a search for yield. So as the crisis in Greece only looks to be temporarily fixed—in today’s market something is better than nothing. We just can’t wait around for Greeks to pay their taxes. Jacob Gaffney is editor at and HousingWire Magazine. Write to him.

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