Greek Fire, Part 33

Things are getting very ugly in Greece, folks, to the point where it's fashionable to openly talk about how bad things could get if the Greek Fire burns down the government of Georges Papandreou.

Beyond the immediate hit to banks, the biggest fear is that of contagion -- a difficult-to-predict chain reaction that could roil markets and make it harder for other indebted countries to cope with their debts, with the result being higher borrowing costs for eurozone countries.

Some even say the end of that road could be one or more of the weakest euro members -- such as Greece -- leaving the shared currency, though the political will to prevent that remains strong.

Some are comparing a Greek default to the collapse of U.S. investment bank Lehman Brothers in September, 2008, which triggered the most severe phase of the world financial crisis, freezing credit markets and leading to a slump in global trade.

It's not clear a Greek default would be that sweeping, but economists say that like Lehman's collapse, its damage could be greater than expected.

"The risk of a 'Lehman moment' for the eurozone is increasing," says Neil MacKinnon, analyst at VTB Capital. "The nature of the eurozone debt and banking crisis is similar to previous financial crises in modern times because of the inter-connectedness between the banking sectors and government debt."

Now last time I checked, Greece (the country, some $330 billion in GDP) was only about half the size of Lehman Brothers (the company, some $600 billion in assets) was when it fell.   But the problem, as it was with Lehman, is counterparties.

A whole mess of European banks own Greek bonds right now, and Greek bonds are getting to the "completely worthless" stage of the game.  Greek 2-year rates are now above 30%. the equivalent of big red AWOOOGA "Nigerian email scam" klaxons.  Imagine how bad your credit would have to be to get a 30% interest rate on a credit card, and you see the kind of trouble Greece is in.

The bottom line is that the fate of the Greek government will be decided in the next several days, perhaps as soon as Sunday.  If the Greek vote to accept the EU's bailout terms fails, then literally all bets are off as to what will happen.

I've been chasing the Greek Fire story for over a year now, and it's looking like things about to go up in a towering inferno very very soon.  Iceland defaulted on $85 billion three years ago, and they're back in the game now.  But an Iceland style default plan may not work on Greece.

“People should be careful when it comes to drawing comparisons between Iceland on the one hand, and Greece, Portugal, Spain and Ireland on the other,” Finance Minister Steingrimur J. Sigfusson said in an interview in Reykjavik. “Iceland didn’t have the ability to save the banks. Trying to rewrite the events that led to that eventuality as some sort of an export product is irresponsible.”

Iceland’s success in rebuilding its economy has been contrasted with the plight of euro member Ireland by economists including Nobel laureate Paul Krugman. Ireland, where most bank debt has been protected by a state guarantee since 2008, would have been better off using Iceland’s “bankrupting yourself to recovery” model, Krugman argued in a Nov. 24 New York Times column. Sigfusson says the advice could be dangerous, as European leaders try to agree on how investors share the cost of a second Greek rescue. 

Then again...it might work.  The sure losers will be the European banks of course...but how much damage will they do as they thrash about on fire?