Fried in Greece


Another big credit crunch is brewing, this one starting in Greece.  It may not be obvious how and why this has the potential to affect us across the Atlantic, but it does.

In many ways, this is just a mirror of the Goldman grilling in the US House – a story of cavalier disregard for reality unraveling as the people nominally in charge of things try to get a grip on what is actually going on.  How this one is handled will resonate for at least the next few months as the developed world struggles to get a handle on what’s really happening and what they can do about it.

The first thing that needs to be understood is that this situation cannot be called a surprise by anyone.  Greece is one of a small number of Euro-zone nations that have been in serious risk of default and have been looking for a bailout from the larger Euro partners.  They simply cannot pay the tab for the debt they’ve incurred, about 115% of annual gross domestic product.

The trouble is currently confined to Portugal, Italy, Greece, and Spain – PIGS, for short – but solving the problem will require their crushing debt to be absorbed by larger nations.  That falls heavily on Germany.  This is all assuming a package can be put together that will not result in riots across Greece and a more general collapse.

The German government has been slow to act because they are certain they have been and currently are being lied to about the size of the problem.  They might back the proposed bailout of €45 billion in a normal situation, but they do not believe it is the end of it.  Throwing away a lot of money without solving the problem would, simply, be a waste.

This may seem arcane and irrelevant to many Americans, but it isn’t.  When sovereign or national debt is defaulted on, money becomes scarce throughout the system.  In this case, the largest single economy in the world, the Eurozone, is threatened with the possibility of seeing a lot of money vaporize through a general crash unless they start printing a lot more quickly.  That would force those who rely on credit in Europe to look for money elsewhere, especially the UK and US.  More demand for our money would drive up the cost of borrowing here just as there are signs that our economy is beginning to turn around.

As difficult as it has been for us to get a handle on our situation and prevent it from falling down in a general collapse, this situation will make it even harder.  Politicians on both sides have started to question the lack of control over the Federal Reserve lately, but a situation like this takes a lot of control away from even Ben Bernanke.  That’s where the parallels with Goldman start to look interesting.

There is little doubt now that at least some of the pieces of paper the Goldman was selling had little to no underlying value.  While the young traders who conceived these “monstrosities” were responding only to the their own greed and personal incentives, somewhere at the top of Goldman there was a responsibility to understand what the firm was actually doing.  That’s where “too big to fail” is met and matched by “too big to understand” – the delusion endemic in the whole system allowed a lot of people that should have known what was going on to look the other way.  They didn’t understand just what was happening, nor did they care to.

Is it a lie or a cheat when you aren’t deliberately defrauding people but really just have no idea what the Hell you are doing?

The same basic problem is confronting the German government right now as they try to stem what could easily become a Euro-meltdown, followed closely by a world-meltdown.  If they were sure that they knew what was going on, they might act.  Without that knowledge, they have little to nothing to go on and reasonably believe that the potential liability might be nearly limitless.  It’s not as though they don’t have problems of their own, of course.  But achieving market stability means putting a reasonable cap on the risk that the market is going to be stuck with, and without good information you can’t do that.  The goal is to calm markets and keep it all orderly because it’s a sharp run for the exits that causes paper wealth to suddenly vaporize.

What is really going on?  The short version is that no one really knows.  The long version is that it’s clearly bad and has the potential to suck the whole world down with it.  Stay tuned to see how it develops.