Risky business


The headlines have been screaming it for a week – “Markets soft due to ongoing Greek Crisis,” or something similar.  But like The Onion, these headlines often have all the punchline in them and the article doesn’t give much more.  Why is the Greek crisis important for US stocks and our economy?  Why should we care?

The answer is  complicated and hard to explain in an article of less than a few thousand words.  The short version of it is very scary – because a Greek default could bring down many financial institutions across the developed world.  News outlets have been shying away from this and done, on balance, a lousy job portraying the real problem with Greece.

Not that something awful is about to happen – but the odds of cataclysm are high enough that they have become scary.  That means we have to understand that worst case scenario to understand why even a small threat of it multiplies out to a huge risk.

As many of you know, the Greek Crisis has been running in slow-motion for a long time.  The European Central Bank (ECB) has been more or less kicking the can down the road to forestall a pending default on debt to give them the time necessary to formulate a plan (or, perhaps, just stall because it is human nature – pick one).

The situation requires caution because if Greece is allowed to default on their debt – which may be the best thing for Greece in the long run – other nations with bigger debts will certainly ask for the same treatment.  The total tab will be very large and threaten the solvency of many banks across Europe.   The Euro itself could break up if it no longer is in the best interests of the member nations to be tied to other nations that could drag them down.

This may be simple enough to understand, but it still does not explain why the US markets are so jittery.  That takes a few revelations deep in the Credit Default Swap (CDS)  territory, a place that is concealed from public scrutiny by design.  It turns out that European banks wisely bought insurance against the possible default of their Greek debt.  Such a strange insurance comes only in the form of a CDS, and in this case they were issued primarily by our old friends Goldman Sachs.  Without getting into the details, the net insurance of the Greek debt is held primarily in the US because that’s where the dark side of international markets does things like this.

If Greece fails, our financial institutions are holding about half of the problem.  And if they go, so goes Portugal, Ireland, and maybe Spain and Italy.  The total potential default is about $500B, which is to say that the total liability to US institutions could run about 1/3 what we had to do in TARP back in 2008.  Except, of course, that we’re a lot weaker than we were at that time and we’ve picked up a lot more debt.  This is all before we have to account for any secondary effects that could include more CDSs against various European banks that might fail because of the initial shock.

Will this happen?  We do not know for sure yet just how it will go down.  The risk of a major cataclysm, however, has risen to an unacceptable level for many investors who would rather sit on their cash and not take any risk in the markets at all.  And so we wait.

Will the nation that gave us Western Civilization bring it down?  It’s still hard to say.  But the fact that we are even being forced to contemplate things like this is scary.  Hopefully, it’s scary enough to force some serious reckoning and plans for action.  It would be a shame to waste a crisis like this.