Are concerns over a Greek Euro exit overdone ?

The press and the market continues to speculate about the negative impact of an exit of Greece from the Euro (expectations seems to be over 50%) and both the financial consequences of such an exit on the EZ (indeed everyone else) and, in particular, on the adverse contagion issues in respect of the other PIIGS and core EZ countries, for that matter. Yes it is true that the Greek party Syriza (comprising leftist anti bail out elements) came a surprising second in the last elections and, until recently, has lead in the polls. However, the most recent polls suggest that the Greeks may well be rethinking. New Democracy (23.1%) is narrowly back in the lead (with indications that its support is increasing), followed by Syriza and then Pasok some 10 points behind. If the next elections (due on 17th June) reflect recent polls, a coalition comprising New Democracy and Pasok will be able to form a working majority in Parliament, something which I believe the market has not picked up on as yet

Early days, but I for one believe that the trend away from Syriza will continue. Greeks, by an overwhelming majority (between 75% to 80%) want to remain in the Euro, as they realise that the reintroduction of the Drachma will result in an effective devaluation of at least 50%, by all accounts. The resultant hardship (the need to close the current account deficit to zero immediately) will make the current austerity plans seems like a mild dose of influenza, compared with the pneumonia that will follow an Euro exit. Yes the EZ will be negatively impacted, but the Greeks will make up their minds, based on the likely impact on themselves. This suggests to me that voters will swing away from Syriza and to New Democracy, in particular.

Whilst the Greeks want to remain in the Euro, they do not want to abide by the austerity measures, which their previous administration agreed to. Yes the austerity measures are tough, very likely too tough, but Greece needs to sort out the fiscal mess which it created for itself. The EU suggests that the Geeks will be offered some “sweeteners” if they chose to remain in the Euro, including some kind of growth measures (whatever they are) and possibly a watering down some aspects of the austerity measures. Will this be enough to persuade the Greek voters from following the nonsensical path proposed by the head of the Syriza, Mr Tsipras. Personally, I am beginning to believe that it may. Am I convinced – certainly not, but as days go by, I would not be surprised if the polls indicate that support for Syriza ebbs away and New Democracy’s lead increases.

If I’m right, markets should begin to recover. Personally, I just wish that Greece goes away. The gloom and doom scenario guys are overstating the impact of a Greek exit in my humble view. Yes, there will be huge losses for the EZ, but certainly not of the order of E1tr suggested by Mr Dallara of the IIF – do you think he has a vested interest – of course he does, as he acts for the small group of remaining private sector bondholders who will lose everything if Greece exit’s the Euro. He has every interest in exaggerating the size of the potential losses, in an attempt to get the EZ to offer more assistance to the EZ. Estimates of losses for the EZ (including banks etc) from a Geek exit, range from E150bn (too low in my opinion) to Mr Dallara’s E1tr (ludicrously high) – big numbers in any event. However, a Greek exit will force the ECB to act. Citi estimates that the ECB will have to provide some E800bn in liquidity to mitigate a run on EZ banks in the event of a Greek exit. In addition, the ECB will lower interest rates, buy Spanish and Italian bonds (quite possibly other country bonds) in size and introduce QE, etc, etc, something which is necessary. Draghi will have the perfect excuse to act. As a result, after the initial shock, I for one believe that the EZ will finally have begun to take the action necessary to start to resolve the crisis – there would be no alternative. Consequently, I really hope that Greek voters follow Syriza, but I fear that they wont.

Trying to predict anything involving the Greeks is virtually mission impossible. However, I am beginning to wonder whether the current excitement/panic is way overdone. I have closed all my shorts and remain hugely cashed up, but may well nibble away a bit more in coming weeks. However, it is impossible, in my humble view, to come up with an informed view at present and, as a result, extreme caution is the name of the game. There will be time.


As far as the EZ is concerned, Mrs Merkel remains the only serious player who wants Greece to remain in the Euro – the reason is that she just cannot get a handle on the financial and economic consequences of a Greek exit and is therefore concerned, given her inherent cautious nature. Most other players, including her Finance Minister, Mr Schaeuble are keen to kick Greece out. At present Mrs Merkel has won the argument, but I suspect her position is weakening.

There is a common misapprehension that the EZ cannot force an exit of Greece. Whilst technically true, it certainly can be engineered through the ECB. The ECB at present has stopped financing for Greek banks not because of an ECB policy decision, but technically because EU funds have not yet been used to recap 4 (insolvent) large Greek banks and, the ECB cannot provide funding to insolvent banks. Indeed, the EZ released E25bn to Greece’s recapitalisation agency as part of the new E174bn rescue on April 19, well ahead of the election on 6th May. The problem is on the Greek side (are you surprised) and involves continued negotiations between Athens and the 4 Greek banks as to how much control the government will have in exchange for the funding. Greek officials expected the money to be disbursed by the end of last week, but I have not seen any announcement as yet – typically Greek. When the EU funds are received by the Greek banks, the ECB is expected to continue with its funding operations to Greek banks, though there is an issue as to whether Greek banks have any eligible collateral left to access ECB funding.

However, Greek banks can tap the emergency liquidity assistance programme (“ELA” and which requires lower quality collateral), through their Central Bank, which they are doing at present. The consequences of this (especially as Greeks are withdrawing funds from their banks and Greek banks are, as a result,  increasingly turning to the ELA – estimated at approximately E60bn at the last count) is that the counter parties of the ELA, namely the EZ Central Banks (Germany, in particular, but also Finland, Holland and, I believe Austria and who are providing the funds for the ELA) are having to increase their exposure (and their risk), given the Target 2 arrangements. Not great news for these guys.

It is estimated (by Morgan Stanley) that Greek banks have some E130bn of eligible collateral left to use to access funds from the ELA. A haircut of 50% is considered necessary, which technically suggests that Greek banks can borrow a further E65bn from their Central Bank in accordance with the ELA arrangements. Unfortunately, there is scope to increase the collateral available to Greek banks, (a big Whoops), which will be acceptable for ELA. However, by a majority of 2/3rds, the ECB can stop a steep an unsustainable increase of lending under the Target 2 arrangements, which will require Greece to exit the Euro some time thereafter. As a result, there is a threat (indeed ever rising threat) that the ECB and the affected EZ Central Banks will cut off further lending through the ELA, especially if withdrawals from Greek banks continues to increase significantly. Interestingly, whilst some 20% to 25% of deposits at Greek banks have exited since 2009, the surprising issue is that approx 75% remains – indeed, some E170bn remained with banks at the end of March. This is a serious issue, though difficult to assess. Cutting off ELA funding to Greeks banks by the ECB will certainly focus the minds of Greek voters, though will really spook markets, and Spanish and Italian bond yields.

I remain of the view that Greece is far too much of a problem and it’s ability to continue to create problems is way above it’s perceived threat. In addition, we all know that the Greeks will never comply – not a great precedent to the Irish, Portuguese Spanish and Italians. As a result, I feel that an exit by Greece in the next 12 months is a 75% certainty. As the EU/ECB considers the implications of a Greek exit (which clearly they are), plans will be drawn which will make a Greek exit more possible, though clearly will not be painless. At some stage, even Mrs Merkel is likely to change her mind.

It is near impossible to assess the possibilities at present, but my hunch (and that’s all it is – after think Greece, Turkey (totally intended) and Christmas) is that Greek voters will swing away from Syriza, which will be positive for markets. However, if Greeks start withdrawing funds in size from their banks (E1.2bn or 0.75% of deposits was withdrawn last Monday/Tuesday) and the ECB restricts ELA financing, as described above…….

Having said all that depositors seem (unsurprisingly) to be withdrawing deposits from the (perceived or actual) weaker EZ banks. For example, Santander is reported to have lost £200mn (just under 20bps of deposits) from it’s UK operations last week – indeed, I am asked about Santander UK virtually every day. Outflows continue at Spanish (Bankia, in particular) Belgium, French and Italian banks. The EZ must force the recap of it’s banks or this is going to be a serious problem. In any event, the recap of EZ banks is a prior requisite for a solution in the EZ.

Very tricky and I will remain excessively cashed up at present. Too dangerous (indeed not enough info to form a view), though given market sentiment and the current situation, shorts are likely to remain winners for a while longer.

There are rumours circulating today (from the UK’s Sunday Times) that the French Government may have to nationalise Caisse Centrale du Credit Immobilier de France, a French mortgage bank, with some E33bn of mortgages or roughly 4.0% of the market. Whoops. Welcome to the real world Monsieur Hollande.

Kiron Sarkar

21st May 2012

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