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Saturday, 16 December 2017

Making Greece less contagious not more solvent

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The fat tail risk of a Greek default has given way to another move toward an uneasy equilibrium. Kicking the can down the road has helped to buy time but it is difficult to gauge how much time has actually been brought. What is clear is that bailing in the banks/financials actually increases the chances of an eventual default/hard-restructure as the negative impact to European banks is limited.

The European sovereign debt crisis has effectively been a banking crisis in disguise. Policy makers have preferred a liquidity solution largely because owning up that it was anything more would create a negative impact to the banks in the core countries. The second bailout for Greece with its still to be fully worked out private sector involvement provides a means of limiting the fallout to European banks.

“Germany is preparing the ground for our official bankruptcy as soon as this can happen without cost to the German banks” – PASOK party member Vasso Papandreou

Divyang Shah, Senior IFR Markets Strategist

Divyang Shah, Senior IFR Markets Strategist

Indeed it is worth recognizing that the second bailout for Greece does not improve the solvency of Greece with debt dynamics remaining unsustainable. A few quarters down the line we could be revisiting another voluntary involvement of the private sector should:

1) the implementation risks related to misses on privatization and tax receipts and/or

2) a still divided political and a disillusioned electorate decide the limits of austerity have been reached.

This time with the banks/financials having been ’taken care of’ there wont be a third bailout and instead a default or hard-restructuring should be seen as significant risks.

Comments to Reuters from PASOK party member Vasso Papandreou (also a former European Commissioner) are interesting in this regard saying: “Germany is preparing the ground for our official bankruptcy as soon as this can happen without cost to the German banks”.

The impression left is that it is not about saving Greece but saving the European banks from what is still seen as being an inevitable default from Greece.

In the meantime what will be important is the shape of the private sector bail-in for banks/financials as this will help mould the perceptions of risk related to the debt of Ireland and Portugal.

A look at CDS or the 2-year yield on Ireland and Portugal shows that they are still regarded as embedding a restructuring risk. It still makes sense for investors to continue to look for the exit on Portugal and Ireland otherwise face the risk of private sector involvement that is a little less ’voluntary’ and less focused on banks/financials. The question still remains as to whether it will be Ireland or Portugal next on the markets radar screens as a candidate needing another bailout.

(See also: “Will it be Portugal or Ireland next?”

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