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What would a Greek default do to the euro?



April 26, 2010 – Comments (3)

As Fools who followed along with our trip to Greece know, we think the probability of the EU letting Greece default on its debt is much lower than the probability currently being implied by the bond market. There is no legal mechanism by which the country could leave/be kicked out of the union, and it seems to us (and it still seems that way) that Europe long-term is better off by rescuing Greece today than it is letting the country default -- thereby destroying confidence in the EU for a multiyear period.

That said, there is an interesting article in today's WSJ that discusses what could happen to the euro in the wake of a Greek default. Here's the meat of it:

However, even a messy default by Greece alone would not necessarily mean the end of the euro area. The day after a formal default, Greek banks would no longer have access to the regular monetary policy operations of the European Central Bank because the ECB could no longer accept their collateral—Greek debt—which would immediately have junk status. The country would thus effectively cease to be part of the euro area. Its status would resemble that of Montenegro, which adopted the euro as legal tender without officially being a member of the single currency zone.

In Greece, following a messy default, euro notes and coins would still circulate in the economy, but one euro in a Greek bank account would no longer be automatically equivalent to a euro in a bank account elsewhere in the euro area, as Greek banks might immediately become insolvent and thus be shut out of the payment systems. Until Greek solvency was re-established, the euro zone would thus de facto have lost one of its members, even though the Greek Central Bank head would still sit on the Governing Council of the ECB and the Greek finance minister would still be a member of the Euro Group, with their normal voting powers intact.

That, in short, is pretty messy, though not impossible. And I still don't think the EU would want to bring this chaos on itself given that it does have the political and financial ability to prevent it given the current IMF construct. Time will tell, of course, but NBG is still looking alluring to us.

3 Comments – Post Your Own

#1) On April 26, 2010 at 2:11 PM, JakilaTheHun (99.92) wrote:

I agree with you on NBG, but I think the market is still assuming too little risk on Greek debt.  If you ask me, the odds are about 75-25 in favor of them getting some sort of "bail out", but if they don't get that, then they are basically insolvent, which would make the bonds nearly worthless. 

I wouldn't want to own Greek bonds for anything less than a 50% return.  Of course, I'm no bond expert, so maybe I'm overly conservative, but I can't see that I'd have much recourse against a foreign sovereign government if they defaulted.  Why not just buy equities if you're taking on that much risk?  You'll get a better return.  

And that's basically my reasoning as to why I'd rather buy NBG.  NBG is actually a well-run bank and even if Greece defaulted, it's possible that you'd still recover your investment.  Things would be ugly for several years, but NBG's earnings power is clearly above what the market would indicate.  Moreover, they are more diversified than many investors might be assuming.  Downside is that a sovereign default in Greece would almost certainly trigger severe deflation, which would harm NBG; but they are well-capitalized enough so that they'd have a chance to survive. 

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#2) On April 26, 2010 at 3:55 PM, jason2713 (< 20) wrote:

Yes I agree as well.

I highly, highly doubt the EU will allow Greece to default.  Just no way they can.  And even if they turn their backs on Greece, the IMF will have to scoop in.

I guess time will tell, won't it?


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#3) On April 27, 2010 at 9:11 AM, Melaschasm (< 20) wrote:

I have one major disagreement with the WSJ article.  Euro's in Greece would still be worth the same as anywhere else.  The only difference is that debt holders (potentially including savings accounts) would be at risk of losing all or some of their money.

This is much like what happens in the US when a local government or bank goes under.  The local government bonds lose value, and the FDIC only protects the first $100,000, and the rest of a person's savings are at risk.

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