Why a Greek Default is Important to Us

I know that if I emphasize too strongly what is happening in Greece I will be accused of being another Chicken Little proclaiming that “the sky is falling.” But reality is that a default by Greece on its debt obligations will likely have a serious adverse impact on us in the United States. But before I explain why let me back up a bit and give you a brief overview of what’s going on.

The Greek sovereign debt crisis has grown to the point that it is no longer a question of if Greece will default on its debt it’s now only a matter of when. It’s going to happen. Last week Standard & Poors lowered the country’s debt rating to triple C – its worst rating for any country in the world. The Greek government is teetering on collapse as massive demonstrations express their rage and frustration in the streets.

A survey indicated that 85 percent of all Greeks would rather default on their country’s debt than institute the severe austerity measures that are being proposed for a temporary bailout. And make no mistake it is a temporary bailout. Barring an absolute miracle any bailout will only delay the inevitable. They have already tried “kicking the can down the road” too many times and at some point they will have to pay the piper.

There are three ways a default by Greece on their debt will affect us:

1. A small portion of their debt is borrowed from U.S. banks – $10 billion or about 5% of their total debt. It’s not pocket change but that amount is not a serious exposure to their debt. That can be absorbed by our banks.

2. However, U.S. banks through credit defaults swaps have indirect exposure to 56% of the total Greek debt. This represents $116 billion of the total $206 billion that Greece owes. That’s huge! Simply put, a credit default swap is default insurance. What has happened is European banks have lent money to Greece but insured their Greek loans with default insurance from U.S. banks.

So the big question is, which no one has an answer for, “Will the Greeks be able to restructure their debt (negotiate a lower interest rate, maybe a forgiveness on some of the debt, etc.) or will it be a complete default?” If it is a restructuring of debt (kind of a “soft landing”) the European banks will absorb the losses. It will not likely trigger the default insurance.  If it is a complete default, then it is likely that the American banks’ credit default swaps will take the hit. And because most of those American banks who issued the credit default swaps are “too big to fail” guess who will be footing the bill?

3. As tight as credit has been over the past three years, it’s going to get even tighter if $100+ billion is taken out of U.S. banks to pay off the credit default swaps on the defaulting European bank loans to Greece.  That money would better served lending to worthy businesses and individuals in the U.S.  That’s the real killer concern.

Here’s my thinking on this situation:

1. Banks are hoarding cash. They are reluctant to lend to businesses, to consumers and on commercial real estate which would help get this economy going again. The potential default by Greece and others – Portugal, Ireland, and Italy are next in line – will only make matters worse if American banks are picking up the tab through credit default swaps.

2. Congress needs to enact legislation regarding credit default swaps that either bans this financial product or greatly reduces the American taxpayers’ risk if something goes horribly wrong.

3. Finally, it’s time to get tough on banks that make stupid investment decisions. The federal government should not have to provide bailout money to keep these banks solvent. Let them fail!

Sources: Time to Get Outraged, Thoughts from the Frontline by John Mauldin, June 10, 2011; Greek Debt Tsunami Could Reach U.S. Shores, MSNBC.com by John W. Schoen, June 16, 2011; Greek Crisis May Put California Bank in Play, The Street, by Dan Freed, June 16, 2011; Global Markets Shaken by Greek Debt Crisis, AlJazeera.net, June 16, 2011.

Oregon Economy Shows Impressive Growth

Tom Potiowsky, the Oregon State Economist, revealed the latest economic news at the June 1st Oregon/SW Washington CCIM Chapter meeting, most of which was quite positive.  Shown below are the highlights:

• Oregon job growth surged in the first quarter of 2011 rising at an annualized growth rate of 5.2 percent.  This is the third strongest quarterly job growth since 1990.  On a year-over-year basis, job growth is up 1.8 percent, the best since the first quarter of 2007.
• The unemployment rate has slowly edged down to 9.6 percent.  This is a full two percentage points below the May 2009 unemployment rate peak of 11.6 percent.
• For the last six months, job gains have been averaging over 4,500 jobs per month.  Oregon has the 7th fastest job growth year-over-year for March among the 50 states.
• Job gains in the first quarter were broad based with virtually all sectors seeing strong growth.  The exceptions to this trend were the wood products industry, and state and local governments.
• Personal income growth increased 3.3 percent in the 4th quarter of 2010.
• The declining value of the U.S. dollar is helping those businesses dependent on exporting their products overseas.  Oregon exports are up a whopping 18.6 percent over the previous year but much of this increase has to do with the abysmal performance from the previous year more than a spectacular increase in 2011.

Some potential concerns or "economic headwinds" as Mr. Potiowsky called them are:

• The federal government needs to get its financial house in order but it can't do it cold turkey.  Substantial cuts in spending could result in weakening an already fragile recovery.
• State and local governments are also in bad shape and represent between 10 and 15 percent of the overall economy.  Forty four states and the District of Columbia are projecting combined budget shortfalls of $125 billion for fiscal year 2012.  How they muddle through will need to be handled carefully to avoid harming the recovery.
• The housing sector continues to languish.  The recent Case-Shiller report indicated a 7.6 percent decline in year-over-year house prices in the Portland metropolitan area.  This will likely continue until the majority of foreclosures have worked their way through the system.
• If the credit crunch does not continue easing, commercial real estate may be even slower to recover than anticipated.  Credit markets are easing, but consumers and businesses still have difficulty getting loans.
• If gasoline prices continue taking up a greater portion of household budgets this will inevitably reduce consumer spending for other goods and services.

Even so, the job growth among a number of employment sectors in the first quarter of 2011 is nothing short of impressive.  The recovery is happening but with a few cautionary signals.  All in all, the economy is certainly looking better than it has for the past 3 years.  Let's hope it continues well into the future.