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.