The Real Cost of a Greek Default

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Rome wasn't built in a day and apparently Greece can't collapse in a timely manner.

Dominating the headlines every day, Greece continues to tick closer to at least a partial default on its debt. The panic surrounding its potential default is crippling global stock markets.

Greek five-year credit default swaps, which measure the likelihood that Greece will default on its debt obligations within the next five years, crossed 6,750 basis points last week. This implies an almost certain chance of default. Credit default swaps are traded over the counter, with very little liquidity, and dabbled in only by large investment firms. And yet, nearly all of them are implying that a Greek default is a foregone conclusion.

Therefore, rather than going against the grain, which I often advocate, it's time we face the fact that Greece is going to default. Instead of worrying about the when, let's concern ourselves with the true cost of a Greek default.

The tangible costs
First, there are the up-front and clear costs of a Greek default; I like to call them tangible costs. Although it's incredibly unlikely that Greece will declare a full-fledged bankruptcy, it's quite plausible that it may default on up to half of its 340 billion euros in sovereign debt.

One thing to remember about this debt is that it's highly concentrated. Outside of Greek banks like National Bank of Greece (NYSE: NBG  ) , only a handful of European banks own a meaningful amount of Greek debt, with the top 40 holders owning 74% of all outstanding debt. Do note there are some big names on this list:


Greek Debt Exposure in Billions of Euro

Total Assets as of 12/31/10
(in billions)

BNP Paribas 5.0 1,998.20
Commerzbank 2.9 754.3
Societe Generale 2.9 1,132.10
Deutsche Bank (NYSE: DB  ) 1.6 1,905.60
ING (NYSE: ING  ) 1.4 1,242.80
RBS (NYSE: RBS  ) 1.1 1,453.60

Sources: Barclays Capital and Morningstar.

Also note just how miniscule these debt writedowns would be in relation to the total assets of each bank based on last year's year-end figures. I'm not saying shareholders of BNP Paribas or Deutsche Bank wouldn't suffer losses from a default, but these banks are capitalized to the extent that a Greek default has almost been built into their corporate strategy.

Now let's take a look at the intangible costs of a Greek default.

The intangibles
Possibly the biggest question mark surrounding an orderly or chaotic default of Greece revolves around those aforementioned pesky credit default swaps. Because these swaps are traded over the counter, there's no good way to measure the real value tied up in them. Most analyst estimates currently range from as low as 3.5 billion euros to as high as 55.4 billion. With the actual numbers likely falling somewhere in between, these figures don't represent a death knell for most European banks.

Many focus their concern on the ability of Ireland's and Portugal's financial systems to absorb the shock of a Greek default.

Based on the results of a stress test conducted in late March, which called for 34 billion euros in additional capital, and the 64 billion euros the Irish government already injected, it seems likely that Ireland's government will remain more than willing to inject capital into the financial system. Add to this the fact that the Irish government forced the nationalization of Ireland's two largest banks -- Allied Irish Banks, which will soon be merged with EBS, and Bank of Ireland (NYSE: IRE  ) -- and I believe you have a recipe for an ugly survival. Please note I said "survival," not "success."

The big question mark here is little ol' Portugal. While not exactly on sound footing, all hope may not be lost. Although Portugal's soaring lending rates have cut it off from the remainder of Europe, its banks -- with the assistance of 12 billion euros from the European Union and the offer of higher interest rates to customers -- have witnessed 10 consecutive months of increasing deposits, according to Bank of Portugal. Don't fall over, but private deposits are now at nearly 127 billion euros -- a record high. Things may not be as bad as once predicted for Portuguese banks.

Clearly, there are other intangibles that can't be quantified, like panic and volatility. The cost of Lehman Brothers in 2008 wasn't so much the bankruptcy itself as it was the shock that something so representative of big business could go under. But we also need to remember that the stock market rebounded with amazing vigor off of those lows once the dust settled. We can't control the emotions of others, but we can remember that sound minds do eventually prevail.

The bottom line
Although I know this will be highly controversial, I'm calling a Greek default largely negligible on the world economy. Bank writedowns will occur, but it's nothing they won't be able to survive. In fact, Bank of America (NYSE: BAC  ) recently took a bigger writedown to settle lawsuits relating to mortgage-backed securities originating from its Countrywide Financial unit than nearly any European bank would have to take based on Greek debt writedowns. As long as Italy and Spain can avoid an Irish- or Portuguese-styled financial collapse, I don't see the worldwide economy plunging into recession. So without further ado, I say, with a heavy heart and sound logic, "Greece, hurry up and default already!"

Have you changed your investing strategy because of a potential debt default by Greece? Share your thoughts in the comments below and sound off on whether I'm nuts, right on, or perhaps a little bit of both.

Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. He sometimes believes failure is the only option. You can follow him on CAPS under the screen name TMFUltraLong. The Motley Fool owns shares of National Bank of Greece and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that will always bail you out.

Read/Post Comments (15) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 04, 2011, at 5:34 PM, colleran wrote:

    No kidding, just default and let the banks absorb it. This anticipation is worse than an actual default. I feel like i am on a stock roller coaster.

  • Report this Comment On October 04, 2011, at 5:39 PM, KyleSanDiego wrote:

    1) So what is the catalyst for the certain Greek default?

    2) When will it occur?

    3) Should we wait on investing until it occurs? Sounds like that will cause the bottom?

  • Report this Comment On October 04, 2011, at 5:42 PM, xetn wrote:

    Interest on Greed debt is over 100%. They will default!. When that happens, it will affect the the whole EU. It will affect the US banks, most notably Goldman-Sachs. The Fed is already in deep. And, when they do finally default, it will affect the other PIGGS as well, most of their banks have lent to Greece.

    The following is from 2010 but is illustrative of the problem:

  • Report this Comment On October 04, 2011, at 5:43 PM, TMFUltraLong wrote:


    Exactly, the bark is going to be considering worse than the bite I figure.


  • Report this Comment On October 04, 2011, at 5:47 PM, TMFUltraLong wrote:


    There could be a multiplicity of catalysts for default. The primary one being, "we give up and simply can't cut enough out of our budget fast enough for this to make a difference." Eventually EU nations could also say that "hey, we're going to just take our losses and move on" while letting Greece default. There are a few scenarios but none seems like a sure fire "this is how they'll do it" scenario.

    I don't have a crystal ball when a default will occur, but I think we're just weeks from a default. Possibly 3-6 weeks from now, but don't hold me to those figures - they're just a guestimate.

    I think you should always be investing because most of us are in this market for the long-haul, not the five minute price swing. I feel the market could have a substantial rally once the act of default finally occurs. Sort of a buy the rumor, sell the news type event in reverse.


  • Report this Comment On October 04, 2011, at 5:48 PM, TMFUltraLong wrote:


    I'd definitely say the Irish banks are in worse shape than the Portugeuse. At least Portugeuse banks are attracting customers. Irish banks are crossing their fingers and hoping they can attract buyers. If I recall correctly Allied Irish Banks is attempting to sell a minority stake of its business either this week or next week. We'll see how well that goes. I just know the Irish government is in better shape than most to continue to keep their banks afloat. They should be able to survive a Greek default, but I'm not saying it will be pretty for them.


  • Report this Comment On October 04, 2011, at 10:46 PM, jimmy4040 wrote:

    No completely wrong on most everything. Your estimates of who owns what in Greek debt are way off. The French especially are hiding it in large measure. Where is Credit Agricole on your list? Why didn't you account for the European leverage ratios? At our worst, our banks were no more than 40-50. Dexia alone is probably in the 60-70 ratio. Plus you didn't account for greatly increased cash flows into the ECB indicating that euro banks aren't lending to each other out of fear. You also didn't mention the downgrade of Italian debt today.

    I don't know whether you're nuts, but you don't know much about your subject.

  • Report this Comment On October 04, 2011, at 10:49 PM, jimmy4040 wrote:

    Oh one more point the laughable eurobank stress tests calculated Greek debt at a discount of 20%. Even at that about 10% of the banks failed. In fact Greek debt is currently trading at 50%+ discount, and will go lower very soon.

  • Report this Comment On October 05, 2011, at 3:27 AM, PostScience wrote:

    It could be a situation that when Greece actually does default, the stock markets will rally.

    Hearing about it every day is pumping up the fear - increasing volatility and thereby driving away buyers.

    Do us a favor, Greece, and default already.

  • Report this Comment On October 05, 2011, at 7:34 AM, dag154 wrote:

    The total Greek debt stands at about 337 billion Euros. Your numbers only account for about 13 billion ... Less than 0,4% of it!!!

    In addition, a default is guaranteed to bankrupt the whole Greek banking system and to bring the country into a far deeper recession.

    Obviously this is bound to affect Europe as well as the world markets.

    Things will not stop there: if European banks have to declare 50 billion Euros in losses, can you imagine the effect on their P&L statements and share price? They will have to cut costs and withdraw from markets in a big way, bringing further destruction to the financial system.

    Can you then imagine the effect on other European countries which are currently in an uncertain position? if bond holders get burned and there is a shortage of cash, the only logical conclusion is that there will be a run on risky bonds.

    And so on, and so forth.

    The fear is well founded. Not so much because of the actual Greek debt issue, but rather because of the string of repercussions that will arrise from a default.

  • Report this Comment On October 05, 2011, at 8:03 AM, Fliujniligui wrote:

    The cost is not coming from Greek debt directly but rather from the failure of institutions to manage debt in supposedly developed countries.

    This means that we might get in a secular risk aversion and near paranoia for many non-AAA+Excellent (Canada, Scandinavia and Germany) government debt and could spell panic in the markets and force writedowns and rating cuts on a wide range of assets which were previously tought to be riskless.

    Fool often takes an event and insulates it from the systemic factors to analyze it. Take the example of an unpunished murder, they would say that the involved guy is not destabilizing society, but the real issue is that when the murderer is not chased until found, this undermines confidence in a basic law which is essential for society to function. The same principle ''Prime debt is repaid in full'' once violated and show failing endangers whole debt market and can trigger a shortfall incommensurate with the punity amounts you stated for BNP and Greece Exposure.

    Greece fails --> maybe France is not so good --> Spreads go up, interest rates goes up --> France has difficulty borrow --> Debt sustainability in France is questionned --> Failure of BNP due to freezing of interbank markets and so on.

    Don't be fool enough to take the risk of investing your money while analysis just ignores the most important points. Get BSBR below book value, there is no such risk, they have no junk debt and 20% tier 1 ratio so why bother about Europe banks and why sell (Everyone is doing it) BSBR ?

  • Report this Comment On October 05, 2011, at 9:09 AM, jimmy4040 wrote:

    From Goldman Sachs:

    "The European crisis threatens US economic growth via tighter financial conditions, reduced credit availability, and weaker growth of US exports to the region. This impact is likely to slow the US economy to the edge of recession by early 2012,"

  • Report this Comment On October 07, 2011, at 1:52 PM, DANE1969 wrote:

    Do any of you SEE-ERS know the answers to:

    1. Has Greece been in this position before,

    if so, --when?

    2. Why, in your valued opinion, has this happened, in the cradle of civilization ?

    3. Where was the global banking community

    [assuming there is one], not to see this coming,in

    and by Greek money-handling?

  • Report this Comment On October 07, 2011, at 1:55 PM, DANE1969 wrote:

    Another addendum: Why do we say "recession ",

    we know it will mean "depression," ultimately.

  • Report this Comment On October 12, 2011, at 4:19 PM, Teacherman1 wrote:

    It looks like you stirred up a hornets nest with this article Sean, but I think you are correct that a good buying opportunity may be coming up.

    Myself, I'm buying IRE for a long term hold while it is at these bargin basement prices.

    Deleted NBG even from my watch list.

    Took some of my profits today in anticipation of others doing the same tomorrow or Friday, so will have cash available.

    Just need to be patient and focus on opportunitistic buying and not give way to panic selling.

    Who knows, Germany may just buy Greece and use it as a "time share" for all of their citizens who had to ante up to keep their "markets" alive.

    JMO and worth exactly what I am charging for it.

    Hope everyone has a good week during this "run up".

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