Here's What Really Matters When Greece Defaults

The sands of time are ticking against Greece. We are no longer talking about if the indebted country will default on its debt, but simply when.

A few days ago, credit rating agency Fitch essentially called Greece insolvent and noted that it would probably not be able to meet a March 20 bond payment of approximately $18 billion. The Eurozone nations have been working feverishly to find a solution to Greece's debt woes but have been held up by either Greece itself or the participation of other EU countries.

Luckily for the EU and the world, a Greece default is in itself relatively meaningless. Speculation is running rampant as to what will and won't be important when the country finally does drop the ball, so I thought I'd take the time here to throw in my two cents on the subject.

What's not important: The actual Greek default.
A Greek default has been a foregone conclusion since late last year and it's not really a surprise, seeing as how Fitch currently has the country rated a CCC -- one grade above default. Current two-year bond rates in Greece are yielding a mind-numbing 172% and have been as high as 206%. These figures make no mistake that Greece is on the precipice of default.

What is important: The type of default.
Admittedly Greece is a small fry when it comes to annual GDP, but the method by which Greece defaults is important. It's much postulated that Greece will partially default on roughly $100 billion of its $205 billion in privately held debt. This would allow the country to save in the neighborhood of $4 billion in debt-serving costs annually, with the hope that it can get its debt-to-GDP ratio down to 120% by 2020. This type of default is already being factored in by the market. Anything larger than $100 billion could stymie the U.S. stock market rally and crush the financials.

What's not important: U.S. money-center banks' exposure to Greece.
If we've learned anything from large U.S. banks, it's that they can absorb pretty substantial losses without too much trouble. Bank of America (NYSE: BAC  ) absorbed an $8.8 billion quarterly loss related to its mortgage mess originating from Countrywide Financial and it's still profitable for the year (though just barely). JPMorgan Chase (NYSE: JPM  ) CEO Jamie Dimon described his bank's exposure to Greece as "nearly zero" back in June, while Greek debt hasn't even appeared on Goldman Sachs' (NYSE: GS  ) or Citigroup's (NYSE: C  ) quarterly reports for the past few quarters.

What is important: U.S. money-center banks' exposure to everyone else.
The really tricky thing here is how to negotiate an organized Greek default without enticing the other troubled nations -- Ireland, Portugal, Italy and Spain -- to do the same thing. If the EU makes it too easy for Greece to default, then the others are likely to follow. However, if the EU takes a hardline stance with Greece, the other nations are likely to note this and continue to make their debt payments. Beyond Greece, JPMorgan Chase and Citigroup have very significant loan risks. Citigroup is currently on the hook for $12.3 billion to Italy and $10.8 billion to Spain, while JPMorgan Chase has lent $18.8 billion to Ireland, $12.2 billion to Italy, and $12 billion to Spain. These are not absorbable chunks of change.

What's not important: How Greece got into debt.
I know this is controversial, but I believe it really doesn't matter how Greece got into this mess. Unfortunately, we do know that a burst housing bubble and a gross misrepresentation of borrowings by former Greek leaders were a big part of Greece's debt woes. But reflecting on the past isn't going to change the present situation.

What is important: Making sure this doesn't happen again.
What the EU does need to focus on is how to get Greece back on the right track. It's brutally apparent that Greece needs to reduce its spending through some fairly deep austerity measures, but that alone, unfortunately, will not allow it to get out of its prolonged recession. It therefore seems almost inevitable that Greek debtors will need to take a debt haircut just to allow Greece to get back on its feet. Once they're standing again, however, it seems logical to me that strict spending limits to GDP need to be imposed and everyone needs to figure out a way to lower Greece's ridiculously high unemployment rate, which currently sits at 18.8%.

Foolish roundup
If you take anything from what I've said above, it should be that a Greece default itself won't be detrimental to the EU, but the nature of the default and how the EU negotiates with Greece during and after its default will likely determine the direction the EU is headed over the next six to 12 months.

What's your take on Greece's ongoing soap opera with the EU? Share your thoughts in the comments section below.

Also, if you want to worry less about your investments, then I invite you to download a copy of our latest report, "3 American Companies Set to Dominate the World." It highlights three companies that are trouncing the competition in the emerging markets and are likely to be little affected by a Greek default. Best of all, this report is completely free for a limited time, so don't miss out!

Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. He can't fathom the idea of nearly one in five people out of work. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 always puts its readers' interests first.


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  • Report this Comment On January 26, 2012, at 9:55 AM, andreapsoras wrote:

    Hello Sean,

    I disagree with your comment that the reason Greece is in this situation or 'how it got there' does not matter.

    Actually it does. Understanding the how gives a better solution to the problem.

    When the Germans proposed the Euro and "free" Trade EU zone, the countries entering would have to eliminate their tariffs, a key form by which governments raise fiscal revenues rather than taxing the people more aggressively ie, using direct taxation. Tariffs, duties and excise taxes are 'indirect' taxation and the US uses these in the Constitution's Article 1 Section 8 so that your taxes aren't rasied or higher. In the US anyway the 16th Amendment wasnt from the founders, who believed in using indirect taxation which more evenly distributes wealth and spurs wealth develpment better than direct taxation. In the US however, because of US compliance with G20, we've eliminated our taxes with countries into which the US went into nontariff'd ie, 'free' trade to comply with G20. This gives us the economic and fiscal problems w hile US compliance with G20 also has been for the US to de-industrialize.

    After Germany's reunification, the Germans at Maastricht in 1991 propsed both the Euro and the 'free' trade to advantage itself. In order to enter the EU, Greece had to eliminate its tariffs against Germany's production exported to Greece, meanwhile Greece would either have to eliminate those industries competing against German production, and/or would not be buying what it's own country produced, but would by what Germany produced. Formerly it would hit those imports with tariffs, or tax the sale of its own domestic production by way of sales, ie an excise tax that would be a fiscal revenue back to its own government.

    As a part of the EU, however, it's not been able to enjoy fiscal revenues under its former regimes for the reasons I've described and others, but again, look at the sleazy underhanded way the Germans have advantaged themselves in their commercial and financial ways to attempt to kingdom tow now using commercial tactics and 'fiscal' union rather than panzers.

    Notice Germany has a relatively low unemployment rate meanwhile offshored very little production into former warsaw pact countries other than east germany while most of the EU countries and German dominated G20 Agreement countries have either higher unemployment rates and/or increasing employment and fiscal budget problems. Meanwhile many offshored production into former warsaw pact countries or other asymmetric economies and societies as in the case of the US with NAFTA or PNTR under the G20 Agreement regime.

    Again all of this has served as Germany's tactic for commercial and cultural war against the US and the UK and some of the other former WW2 allies.

    The solution is found by using the following: 1) Dissolve the Euro and 2) dissolve the EU 3) with all european countries restoring their fiscal revenue indirect taxation using tariffs, duties and excise taxes. 4) Dissolve the G20 Agreements, with all former G20 signatories restoring their indirect taxation for fiscal revenues. This includes the US, which would no longer have to de-industrialize to suit the Germans and the German dominated G20 agreements to which the US has been complying; the US had to 'constrain' in effect collapse our economy to suit the Germans which have a production based, export driven economy by which it also has used this to wage its commercial war. US production the Germans deemed competed with its own but the US in complying with G20 would have to eliminate our production perceived to be competition to the Germans.

    It's done this however using the US voters' wallet indirectly with the US going into 'free' trade agreements with very asymmetric societies and those economies, with the closest symmetrically being Canada. I'd heard observed by a european central banker that Germany was shrewd about its trade strategies whereas the US was crippled by foolishly going into 'free' trade and associated agreements with asymmetric economies and societies like Mexico and the PRC.

    Greece has been a casualty to German attempts to kingdom tow while the Greeks suffer that browbeating teuton wannabe abuse and jack boot tyrannies. There are families that have to put their children in foster care and worse. Meanwhile the Germans had backed the debt any country undertook to buy german production with that employing germans, but in turn those soveriegn buyers were not buying from their own companies, or those companies were closed so as to not compete with the germans and those producers which would export. See the circle? Really sleazy.

    Understanding why and how things are is really key, especially in the case where Germany wants all those countries including the UK to give up their sovereignty to advantage the Germans. The Swiss, the Brits and the Swedes were onto this and demured but those countries on the continent have to be protected from this bund assault and the strategy I described is to be used.

    Respectfully,

    Andrea Psoras

    New York

  • Report this Comment On January 31, 2012, at 10:16 AM, steveat wrote:

    FYI, Canadians never did like NAFTA. The newer generation don't know about it and don't know any better. Canada lost a lot of good companies moving over the boarder into Mexico.

    Should you blame Germany for this or the countries that fell into agreement with them and the EU? Maybe the Germans do have the upper hand, but they are the ones bailing people out too.

    Take it down a notch to the individual. Unemployment is not the responsibility of the government to solve. It may be a vehicle to find employment, but the ultimate responsibility/onus of the person that needs a job.

    There ARE jobs out there. The problem is too much "pride". If you can't find work, you make work. It's a serious lack of ambition, however, I do realize that if everyone was ambitious, this world would be messed up as well. We need leaders, we need lifers, we need lazy people..we need all varieties.

    Instead of pointing fingers, do something about it. Go out and assist your friend/colleague/neighbour to find a job. The government can only meet you half way and sometimes, you can't expect anyone or anything to meet half way and you have to do it yourself.

    My 2 cents

    Steve

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