By Peter Tchir
I have been a proponent that Greece should default sooner rather than later
for a long time. At first most people argued that Greece would never have to
default. Now many people argue that Greece should default, but now isn’t a good
time. The argument goes that Europe needs time to prepare for the default or
the risk of contagion is too high.
My view is that Europe needs to let Greece default. Europe needs to abandon
the existing perimeter and fall back to a more defensible position. Europe
doesn’t need to collapse, but it does need to retreat to a core, stronger
position, where it can dig in its heels and defend itself. Battles are not lost
because every soldier is killed, battles are lost when morale gets so low that
the soldiers give up and flee for their lives. Wars are won when isolated,
broken units, are captured or killed. I think Europe has to take the pain now,
or risk further pain.
My argument against “waiting for a better time” is that it may never come.
Europe has squandered the last year. Europe was in much better shape to deal
with a Greek default last year than they are now. Contagion was a concern back
then in regards to Ireland and Portugal, now it is a reality. Only the darkest
of the doom and gloom crowd believed that contagion could really spread to Spain
and Italy, yet now that risk is palpable. Banks were more worried about
fighting Dodd-Frank, and raising dividends, and creating almost record bonus
pools, not trying to convince employees that the firm’s are solvent.
Contagion in many ways has already hit. The EU stocks are down over 20% in
the past 12 months in most cases. Germany has performed better than the rest,
but that is a very large drop and the market in Europe as a whole are in a Bear
Market. The U.K. with its proximity to Europe, and Japan with the earthquake
are also lower, but the U.S. stock market has remained relatively unscathed
(despite what you might be reading this weekend about how our sell-off is
overdone). China and Brazil are experiencing some troubles in their own stock
markets. In spite of the hype of the BRIC’s coming to the rescue, they may be
too busy taking care of themselves. It is worth noting that the EUR/USD
exchange rate was 1.36 on September 30th last year, and is 1.35 now, so it is
not all about exchange rates.
The credit story is more bleak and stark. Credit has clearly picked the safe
havens, the next Greece, and those in between. Italy and Spain are now trading
almost where Portugal was a year ago. How much easier would it have been for
Italy to withstand a Greek default when it’s 5 year bonds were trading at Bunds
+ 134 instead of Bunds + 407. CDS has blown out across the board, including the
allegedly cash rich China, but there is a “basis” swap element as the CDS trades
in a currency different than what the country uses (ie, all Eurozone CDS trades
in dollars).
It is hard to look at the data and note with that the bold steps of letting
Greece default, had been taken last year when countries were in better shape.
It is also clear, that the contagion has occurred without a default. Portugal
has clearly moved to the plagued group and Italy and Spain are trying to fight
it off.
Last September, the Eurozone and the U.S. had just posted 2nd quarter GDP
growth of about 0.9%. This year, both the Eurozone and U.S. only had 0.2%
growth in the 2nd quarter. At the risk of being ridiculed by proper economists,
you cannot guarantee that GDP growth will be even worse or in contraction if we
wait any longer for Greece to default.
It also worth pointing out that at the time, the ECB was only an amateur at
overpaying for bonds. It has since purchased even more bonds well above the
current market price. All that purchasing power would be nice to have now, but
it has been spent. They can always spend more, but the ECB would be much
stronger if it wasn’t sitting on such a big inventory of losing positions, that
clearly did little to stem the crisis.
What about the banks? Don’t we need to wait so the banks can be
stronger?
It doesn’t take a rocket scientist to see that the banks squandered a year to
improve their capital base. BAC wasn’t selling cheap options to Warren Buffett
when their stock was at 13. The SocGen CEO wasn’t on TV trying to convince
investors that they had no funding or capital problems when his stock was at
42. The banks are even worse off than most of the countries, but why should
anyone assume that waiting will make it easier for them to digest a Greek
default.
To me, it seems that a lot has already been priced in and that the contagion
is occurring whether we want it to or not, so we may as well let Greece default
now and figure out how much has already been priced in and how to really stop
the contagion from spreading to Italy and Spain and to banks that deserve to be
saved. Let’s just admit it is gangrene and that it has already spread farther
than is safe, but it is still better to cut off an arm to save the body. If we
keep waiting it may not be possible to save the patient. The patient is getting
weaker by the day, and being blind to that is just as big and just as dangerous
as letting Greece default now.
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