Don't Be Fooled about Greece's Future

Credit Suisse has been writing about a Greek default for some weeks now. The latest piece came this week when CS announced that its view remains that Greece will probably undergo a disorderly default before March 20, when her next bond repayments are due.  

For Greece - even if the country gets the second bailout, which will be used basically to push cash back into the banking system - Europe will have a first lien on nearly 150% of its GDP.

This makes my point of earlier this week even more probable - that Greece is becoming the first European Union client state.  The European Central Bank, the EU and the International Monetary Fund, for all their talk and posturing about solutions being at hand, have simply placed Greece in a position from which she will likely never be able to extricate herself, at least not in our generation. And in so doing , they have also jeopardized their own futures.

So, where is Greece, and where are we who are watching, and who will probably feel the aftermath of the default, when and if it occurs?

1. Greece is poised to default, the end-game everyone anticipated in 2011. It is very likely not a matter of if but when.

2. That default will trigger credit-default swap contracts, derivatives known as CDS that protect the owner from events such as default.

3. This will implode the banking system, as those who sold the CDS (financial institutions) do not have enough cash or assets to pay the owners of the CDS.

4. The idea is that sovereign default is very unlikely, so you can sell protection (CDS) against that possibility for a low premium, and cover that bet by buying your own protection from another player.

5. If that player (counterparty) can't pay you off, then you can't meet your obligations on the CDS you originated and sold.

6. So the failure of one counterparty can trigger a systemic failure akin to a row of dominoes being toppled by the fall of one domino.

7. Those absorbing the losses caused by a Greek default will want to cash in their insurance, i.e. the CDS they own against a Greek default. They have every incentive to demand a default be recognized as a default. If they accept the official plan to avoid calling a default a default, then all the losses will be theirs and none will fall to the counterparties who sold them the CDS.

How is this fair? The official response of avoiding default is focused on self-preservation, not fairness, justice or the rule of law.

So, dear readers, we are still in the eye of a real financial hurricane and nobody has the wherewithal to save either the ECB, the banking system or Greece.