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The Greek bailout: spreading the losses around






This collection of charts covers the range of the market's response to the emergence of the Greek crisis and its apparent resolution that came today in the form of a nearly $1 trillion bailout of Greece. Equity markets worldwide today rallied sharply, while the implied volatility of equity options fell significantly; the world breathed a huge sigh of relief as fear of another banking crisis subsided. Greek government bond yields fell hugely as the threat of a default faded, while German yields rose marginally as its value as a safe-haven was marginally diminished; Greece may be much less likely to default, but Germany has now taken on a significant new contingent liability by backstopping the Greek government. Greek CDS fell by 355 bps, but remain at levels that equate the risk of its bonds to that of junk bonds; investors are feeling much better, but they are far from being completely reassured that we've seen the end of the Greek problem. U.S. credit spreads fell, and are now only slightly wider year to date; Greece is unlikely to pose a significant problem to the U.S. economy. Currencies, curiously, were largely unchanged today; this may reflect the fact that the market had effectively discounted the likelihood that the ECB will eventually be forced to monetize some portion of Europe's added debt burden.


The way I see it, the bailout is equivalent to spreading the prospective losses to Greek creditors among a handful or so of major developed countries and the IMF (the U.S. is sharing in this because it supplies about 40% of the funding of the IMF's share of the bailout). Creditors with excellent reputations have tarnished that reputation somewhat because they are now on the hook for a portion of potential Greek losses, should they occur. Presumably, countries like Germany were persuaded to do this to themselves to avoid the potential fallout—in the form of bank failures—from a Greek default.

Whatever the case, the world's investors last week were feeling very uncomfortable holding Greek debt, and now the bailer-outers of Greece have effectively said they are willing to shoulder a significant portion of the default risk of Greek debt. The world is somewhat relieved because a festering source of systemic risk has been effectively socialized. It's similar to what we did in the U.S. with the housing market crash: e.g., the gargantuan losses of Freddie and Fannie became losses that will be born by U.S. taxpayers. This sounds a lot like "spreading the wealth losses around," to borrow a turn of phrase from Obama.

The bailout of Greece doesn't eliminate the risk that Greece will fail to put its fiscal house in order, but it does place much greater political pressure on Greece to do so. Meanwhile it shifts the burden of the risk to other major players and buys everyone some time; if world economies continue to recover, there's a decent chance that growth will reduce government deficits.

So while this is not an optimal state of affairs, it is most likely better than what we had before.

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