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Carmageddon, free markets, and the PIIGS crisis

Residents of the Los Angeles metropolitan area have known for almost two months that this weekend would be our worst traffic nightmare: the two-day closing of a key stretch of the 405 freeway. Signs have been posted everywhere with the warning, even as far away as San Diego. And what happened? Absolutely nothing. In fact, traffic hasn't been so good for as long as I can remember. Why? Because almost everyone stayed home to avoid the traffic.

If you want a good example of how powerful free markets can be, this is it.

If you want a reason to not worry about the looming PIIGS sovereign debt crisis, this is it.

When people have access to information and an incentive to act on it, they will.

The world has known since April of last year that the governments of Portugal, Ireland, Italy, Greece, and Spain were in a bind and might not be able to meet their outsized debt obligations. For many months markets have been bombarded with the news that if one of the PIIGS defaults, it could trigger a default contagion that could bring down other PIIGS and perhaps the entire European banking system. Only those who have been in a coma could not know by now that this has the potential to be Debt Armageddon.

How many people are likely to be blindsided by a Greek default? Not many, I think, because the price of Greek debt already reflects something like a 40% default "haircut." How seriously could European banks be affected by a default? It would be painful, but it's quite likely to be far less than a catastrophe, as suggested by 2-yr Euro swap spreads of 70 bps. Would a PIIGS default present a serious problem for the U.S. economy? Not likely at all, as suggested by 2-yr U.S. swap spreads of 30 bps.

The reality of a PIIGS default is likely to be much less than the world fears, because the world has had a long time to prepare for it and most of the ill effects have already been priced in by the market.

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