Wednesday, May 5, 2010

Three Dead in Greece (Runaway Debt II)

Things in Greece turned deadly serious today with no end in sight, and your retirement funds suffered and will continue to suffer as a result. The essential problem revolves around too much debt and the fact that around the world governments basically used massive public debt to save the financial system from a massive private debt crisis. So, yesterday the global financial markets got hammered. Why?

First, look at Greece. Widespread riots and protests, fire bombings, destruction and now death. The problem is that the government agreed to deep spending cuts and tax increases as part of the Euro/IMF bailout package. But, the economy is already a mess. So the people edge towards open revolt. Trying to predict what happens next is an exercise in chaos theory. But, there is huge popular resistance to any austerity program and without such a program Greece will default on its sovereign debt. Interest rates on Greek debt soared to over 14 percent yesterday. Notably, Greece really has not yet imposed austerity measures but just talking about them is causing this reaction. So there is no easy way out here. The vote on the austerity measures is scheduled for later this week, so fasten your seat belts for at least a couple of days.

Second, should Greece default, there will be massive losses. Where these losses fall is a function of our magical derivatives markets, which still have no transparency and no regulation. As dre cummings points out such regulation may well have forestalled this mess in the first instance. But a bigger problems lurks behind the flight to safety of today. Because of our wonderful laissez faire approach to derivatives regulation (among other market fundamentalist catastrophes) there is literally no way to know where the losses will land. So where is the money flowing today? Back into the dollar and Treasuries, just like post-Lehman. The market speaks: there is simply no other sure shelter because of the lack of transparency in who is exposed to what.

Hopefully the Greeks implement austerity notwithstanding the riots. Hopefully the Germans approve their part of the bailout. Hopefully Spain, Portugal, Italy, and Ireland do not follow Greece over the brink. Hopefully the UK does not get caught in the vortex of this mega-storm. If so, we may be OK for a while.

Otherwise, there is a possibility this thing gets out of hand. That could cause a huge financial crisis like what occurred in late 2008. This possibility is impossible to quantify. The closest thing is the VIX index, which is soaring.

1 comment:

  1. Professor:

    I have heard that Goldman Sachs played some role in the financial crisis in Greece. True? What did Goldman do? Misrepresent the underlying nature of an investment vehicle to one client while working with another to ensure it was loaded with subprime mortgages sure to fail?