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Racing Against a Greek Default & PIIGS Contagion

Greek Prime Minister George Papandreou left Brussels and returned to Athens for 24 hours to calm down ‘rebelling’ PASOK deputies. No political development is possible before the final decisions on the Greek debt before Wednesday. Within ruling party PASOK voices are loud that the government cannot take such historical decisions alone, especially when it comes to the deployment of permanent supervisors by the Troika, further transfer of national sovereignty and whatever else the EU leaders asked from Greece in order to ‘save’ it.  Some deputies favor early elections, others a government of national consent.

Back in Brussels, Finance Minister Evangelos Venizelos and deputy Fin Min Sachinidis struggle to persuade bankers and other Greek state bondholders  for a voluntary haircut. Bankers insist on a maximum 40% haircut. The threaten that a haircut of 50+% will be considered as a credt event, a bankruptcy. Should they refuse to agree on a 50% loss – as it is speculating in Brussels – then the European leaders will enforce the 50% with the highest risk of a contagion.

When economics speak of a “Contagion” they certainly not mean the US film currently in movie theaters. But for sure they have parallels in mind, i.e. the spread of  a country’s bonds crisis to other countries that have similar economic problems. Contagion is a highly transmittable disease and could lead the weak members of the euro zone  like Portugal, Ireland, Italy and Spain to come into a similar situation like Greece and thus as soon as possible. A domino effect with fatal impact on the eurozone that might end up with Germany leaving the euro zone.

Merkel had to spend a months wage for a gift to Sarkozy’s baby girl

And yet. Germany will also have to pay some price for its political ambitions to rule over theEU in general and the euro zone in particular.

“Financial contagion refers to a scenario in which small shocks, which initially affect only a few financial institutions or a particular region of an economy, spread to the rest of financial sectors and other countries whose economies were previously healthy, in a manner similar to the transmission of a medical disease. Financial contagion happens at both the international level and the domestic level. At the domestic level, usually the failure of a domestic bank or financial intermediary triggers transmission when it defaults on interbank liabilities and sells assets in a fire sale, thereby undermining confidence in similar banks. An example of this phenomenon is the failure of Lehman Brothers and the subsequent turmoil in the United States financial markets. International financial contagion, which happens in both advanced economies and developing economies, is the transmission of financial crisis across financial markets for direct or indirect economies. However, under today’s financial system, with large volume of cash flow, such as hedge fund and cross-regional operation of large banks, financial contagion usually happens simultaneously both among domestic institutions and across countries. The cause of financial contagion usually is beyond the explanation of real economy, such as the bilateral trade volume. “(wikipedia)

 On Greek domestic level, banks and insurance funds will immediately feel the impact of the haircut. Contrary to the July 21st Agreement, the insurance funds will not be exempted from the haircut this time. The state will have immediately to cut expenditures and will cut even further public sector salaries. Cuts in pensions will be inevitable, as Greek insurance funds have state bonds worth 25,5 billion euro. Pensions are paid through the budget even thought employees do pay their contributions, month in, month out before they receive one salary euro.

On bank level, well… Greek banks will seek the aid of EFSF; they will belong to the European Stability Fund and in two years the latest, they will change ownership. Savings are apparently not in danger. Greek banks currently offer interest rates between 3,5-7+%. 

PS I can’t resist a slight consiracy touch and write that “If you want my personal opinion, I think, EU leaders and bankers have already agreed on the haircut but they give us time to digest the bad news. Until Wednesday….”

KTG is open to correction and additional information on the issue.

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