With Greece on the verge of default, we're about to learn how little has really changed since governments around the world wrote the last round of bailout checks to prop up failing financial institutions. Just as the collapse of the US subprime mortgage market rippled into nearly every corner of the global financial system, so too will a pending default by Greece.
A look at Greece's borrowing history shows that defaulting on debt obligations is nothing new for the country. Over the last two centuries, Greece has been in a state of default more than half the time. What's different today is the interconnected nature of the global financial system. In the past, a default was a traumatic event for financial institutions with direct exposure, but it didn't pose a threat to the rest of the world. Unfortunately, that's no longer the case.
A Greek default would send shock waves through Europe's banking system. Massive write-downs by banks are sure to be followed by even larger taxpayer-funded bailouts. Similar to the response to the subprime crisis, governments will argue that some institutions are simply too big to let fail.
But the cost of bailouts won't be limited to Europe. A Greek default would start in Athens, but it wouldn't be long before it's felt in Paris, Berlin, New York and Toronto. In today's intertwined financial markets, everyone has exposure to everyone else's problems.
Consider your own seemingly sleepy neighborhood bank -- it may not be as safe as you think. Its investment division may have entered into a swap agreement with a financial institution in Europe. That institution could have a Greek subsidiary that holds Greek bonds (soon to be worthless) as part of its banking reserves. A Greek default could force the subsidiary into bankruptcy, which would in turn blow up the balance sheet of the parent bank in France or Germany. Before you know it, Greece's delinquent borrowing habits will end up rolling across the Atlantic and on to your bank's doorstep.
The market volatility stemming from a Greek default might also torpedo the hedging strategies implemented by your bank's proprietary trading desk. Just look at the $2 billion loss JP Morgan is now swallowing for evidence of how quickly a hedge book can go offside. And by no means is JP Morgan alone. Swiss-banking giant UBS took its own $2.3 billion hit last year after the market moved against the bets made by a rogue trader.
The proposed Volcker rule, which will restrict a bank's trading activities, is a step towards restoring sanity to financial markets. In my new book, The End of Growth, I argue that resurrecting the principles laid out in the Glass-Steagall Act, which erected walls between deposit-taking institutions and investment banking, would be an even larger step.
The subprime crisis should have triggered regulatory changes designed to safeguard taxpayers from the need to continually bail out imprudent banks. It didn't. If a Greek default comes with a silver lining, it may just be to galvanize regulators into taking action on reforms that are long overdue.
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http://viableopposition.blogspot.ca/2011/11/sovereign-debt-default-learning-lessons.html
The difference this time is that the entire developed world is living under a cloud of ever-rising sovereign debt, an unsustainable reality.
If history is any indication (see Reinhart and Rogoff's This Time is Different: 800 Years of Financial Folly), then central banks the world over will monetise global debt; in other words, debase our currency through money printing (Romans did this during the twilight of their empire by making their coins smaller or replacing the silver with lesser valued metals).
What will this mean for the global consumer? Inflation or, if we're unlucky, hyperinflation as seen in Zimbabwe/Weimer Republic (Germany)/etc..
On top of this mess, once you realise that our fiat currency is ONLY backed by government assurances (not gold or silver as in the past), then you need to either have faith in the government to be honest and do the right thing or protect your assets/finances outside of the mainstream financial system (physical gold and silver).
The market has tried to bake a default in, because everyone knows that it's going to happen. But I have a suspicion that the too many people have been playing on the market shoreline and trying to dance back and forth as the waves come in and go out and one of these days a tidal wave will wash them out to sea.
The large banks with investment division will suffer marginal losses in their investments in EU banks who actually hold Greek debt. Tough luck.
The problem with the EU entering sovereign insolvency is that their current recession will deepen, lowering demand for our exports and their currency will tank in value enabling them to buy fewer of our exports.
The lesson we should draw from Greece and the EU is not to further limit investment here, but to stop our insane government borrow and spend policies NOW before we join Greece in about 3-4 years,
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Political procrastination is gonna bite us all in the butt - again. Aaarghh!!!