THE BLOG

Greece: Who Really Should Pay?

02/06/2015 12:29 pm ET | Updated Apr 08, 2015

This time around it's Greeks who should beware of foreigners bearing gifts.

Ever since the financial crisis of 2008 hit Greece, I've wondered who really should pay.

Today, trying to find a reason for my unease with what's happening to the Greek people, I took a look at the definitions of two forms of risk that investors can incur when buying foreign debt: systemic risk and sovereign risk.

Systemic Risk

Systemic risk is a term that came up quite frequently during the global financial crisis of 2008. I could never quite figure out what the term meant just by reading about systemic risk as part of a larger context in news stories.

Recently, however, I saw that familiar term used in relation to medical treatments. What I read was that chemotherapy imposes a systemic risk on the body, while surgery and radiation treatments for cancer are more targeted risks to the patient.

In regard to investing, Wikipedia says, "In finance, systemic risk is the risk of collapse of an entire financial system or entire market."

We all know, or think we know, what an entire body is, but what is meant by "an entire market"?

To answer that, perhaps we need to look at what "diversification of assets" means to investors. Wikipedia says that diversification is one way that systemic risk can be controlled, to some extent.

The four ways Wikipedia lists for mitigating systemic risk are "Avoidance, Diversification, Hedging and Insurance by transferring risk."

Avoidance is pretty clear, but what is diversification? Wikipedia says, "In finance, diversification means reducing non-systemic risk by investing in a variety of assets."

So really, diversification doesn't reduce systemic risk at all, does it? It only reduces other kinds of risk. What about the other two means of controlling systemic risk?

Interestingly enough, recently I read that large institutional investors, such as pension funds, are pulling out of hedge funds. Institutional investors have found the risk of investing with hedge funds too great.

Also mentioned in Wikipedia's article on systemic risk is that sharing the risk is another way that people reduce systemic risk.

This is why insurance is on the list. But, of course, sharing the risk doesn't always work out, and it usually costs the buyer some money.

Systemic risk seems to be the risk that an entity, be it a physical body, a financial market such as the stock or bond markets, or a political system is in danger of extinction or severe damage. And there's no real way to ward off all the danger.

Sovereign Risk

So when it comes to sovereign debt, how do we look at systemic risk?

For example, is Greece really at systemic risk right now? What if the country gets dumped out of the European Union? Will the nation of Greece still exist?

We think it would, but it would be quite damaged. No one would want to loan it money anymore.

Sovereign debt risk is the risk that a sovereign government won't be able to pay back its debts to its creditors. These creditors include foreign bond holders, big banks, and national governments.

When a government can't pay, its currency exchange rates are often affected. This impacts all kinds of private contracts in the forex market. This is why foreign corporations, large investors, and all kinds of banks are affected by sovereign risk, as well as the sovereign government that's unable to pay its debts.

Like systemic risk, there isn't a lot investors can do about sovereign debt risk except shift their sovereign debt risk onto others' shoulders, and perhaps also increase the systemic risk for those others.

Shifting the Greek Burden

It seems to me that's exactly what the holders of forex forwards, futures and other contracts involving currency exchange, and the creditors who hold Greek sovereign debt, have done to Greek taxpayers.

Taxes in Greece are astronomical. Banks have ceased to be trusted. And property taxes on houses in Greece now are so high that Greek people can't even afford sell or buy houses anymore.

Investors were the ones who chose to gamble when making forex contracts, buying Greek bonds and derivatives, and making loans to Greece. Other governments have given Greece loans, and the ECB is now considering a bailout. Those investors were all supposed to bear the risk of sovereign failure.

I don't understand. Why aren't the big investors, banks, and governments who made the loans to Greece paying the price?

Why are the Greek people alone being asked to bear the burden of partial failure of a global financial system that has become as interconnected and complex as a biological system such as the human body consisting of more than 37 trillion cells?

Ruining Greece's economy is like ripping out the heart of democratic Europe and hoping the Eurozone will survive.