Thursday, October 13, 2011

A Comment on Greece

I am not an economist, financial analyst, or expert in finance. Aspiring, perhaps, but not yet. To be frank, I am far from any of these things. One thing I do believe I have, however, is common sense. So here begins my thoughts on the Greek sovereign debt crisis.

I read today in an International Business Times article that the "Market needs a real concrete plan from Europe to break out". Two ideas were presented: either through the recapitalization of their banks or through strengthening of peripheral Eurozone countries' economies, so that they can pay back their debts in an organic manner.

I agree with the latter. Pumping capital into banks will only put off the inevitable default of Greece and perhaps other struggling Eurozone countries.

A 2010 estimate of Greek debt was $469.8 billion. That's 142.8 % of their GDP. I've searched for quite some time now to find the revenue from taxation in Greece. I also tried to find the amount of money Greece owes in interest on its debt to no avail. Comparable statistics probably would not be of use here because tax rates and interest rates vary. If Greece takes on more debt by bailout, how can they possibly cover the interest on their debts, let alone make payments towards the principle?

Let's have a look at CDS spreads on European sovereign debt, specifically Greece.

The market is pricing in an imminent default by Greece on their debts. The spread is now approximately 5,400 basis points. That means it costs 54% to insure $10 million dollars worth of Credit Default Swaps on Greek sovereign debt. On the other hand, it costs only 6% to insure $10 million dollars worth of UK debt.

Let's compare that to the spread on BBB- indexes of CDS on subprime mortgages


The data set here is through July 13, 2007, 3 months before the Dow peaked at 14,078. I wish I were able to find a more complete data set to further illustrate my point, which is that if the spread was at 2,800 basis points when the CDOs upon which the CDSs were created began to default, then surely Greek debt is due for an imminent default being that its spread is at 5,400 basis points. (I know that it is likely the spread on the BBB- index of CDSs on subprime mortgages increased into 2008, until the whole system fell apart. However, I'm not sure how much further the spread would have widened, especially given that the CEOs of Merrill Lynch and Citi group resigned due to losses on CDOs in late October, 2007 and early November, 2007, respectively. )

In summary, I strongly believe that the only way for Greece to get out of this crisis avoiding default is for significant organic growth to take place in their economy. This would possibly allow them to begin paying off their debts without taking on more debt, which would lead to a solvency crisis. By looking at the spread of Credit Default Swaps on Greece Sovereign debt, it is clear that the market is pricing in an imminent default. (Did I mention Greek 2-yr bond yields are 50% and 10-yr are 24%?) You couldn't pay me 75% to purchase Greek debt!

Cheers!

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