Beware The Athenian Haircut – It’s Coming

[Update at end of post]

So the week that began with the usual suspects predicting imminent collapse of the Eurozone ended with the same suspects predicting imminent collapse of the Eurozone, although their reputations were slightly diminished, as the Eurozone had not in fact collapsed.

Moreover, a key vote in the Greek parliament, on accepting yet more austerity, had been won, but the spectre of default still hangs over Athens. So who is right? Is the Eurozone teetering on the edge? And if it’s so near to collapse, why is the currency still trading at such a high level against Pound and US Dollar?

Ah well. As long as the Germans – and to a lesser extent the French – maintain their determination to make the single currency a success, there will be no collapse of the Eurozone. However – and it’s quite a big however – that does not mean that the situation in Greece is sorted – far from it.

And if Greece defaults, it’s not only the other Eurozone countries that are on the hook. As Mark Weisbrot has explained, the European Central Bank (ECB), in taking a hard line with countries like Greece, has sent out appropriately tough signals to the money markets, and thus the Euro has held firm on the exchanges.

But this has also translated into Greece having to accept the kinds of conditions that will almost certainly mean the country is unable to repay all its loans. Getting private sector banks to “roll over” their lending will not be enough: as I’ve said on two previous occasions, someone is going to have to take a haircut.

In other words, some lenders will have to accept that they are not going to get 100 cents on the Euro from their Greek debts. Most of that debt is in France and Germany, so coming into view is a test of not just the Franco-German commitment, but of their banks’ resilience.

If that does not happen in an organised manner, then the shock will reverberate beyond the Eurozone: the UK has some exposure to Greece, as does the USA. Moreover, the latter is the senior partner in the International Monetary Fund (IMF), and if Greece defaults, the US will have the biggest tab to pick up.

As Weisbrot says, with Lehman Brothers still fresh in the memory, one might think that Washington would be paying serious attention to the prospects for Greece – maybe even getting the ECB to do likewise, and prepare for an organised restructuring of all that debt. Because some kind of deal will have to come.

[UPDATE: What did I tell you? Less than two hours after publishing this post, an article appeared (read it HERE) confirming that action is under way to avoid an "unruly" default, by getting private sector investors to take a haircut. There is also the problem that banks in France and Germany took out insurance on loans to Greece via Credit Default Swaps (CDS), which in turn may involve banks and hedge funds in the UK and USA. If the CDS were triggered, this could invoke a contagion which would draw in many players who had not made loans to the Greeks. This underscores the need for discipline in handling what is now becoming inevitable. It may also provide the model for tackling similar situations in Ireland and Portugal]