JUNE 17, 2011
The Next Global Credit Crisis: Why U.S. Banks and Greek Debt Will be the Toxic Trigger 

BY SHAH GILANI, Contributing Editor, Money Morning

Will a hidden link between the Greek debt situation and the U.S. banking system ignite the next global credit crisis?

The odds of the "next" global credit crisis are increasing with each new day, and with each new revelation. And escalating fears are hitting worldwide stock markets hard.

Just yesterday (Thursday), Greece's leaders revealed that the country's socialist government is on the brink of collapse. Greek protesters - angered by brutal austerity measures that will almost certainly heighten the country's record 16.2% unemployment rate - are rioting in the streets of Athens.

On Wednesday, Moody's Investors Service (NYSE: MCO) warned France's three largest banks that their exposure to Greek debt could lead to credit-rating downgrades. There are even concerns that the European Central Bank (ECB) may be technically insolvent - meaning it wouldn't survive a global financial meltdown.

Investors are right to be worried.

But with the European banking system's financial woes currently dominating the headlines, those investors might be very surprised to discover that it's actually the U.S. financial system that may end up as the real weak link in the event of a Greek debt default.

And investors don't even know this link exists.

The Scary Facts About Greece's Finances

Since last May, when the International Monetary Fund (IMF) and Eurozone members ponied up $159 billion (110 billion euros) for a Greek bailout, Greece has had to implement radical austerity measures. Terms of the bailout forced Greece to boost taxes and slash government spending. There was a public outcry, but the country's citizenry largely went along; it had no choice.

One in three Greek workers is employed by the government. As austerity-mandated layoffs have progressed, Greece's unemployment rate has zoomed from 11.7% in the first quarter of last year to the record 16.2% rate recently reported.

And given that government spending is still at 46.8% of gross domestic product (GDP), additional budget cuts will be coming - meaning Greece's national jobless rate is certain to increase.

So is the national anger level.

The sometimes-violent demonstrations on Wednesday forced Greece's Socialist Party Prime Minister George Papandreou to reach out to the opposition party in an effort to form a coalition government.

He was quickly rebuffed, is reshuffling his cabinet and will call for a vote of confidence. A no-confidence vote - pretty much a foregone conclusion at this point - would require new elections to be held quickly.

The Surprising Trigger for the Next Global Credit Crisis?

This kind of leadership chaos is unnerving to stock-and-bond investors around the world - especially since Greece needs an infusion of $85 billion (60 billion euros) by mid-July to remain solvent.

And Wednesday's announcement by Moody's isn't helping. In addition to its warning that France's three biggest banks may be downgraded, the U.S.-based credit-rating firm made it clear that there were other banks in France, Germany and the rest of Europe that could face the same treatment in the event of a Greek debt default.

All of this is widely known. But the largely untold "rest of the story" is this: If the European banking sector implodes, the U.S. financial system could take an unqualified beating.

B ig U.S. banks have been lending generously to banks across Europe. C lose to 29% of their lending books during the past two years have gone to their heavyweight European counterparts. While they have pulled back considerably as a result of recent turmoil, U.S. banks are widely believed to have $41 billion of direct exposure to Greece.

The amount of exposure to the rest of Europe is not easily quantifiable. And this U.S. financial system link doesn't end there: U.S. money-market funds have a hefty European exposure, too.

A recent report in The Wall Street Journal said that the three large banks Moody's is threatening to downgrade - BNP Paribas SA, Credit Agricole SA, and Societe Generale SA (PINK ADR: SCGLY) - get a significant amount of their short-term funding from America's money markets.

According to The Journal, about 12% of the loans made by our biggest money-market funds were made to those three banks.

The interconnectedness of U.S. banks and money-market funds to global banks, many of whom are now at risk from a Greek default, is a sobering revelation.

Even the European Central Bank won't be immune.

Bad News for the ECB?

According to Open Europe, a U.K. think tank, the ECB will be close to insolvency if Greece defaults - or even "restructures" - its outstanding debts.

The ECB has $116 billion (82 billion euros) of equity capital against a balance sheet just shy of $2.84 trillion (2 trillion euros) of "assets" consisting of bonds, loans and "credits". Of that amount, it holds $637 billion (444 billion euros) of debt paper from the so-called "PIIGS" countries of Portugal, Ireland, Italy, Greece and Spain.

Of that total, approximately $270 billion (190 billion euros) are Greece's crumbled paper. Open Europe estimates that a 40% to 50% haircut on Greek debt would come close to wiping out the ECB's capital base. And the spillover from the contagion - the next global credit crisis - would sink the central bank almost overnight.

Lorenzo Bini Smaghi, an ECB executive board member, doesn't buy the conclusions reached in Open Europe's rapidly circulating report - telling the WSJ.com blog that they are "fundamentally flawed."

For instance, on the subject of the ECB's holding bonds that might fall precipitously, Bini Smaghi said that "not being a liquidity-constrained institution, we can act as a buy-side counterparty in markets where sell-offs are taking place, and our investment in those markets can be held to maturity, so that only default risk could threaten our profit and loss accounts."

In terms of collateral, the ECB board member said that "assets held as collateral only constitute a guarantee, not a direct exposure. Accordingly, related price decreases could only induce Euro system losses if those decreases took place after the default of the counterparty."

But here's what's frightening: In dismissing claims that the ECB could fail, Bini Smaghi makes arguments that repeatedly rely on the premise that there won't be any actual defaults.

When talking about the bonds the central bank holds, he opened up the proverbial can of worms by saying that "only default risk could threaten our profit and loss accounts."

Doesn't he realize that default is exactly what's on the table?

It's the "Euro system losses" that would take place as a result of a Greek default that has the global investing community frightened to death. European contagion spells global contagion.

French President Nicholas Sarkozy is in Germany today (Friday) to meet with German Chancellor Angela Merkel. Not surprisingly, the topic will be the Greek debt crisis. President Sarkozy will be pleading with the German Chancellor to back off Germany's call for Greek debts to be "restructured."

The rift between France and Germany, the strongest members of the European Union (EU), could be the straw that breaks the Union's back. That could certainly mean that the next global credit crisis is fait accompli. And it would also represent a definite end to the global recovery.

Merkel to meet Sarkozy on Greek crisis
 Published: 16 Jun 11 17:07 CET



German Chancellor Angela Merkel faces a showdown with French President Nicolas Sarkozy on Friday as the two leaders meet to discuss eurozone plans to rescue crisis-hit Greece.

The German government is playing for time in its promotion of a plan to make private investors – often banks – swap the Greek national debt they hold for new seven-year bonds. The idea has been deemed a step too far by the European Central Bank (ECB) and other European governments, notably France.

They want to offer private holders of Greek bonds the option of voluntarily reinvesting the profits they make from Greek bonds in the country. France in particular is concerned that a number of its top banks are very badly exposed to Greek debt, and are themselves suffering in ratings as a result. The idea of forcing private investors to take part in the rescue package is thus unpopular in France, according to Der Spiegel.

The ECB sees the state debt crisis as the greatest danger to the European financial system and warned in its financial stability report on Wednesday that it could be damaged by the continuing problems.

“Any solution must be voluntary enough that a state insolvency or a non-payment rating can be avoided,” said ECB Vice President Vitor Constancio in Frankfurt.

He said that currently the risk of such a financial disaster was limited to Greece, Ireland and Portugal as far as the markets were concerned. This could no longer be guaranteed if a country were to go bankrupt, he said, according to Der Spiegel.

The worry is, the magazine reported, that any intimation of forcing investors to keep their money in the bonds could lead to rating agencies saying that Greece was unable to pay its debts, which could lead to incalculable chain reactions on the finance markets. This could result in a dramatic loss in value of Greek debt, billions of euros worth of which the ECB is holding.

The Handelsblatt daily reported on Thursday that although there was a row of top-rank European meetings scheduled for the next week or so, a decision could be delayed until July. A special meeting of eurozone finance ministers is planned for Sunday while European Union leaders meet in a summit next Friday, where at least a basic declaration should be released on what should be done for Greece.

But Germany would like to put off making a decision on the second European aid package for Greece until September, essentially admitting the EU is unable to act now.

“The argument is – we want to buy time because we don’t know what we should do,” an EU diplomat familiar with the issue told the paper.

EU Currency Commissioner Olli Rehn has suggested the Greek rescue package be split into two parts, with the release of the next tranche of €12 billion in credit on Sunday. An agreement for a longer-term could then be made in July.

“This way we prevent a credit collapse scenario and ease the way for agreement on a mid-term strategy,” he told the Handelsblatt.

The Local/hc

Bankrupt but armed to the teeth
 Friday 17 June 2011 Steve McGiffen

Nothing exposes the hypocrisy of those currently running the EU more than the recent discovery by French journalist Jean-Louis Denier that the Greek government is being encouraged to spend vast sums of money on a range of hardware which no-one needs and no sane person wants.

Having spent the last couple of years arguing that austerity is not the "necessary" policy response demanded by the financial and economic crisis, behind the scenes it isn't in any real sense austerity which is happening at all.

It turns out that throughout this crisis of Greek public debt - and under the direction of the same international potentates who are imposing spending cuts on welfare, pensions, health care, the public sector and all of the other usual targets - Greece's "socialist" government has continued to spend vast sums on armaments.

The fact that the principal suppliers of these arms are two of the biggest proponents of austerity, the US and Germany, should not surprise us.

We have moved beyond a situation in which lying by leaders is not so much accepted as expected, to one in which reality plays no role whatsoever in their discourse.

Greece may, in the estimation of politicians and the mass media, be a badly governed, corrupt kleptocracy populated by robber barons and a lazy, feckless class of reluctant workers.

But it is at least armed to the teeth.

The immediate cause of Greece's financial crisis was the doubling from 2005 to 2008 of the value of loans from Western banks to the country's government. By the end of that period, these loans amounted to $160 billion (£100bn).

At the same time the "defence" bill of this relatively small, relatively poor EU member grew by a third in the five years to 2009 as it became the world's fourth largest importer of armaments.

This is a country with fewer than 11 million people, one of the world's lowest birth-rates and a negative growth rate.

With a GDP higher than Spain's it isn't as poor as sometimes assumed. But its wealth is unequally distributed and it spends only 4 per cent of its annual budget on education, putting it 105th in a global league table. Within the EU, only Slovakia spends proportionally less on schooling its people. The Greek "defence" budget is even higher than this, at 4.3 per cent of GDP.

Such figures can be hard to credit - it's more than two millennia since any part of Greece was a superpower, yet its leaders prefer bombs to books.

So it's clear clear that the ever-increasing bail-outs are, directly or indirectly, consecrated to the purchase of arms. Year on year, Greece has been spending money it does not have on weapons it does not need.

According to a joint investigation by Greek and German justices, bribery of top Greek politicians, public officials and military leaders has been used to secure contracts.

The money to purchase these weapons is supplied by bank loans which come from the same countries which are supplying the arms, including the US, Germany and France.

Greece has splashed out about $3bn on French combat helicopters, $2 billion on US fighter planes and roughly the same figure on French Mirage aircraft. German submarines come in at nearly $6bn and the outlay on French combat helicopters is a trifling half a million or so.

This presumably exempts Greece from recent criticism from outgoing US Defence Secretary Robert Gates that Europeans don't spend enough on arming themselves.

Yet just what Greece is expecting to defend itself from is unclear.

Its old enemy Turkey is in fact gradually reducing its arms purchases and last year proposed an accord to Greece under which each would cut its spending on weaponry by a fifth.

Despite its financial crisis, Greece refused to agree to this.

Only in 2009 did Athens start to experience difficulties in paying for imported arms and at that point the EU began to show concern.

When it could meet the bill for the astronomical sums spent on weaponry which, mercifully enough, is for the most part unlikely ever to be used, no-one had a problem.

This puts into a strange new context the recent spat between Germany and the European Central Bank as to how best to help Greece to pay its debts without destabilising markets.

Every single aspect of this row serves merely to cover up the reality of a situation in which a middle-income country can no longer afford to provide the means whereby its people can lead decent, productive, satisfying lives, yet can spend billions and billions on instruments designed to bring other lives to a premature end.

In Greece, protests continue as a new round of cuts, amounting to around £4bn billion before the end of the year, is debated in the Greek parliament.

Deputies from the ruling former social-democratic Pasok are beginning to defect.

I was recently asked an interesting question by a young woman from the US who had been watching events unfolding in Spain. "An uprising in a dictatorship has an easy solution, in a sense." she said. "You can introduce parliamentary democracy and hope that this provides a platform for resolving grievances which everyone can respect. But what happens if you have an uprising in a parliamentary democracy?"

I couldn't answer. But I suspect we may soon find out.