Greece's Obese Tail - Follow-Up

Posted on October 27, 2011 by David Laidlaw

In July we posted commentary on Greece’s debt problems.  We hypothesized that Greece (and Ireland and Portugal) could repay about half their debt.  Including the 3 countries in the calculation, a 50% loss would wipe out $200 billion in assets.  This would lead to European banks losing about 25% of their capital (or about $150 billion) assuming the banks owned 75% of the debt.  As a result of the loss banks would need to recapitalize or fail.

As of last night, we now know that our 50% cut was accurate.  European leaders persuaded investors to take a voluntary 50% loss on all Greek debt.  They also increased the rescue fund to $1.4 trillion.  And as we speculated, banks will need to recapitalize after the debt write-down, which may be why the rescue fund was increased.  Greek Prime Minister George Papandreou said recapitalization may start with Greece buying shares in its banks. 

The market is up today on the news.  It provides some clarity and the 50% cut is better than outright default.  Greece’s total debt was about $240 billion, meaning investors lost $120 billion last night.  Given that the rescue fund is $1.4 trillion, more losses must be anticipated.  In fact, it would not be surprising if more countries persuaded investors to take a “voluntary” 50% loss.