How will the historians call this one? The European Crisis? Euro-doom? If you’ve been under a rock for the past few months, you may not have noticed the recent downturn in the markets. The headlines are all about the potential default of Greece on its debt, possibly followed in short order by a slew of other EU counties — Spain, Portugal, Ireland and Italy top the list.
Naturally, I have received a few e-mails and phone calls on this one; so, let’s talk about what happens if/when one or some of these countries go down for the count.
Putting It Into Perspective
Before we get all hot and bothered by a Greek default, let’s look at the difference between a country’s default and the sub-prime crisis. Why, you ask? Because of comments like this from one trader:
This is similar to what took place pre-Lehman Brothers.
Nonsense.
When a large amount of homeowners take out mortgages they can’t afford, and the values of their homes drop, they leave the banks holding the bag. A $500,000 mortgage on a $300,000 house is, essentially, worthless to a bank. Sure, it can recover a portion of the money it lent, but $0.60 on the dollar is a huge blow. Do that to the bank a few million times over the course of two or three years, and…voila! You have a banking crisis!
When a country “defaults” on its debt, it typically does not walk away, sending the keys to its foreign bond holders. Instead, the country restructures – slashing its budgets, cutting spending, and perhaps seeing some of its debt “forgiven” by bond holders…in exchange for a higher interest rate on the lower amount. That debt doesn’t go to zero or even $0.60 on the dollar (usually). It gets restructured, perhaps cut a bit, and then worked out over longer periods of time.
Though these are very rough calculations, you get the point — the sub-prime crisis was much larger than the Greek debt crisis. And, they are totally different. Investors are incentivized to buy Greek debt at a discount as they may earn capital gains and interest on their bonds. (A default would not normally stop interest payments altogether. It would instead cause existing debt to be refinanced.)
Investors in sub-prime loans after 2007 would earn no interest (if the loan defaulted), and could only make money from gains. As such, the loans would have to be sold for less than $0.60 on the dollar if the bank didn’t want to hold the non-interest paying debt.
So…What If Greece Defaults?
But it’s still a problem if Greece defaults, right? Not really. And to put that into perspective, let’s use common sense backed by some statistics and history. First, the common sense – and no offense to our readers in Greece, but…what the heck is in Greece from a global economic standpoint? Nothing!
Greece exports a little, but to Italy and Germany (mainly, about 11%), and to Bulgaria, Cyprus, the US (5%), the UK (5%) and Romania. They import a little as well. How “little” you ask? The entire economy of Greece is $331 billion — about 2.3% the size of that of the US. In short, if Greece fell off the face of the Earth economically, we would barely notice.
But It’s The Whole Eurozone!
Let’s say they haven’t contained the crisis — that, along with Greece, Spain, Portugal, Ireland, and Italy all default on their debt. In fact, they all collapse economically. What’s the damage? With GDPs respectively of $1.4 trillion and $2.1 trillion, Spain and Italy are the two “big” elephants in the room. The GDPs of Portugal and Ireland are each about $228 billion. You know…just shy of Apple’s (AAPL) market cap as of yesterday’s close.
First, let’s be realists — the odds of all five countries experiencing a total economic collapse to zero are practically nil. They all need to get spending and debt under control. Maybe they all need to restructure and refinance their debt. But they ain’t all going to zero.
Now, let’s amuse ourselves. What if their combined economies — coming in at 31% of US GDP — all collapsed entirely. What if they all went to zero…
The World’s Second Largest Economy Just Collapsed? Big Deal.
Before its dissolution, the USSR’s economy was second only to that of the United States. In 1989, the GDP of the USSR was $2.7 trillion — about 49% of US GDP ($5.5 trillion). And if you think that Greece’s finances are screwed up, you should see what the USSR looked like before it collapsed! Out-of-control government spending to prop up failed enterprises and fund military expansion and cold wars, all while subsidizing consumers.
In 1991, the Soviet Union was dissolved. The currency was wiped out. Debt defaulted. Civil unrest. Cats and dogs living together. You get the idea.
The Soviet Union essentially went to zero. And how did our markets respond?
Is This a Crisis or an Opportunity?
Some will say that I’m oversimplifying things. I’d argue that they’re overcomplicating things. Image what the news was like from 1989 through 1993, just before, during, and after the collapse of the Soviet Union. Did the media keep a cool head? Did reporters brush it off, seeing clearly into the future that the collapse of the world’s second largest economy was nothing compared to the potential 2010 debt restructuring of Greece’s tiny economy?
Let’s rely on common sense. We’ve survived two world wars, a depression, dozens of recessions, a cold war, and more, including the creation of the Euro. And this is what we’re worried about?
Filed under: Economics & History
Interesting point but are those countries the only ones facing the problems you brought up? You continuously compared the different GDP’s of these countries to America but America is right around the corner to instituting maximum austerity as these countries seem to be on their way to. I still think that value investing and re-adjusting your portfolio as events take place is the best option as opposed to trying to estimate the time and occurrence of some kind of crash.
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Joe, I’m glad someone finally pointed out that the sub-prime was caused by people buying houses they couldn’t afford (even though in some cases the blame may not lie totally with them). I’ve been saying this for the last year+ and no one will listen. When Wall Street is the big bad bully you sure can’t blame the profligate spending of the America people for a little economic crisis can you?
On second thought, maybe this is a discussion for another website!
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Joe, nice post. I agree, the general consensus seems to be any bad news is the next “end of the world as we know it” headline. I try to just keep my focus on my company, and the companies I invest in. Macro matters, but micro..ie the business your firm is doing matters more. I can’t control anything else anyway. I do follow what Buffet said was his #1 “indicator” in the railroad associations monthly reports for railcar data. Anyone looking at Santander (STD). Seem like it might be a good play right now if you are willing to take some risk. Been pounded because of the EuroScare. Have a growing SouthAmerica franchise, just bought out BofA on a JV deal.
Casey Mattson, CPA
http://www.jmpcpas.com
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Many companies out there truly need grants to continue running. Our FDIC financial institutions could be struggling with the other companies having difficulties with our recession. The asset ratio of banks in America is not looking to good with multiple mortgages being past due as things are. Banks can’t add services like payday cash advances because they won’t make any money off them, so what are they going to do to make a lot more cash? Banks already make money through things like overdraft fees, so they cannot do away with their free services like free checking or they risk losing customers to other institutions.
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Yep – I am attempting to profit from the fear in Europe by opening a position in Santander (STD).
My analysis is on my blog http://www.globalstockinvestingtoday.com, dated 2nd June 2010.
Any issues that are raised after reviewing the analysis,would be welcomed!
Joe,
Another great post – keep them coming,they are so few and far between!
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Hey Joe,
Great to read your thoughts. Good stuff. Let me chime into this interesting discussion by saying, Goldman Sachs covertly funneled billions into the Greek economy and mis-labeled what were actually loans as “currency trades.” The rest of the world had no idea things were so bleak inside of Greece. The countries debt bubble got bigger and bigger when it should have been long popped. Meanwhile, GS bet against the economy it was supposedly “helping” by buying up truck loads of Credit Default Swaps, which exponentially increased the resulting debt obligations after the collapse.
The sub-prime crisis was made infinitely worse because large banking institutions were doing the same thing to the housing market- the bubble expanded with fast and sleazy debt and suppressed rates (which have and will continue to discourage personal savings). Why would large banks want to do this? Like you said they got pennies on the dollar for this real estate- to drive out the smaller competition, consolidate their influence / wealth and collect the insurance money on all the junk debt. Besides, the banks always knew, with insiders like Paulson, Rubin, and Greenspan whispering in presidential ears, that they would have a safety net.
Greece is like the sub-prime crisis for this very reason. It is a representation of what is happening all over the world. Everyone now knows the worlds wealthiest banks have been manipulating entire economies. We still don’t know how much debt is out there (or if we do we haven’t psychologically digested it). I think this is one reason why Bernanke has made sure reform legislation does not have reserve requirements in it. Reserve requirements would require audits, and the Fed is surely scared of what we will find. Not to mention the scam known as fractional reserve banking is the lifeblood of international finance. There is no more trust in the system.
Banks have been consolidating wealth by expanding then retracting the money supply (or manufacturing collapse) since the days of the Roman Empire. Currently the US is paying 500 billion dollars a year in interest on the National debt (and this is with interest rates at record lows!). There is no excuse for this. The Federal Reserve, a privately held corporation run by the aforementioned bankers, has driven the dollar to 4 cents of its 1913 value and kept the US in a state of perpetual debt. It needs to be abolished right this second.
Keep up the good work Joe. We should definitely link up for coffee or a beer sometime soon.
All the best,
Rory Fanning
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Spot on again Joe,
I’m sat in the middle of it here as a Brit in France, and I’m cheering the new UK government along as they start to slash public spending and idiotic government departments that serve no purpose whatsoever, given I’ve been focusing my investment attention on the UK of late and a short list of really great quality value plays this cheers me no end.
As you say, these are countries not out of work home owners and they do have huge scope for cutting costs. I don’t want to insult the Greeks either, but when someone who lived there tells me that the red tape in the public sector is so bad that you have to visit three offices, to have your paperwork stamped, just to get a driving licence it gives a strong indication that some streamlining is in order. These same paper stampers retire in their 50s on nice final salary schemes all paid for by the budget deficit. Would I be rioting if someone took those employment terms away for me? you betcha.
Add to that tax evasion in Greece is apparently rampant, and people actually paint their pool covers green (grass is green) to avoid the tax man seeing that they have a swimming pool via Google earth and we have yet another avenue for saving a few quid.
Ken Fisher has recently described what we’re going through as a wall of pessimism, where any excuse is used by people to jump out of the market, this “debt situation” being a prime example I suppose. All power to em if that’s the case.
Do I think this is an opportunity? Well I’ve been buying.
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