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« Silver prices Update 15th June 2011 | Main | Silver ETF gets help from its friends »

The Risk of an Unorderly Default

ECB Exposure to the PIIGS 10 June 2011.JPG

The situation is becoming harder to deal within the Eurozone as the requirement for more bailout money is needed and those expected to foot the bill are starting to feel a little nauseous. Scanning the air waves we came across this piece on the Business Insider which may interest you.

Greece needs to force a 7-year extension on its bondholders if it is to receive more bailout cash from European powers, says German finance minister Wolfgang Schäuble.

Schäuble has outlined in a letter that the German government wants this extension as part of a second bailout for Greece. Essentially, he wants private sector bondholders to play a part in this next part of the deal.

And Schäuble is using fears of a default to try to force the ECB to agree to a deal, saying that if a deal isn't done by mid-July, "we face the real risk of the first unorderly default within the eurozone."

This sounds strikingly like the current fight in U.S. Congress over the debt limit, with only one big difference: everyone is scared about a Greek debt default, while fears over a U.S. technical default are waning.

The party most afraid of a Greek debt default is the ECB. Not only is it exposed to Greek sovereign debt, it is also exposed to the country's banking sector, which will surely be in crisis if the country defaults.

Any sort of default could be devastating to the ECB. It may have to step back from its no restructuring position, if it is to survive intact.
From Open Europe:

The most critical threat to the ECB’s books is Greece, which is likely to face a default within the next few years even if the EU and IMF give it a second bail-out package. We estimate that through its bank lending and government bond buying programme, the ECB has taken on around €190bn in Greek assets. In order for Greece to get its debt down to sustainable levels, we estimate that the country needs to impose a haircut of 50% to the majority of its debt, in which case the government bonds the ECB has purchased and the collateral it is holding from Greek banks will take big hits.

As noted, a Greek restructuring would bring down the country’s banks, which would not be able to repay any of the loans which they have received from the ECB. Consequently, the ECB would take control of the collateral which the Greek banks posted in order to receive the loans in the first place. However, the value of this collateral would also fall significantly following a restructuring. This means the ECB will not fully recoup the loans it has handed out, and will only be left with the remaining value of the collateral. We expect the ECB’s holdings of state-backed paper to be worth between 25% and 50% of its original value following a Greek debt restructuring (this is what we assess in table 3).

Under this scenario, we expect the ECB to face losses of between €44.5bn and €65.75bn (equal to between 2.35% - 3.47% of assets). Although such loses would not wipe out all of the ECB’s capital and reserves, it will make it between 52 and 123 times leveraged. 15 A business this leveraged would be considered insolvent by any account – Lehman Brothers was leveraged around 30 times when it went under. Therefore, the ECB would likely need to be recapitalised in such a scenario.

All a bit grim, isn't it?

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sk chart 22 May 2011.JPG

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Reader Comments (3)

Good article. Thanks.

Bondholders taking a hit on bad loans. What a novel concept. Gee, I just hope no bankers are injured in the process. That would just be awful.

And the ECB Heaven forfend.

June 10, 2011 | Unregistered Commenterfallingman

Bondholders taking losses on bad loans. What a novel concept. I just hope no bankers are injured in the process. That would be just awful.

June 10, 2011 | Unregistered Commenterfallingman

Bondholders taking a hit on bad loans. What a novel concept. I just hope no bankers are injured. That would be awful.

June 10, 2011 | Unregistered Commenterfallingman

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