Greek Contagion: One Hell of a Tail Risk

February 14, 2010

The crisis of confidence in Greece’s fiscal health has dented U.S. equities, though not enough to compromise a budding American economic recovery. Even a significant slowdown in European growth prospects might have limited immediate impact on the United States. However, that benign backdrop could vanish, economists at Morgan Stanley say, if the Greek situation were to turn in to an outright credit crisis.  They call it the “contagion tail risk”:

While the retreat in risky assets in the past few weeks is not yet a headwind for growth, it is hardly a plus.  If the crisis spills over into broader risk aversion and a drying up of liquidity — the functional equivalent of the US subprime crisis — the consequences could be more dire.

JP Morgan, for its part, notes that it’s not just Greece investors need to worry about.

No country in the Euro area has yet experienced a liquidity issue, even though marginal borrowing costs have risen.  Nevertheless, a liquidity issue could arise in the coming months, as new funds are needed and as existing debt is rolled over.

Neither firm expects the problem to be insoluble. Like most analysts, they expect the EU will step in if necessary. But just as with the U.S. housing crisis, the mere threat of a meltdown could be enough to damage what fragile trust financial institutions have managed to rebuild after the 2008/2009 credit crunch.

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It would seem that being overly in debt is akin to owning a house or shopping mall that needs repair and you can’t afford to keep up the maintainence and the mortgage payments. You still think you have something, but if you loose your job, or tenants, and your lenders call the loan, then you you have lost everything. I think that Greece, plus the United States is taking that kind of risk. I think that the politicians in both countries are so busy trying to look good, that they are unwilling to face realty.

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