Uncertainty Over Impact of a Default by Greece

By LANDON THOMAS Jr.

APRIL 27, 2015

The New York Times

When it comes to assessing the consequences of a messy Greek default on global markets, two views have vied for supremacy in the minds of investors.

First, there was the chaos theory of imploding European banks and a spreading bond market panic. Then, after aggressive action from the European Central Bank, a calamity in Greece — be it a default or an exit from the euro — came to be seen as manageable. Investors, hungry for yield, in turn piled into European stocks and bonds.

Now, with Greece nearly out of cash and talks with the country’s creditors at an impasse, regulators, investors and economists are coming around to a view that after five years of endless analysis and speculation, no one really knows how the markets will react.

And that may be the scariest thought of all.

“There is just no playbook for this,” said Atul Lele, chief investment officer at the Deltec International Group, a Bahamas-based investment company. “That is what concerns me.”

Nothing vexes a professional investor more than uncertainty, that creeping belief that after all the number-crunching and analyzing, one is still unable to predict anything resembling a likely outcome.

And that is where many investors find themselves at this moment as they struggle to interpret the mix of bureaucratic machinations and inscrutable politics that have come to define Europe’s relationship with Greece.

On Monday, the Greek stock market rallied and bond yields dipped in the face of speculation that Greece’s controversial finance minister, Yanis Varoufakis, would assume a reduced role in future talks with Greece’s creditors.

During talks last week in Riga, Latvia, eurozone officials complained that Mr. Varoufakis was obstructing progress on a debt deal by not providing details on the economic reforms that Europe is demanding from Greece before releasing another round of loans.

But the notion that Prime Minister Alexis Tsipras will just dump Mr. Varoufakis to appease the International Monetary Fund and Germany is also not assured. Over the last two years, the two men have become very close, both personally and in terms of their shared view that austerity in Greece must come to an end.

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They have bonded over endless phone calls before Mr. Tsipras’s party won the election earlier this year. While Mr. Varoufakis was on a teaching break at the University of Texas in 2013, Mr. Tsipras came to Austin for a visit, and the two men and their wives drank beer and danced to country music in the city’s honky-tonk bars.

Over the weekend, Mr. Tsipras reaffirmed his support for his embattled finance minister in a phone call and email exchange with Jeroen Dijsselbloem, the Dutch finance minister who represents European creditors and who has clashed on several occasions with Mr. Varoufakis.

In a brief interview on Monday, Mr. Varoufakis said that while a new team was being formed in relation to creditor talks, he will oversee it and continue to represent Greece in these negotiations.

“I am not going anywhere,” Mr. Varoufakis said.

In addition to pushing for Mr. Varoufakis’s ouster, Mr. Dijsselbloem asked that creditor missions be allowed to resume their work in Greek government ministries.

To both these requests, Mr. Tsipras’s response was no, Mr. Varoufakis said.

Unlike the market talk during the earlier crisis in 2011 and 2012, the debate among investors now is not focused on which banks and funds will suffer from their Greek investments, as these exposures have been sharply pared back.

Instead, the current market worry is both more diffuse and less clear.

Global investors have bought billions of euros worth of stocks and bonds in other debt-heavy nations like Italy, Spain and Portugal — driving their bond yields to record lows. They have done so in the belief that with Europe showing signs of recovery, and with Mario Draghi at the E.C.B. promising to buy European bonds in bulk, a default in Greece would not pose a broad threat. Greece, after all, represents just 2 percent of the eurozone economy.

Yet for many bankers and regulators — many of whom still bear the scars of the collapse of Lehman Brothers in 2008 — it is precisely this mix of complacency and uncertainty that worries them.

“The bottom line is that no one really knows what will happen if Greece does not pay,” said Hans Humes, who runs Greylock Capital, a hedge fund that specializes in distressed bonds.

It is not for a want of trying.

Over the last year, investors have taken some unusual steps to gain just the slightest information edge when it comes to grasping these complexities.

One investor commissioned a psychiatrist to assess the mental health of Mr. Varoufakis via video clips, to try to better understand the opinionated academic’s brazen negotiating tactics.

Another commissioned a psychological profile of Chancellor Angela Merkel of Germany from a former British spy, as it is widely accepted that Europe’s ultimate decision on Greece will be made by her and not 18 finance ministers.

And one banker, seeking some historical perspective, has been scouring Byzantine history books for fresh insights.

There have been few answers so far, however.

“We just don’t know,” said one frustrated hedge fund investor after a weekend spent scrutinizing the websites of Greek newspapers for a clue.

One thing is for certain, though: As long as the debt talks stumble on without agreement, the greater the likelihood is that Greece either misses a debt payment (it owes 763 million euros, or about $830 million, to the International Monetary Fund on May 12) or submits to capital controls to stem a fatal bank run.

Greek finance officials have been looking into the possibility of Greece issuing i.o.u.s, or scrip payments, as a way to save scarce euros.

Mr. Varoufakis has long argued that a Greek default and exit from the euro would be seismic and carry a broad cost to Europe of over €1 trillion.

European officials have dismissed this is as scaremongering and they point to a new rescue fund of €700 billion that they have set up as well as the improved health of their banks.

Eric Dor, an expert on eurozone capital flows at the Iéseg School of Management in France, says in a paper that while private sector investors hold fewer Greek bonds these days, the exposure of the European taxpayer to Greek debt has skyrocketed to €318 billion.

By refusing to pay Greece the €7.2 billion from the last bailout because of disagreements over economic reforms, Europe is now courting a default on this much larger sum.

It is surprising, Mr. Dor argues in his paper, that European policy makers would take such a risk to defend their economic principles.

Senior members of the United States government, in perhaps their only area of agreement with Mr. Varoufakis, also worry that Europe may be underplaying the consequences of a Greek default.

“We view this as serious,” said one official, who spoke on the condition of anonymity. “This is a world of unknown unknowns.”