Market Memo: Would a Greek exit from the euro be Lehman-like?
As Greece grapples with tightened austerity measures, tax reform and growing citizen unrest, international equity strategist Brian Holland and international fixed-income manager Ihab Salib weigh in on what may happen if Greece’s membership in the eurozone and its common currency come to an end.
Holland: Prior to the collapse of Lehman, there were few people who could imagine what the massive impact of its demise would have on the entire financial sector. A Greek exit has presented the same possibilities, although we agree that the overall effect would be more muted today than it would have been when the debt crisis first arose at the end of 2009.
Much like the global financial sector, however, the European Union (EU) is highly intertwined so we do believe a Greek exit, despite the small relative size of its economy, would come with serious ramifications to the union. Although the EU and European Central Bank (ECB) have taken measures to diminish the financial impact of a Greek exit with regard to the European banking system from a sovereign perspective, many banks still have cross-border liabilities that would affect their capital bases.
Additionally, the stability of the EU and the common currency would be called into question, with intensified focus directed at Spain and/or Portugal. For this reason, we agree that it is in the best interest of the EU, at least for the foreseeable future, to avoid a Greek exit until a formalized plan for an organized withdrawal from the EU is put into place. Given the shaky state of the EU economy and finances, now is not that time.
Nevertheless, there may come a time when the Greeks decide that the pains of the austerity measures are not worth membership in the EU. If, or perhaps when that happens, we will see a return to the drachma and serial devaluations.
Salib: I agree with Brian that in late 2009 through 2011, the impact of a Greek exit could have been even larger than what occurred post-Lehman because the market did not have an understanding of where the losses were and how far they would extend across banks and other financial institutions. That’s not the case today. Although there would be impacts on Europe and the global economies, we believe the market has a much better handle on who holds what debt and how the losses would impact those entities.
Consider that the majority of Greek debt now is held by official institutions, so it isn’t circulating in the market. Also, many institutions have had time to develop contingency plans to react to the “what if.” It is similar to the concern over what would happen if Greece defaulted on its debt. By the time it did happen in March of 2012, the market was fully prepared and the impact was minimal.
That said, while possible, we don’t believe that Greece will leave the EU anytime soon. One reason is the European community has much more to lose—not so much in terms of Greece’s departure—but because of the broader market effects that Brian referred to. As a result, policymakers are more likely to help Greece pay its bills rather than see it leave the EU.