The Potential Implications of The Greek Default

What has been expected for months became official on Friday.  Greece has now officially defaulted on its debt.  This raises the important question of what can we now expect from investment markets.  Initially, the response is likely to be minimal, as policy makers have been preparing for months for a Greek credit event.  This has included flooding the European banking system with liquidity and helping to orchestrate Thursday’s PSI deal to come together as planned.  Today’s trading in stocks, bonds and commodities were evidence of the muted initial reaction. 

Of course, it is never what is anticipated that shocks the market.  Instead, any market fallout will likely result from unexpected spillover effects from the default and would likely only begin to surface sometime out over the next few weeks.  A prime candidate for trouble would be the settlement of the CDS contracts written as insurance for the Greek debt.  If a financial institution that wrote the CDS insurance is unable to make payment on the claims (the circumstances that took AIG under back in 2008), this could potentially spark a contagion effect.  But sustained problems with CDS is also unlikely in the end, as the European Central Bank has gone to great lengths to try and protect banking institutions from this type of outcome and would likely quickly intervene with additional support if necessary.  Perhaps we will see some small market shocks along the way, but it does not appear at least at this juncture that anything material is likely to come from these settlements.

Instead, the real danger from the Greek default likely still lurks in the shadows.  And it would ultimately be something that policy makers are not currently seeing or monitoring.  And rather than it being associated with Greece, the actual threat most likely resides with one of the several other struggling nations in the Euro Zone.  Portugal is the first name that comes to mind in this regard, but Spain may ultimately be the prime target in the end that could potentially unravel the markets.  And if this were to occur, it is likely that it would take several months to unfold.

Hopefully such contagion effects can be contained and we can begin to move past the situation in Europe.  In the end, this will require policy makers in the region to take more clear and decisive action than they have taken to this point.

I plan on writing a more detailed article for Seeking Alpha on this topic over the weekend.  I will post a link to the article here if and when it is published, most likely on Sunday.

Thanks and enjoy the weekend.

Published by Eric Parnell

Registered Investment Advisor

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