Understanding the Real Implications of a Greek Default

Papandreou to Merkel: “The keys are in the mailbox.”

Just like an “underwater” homeowner, the Greeks are simply walking away from their obligations and telling their creditors, “It’s yours.”

While it’s true that the Greeks haven’t actually walked away yet, Prime Minister George Papandreou walked away today…and that’s the first step.

“Wait a minute!” you may be saying. “Didn’t the Greeks strike a bailout-salvaging political deal over the weekend? Didn’t Papandreou agree to step down in order to enable an interim, power-sharing government to secure the EU’s 130 billion euro rescue package?”

Absolutely, if you believe American or Northern European press reports. Absolutely not, if you believe most Greek press reports…or listen to your common sense.

Papandreou did not step down to “make way for the rescue package.” He stepped down to get out of the middle of a firefight. As the Greek newspaper, Ekathimerini, put it yesterday, “Let’s not forget what prompted George Papandreou’s ill-fated and panic-stricken effort to unburden himself of the weight of government by calling a referendum: the need for radical reforms, the popular rage that this has provoked and the sporadic violence of small but persistent groups…”

No one wants to be the “austerity candidate.” Politics is about dispensing goodies, not about taking them away. Papandreou clearly understands this reality and wants nothing to do with it.

“It is no coincidence,” Ekathimerini continues, “that both times that Papandreou tried to throw away the burden of government were during widespread demonstrations and violence. Last June, during the parliamentary debate on harsh new austerity measures, which were accompanied by violence in Syntagma Square, Papandreou suddenly told New Democracy party leader Antonis Samaras that he would resign as prime minister in order to make way for a government of national unity; the second followed the demonstrations of October 28 and the cancellation of the annual military parade in Thessaloniki, just after a deal with our EU partners and the IMF to write down a large part of our debt.”

Not surprisingly, Papandreou would much rather hand over the keys and infuriate Greece’s creditors than pay the mortgage and infuriate his own people.

Publicly, most Greek politicians keep talking as if the country will continue paying its mortgage. But that’s an easy thing to talk about as long as their creditors are continuing to extend fresh credit. Just wait until the money runs out.

That’s when the Greeks will walk away and the keys will land in the mailbox.

But don’t pity the Greeks. The Germen “repo men” can’t evict them. And there’s nothing to repossess. The lenders should have asked for collateral, but they didn’t. Which means the Greek borrowers get to “keep their house,” even after defaulting, while the lenders will have to mark their bad loans down to zero…exactly like a defaulted mortgage.

So why shouldn’t Greece hand over the keys? That’s what millions of American mortgage-holders have done since the housing bubble burst. That’s what capitalism is all about: free exchanges of capital and/or services between consenting adults. Sometimes these exchanges produce wealth; sometimes they produce capital losses. That’s capitalism.

When a bank loans money to a homebuyer, the bank understands that it will receive either monthly interest payments…or the house itself. The borrower understands that he must either make monthly payments…or give the house to the bank. That’s the deal. It’s a contract. It’s not a moral obligation.

Sovereign finance is no different. When a bank loans money to a sovereign borrower, the bank understands it will receive interest payments for as long as the sovereign borrower remains solvent. After that, nothing. That’s the deal. It’s a contract. It’s not a moral obligation.

It is not the sovereign borrower’s fault that the banks demanded no collateral before extending the loan. It is the lender’s responsibility to collateralize his loans, not the borrowers.

Most of the Greeks on the street are hip to this reality, which is why they would prefer a default over austerity. Clearly, Papandreou is on the same page, which is why he asked for a national referendum on the bailouts. He knew the people wanted to hand over the keys and he had no interest in stopping them.

But the bankers in the north of Europe had every interest in stopping the Greeks from handing over the keys, which is why they pressured Papandreou into canceling the referendum. He did so, grudgingly…and then stepped aside.

This may be an event that “secures Greek’s rescue package,” just as the US press is reporting this morning, but it is also an event that moves Greece one step closer to its inevitable default.

All hope is not lost however. The Greeks did reaffirm their commitment to the gyro.

Eric Fry
for The Daily Reckoning

The Daily Reckoning