The Euro’s Last Gasp

By Bill Wilson
While Obama sits here and plays rhetorical games with the $14.294 trillion debt ceiling, attempting to sucker Republicans into increasing taxes, there are strong headwinds from across the Atlantic that threaten the U.S. economy.

Greece’s default is inevitable. And the fate of the euro is in question.

The only real question currently facing policymakers in Brussels is whether banks foolish enough to lend money to a bankrupt socialist government will take losses, or if the European Central Bank (ECB) will simply print more money to bail out Greece’s creditors.

That decision will have major ripple effects. If bondholders take losses on Greek debt, American financial institutions like Bank of America, Goldman Sachs, and AIG are said to be on the hook for honoring credit default swaps sold to insure against Greece’s default on its €340 billion debt.

If, on the other hand, the banks are bailed out, and the ECB buys back the Greek bonds with printed money, then it is the central bank that is on the hook for any Greek default.

At that point, a Greek default would in principle lead to the ECB’s insolvency. The European Central Bank (ECB) is already on the hook directly for over €120 billion in Greek debt, including tens of billions of Greek debt it accepted as collateral when making other loans.

So, whether the ECB further intervenes at this point or not, a Greek default would hurt the ECB — and the euro — most of all.

Even if U.S. financial institutions foolish enough to insure against Greek default were still to be the ones on the hook to honor the swaps, nobody expects the global banking ruling class to really take any real losses on sovereign debt, no matter how richly deserved. The assumption is that these institutions cannot afford to honor the credit default swaps. So, who would bail them out?

The Federal Reserve, as usual. As in 2008 and 2009, the Fed’s emergency facilities would once again likely bail out financial institutions all over the world deemed too big to fail. Or, perhaps the newly minted, FDIC-operated, so-called “orderly liquidation fund” under Dodd-Frank — really, an unlimited bailout fund — would be invoked.
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