Some experts are comparing Greece to Lehman

If eurozone officials decide Greece does not have to repay its debt in full, the European Central Bank says it may stop making repo loans to financial institutions that put up Greece’s debt as collateral, according to a June 10 story by the Financial Times.

If  that happens, it would “almost certainly lead to the collapse of the Greek banking system,” write reporters Richard Milne and David Oakley.

From the article:

The latest eurozone row has principally pitted Germany against the European Central Bank and France. Wolfgang Schäuble, finance minister in Berlin, has called for a “quantified and substantial contribution” from bondholders in Greece in return for a fresh international bail-out.

The ECB on the other hand wants to avoid a “credit event” or a decision by rating agencies that Greece is in default. It has threatened to stop accepting Greek collateral if either of those events happen, which would almost certainly lead to the collapse of the Greek banking system.

Many banks and other financial institutions in Europe finance their own operations in part by borrowing on the repurchase market, using Greece’s debt as collateral. Because fewer repo lenders will accept Greek debt as collateral these days, and those that will are costly, much of the repo lending is being done by the European Central Bank.

If the European Central Bank refuses to repo with these financial institutions, the resulting credit crisis could be similar to that in the U.S. in 2007 and 2008, when money market funds and other financial institutions stopped making repo loans to investment banks, because they didn’t know which banks held troubled mortgages and derivatives.

The withdrawal of repo lenders, also called a run on repo, was the key panic that caused the U.S. credit crisis and forced the taxpayer bailout of the largest banks in 2008.

It’s not possible to know exactly how a collapse of the Greek banking system would affect the U.S., mainly because banks and other financial institutions don’t have to disclose how they may be interconnected.

The Dodd-Frank Act set up an Office of Financial Research at the U.S. Treasury Department to collect data on interconnectedness, but the office is still in the early stage of trying to decide what information to collect and how to collect it.

Reporter Landon Thomas Jr. at  the New York Times made a fine effort June 12 to show  how the Greek problem could become a problem for U.S. investors and taxpayers, using estimates from analysts and bankers.  This is the kind of reporting that was missing before 2008 and  shows how much reporters and analysts have learned about the inner workings of the financial markets in three years.

From Thomas’ article:

The thinking goes like this: though banks and other investors have done much to pare their Greek holdings in the last year, if they are forced to take a loss, and the ratings agencies declare Greece in default, investors would start selling in a panic. And they would not sell just the bonds of countries struggling with debt — Portugal, Ireland, Spain and Italy. In a hasty retreat into cash, traders would unload more liquid assets as well, everything from high-grade corporate bonds to American and emerging market equities — as occurred in 2008 after Lehman failed.

To be sure, much has to be wrong for the European debt crisis to approximate what happened after Lehman failed in 2008. Not only did banks, hedge funds and insurance companies immediately seize up, but the effect on the broader global economy was also striking as trade flows nearly ground to a halt.

Analysts point out that the global financial system has survived sovereign defaults in the past, including Russia’s in 1998 and Argentina’s in 2001.

Unfortunately, Thomas never mentions the repurchase market, even though the selloff he describes would be triggered by repo lenders, as the Financial Times explains.


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