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Slow motion train wreck picks up speed
The Greek debt crisis has been compared with a “slow motion train wreck”. Everyone can see that the fiscal spending in Greece is unsustainable and a fatal crash will result if action is not taken soon. You don’t need to be a financial expert to know that if you constantly spend more than you earn, you are going to get into trouble. In the beginning, you may be able to borrow to fund your spending gap but when you start to have trouble servicing your existing debt, you will have a tough time finding lenders who are willing to lend you more money. Those who are willing will only do so at a very high interest rates to cover their risk. This is exactly what is happening to Greece. Ten year bond yields have been increased from 6 percent in January to nearly 9 percent yesterday.
Watching the developments in Greece reminds me of my father’s “slow motion train wreck” during the Asian financial crisis. When my dad retired in the early 90s, he had a fully paid up house but no income stream. He decided to make his income from trading shares. He took an equity loan on his house and used the money to buy and sell shares. He managed to make a good income during the bull market when foreign investors poured money into the Asian Tiger economies. However, when the Asian Financial Crisis hit in 1997, his share portfolio took a big dive and wiped out his trading capital. Without an income from trading shares, he had to fund his living expenses by further drawings from his line of credit. We, his children could see what he was doing was unsustainable. We suggested that he sell his house and downsize to smaller house to pay off his debt but he refused because if he did this, his neighbours and friends would know he was in financial trouble. The children considered giving him a “bailout” but we knew that unless he acknowledges his problem and comes up with a sustainable plan to fund his future living expenses, we would probably never see our bailout money again and he would be back in the same situation in a few years time. My dad finally agreed to sell his house two years later. In the meantime, his debt had increased by 50 percent. It was truly scary to see how quickly debt can snowball when you have to fund your living expenses and service existing debt with more debt.
Greece’s problems first surfaced in January 2010. Lenders started to worry that they found out that Greece’s budget deficit was actually 12.9 percent which was nearly double the 7.7 percent recorded in 2008. Ten year bond yields shot up from 3 to 6 percent when this was first revealed. Bond yields came down a little after a promises of a bailout by members of the Eurozone and the IMF, if required. Yesterday the European Union’s statistics office Eurostat said that Greece’s budget deficit in 2009, as a percentage of economic output, was 13.6 percent which is even worse than the earlier estimate. Eurostat also warned that the Greek figures may actually be even worse, citing “uncertainties” over the figures related to social security funds and the recording of complex financial swap arrangements. Bond yields have skyrocketed on the news. Ten year bond yields went up to 8.97 percent yesterday. Moody’s Investor Services downgraded its rating on Greece’s debt by one notch to A3 from A2, and warned that further downgrades were a distinct possibility. Greece cannot afford to borrow from the market at these prices so it is now looking more and more likely that they will have to tap on the promised 30 billion euro bailout facility. Will the Eurozone countries deliver on their promise to provide a bailout? At the rate things are going, lending money to Greece will be like throwing it into a black hole. The bailout funds would disappear very quickly especially if Greece cannot reduce its spending and has to refinance existing loans at increasingly higher interest rates. Although we loved our dad and wanted to help him, even his family was not prepared to give him our hard earned money to bail him out without a sustainable long term solution. Eurozone countries are more like neighbours rather than family to Greece. They prefer not to get involved unless Greece’s problem causes too much damage to the whole neighbourhood. The Euro also fell to a new 11 month low against the US dollar yesterday. Yield spreads for other highly indebted euro members including Italy, Portugal and Spain have also increased. Can Greece count on its neighbours to come to its rescue?
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