The little engine that couldn’t!

First the facts. Greek debt amounts to about $380bln or 2.7% of Eurozone total sovereign debt. Greece contributes about 3% to the total Eurozone GDP of $16 trillion. So talk of Greece being the cause of the Euro collapse is a little like the dollar collapsing because Mississippi gets downgraded or defaults. In fact, we have witnessed bigger economic states in the USA default without much effect at all on the greenback…e.g., California and New York to name two.
But that doesn’t mean there isn’t some great trading (ok speculating) to be had -- certainly aided by the capital flight from Greece by Eurozone member banks. More on this shortly.

Some more data. The cost of insuring Greek sovereign debt hit a new lifetime high on Monday (12 June). It now costs €1.6m to insure €10m of Greek debt, a record amount, after the five-year Greek credit default swap jumped 1,600bp. The prices of insuring Ireland and Portugal's debt also hit new all-time highs, according to data from Markit.

On top Greece getting downgraded to CCC, looming quickly is the big sovereign-debt rollover for Italy and Spain. Now, if the debt market locks up, and the global economy falters – then you have about 33% of Eurozone debt in three sovereigns that are struggling with their economies (deficit, employment, debt, negative growth) – things then get very interesting.

A collapse in the euro isn't the only potential catastrophe lying in wait, either. A more immediate concern would be the collapse of a major European financial institution. Any fear of a bank failure will result in another interbank liquidity-and-funding panic.

Figures from the Bank of International Settlements (BIS) show French, German and UK banks have embarked on a mass exodus from Greece, Portugal, Spain and Ireland, in what analysts see as an effort to bolster their balance sheets and conform to new rules designed to protect financial institutions from going bust.

The move is expected to add to tensions in Brussels over how to prevent Greece defaulting on its loans because vital business contracts will cost more to insure.

French banks cut their exposure to Greece from $92bn (£57bn) to $65bn in the last three months of 2010. They also reduced their involvement in Ireland, Portugal and Spain, slicing their total exposure to the four hardest-hit economies by $112bn.

German and French banks held over two-thirds of the Greek government bonds at the end of last year, accounting for 70% of the $54.2bn owned by banks from 24 countries that report to the BIS.

International loans to Greece stood at $161bn at the end of December, down $75bn from a year before.

BNP, which has almost $3 trillion of assets, refused to disclose how much it had reduced its exposure. A spokesman played down its involvement in Greece, Ireland or Portugal, saying that it had no retail operations in those countries.

Of the European banks that are most at risk for Greek default:

* Fortis NV (OTC: FORSY) holds $5 billion in bonds.

* Dexia SA (PINK: DXBGY) holds $4 billion.

* Société Générale (OTC: SCGLY) holds $5.2 billion.

* BNP Paribas SA (NYSE ADR: BNPQY) holds $8 billion.

* ING Groep NV (NYSE ADR: ING) holds $4.6 billion.

* Barclays PLC (NYSE ADR: BCS) holds $6 billion.

* Deutsche Bank AG (NYSE: DB) holds $2.6 billion.

Together, that's a total $35.4 billion in Greek bonds.

There's plenty of opportunity in shorting some of the big European banks and then getting long them after they've taken their hits.

The market is applying a level of pressure well beyond what the Eurozone and European Union (EU) were designed to handle. The Eurozone and the EU are both in trouble.

Change, quick deep structural change is needed now. There could be no better wake-up call than when credit-default-swap (CDS) pricing on Western European states is higher than Eastern European states!

Change = >> Fiscal union, which involves harmonizing aspects of fiscal policy across the euro area, would be a bold move and essentially result in a treasury department for the entire Eurozone.

The euro crisis is just as much underpinned by politics as it is by unbalanced economies, rigid labor and product markets, burst property bubbles and unsustainable public and private debt levels. A Federal Treasury = Fiscal Union for the EU is long overdue.

The alternative – someday – given the lack of fiscal discipline of the EU member states: A Eurozone breakup. The result: widespread series of defaults, bank runs, capital controls and periods during which countries (and their banks) would be frozen out of the markets. It would be extremely messy -- a lot like the 60s & 70s…

To quote the international man of mystery, Austin Powers: “Oops. I did it again, baby!”