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Greek Default Would Be Worse Than Lehman

Banks on the hook for even heavier losses...

THE COLLAPSE of Lehman Brothers in 2008 ignited a financial meltdown that resulted in widespread bank failures and caused the Dow to lose 18% of its value in a single week. 

Yet a Greek default – which, even with a bailout, becomes increasingly likely with each passing day – would actually be much, much worse in many respects, writes Martin Hutchinson, contributing editor to Money Morning.

Sure, it's possible that European Union (EU) taxpayers will soon be dragooned into yet another rescue plan. But that would only delay the inevitable – a catastrophic collapse that will drudge up feelings of panic we haven't witnessed since the global financial crisis hit its apex nearly three years ago.

Here's why.

Greece's debt, at about $430 billion, is less than that of Lehman Brothers, which owed around $600 billion at the time of its bankruptcy. But Greece's finances are much less sound.

Whereas Lehman Brothers participated in the 2003-07 financial bubble with considerable enthusiasm, accumulating vast amounts of the dodgy subprime mortgage paper whose value collapsed in the 2007-08 downturn, Greece's misdeeds date back much further – to its 1981 entry into the EU. 

As the poorest member of that group, Greece became eligible for a vast array of inventive subsidies, primarily related to agriculture. However, the frauds the country perpetrated to justify even larger subsidies were even more inventive. And this allowed Greece to bring its living standards close to the EU average, while still being subsidized as if it was a genuinely poor country.

Indeed, Greece produced nothing close to the level of economic output that would be needed to justify its spending and the lifestyle of its people.

The problem for Greece is thus stark: Its people need to suffer a decline in living standards of about 30% to 40%, so that the country's output is sufficient to repay its debts. 

From 45th place in the world ranking of per-capita gross domestic product (GDP) – above Spain, Israel and New Zealand – it needs to lower its living standards to about 65th place. That would put it on a level with Poland, below Hungary and Slovakia, and only modestly above the very well run Chile. 

Needless to say, the Greek people are not about to vote democratically in favor of this outcome. 

In a truly free-market system, without massive subsidies and with independent currencies, this could be achieved by a collapse in the value of the drachma. Even with the EU and the advent of the European Euro currency, such a collapse would probably have happened 10 years ago if the Greek government had not undertaken fraudulent accounting to make its economy appear qualified for Euro membership.

That's the advantage of a true free market system; the Greek populace can demonstrate all it likes, but if the value of the drachma drops 40%, there's nothing the Greek citizens can do about it – it would be like staging sit-ins against the Law of Gravity. 

In the system we have, the bailout staged last year by the EU and International Monetary Fund (IMF) was too lenient. It gave Greece too much money and left far too many opportunities for the Greeks to trash downtown Athens in protest. 

Since the IMF and the EU insist on being repaid before private creditors, the banks that lent to Greece have been bumped well down the creditors' totem pole. The upshot: Those banks are on the hook for more than $100 billion. 

This is exactly why a Greek default would dwarf the Lehman collapse: There were no artificial forces damaging the banks' position in the Lehman bankruptcy, and Greece has fewer viable assets than did Lehman. That means the losses to the banks – almost all of them European banks, in this case – will probably be greater in the event of a Greek default than they were in the Lehman bankruptcy. 

As was the case for Lehman, a Greek default would require another bank bailout, another period of cockeyed fiscal and monetary policies, and another major recession. 

The only difference this time around is that the global recession and bailout will be centered on the EU – as opposed to the United States.

And that's at least a small bit of comfort to us American taxpayers.

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Now a contributing editor to both the Money Map Report and Money Morning, the much-respected free daily advisory service, Martin Hutchinson is an investment banker with more than 25 years’ experience. A graduate of Cambridge and Harvard universities, he moved from working on Wall Street and in the City, as well as in Spain and South Korea, to helping the governments of Bulgaria, Croatia and Macedonia establish their Treasury bond markets in the late '90s. Business and Economics Editor at United Press International from 2000-4, and a BreakingViews editor since 2006, Hutchinson is also author of the closely-followed Bear's Lair column at the Prudent Bear website.

See full archive of Martin Hutchinson.

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