Sunday, February 5, 2012

If Greece defaults, who will be holding losses?

As the negotiations continue over the haircut that Greece bondholders will take, there is one question that still has not been answered.  Who will be holding the losses?

Market participants inability at answering this question when it applied to sub-prime debt resulted in the creation of the concept of financial contagion.  Under financial contagion, if one firm suffered such significant losses that it could go under, it could in turn bring down the other firms in the financial system that it was linked to.

Is there a firm that has sufficient exposure to Greek debt that it could trigger financial contagion?

The fact that all market participants cannot answer this question three years after the threat of financial contagion was identified highlights the failure of the global policymakers and financial regulators to take steps to protect the global financial system from a repeat of the financial crisis that began on August 9, 2007.

Oh, I am sure that there are financial regulators who would say that the fallout from a Greek bond default would be contained, but these are the same regulators who said that a fallout from sub-prime securities would be contained.

The bottom-line is that any financial regulator who says they know where all the losses on Greek bonds and their related credit default swap contracts would occur is not telling the truth.

More importantly, if the financial regulators actually knew, it would be information that should be shared with all market participants so that they could adjust their exposures accordingly.

I realize I have focused on Greek debt, but it appears that Portugal and Italy are not that far behind.  Does anyone know who will be holding the losses on this debt?

There is only one solution for financial contagion.  This solution is global policy makers and financial regulators requiring banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

Your humble blogger has been advocating the creation of the Mother of all financial databases to capture this data so that market participants can answer the question of who is holding the losses on different types of debt.  With this answer, market participants can adjust their exposures so that financial contagion no longer is a threat.

Absent this information, market participants cannot properly assess risks in the banking system and financial contagion is alive and well.

1 comment:

Fungus FitzJuggler III said...

It is a game of pass the parcel!

Also a way of pushing down the euro...