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Greece needs a managed default

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By Paul Hodges on 14-Jun-2011

Bank lending Jun11.pngMany Greeks have always preferred not to pay taxes, and to retire in their 50s. This lifestyle was well understood by their new partners when they joined the Eurozone a decade ago, since when German/French banks have happily funded it with support from their governments.

The chart, from the Bank of International Settlements (the central bankers’ bank), shows the scale of today’s lending. French banks have lent $57bn, and German banks $34bn. Last December, they had $58bn more at risk of default. But in reality, little has been repaid. And Greece now needs a further EU/IMF bailout, after last year’s $160bn.

Instead, the $58bn has been transferred to the European Central Bank (ECB). This now has $650bn of exposure to the PIIGS (Portugal, Ireland, Italy, Greece, Spain) – the euro countries most at risk of default.

Major arguments are now underway between the ECB and the German governments about what happens next, but the key facts are clear:

• Greece will remain in “can’t pay, won’t pay” mode
• Germany will get even more upset about paying Greece’s bills
• Private investors will continue to pass their Greek debt to governments
• The ECB will worry about default, and its own stability if this occurs

Of course, the politicians will attempt to defer unpleasant actions for as long as possible. But there is little doubt that Greece will end up in default – if not this year, then certainly by 2013.

A managed default is therefore the priority. As this article from the UK’s Daily Telegraph shows, forwarded by a blog reader, an unmanaged default could have very serious consequences for European financial markets.