Jeffrey Kleintop, chief market strategist for LPL financial, sees a eurozone without Greece. That said, he believes that a Greek default and departure from the eurozone will not take a terrible toll on markets, because the situation has dragged on for so long already that many institutions have had ample time to divest themselves of some of their Greek debt.
That’s not to say that it isn’t a serious situation–in fact, says Kleintop (left), “It’s a terrible situation. Greece is in a depression economically, and likely to stay there.” He points out that “their debt is currently trading at 24 cents on the dollar–there’s a high expectation of default, or a major restructuring of debt.”
We spoke with him at length about the Greek situation, and what he sees in store for the markets.
Does that mean other countries with high levels of debt, like Italy and Spain, will follow?
Greece is in a unique situation. It’s very difficult, and Greece will ultimately leave the eurozone at some point.
The situation cannot be applied to other troubled countries in the eurozone. Too many people are saying that Italy is having trouble, Spain is having trouble, and they will follow the same path. If you take out interest payments, their budgets balance, and they don’t have anywhere near the problems Greece does. Greece’s debt is trading at 24 cents; Italy’s is 96 cents on the dollar. The market sees a very different situation in Greece.
What will a default mean for the economy of Europe?
We’ve seen a lot of flight to safety. Banks have done a lot of that. The Greek economy is only a couple of percent of the eurozone’s GDP. But so many banks chose to buy Greek debt because it paid such a high yield. Banks have done a good job unloading that debt over the last two years; they cut their exposure by two thirds. That doesn’t mean it’s not owned elsewhere–by private investors, hedge funds, pension funds–but the risk to the European economy is less from them…. The banking system can absorb a structured default of Greece.
What if it’s not structured? What happens then?
There will be a bigger impact if it’s not structured; you wouldn’t have a counterparty offset from credit default swaps. Banks are not protected against disorderly default, but I think those exposures are relatively small; Spanish banks are impacted, and some Italian banks, but banks have had a few years to shed their positions [in Greek debt]. We’re only talking about $300 billion in debt; not as much as the $2.5 trillion debt of Italy. It’s a relatively small hit.
How likely do you think it is that hedge funds will trigger CDS? And what might that do?
I think there’s maybe a 40% chance of hedge funds triggering CDS; I think those counterparties have adequate resources to back them up…. This [potential default] has been well telegraphed. If it were Spain or Italy, there would be a major problem.
There has been criticism of the new Spanish government for misrepresenting its 2011 financial condition, to make itself look better in 2012. What might that do?
A lot of claims are justified around the way that debt was stated and budgets were stated–not just in Greece, but other countries as well–but I don’t think [Spain, with its] more diverse economy and deeper pockets and lesser indebted situation, will follow Greece. Spanish yields are up and they’ve been downgraded, but the Spanish budget gap is much, much narrower. Same with Italy; [the situation is] very different from Greece, who can’t get there from here. It has to cut its debt by more than half. That’s not the case in Italy and Spain.
But you do foresee Greece defaulting?
Greeks may refuse additional austerity. They will default in some way–either through an organized restructuring, or they might simply walk away from it and reissue the drachma, and pay their debt back in increasingly devalued currency. It’s not a good outcome for Greece, because it will cut them off from capital markets. It’s a question of how much they need to borrow in the short term; they still need to borrow quite a bit of money. Their borrowing exceeds their interest payments.
They’re unlikely to default in the short term, and cut off borrowing, because it’s not in their best interest, but if they can get a second bailout deal they may have enough short-term funding locked up to address their long-term funding. In the long term they are more likely to default–but short-term and long-term are relative. They may not default this year and into next year, but the terms of the agreement may drive them. Three years from now, Greece defaults–walks away from the eurozone. Its economy can’t support anywhere near the amount of debt that it has. It thrives on tourism and has relatively little else to offer.
For the last couple of hundred years, it acted as a foil; the U.K. used Greece as a foil against the Ottoman Empire, with free cash coming in from abroad. The U.S. did it against the USSR in the Cold War. The Maastricht Treaty was signed at the close of the Cold War [and changed that], but for nearly 200 years Greece has never had to really survive on its own. It got money it didn’t have to pay back from outside benefactors. To rectify that without dramatic restructuring of their obligations–I don’t see how they will get there from here.