Revolutionizing Awareness


Posts Tagged ‘Warren Buffett’


Posted by Admin on May 22, 2012


By MICHAEL SIVY | – 4 hrs ago


The scenario everyone recognizes is based on Greece reviving its traditional drachma currency. What this means is that salaries and prices within Greece would be converted from euros to drachmas, and then the drachma currency would be allowed to depreciate to make the Greek economy more competitive. The problem comes with debts that are denominated in euros, especially if the lenders are outside of Greece. These lenders would naturally resist being repaid with less valuable drachmas. However, if Greek borrowers have to repay the loans with euros, the debt would become more expensive for them to pay off after the drachma is devalued.

(PHOTOS: Protests in Athens)

The most likely domino effect, therefore — and the one most widely expected — is that debts to non-Greek creditors are compromised after Greece switches to the drachma. Either there would be lawsuits over which currency to use, or borrowers would default on the loans, or the lenders would be forced to accept reductions in the amount of the loan that has to be repaid, in order to avoid outright defaults. Whichever outcome occurs, the lenders lose money. Just as in the U.S. mortgage-lending crisis, once some banks lose enough money to become troubled, the contamination spreads to other banks, because they all lend to each other.


(MORE: Why Portugal May Be the Next Greece)

But what if Greece’s exit from the euro zone causes other kinds of domino effects that don’t have obvious precedents? The fallout could be a lot harder to control. As I see it, there are two possible scenarios that aren’t getting the attention they should.

Derivatives could set off a global chain reaction. Most people have heard of the complex, “synthetic” financial securities known as derivatives, which Warren Buffett famously referred to as “financial weapons of mass destruction.” In the case of bonds, these are known as credit derivatives. They include all sorts of loans secured by bonds, as well as incredibly complicated vehicles that amount to insurance policies if the bonds default. No one really knows how much of this stuff is sloshing around the international financial system, but the total value for all types of bonds was estimated at more than $50 trillion in 2008 and has continued to grow rapidly since then. Trouble is, if the bonds underlying these derivatives become questionable, all the derivatives become uncertain, too, even if they add up to far more than the value of the bonds themselves. Moreover, some of the synthetic investments based on Greek bonds could be governed by Greek law, some by British law (if anything originated in London), and some by U.S. law (if Wall Street was involved).


What if one legal system accepts the conversion of euro loans into drachmas and another one doesn’t? Everything could be thrown into the courts for months. Even worse, if synthetic investments secured by Greek bonds become untrustworthy, why would anyone trust similarly complex investments involving Spanish bonds or Italian bonds?


Greece recovers quickly and all the other troubled countries want out of the euro zone too. At the opposite end of the spectrum is the possibility that Greece abandons the euro and bounces back surprisingly fast. Paradoxically, that could cause another sort of disaster. Both Argentina and Iceland suffered currency collapses, and after a horrible year or two, both rebounded and were better off than if they had fought to save a failing currency. Analysts point out that both countries were big exporters of grain, meat or fish, and that sales boomed after currencies were devalued. But Greece, in its own way, could profit from a similar recovery — a rebound in tourism. A 30% drop in the exchange rate might make a vacation in Greece the best deal in years.


So why would that be bad? Think of what it would mean for the other countries in the euro zone. How could the Italian government persuade its people of the need for higher taxes or the Spanish government explain soaring unemployment if Greece were obviously better off outside of the euro zone. Result: The entire European Union might unravel, with financial consequences many times greater than those resulting from Greece alone.

I’m certainly not predicting an extreme, doomsday scenario as the most likely outcome of a Greek exit. But it is important to realize just how unpredictable this situation is. In my own stock portfolio, I eliminated all the banks a long time ago and have largely stuck with financially strong companies that deal in essential goods — such as oil & gas, consumer staples and pharmaceuticals. The euro created a financial entity comparable in scale to the U.S., and if it gets into serious trouble the financial effects could be world-shaking.


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